Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes and other financial information included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. You should review the sections titled “Special Note Regarding Forward-Looking Statements” for a discussion of forward-looking statements and in Part I, Item 1A, “Risk Factors” for a discussion of factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis and elsewhere in this Annual Report on Form 10-K.
Overview
We are a growing cancer genomics company transforming the development of next-generation therapies by providing more comprehensive molecular data about each patient’s cancer and immune response. We designed our NeXT Platform to adapt to the complex and evolving understanding of cancer, providing our biopharmaceutical customers with information on all of the approximately 20,000 human genes, together with the immune system, in contrast to many cancer panels that cover roughly only 50 to 500 genes. In parallel with the development of our platform technology, we have also pursued business within the population sequencing market, and we have provided whole genome sequencing services under contract with the U.S. Department of Veterans Affairs (the “VA”) Million Veteran Program (the “VA MVP”), which has enabled us to innovate, scale our operational infrastructure, and achieve greater efficiencies in our lab. In September 2020, we announced receipt of a new task order from the VA MVP with an approximate value of up to $31 million. The cumulative value of task orders received from the VA MVP since inception is approximately $175 million, approximately $132.5 million of which we had recognized as revenue as of December 31, 2020.
In August 2020, we launched NeXT Liquid Biopsy, which is a liquid biopsy assay that analyzes all of the approximately 20,000 human genes versus the more narrowly focused liquid biopsy assays that are currently available. By combining technological innovation, operational scale, and regulatory differentiation, our NeXT Platform is designed to help our customers obtain new insights into the mechanisms of response and resistance to therapy as well as new potential therapeutic targets. Our platform enhances the ability of biopharmaceutical companies to unlock the potential of conducting translational research in the clinic rather than with pre-clinical animal models or cancer cell lines. We also announced in January 2020 a diagnostic test, NeXT Dx Test, which is based on our NeXT Platform, that we envision being used initially by both leading clinical cancer centers as well as biopharmaceutical companies. Most recently, in December 2020, we launched two new capabilities that are integrated into our NeXT Platform: our Systemic HLA Epitope Ranking Pan Algorithm (“SHERPA”) machine learning-based tool for the comprehensive identification and characterization of cancer neoantigens, as well as our Neoantigen Presentation Score (“NEOPS”) for predicting cancer immunotherapy response. SHERPA enables the development of new neoantigen-based diagnostic biomarkers, such as our NEOPS, and novel personalized therapies.
We have the capacity to sequence and analyze approximately 200 trillion bases of DNA per week in our facility. We believe our capacity for this is already larger than the sequencing capacities of most cancer genomics companies, and we continue to build automation and other infrastructure to scale further as demand increases and in support of our NeXT Liquid Biopsy. To date, we have sequenced more than 150,000 human samples, of which more than 100,000 were whole human genomes.
On August 14, 2020, we completed a follow-on equity offering in which we issued and sold 6,578,947 shares of common stock at a public offering price of $19.00 per share. We received net proceeds of $117.5 million after deducting underwriting discounts and commissions. We also incurred $0.4 million of offering expenses, including legal, accounting, printing and other offering-related costs.
Subsequent to the fiscal period ended December 31, 2020 covered by this Annual Report on Form 10-K, on January 29, 2021, we completed another follow-on equity offering in which we issued and sold 3,950,000 shares of common stock at a public offering price of $38.00 per share. We received net proceeds of $141.1 million after deducting underwriting discounts and commissions. The underwriters exercised their option to purchase an additional 592,500 shares shortly thereafter, resulting in additional net proceeds to us of $21.2 million after deducting underwriting discounts and commissions. In total, we raised net proceeds of $162.3 million after deducting underwriting discounts and commissions. We also incurred an estimated $0.4 million of offering expenses, including legal, accounting, printing and other offering-related costs.
Our operations have been impacted by the ongoing COVID-19 pandemic. While the state and county reopening and health orders applicable to us allow for continued operation of so-called Essential Businesses, which includes certain critical healthcare operations and services, we have substantially closed our office facilities and limited access to our laboratory facilities to protect our employees and to comply with the provisions described within the orders. We provided temporary increased pay to certain laboratory personnel in the second quarter for their work during the COVID-19 pandemic. Such increased pay was not provided in the third or fourth quarters, but we may decide to resume increased pay in the future. The previous shelter-in-place order and current reopening and health orders have negatively impacted productivity, disrupted our business, and slowed research and development activities due to us limiting access to our laboratory space that would otherwise be used by our research and development group, and, to the extent such orders remain in place, they may continue to cause such effects on our operations. The reopening and health orders may disrupt the ability of our suppliers to fulfill our purchase orders in a timely manner or at all. Additionally, we are aware of increased demand in the market for certain consumables used in COVID-19 test kits. We use such consumables in our operations, and we may face difficulties in acquiring such consumables if our suppliers prioritize orders related to COVID-19. Several of our customers, including the VA MVP, were delayed in sending us samples in the second and third quarters due to the inability to collect or ship samples during the
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COVID-19 pandemic, and these and additional customers may be disrupted from collecting samples or sending purchase orders and samples to us in the future. Many of our customers, potential customers and potential partners have also put in place policies restricting visitors from other companies, and therefore our sales team and members of management have been unable to meet such parties in person, which may result in reduced acquisition of new customers, fewer orders from existing customers, and fewer potential partnering opportunities. If our laboratory employees were to contract COVID-19, we may significantly curtail our laboratory operations or pause operations altogether until the imminent health risk to our employees subsided. Such disruptions in our operations, and our customers’ and suppliers’ operations, may continue to adversely affect revenues and operating results.
The global COVID-19 pandemic continues to rapidly evolve and to present serious health risks. While authorities in some areas have lifted or relaxed certain of the restrictions described above, in some cases they have subsequently re-imposed various restrictions after observing an increased rate of COVID-19 cases; for example, in December 2020, state and local authorities in California reinstated shelter-in-place orders in light of the increasing rate of COVID-19 cases and shortage of intensive care unit beds across the state. Furthermore, there is no guarantee when or if all such restrictions will be eliminated, such that we and our customers, manufacturers and suppliers will be able to safely resume operations consistent with our pre-COVID-19 operations. Vaccines against COVID-19 have been approved by the FDA and other regulatory authorities, but there is uncertainty as to when these vaccines will be widely available to our employees and the population at large and how quickly and to what extent the vaccines will impact the COVID-19 pandemic.
While the extent of the impact of the current COVID-19 pandemic on our business and financial results is uncertain, a continued and prolonged public health crisis such as the COVID-19 pandemic could have a material negative impact on our business, financial condition, and operating results.
Factors Affecting Our Performance
We believe there are several important factors that have impacted, and that we expect will continue to impact, our operating performance and results of operations, including:
•
The continued development of the market for genomic-based tests. Our performance depends on the willingness of biopharmaceutical customers to continue to seek more comprehensive molecular information to develop more efficacious cancer therapies.
•
Increasing adoption of our products and solutions by existing customers. Our performance depends on our ability to retain and broaden adoption with existing customers. Because our technology is novel, some customers begin using our platform by initiating pilot studies involving a small number of samples to gain experience with our service. As a result, historically a significant portion of our revenues has come from existing customers. We believe that our ability to convert initial pilots into larger orders from existing customers has the potential to drive substantial long-term revenue. We expect there may be some variation in the number of samples they choose to test each quarter.
•
Adoption of our products and solutions by new customers. While new customers initially may not account for significant revenues, we believe that they have the potential to grow substantially over the long term as they gain confidence in our service. Our ability to engage new customers is critical to our long-term success. Our publications, posters and presentations at scientific conferences lead to engagement at the scientific level with potential customers who often make the initial decision to gain experience with our platform. Accessing these new customers through scientific engagement and marketing to gain initial buy-in is critical to our success and gives us the opportunity to demonstrate the utility of our platform.
•
Our revenues and costs are affected by the volume of samples we receive from customers from period to period. The timing and size of sample shipments received after orders have been placed is variable. Since sample shipments can be large, and are often received from a third party, the timing of arrival can be difficult to predict over the short term. Although our long-term performance is not affected, we do see quarter-to-quarter volatility due to these factors. Samples arriving later than expected may not be processed in the quarter proposed and result in revenue the following quarter. Since many of our customers request defined turnaround times, we employ project managers to coordinate and manage the complex process from sample receipt to sequencing and delivery of results.
•
Investment in product innovation to support commercial growth. Investment in research and development, including the development of new products and capabilities is critical to establish and maintain our leading position. We have invested significantly in our NeXT Platform, introducing two new products and additional capabilities in 2020 alone: NeXT Liquid Biopsy (exome-wide liquid biopsy platform), NeXT Dx Test (comprehensive genomic cancer profiling test enabling advanced composite biomarkers for cancer treatment), NeXT SHERPA and NeXT NEOPS (neoantigen prediction capabilities). We are currently investing in the development of future new product offerings, including NeXT Personal (liquid biopsy offering for personalized tumor tracking for patients), NeXT CDx (diagnostic test), and NeXT Database (comprehensive tumor immune-genomics database). We are also collaborating with key opinion leaders from academic cancer centers, such as Inova Health System and the Parker Institute for Cancer Immunotherapy, to support the clinical utility of our platform. We believe this work is critical to gaining customer adoption and expect our investments in these efforts to increase.
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•
Leverage our operational infrastructure. We have invested significantly, and will continue to invest, in our sample processing capabilities and commercial infrastructure. With our current operating model and infrastructure, we can increase our production and commercialize new generations of our platform, but as our volumes continue to increase we will ultimately need to invest in additional production capabilities. We expect to grow our revenues and spread our costs over a larger volume of services. In addition, we may invest significant amounts in infrastructure to support new products resulting from our research and development activities.
Components of Operating Results
Revenues
We derive our revenues primarily from sequencing and data analysis services to support the development of next-generation cancer therapies and to support large-scale genetic research programs. We support our customers by providing high-accuracy, validated genomic sequencing and advanced analytics. Many of these analytics are related to state-of-the-art biomarkers, including those relevant to immuno-oncology therapeutics such as checkpoint inhibitors.
Our revenues are primarily generated through contracts with companies in the pharmaceutical industry, healthcare organizations, and government entities. Our ability to increase our revenues will depend on our ability to further penetrate this market. To do this, we are developing a growing set of state-of-the-art products, advancing our operational infrastructure, expanding our international presence, building our regulatory credentials, and expanding our targeted marketing efforts. Unlike diagnostic or therapeutic companies, we have not to date sought reimbursement through traditional healthcare payors. We sell through a small direct sales force.
We derive a substantial portion of our current and expected future revenues from sales of our DNA sequencing and data analysis services to the VA MVP. Our contract with the VA MVP does not include specific testing turnaround times. Therefore, we have the ability to modulate the volume of samples processed for the VA MVP up or down to complement sample volumes from all other customers, which can vary from period to period.
We have one reportable segment from the sale of sequencing and data analysis services. Substantially all of our revenues to date have been derived from sales in the United States.
Costs and Expenses
Costs of revenues
Costs of revenues consist of raw materials costs, personnel costs (salaries, bonuses, stock-based compensation, payroll taxes, and benefits), laboratory supplies and consumables, depreciation and maintenance on equipment, and allocated facilities and information technology (“IT”) costs. We expect costs of revenues to increase as our revenues grow, and in the short term costs of revenues may outpace revenue growth as we invest in expanding our laboratory capacity, but over time the cost per sample processed is expected to decrease due to economies of scale we may gain as volume increases, automation initiatives, and other cost reductions.
Research and development expenses
Research and development expenses consist of costs incurred for the research and development of our products. These expenses consist primarily of personnel costs (salaries, bonuses, stock-based compensation, payroll taxes, and benefits), laboratory supplies and consumables, costs of purchasing samples for research purposes, depreciation and maintenance on equipment, and allocated facilities and IT costs. We include in research and development expenses the costs to further develop software we use to operate our laboratory, analyze the data it generates, and automate our operations. These expenses also include costs associated with our collaborations, which we expect to increase over time.
We expense our research and development expenses in the period in which they are incurred. We expect to increase our research and development expenses as we continue to develop new products.
Selling, general, and administrative expenses
Selling expenses consist of personnel costs (salaries, commissions, bonuses, stock-based compensation, payroll taxes, and benefits), customer support expenses, direct marketing expenses, and market research. Our general and administrative expenses include costs for our executive, accounting, finance, legal, and human resources functions. These expenses consist of personnel costs (salaries, bonuses, stock-based compensation, payroll taxes, and benefits), corporate insurance, audit and legal expenses, consulting costs, and allocated facilities and IT costs. We expense all selling, general and administrative expenses as incurred.
We expect our selling expenses will continue to increase in absolute dollars, primarily driven by our efforts to expand our commercial capability and to expand our brand awareness and customer base through targeted marketing initiatives with an increased presence both within and outside the United States. We also expect general and administrative expenses to increase as we scale our operations.
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Interest Income
Interest income consists primarily of interest earned on our cash and cash equivalents and short-term investments. Interest income increased significantly beginning in the second half of 2019 as a result of us investing proceeds from the initial public offering of our common stock in June 2019 (our “IPO”). More recently, interest income has been adversely impacted by recent declines in yields on debt securities. We expect that our interest income will continue to decline in the near future as the decline in yields is expected to more than offset the increased investments balances after our August 2020 and January 2021 follow-on offerings.
Interest Expense
Previously, interest expense primarily consisted of cash and non-cash interest costs related to our term loan, convertible promissory notes, revolving loan and security agreement (the “Revolving Loan”) with TriplePoint Capital LLC (“TriplePoint”), and growth capital loan (the “Growth Capital Loan”) with TriplePoint. After the payoff of our Growth Capital Loan in August 2019, we no longer have any outstanding debt and have not incurred material interest expense from that point forward.
Loss on Debt Extinguishment
We incurred a loss on debt extinguishment in 2018 resulting from changes in the maturity dates of the convertible notes issued in 2017. We also incurred a loss on debt extinguishment in 2019 upon the payoff of the Growth Capital Loan. See Note 6 to our consolidated financial statements included elsewhere in this annual report.
Other Income (Expense), Net
Other income (expense), net consists primarily of foreign currency exchange gains and losses. In 2019, other income (expense), net also consisted of changes in fair value of convertible preferred stock warrant liability. Due to the conversion of convertible preferred stock warrants to common stock warrants upon our IPO, changes in fair value of such warrants are no longer recorded through income since our IPO. See Note 10 to our consolidated financial statements included elsewhere in this annual report for further discussion of this item. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.
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Trend Financial Information
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto in Item 8 of Part II, “Financial Statements and Supplementary Data”. Historical results are not necessarily indicative of future results.
Year Ended December 31,
2020
2019
2018
2017
Consolidated Statements of Operations:
(in thousands, except share and per share data)
Revenues
$
78,648
$
65,207
$
37,774
$
9,393
Costs and expenses
Costs of revenues
58,534
43,127
25,969
11,736
Research and development
28,568
22,418
14,304
9,919
Selling, general and administrative
33,692
22,080
11,271
9,901
Total costs and expenses
120,794
87,625
51,544
31,556
Loss from operations
(42,146
)
(22,418
)
(13,770
)
(22,163
)
Interest income
949
1,620
293
100
Interest expense
(2
)
(1,133
)
(1,894
)
(1,303
)
Loss on debt extinguishment
—
(1,704
)
(4,658
)
—
Other (expense) income, net
(24
)
(1,440
)
150
(227
)
Loss before income taxes
(41,223
)
(25,075
)
(19,879
)
(23,593
)
Provision for income taxes
(57
)
(9
)
(7
)
(5
)
Net loss
$
(41,280
)
$
(25,084
)
$
(19,886
)
$
(23,598
)
Net loss per share, basic and diluted
$
(1.20
)
$
(1.39
)
$
(6.49
)
$
(7.78
)
Weighted-average shares outstanding, basic and diluted
34,374,903
18,011,470
3,063,157
3,031,636
December 31,
2020
2019
2018
2017
Consolidated Balance Sheet Data:
(in thousands)
Cash and cash equivalents, and short-term investments
$
203,290
$
128,289
$
19,744
$
22,617
Working capital
180,083
89,616
(28,291
)
(22,262
)
Total assets
244,842
157,291
41,670
33,563
Total debt
—
—
4,996
17,506
Long-term obligations
9,261
639
804
1,183
Total liabilities
49,897
50,601
58,654
50,171
Redeemable convertible preferred stock
—
—
89,404
75,995
Total stockholders' equity (deficit)
194,945
106,690
(106,388
)
(92,603
)
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Results of Operations
This section of this Annual Report on Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2019.
Revenues
The following table shows revenues by customer type (in thousands):
Years Ended December 31,
Change
2020
2019
2018
2020 vs 2019
2019 vs 2018
VA MVP
$
56,154
$
43,545
$
18,601
29%
134%
All other customers
22,494
21,662
19,173
4%
13%
Total revenues
$
78,648
$
65,207
$
37,774
21%
73%
The following table shows concentration of revenues by customer:
Year Ended December 31,
2020
2019
2018
VA MVP
71%
67%
49%
Pfizer Inc.
*
13%
10%
Merck & Co., Inc.
*
*
12%
* Less than 10% of revenues
VA MVP
The increase in revenues from the VA MVP in 2020 was driven by an increase in the volume of samples we tested in the period. This increase was driven by a significant rise in the number of samples we received from the VA MVP for testing during 2020 compared to those received for testing during 2019. Our increasingly automated laboratory has supported this higher level of sample volumes.
All Other Customers
The increase in revenues from all other customers in 2020 was driven primarily by an increase in the volume of samples we tested in the period. Approximately $1.0 million of the increase was attributed to a new biobank customer and $0.65 million of the increase in revenues was related to the completion of a research collaboration with a biopharmaceutical customer in the gene therapy space. Approximately one-third of total revenues from all other customers were derived from our NeXT Platform products, whereas revenues from NeXT products in 2019 were insignificant.
Costs and Expenses
Year Ended December 31,
Change
2020
2019
2018
2020 vs 2019
2019 vs 2018
(in thousands)
Costs of revenues
$
58,534
$
43,127
$
25,969
36%
66%
Research and development
28,568
22,418
14,304
27%
57%
Selling, general and administrative
33,692
22,080
11,271
53%
96%
Total costs and expenses
$
120,794
$
87,625
$
51,544
38%
70%
Costs of revenues
The increase in costs of revenues in 2020 was primarily due to the increase in revenue volume, including from the VA MVP, discussed above. The cost components related to the increase in costs of revenues were a $10.3 million increase in raw materials due primarily to higher VA MVP sample volumes; a $2.3 million increase related to personnel-related costs; a $0.9 million increase in depreciation and maintenance costs due to our additions of laboratory equipment; a $0.8 million increase in the cost of laboratory supplies and consumables; a $0.6 million increase in IT and facility costs; and a $0.5 million increase in other costs. Costs of revenues increased more than revenues primarily due to increased raw materials costs and the addition of laboratory personnel in anticipation of higher future laboratory throughput.
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Research and development
The increase in research and development in 2020 was primarily due to development of new products and capabilities (such as those noted in the Factors Affecting Our Performance section above) and lab automation efforts, and consisted of an increase of $6.1 million in personnel-related costs; a $0.9 million increase in IT and facilities costs; and a $0.7 million increase in other costs, partially offset by a $1.5 million decrease in laboratory supplies and consumables for research and development projects.
Selling, general and administrative
The increase in selling, general and administrative in 2020 was due to a $8.8 million increase in personnel-related costs primarily related to increased headcount to support expansion of our commercial team; a $3.0 million increase in professional services primarily related to public company-related costs (including corporate insurance, audit fees, and legal expenses), partially offset by a $0.2 million decrease in other costs.
Interest Income, Interest Expense, Loss on Debt Extinguishment and Other Income (Expense), Net
Year Ended December 31,
Change
2020
2019
2018
2020 vs 2019
2019 vs 2018
(in thousands)
Interest income
$
949
$
1,620
$
293
(41
)%
453
%
Interest expense
(2
)
(1,133
)
(1,894
)
(100
)%
(40
)%
Loss on debt extinguishment
—
(1,704
)
(4,658
)
(63
)%
Other income (expense), net
(24
)
(1,440
)
150
Total
$
923
$
(2,657
)
$
(6,109
)
Interest income
The decrease in interest income in 2020 was driven by declines in yields on debt securities, partially offset by higher average cash and investment balances subsequent to our follow-on offering in August 2020.
Interest expense
Interest expense in 2019 included cash and non-cash interest expense related to the Revolving Loan and Growth Capital Loan. The Revolving Loan was paid off in late March 2019 with proceeds from the Growth Capital Loan. The Growth Capital Loan was fully repaid in August 2019. Since we repaid the Growth Capital Loan, we have had no outstanding debt and therefore did not incur significant interest expense in 2020.
Loss on debt extinguishment
The $1.7 million loss on debt extinguishment in 2019 resulted from the extinguishment of our $20 million Growth Capital Loan facility.
Other Income (Expense), Net
Other expense in 2020 was primarily comprised of foreign currency remeasurements. Other expense in 2019 was primarily comprised of increases in the fair values of warrants for Series B and Series C redeemable convertible preferred stock as a result of increases to the estimated fair value of our equity during the period.
Liquidity and Capital Resources
The following tables present selected financial information and statistics as of and for the years ended December 31, 2020, 2019, and 2018 (in thousands):
December 31,
2020
2019
2018
Cash and cash equivalents, and short-term investments
$
203,290
$
128,289
$
19,744
Property and equipment, net
11,834
14,106
11,452
Contract liabilities
21,034
35,977
42,897
Total debt
—
—
4,996
Working capital
180,083
89,616
(28,291
)
Year Ended December 31,
2020
2019
2018
Net cash (used in) provided by operating activities
$
(42,653
)
$
(18,069
)
$
5,572
Net cash used in investing activities
(65,143
)
(81,579
)
(7,852
)
Net cash provided by (used in) financing activities
121,268
134,948
(591
)
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From our inception through December 31, 2020, we have funded our operations primarily from $117.5 million in net proceeds from our follow-on offering in August 2020, $144.0 million in net proceeds from our IPO in June 2019, and $89.6 million from issuance of redeemable convertible preferred stock, as well as cash from operations and debt financing. As of December 31, 2020, we had cash and cash equivalents in the amount of $68.5 million and short-term investments in the amount of $134.8 million.
We have incurred net losses since our inception. We anticipate that our current cash and cash equivalents and short-term investments, together with cash provided by operating activities, are sufficient to fund our near-term capital and operating needs for at least the next 12 months.
We have based these future funding requirements on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. If our available cash balances, net proceeds from the offerings and anticipated cash flow from operations are insufficient to satisfy our liquidity requirements, including because of lower demand for our services or other risks described in this Annual Report on Form 10-K, such as the COVID-19 pandemic, we may seek to sell additional common or preferred equity or convertible debt securities, enter into an additional credit facility or another form of third-party funding or seek other debt financing. The sale of equity and convertible debt securities may result in dilution to our stockholders and, in the case of preferred equity securities or convertible debt, those securities could provide for rights, preferences or privileges senior to those of our common stock. The terms of debt securities issued or borrowings pursuant to a credit agreement could impose significant restrictions on our operations. Additional capital may not be available on reasonable terms, or at all.
Our short-term investments portfolio is primarily invested in highly rated securities, with the primary objective of minimizing the potential risk of principal loss. Our investment policy generally requires securities to be investment grade and limits the amount of credit exposure to any one issuer.
During 2020, cash used in operating activities of $42.7 million was a result of $41.3 million of net loss and the net negative change in operating assets and liabilities of $17.2 million ($14.9 million of which was related to reductions in outstanding customer prepayments as we fulfilled the related revenue contracts), partially offset by non-cash adjustments to net income of $15.8 million (the most significant non-cash expenses for us in 2020 were $8.2 million of stock-based compensation and $5.8 million of depreciation and amortization).
During 2019, cash used by operating activities of $18.1 million was a result of $25.1 million of net loss and the net negative change in operating assets and liabilities of $7.3 million, partially offset by non-cash negative adjustments to net income of $14.3 million.
During 2020, cash used in investing activities was $65.1 million due to net purchases of short-term investments of $61.9 million and $3.2 million acquisitions of property and equipment used for our sequencing and data analysis services. Cash provided by financing activities of $121.3 million during the same period consisted of $117.5 million net proceeds from our August 2020 follow-on offering, $2.8 million proceeds from stock option exercises, and $1.4 million proceeds from ESPP purchases, partially offset by $0.4 million payments in offering costs.
During 2019, cash used by investing activities of $81.6 million consisted of net purchases of short-term investments of $73.2 million and cash used to acquire property and equipment of $8.4 million . Cash provided by financing activities of $134.9 million during 2019 consisted primarily of $139.8 million of proceeds from our IPO, net of underwriting discounts and commissions, $1.4 million of proceeds from issuance of common stock under employee stock plans, and net proceeds from the issuance of a Growth Capital Loan of $20.0 million, partially offset by cash used to repay a revolving loan and issue and repay the Growth Capital Loan of $26.3 million.
Material Cash Requirements for Known Contractual and Other Obligations
The following is a description of commitments for capital expenditures and other known and reasonably likely cash requirements as of December 31, 2020. We anticipate fulfilling such commitments with our existing cash and cash equivalents and short-term investments, which amounted to $203.3 million as of December 31, 2020.
Our non-cancellable operating lease payments were $15.5 million as of December 31, 2020. The timing of these future payments, by year, can be found in Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements in Note 7, “Leases.”
We had capital expenditures commitments in the amount of approximately $1.7 million as of December 31, 2020, which was comprised primarily of laboratory equipment and computer equipment. Such purchases will likely occur within the first half of 2021. Furthermore, overall capital expenditures in 2021 will likely exceed total capital expenditures in 2020.
We previously entered into various forms of convertible debt and revolving loans to finance our operations prior to our IPO. We paid off all remaining debt in August 2019 and have incurred no additional debt since. Further information regarding the Company’s debt issuances and payment commitments can be found in Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements in Note 6, “Borrowings.”
Certain of our customers prepay us for a portion of the services that they expect to order from us before they place purchase orders and we deliver those services. In some cases, this prepayment can be substantial and may be paid months or a year or more in advance of these customers providing samples to us and before our delivery of the services to which some or all of the deposit relates.
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As of December 31 , 2020, we had approximately $ 21.0 million in customer deposits, including $ 18.4 million from one customer. We are generally not required by our contracts to retain these deposits in cash or otherwise and we have generally used these deposits to make capital expenditures and fund our operations. When a customer that has prepaid us for future services cancels its contract with us or reduces the level of services that it expects to receive, we are required to repay that customer’s deposit with little or no notice. We do not expect to refund material amounts of cash under such circumstances.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with the accounting policies discussed below have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.
Revenue Recognition
Revenue Recognition
We generate our revenues from selling sequencing and data analysis services. We agree to provide services to our customers through a contract, which may be in the form of a combination of a signed agreement, statement of work and/or a purchase order.
We have evaluated the performance obligations contained in contracts with customers to determine whether any of the performance obligations are distinct, such that the customers can benefit from the obligations on their own, and whether the obligations can be separately identifiable from other obligations in the contract. For the significant majority of our contracts to date, the customer orders a specified quantity of a sequencing; therefore, the delivery of the ordered quantity per the purchase order is accounted for as one performance obligation. Our contracts include only one performance obligation—the delivery of the sequencing and data analysis services to the customer.
Fees for our sequencing and data analysis services are predominantly based on a fixed price per sample. The fixed prices identified in the arrangements only change if a pricing amendment is agreed with a customer. In limited cases we provide our customers a discount if samples received above a certain volume are purchased. In such cases, the discount applies prospectively. We have analyzed such discounts if they represent a material right provided to a customer. We have concluded that such discounts do not represent a material right provided to a customer since they are not deemed to be incremental to the pricing offered to the customer or are not enforceable options to acquire additional goods. As a result, these discounts do not constitute a material right and do not meet the definition of a separate performance obligation. We do not offer retrospective discounts or rebates. Accordingly, all of the transaction price, net of any discounts, is allocated to one performance obligation. Therefore, upon delivery of the services, there are no remaining performance obligations.
Contracts that contain multiple distinct performance obligations would require an allocation of the transaction price to each performance obligation based on a relative stand-alone selling price basis. Sometimes we deliver sequencing results in two or more batches; however, since the quantity delivered per batch of each individual test per sales order in these instances is in the same ratio as in the original sales order, allocating the transaction price on a relative stand-alone selling price basis would have no impact on the revenue recognized in any period presented.
We recognize revenue when control of the promised services is transferred to our customers. Management applies judgment in evaluating when a customer obtains control of the promised service, which is when the sequencing and data analysis service results are delivered to customers, at an amount that reflects the consideration to which we expect to be entitled to in exchange for those services. Revenue is recorded net of sales or other transaction taxes collected from clients and remitted to taxing authorities.
A customer contract liability will arise when we have received payments from its customers in advance, but has not yet provided genome and exome sequencing and data analysis services to a customer and satisfied its performance obligations. We record a customer contract liability for performance obligations outstanding related to payments received in advance for customer deposits. We expect to satisfy these remaining performance obligations and recognize the related revenues upon providing sequencing and data analysis services.
All of our revenues and trade receivables are generated from contracts with customers and substantially all of our revenues are derived from U.S. domestic operations. The following section describes the accounting policies that we believe have significant judgment, or changes in judgment, as a result of adopting ASC Topic 606.
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Payment Terms
Payment terms and conditions vary by contract and customer. Our standard payment terms are typically less than 90 days from the date of invoice. In instances where the timing of our revenue recognition differs from the timing of its invoicing, we have determined that our contracts do not include a significant financing component. The primary purposes of our invoicing terms are to provide customers with simplified and predictable ways of purchasing our services and provide payment protection for us.
Stock-Based Compensation
We account for stock-based compensation arrangements with employees, using a fair value-based method, for costs related to all stock-based payments including stock options and stock awards. Our determination of the fair value of stock options on the date of grant utilizes the Black-Scholes option-pricing model.
The fair value of the option granted is recognized over the period during which an optionee is required to provide services in exchange for the option award, known as the requisite service period which usually is the vesting period, on a straight-line basis.
Estimating the fair value of equity-settled awards as of the grant date using valuation models, such as the Black-Scholes option-pricing model, is affected by assumptions regarding a number of complex variables. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation expense is recognized. These inputs are subjective and generally require significant analysis and judgment to develop.
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Expected Term —The expected term assumption represents the weighted-average period that the stock-based awards are expected to be outstanding. We have elected to use the “simplified method” for estimating the expected term of the options, whereby the expected term equals the arithmetic average of the vesting term and the original contractual term of the option.
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Expected Volatility —For all stock options granted to date, the volatility data was estimated based on a study of publicly traded industry peer companies. For purposes of identifying these peer companies, we considered the industry, stage of development, size, and financial leverage of potential comparable companies.
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Expected Dividend Yield —The Black-Scholes option-pricing valuation model calls for a single expected dividend yield as an input. We currently have no history or expectation of paying cash dividends on our common stock.
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Risk-Free Interest Rate —The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon issues similar in duration to the expected term of the equity-settled award.
We estimated the fair value of the time-based employee stock options using the Black-Scholes option-pricing model based on the date of grant with the following assumptions:
Common Stock Valuations
The estimated fair value of the common stock underlying our stock options was determined at each grant date by our board of directors, with input from management. All options to purchase shares of our common stock are intended to be exercisable at a price per share not less than the per-share fair value of our common stock underlying those options on the date of grant.
In the absence of a public trading market for our common stock prior to our IPO, on each grant date, we developed an estimate of the fair value of our common stock based on the information known to us on the date of grant, upon a review of any recent events and their potential impact on the estimated fair value per share of the common stock, and in part on input from an independent third-party valuation firm. As provided in Section 409A of the U.S. Internal Revenue Code of 1986, as amended (the “Code”), we generally relied on our valuations for up to 12 months unless we experienced a material event that would have affected the estimated fair value per common share.
Our valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation (the “Practice Aid”). The methodology to determine the fair value of our common stock included estimating the fair value of the enterprise using the “backsolve” method, which estimates the fair value of our company by reference to the value and preferences of our last round of financing, as well as our capitalization.
The assumptions used to determine the estimated fair value of our common stock were based on numerous objective and subjective factors, combined with management’s judgment, including external market conditions affecting the pharmaceutical and biotechnology industry and trends within the industry:
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our stage of development;
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the rights, preferences, and privileges of our redeemable convertible preferred stock relative to those of our common stock;
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the prices at which we sold shares of our redeemable convertible preferred stock;
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our financial condition and operating results, including our levels of available capital resources;
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the progress of our research and development efforts, our stage of development, and business strategy;
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equity market conditions affecting comparable public companies; and
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general U.S. market conditions and the lack of marketability of our common stock.
The Practice Aid identifies various available methods for allocating enterprise value across classes and series of capital stock to determine the estimated fair value of common stock at each valuation date. In accordance with the Practice Aid, we considered the following methods:
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Income approach . The income approach attempts to value an asset or security by estimating the present value of the future economic benefits it is expected to produce. These benefits can include earnings, cost savings, tax deductions, and disposition proceeds from the asset. An indication of value may be developed in this approach by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation over the asset’s holding period, and the risks associated with realizing the cash flows in the amounts and at the times projected. The discount rate selected is typically based on rates of return available from alternative investments of similar type and quality as of the valuation date. The most commonly employed income approach to valuation is the discounted cash flow analysis.
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Market Approach . The market approach attempts to value an asset or security by examining observable market values for similar assets or securities. Sales and offering prices for comparable assets are adjusted to reflect differences between the asset being valued and the comparable assets, such as, location, time and terms of sale, utility, and physical characteristics. When applied to the valuation of equity, the analysis may include consideration of the financial condition and operating performance of the company being valued relative to those of publicly traded companies or to those of companies acquired in a single transaction, which operate in the same or similar lines of business.
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Cost Approach . The cost approach to valuation is based upon the concept of replacement cost as an indicator of value and the notion that an investor would pay no more for an asset than what it would cost to replace the asset with one of equal utility. The cost approach estimates value based upon the estimated cost of replacing or reproducing the asset, less adjustments for physical deterioration and functional obsolescence, if relevant. When applied to an enterprise, a type of cost approach referred to as the Net Asset Method is sometimes employed. This method measures the value of equity as the sum of the values of its assets reduced by the sum of the values of its liabilities. The resulting equity is reflective of a 100% ownership interest in the business. This approach is frequently used in valuing holding companies.
Based on our early stage of development and other relevant factors, we considered all three approaches and chose to apply both income and market approaches in our analyses. We determined these approaches were the most appropriate methods for allocating our enterprise value to determine the estimated fair value of our common stock for valuations performed for periods up to our IPO. In determining the estimated fair value of our common stock, our board of directors also considered the fact that our stockholders could not freely trade our common stock in the public markets. Accordingly, we applied discounts to reflect the lack of marketability of our common stock based on the weighted-average expected time to liquidity. The estimated fair value of our common stock at each grant date reflected a non-marketability discount partially based on the anticipated likelihood and timing of a future liquidity event.
Following our IPO, our board of directors determines the fair value of our common stock based on the closing quoted market price of our common stock on the date of grant.
JOBS Act Accounting Election
We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
Recent Accounting Pronouncements
See the sections titled “Summary of Significant Accounting Policies—Recent Accounting Pronouncements” and “—Recent Accounting Pronouncements Not Yet Adopted” in Note 2 to our consolidated financial statements for additional information.