Company Quick10K Filing
Castle Biosciences
Price19.61 EPS0
Shares17 P/E73
MCap335 P/FCF446
Net Debt-70 EBIT7
TEV265 TEV/EBIT36
TTM 2019-09-30, in MM, except price, ratios
10-Q 2020-03-31 Filed 2020-05-11
10-K 2019-12-31 Filed 2020-03-10
10-Q 2019-09-30 Filed 2019-11-12
10-Q 2019-06-30 Filed 2019-09-03
S-1 2019-06-26 Public Filing
8-K 2020-05-11 Earnings, Exhibits
8-K 2020-04-15 Regulation FD, Other Events, Exhibits
8-K 2020-04-01 Regulation FD, Other Events
8-K 2020-03-10 Earnings, Regulation FD, Exhibits
8-K 2020-02-28 Enter Agreement, Off-BS Arrangement
8-K 2020-01-09 Earnings, Regulation FD, Exhibits
8-K 2019-12-13 Enter Agreement, Exhibits
8-K 2019-11-11 Earnings, Regulation FD, Exhibits
8-K 2019-11-11 Earnings, Exhibits
8-K 2019-09-03 Earnings, Exhibits
8-K 2019-07-29 Sale of Shares, Amend Bylaw, Other Events, Exhibits

CSTL 10Q Quarterly Report

Part I - Financial Information
Item 1. Financial Statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Qualitative and Quantitative Disclosures About Market Risk.
Item 4. Controls and Procedures.
Part II - Other Information
Item 1. Legal Proceedings.
Item 1A. Risk Factors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Item 3. Defaults Upon Senior Securities.
Item 4. Mine Safety Disclosures.
Item 5. Other Information.
Item 6. Exhibits.
EX-10.1 exhibit101-q12020.htm
EX-10.2 exhibit102-q12020.htm
EX-10.3 exhibit103-q12020.htm
EX-31.1 exhibit311-q12020.htm
EX-31.2 exhibit312-q12020.htm
EX-32.1 exhibit321-q12020.htm
EX-32.2 exhibit322-q12020.htm

Castle Biosciences Earnings 2020-03-31

Balance SheetIncome StatementCash Flow
115814713-21-552018201820192020
Assets, Equity
1511851-12018201820192020
Rev, G Profit, Net Income
806347311502018201820192020
Ops, Inv, Fin

10-Q 1 q12020.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to  _________                   

Commission File Number: 001-38984
 
CASTLE BIOSCIENCES, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
77-0701774
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
820 S. Friendswood Drive, Suite 201, Friendswood, Texas
 
77546
(Address of principal executive offices)
 
(Zip Code)
(866) 788-9007
(Registrant’s telephone number, including area code)
 

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.001 par value per share
CSTL
The Nasdaq Global Market
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of ‘‘large accelerated filer,’’ ‘‘accelerated filer,’’ ‘‘smaller reporting company,’’ and ‘‘emerging growth company’’ in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
x
Smaller reporting company
x
 
 
Emerging growth company
x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 30, 2020, there were 17,220,032 shares of common stock, $0.001 par value per share, issued and outstanding.
 



Table of Contents
 
 
Page
PART I.
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
PART II.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


1


PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.
CASTLE BIOSCIENCES, INC.
CONDENSED BALANCE SHEETS
(in thousands, except share and per share data)
 
 
 
 
 
March 31, 2020
 
December 31, 2019
ASSETS
(unaudited)
 
 
Current Assets
 

 
 

Cash and cash equivalents
$
98,653

 
$
98,845

Accounts receivable, net
14,600

 
14,648

Inventory
1,219

 
1,237

Prepaid expenses and other current assets
2,080

 
1,951

Total current assets
116,552

 
116,681

 
 
 
 
Long-term accounts receivable, net
756

 
870

Property and equipment, net
2,733

 
2,060

Other assets – long-term
216

 
135

Total assets
$
120,257

 
$
119,746

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
1,934

 
$
1,865

Accrued compensation
3,134

 
5,779

Other accrued liabilities
1,855

 
1,812

Current portion of long-term debt
8,333

 
5,833

Total current liabilities
15,256

 
15,289

Long-term debt
17,013

 
19,289

Deferred rent liability
54

 
55

Total liabilities
32,323

 
34,633

Commitments and Contingencies (Note 9)


 


Stockholders’ Equity
 
 
 
Preferred stock, $0.001 par value; 10,000,000 shares authorized as of March 31, 2020 and December 31, 2019; no shares issued and outstanding as of March 31, 2020 and December 31, 2019.

 

Common stock, $0.001 par value; 200,000,000 shares authorized as of March 31, 2020 and December 31, 2019, 17,203,496 and 17,130,907 shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively.
17

 
17

Additional paid-in capital
139,559

 
137,308

Accumulated deficit
(51,642
)
 
(52,212
)
Total stockholders’ equity
87,934

 
85,113

Total liabilities and stockholders’ equity
$
120,257

 
$
119,746


The accompanying notes are an integral part of these unaudited condensed financial statements.

1


CASTLE BIOSCIENCES, INC.
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(in thousands, except per share data)
 
 
Three Months Ended March 31,
 
 
2020
 
2019
NET REVENUES
 
$
17,418

 
$
8,717

COST OF SALES
 
2,391

 
1,598

Gross margin
 
15,027

 
7,119

OPERATING EXPENSES
 
 
 
 
Research and development
 
2,913

 
1,394

Selling, general and administrative
 
11,078

 
6,047

Total operating expenses
 
13,991

 
7,441

Operating income (loss)
 
1,036

 
(322
)
Interest income
 
298

 
21

Interest expense
 
(764
)
 
(1,024
)
Other expense, net
 

 
(33
)
Income (loss) before income taxes
 
570

 
(1,358
)
Income tax expense
 

 

Net income (loss) and comprehensive income (loss)
 
570

 
(1,358
)
Convertible preferred stock cumulative dividends
 

 
928

Accretion of redeemable convertible preferred stock to redemption value
 

 
56

Net income (loss) and comprehensive income (loss) attributable to common stockholders
 
$
570

 
$
(2,342
)
 
 
 
 
 
Earnings (loss) per share attributable to common stockholders:
 
 
 
 
Basic
 
$
0.03

 
$
(1.22
)
Diluted
 
$
0.03

 
$
(1.22
)
 
 
 
 
 
Weighted-average shares outstanding:
 
 
 
 
Basic
 
17,372

 
1,917

Diluted
 
18,734

 
1,917


The accompanying notes are an integral part of these unaudited condensed financial statements.



2


CASTLE BIOSCIENCES, INC.
CONDENSED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)
(UNAUDITED)
(in thousands, except share data)
 
Convertible
 Preferred
Stock Series C
 
Redeemable
 Convertible
Preferred Stock
Series A, B, D, E-1,
 E-2, E-2A, E-3 and F
 
 
Preferred Stock
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Deficit
 
Total
Stockholders’
Equity (Deficit)
 
Shares
 
Amount
 
Shares
 
Amount
 
 
Shares
 
Amount
 
Shares
 
Amount
 
BALANCE, JANUARY 1, 2019
503,056

 
$
1,501

 
9,456,775

 
$
44,995

 
 

 
$

 
1,916,224

 
$
2

 
$
921

 
$
(57,489
)
 
$
(56,566
)
Stock compensation expense

 

 

 

 
 

 

 

 

 
168

 

 
168

Exercise of common stock options

 

 

 

 
 

 

 
477

 

 
1

 

 
1

Accretion of redeemable convertible preferred stock to redemption value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Series E-1

 

 

 
1

 
 

 

 

 

 
(1
)
 

 
(1
)
Series E-3

 

 

 
3

 
 

 

 

 

 
(3
)
 

 
(3
)
Series F

 

 

 
52

 
 

 

 

 

 
(52
)
 

 
(52
)
Recognition of beneficial conversion feature on convertible promissory notes

 

 

 

 
 

 

 

 

 
8,378

 

 
8,378

Net loss

 

 

 

 
 

 

 

 

 

 
(1,358
)
 
(1,358
)
BALANCE, MARCH 31, 2019
503,056

 
$
1,501

 
9,456,775

 
$
45,051

 
 

 
$

 
1,916,701

 
$
2

 
$
9,412

 
$
(58,847
)
 
$
(49,433
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, JANUARY 1, 2020

 
$

 

 
$

 
 

 
$

 
17,130,907

 
$
17

 
$
137,308

 
$
(52,212
)
 
$
85,113

Stock compensation expense

 

 

 

 
 

 

 

 

 
1,577

 

 
1,577

Exercise of common stock options

 

 

 

 
 

 

 
32,602

 

 
71

 

 
71

Issuance of common stock under the employee stock purchase plan

 

 

 

 
 

 

 
39,987

 

 
603

 

 
603

Net income

 

 

 

 
 

 

 

 

 

 
570

 
570

BALANCE, MARCH 31, 2020

 
$

 

 
$

 
 

 
$

 
17,203,496

 
$
17

 
$
139,559

 
$
(51,642
)
 
$
87,934


The accompanying notes are an integral part of these unaudited condensed financial statements.

3


CASTLE BIOSCIENCES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
 
Three Months Ended March 31,
 
2020
 
2019
OPERATING ACTIVITIES
 

 
 
Net income (loss)
$
570

 
$
(1,358
)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
 
 
 
Depreciation
91

 
77

Stock compensation expense
1,577

 
168

Amortization of intangibles

 
3

Amortization of debt discounts and issuance costs
224

 
334

Change in fair value of preferred stock warrant liability

 
(13
)
Change in fair value of embedded derivative

 
46

Change in operating assets and liabilities:
 
 
 
Accounts receivable
161

 
3,841

Prepaid expenses and other current assets
(129
)
 
(66
)
Inventory
19

 
73

Other assets
(77
)
 
(14
)
Accounts payable
56

 
(329
)
Accrued compensation
(2,645
)
 
(1,809
)
Other accrued liabilities
(96
)
 
321

Deferred rent liability
(2
)
 
14

Net cash (used in) provided by operating activities
(251
)
 
1,288

 
 
 
 
INVESTING ACTIVITES
 
 
 
Purchases of property and equipment
(500
)
 
(244
)
Net cash used in investing activities
(500
)
 
(244
)
 
 
 
 
FINANCING ACTIVITIES
 
 
 
Proceeds from issuance of convertible promissory notes (including $4,756 from related parties for the three months ended March 31, 2019), net of issuance costs

 
11,695

Repayments on line of credit

 
(989
)
Proceeds from exercise of common stock options
71

 
1

Proceeds from contributions to the employee stock purchase plan
488

 

Net cash provided by financing activities
559

 
10,707

 
 
 
 
NET CHANGE IN CASH AND CASH EQUIVALENTS
(192
)
 
11,751

Beginning of period
98,845

 
4,479

End of period
$
98,653

 
$
16,230

 
 
 
 
DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Accrued capital expenditures
$
270

 
$
83

Initial public offering costs incurred but not paid
$

 
$
463

The accompanying notes are an integral part of these unaudited condensed financial statements.

4

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)



1. Organization and Description of Business
Castle Biosciences, Inc. (the ‘‘Company’’) was incorporated in the state of Delaware on September 12, 2007. The Company is a commercial-stage dermatological cancer company focused on providing physicians and their patients with personalized, clinically actionable genomic information to make more accurate treatment decisions. The Company is based in Friendswood, Texas (a suburb of Houston, Texas) and its laboratory operations are conducted at the Company’s facility located in Phoenix, Arizona.
Impact of COVID-19 Pandemic
In December 2019, a novel strain of coronavirus, SARS-CoV-2, which causes coronavirus disease 2019, or COVID-19, surfaced in Wuhan, China. Since then, COVID-19 has spread to multiple countries, including the United States. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. To date, the Company has maintained uninterrupted business operations with normal turnaround times for its delivery of test reports. The Company has implemented adjustments to its operations designed to keep employees safe and comply with federal, state and local guidelines, including those regarding social distancing.
The Company has recently experienced a decline in orders, which it believes is linked to delays and/or cancellations in patient visits, resulting in reduced diagnostic biopsies and thus reduced diagnoses of cutaneous melanoma in response to COVID-19. For example, from April 1, 2020 to May 6, 2020, orders for the Company’s lead product, DecisionDx-Melanoma, declined significantly compared to the same period in 2019. As it relates to the impact of COVID-19 on the Company’s uveal melanoma test, DecisionDx-UM, order volume has exhibited some softening since early April 2020.

In response to COVID-19, the United States government has passed legislation and taken other actions to provide financial relief to companies and other organizations affected by the pandemic. Refer to Note 12 for information on certain payments received by the Company in April 2020 as a result of these actions. The Company intends to fund planned operations for the next 12 months using a portion of its cash and cash equivalents on hand, which totaled $98.7 million at March 31, 2020, and collections from test report sales. The extent to which COVID-19 may impact the Company’s business, results of operations, financial condition and cash flows will depend on future developments, which are highly uncertain and cannot be predicted with confidence.

2. Summary of Significant Accounting Policies
Basis of Presentation
The Company’s financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (‘‘U.S. GAAP’’). The Company has no subsidiaries and all operations are conducted by the Company.
Unaudited Interim Financial Information
The accompanying balance sheet as of March 31, 2020; the statements of operations and comprehensive income (loss), the statements of convertible preferred stock and stockholders’ equity (deficit) for the three months ended March 31, 2020 and 2019; and the statements of cash flows for the three months ended March 31, 2020 and 2019 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the audited annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of March 31, 2020 and the results of its operations and its cash flows for the three months ended March 31, 2020 and 2019. The financial data and other information disclosed in these notes related to the three months ended March 31, 2020 and 2019 are also unaudited. The results for the three months ended March 31, 2020 are not necessarily indicative of results to be expected for the year ending December 31, 2020, any other interim periods, or any future year or period. The balance sheet as of December 31, 2019 included herein was derived from the audited financial statements as of that date. Certain disclosures have been condensed or omitted from the interim financial statements. These financial statements should be read in conjunction with the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 filed with the Securities and Exchange Commission on March 10, 2020.

5

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates include revenue recognition, the valuation of stock-based compensation, assessing future tax exposure and the realization of deferred tax assets, the useful lives and recoverability of property and equipment, and contingent liabilities. The Company bases these estimates on historical and anticipated results, trends, and various other assumptions that the Company believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities and recorded revenues and expenses that are not readily apparent from other sources. Actual results could differ from those estimates and assumptions. The Company has considered the potential impact of the COVID-19 pandemic on its estimates and assumptions and while there was not a material impact to the Company’s condensed financial statements as of and for the three months ended March 31, 2020; the extent to which the COVID-19 pandemic may impact the Company’s estimates is uncertain and subject to change.
Operating Segments
Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions on how to allocate resources and assess performance. The Company views its operations and manages its business as one operating segment. All revenues are attributable to U.S.-based operations and all assets are held in the United States.
Cash and Cash Equivalents including Concentrations of Credit Risk
Cash equivalents consist of short-term, highly liquid investments with original maturities of three months or less. The Company’s cash equivalents consist of money market funds, which are not insured by the Federal Deposit Insurance Corporation (“FDIC”), that are primarily invested in short-term U.S. government obligations. Cash deposits at financial institutions may exceed the amount of insurance provided by the FDIC. Management believes that the Company is not exposed to significant credit risk on its cash deposits due to the financial position of the institutions in which deposits are held. The Company has not experienced any losses on its cash or cash equivalents.
Revenue Recognition
Revenue is recognized in accordance with Financial Accounting Standards Board (‘‘FASB’’) Accounting Standards Codification (‘‘ASC’’) Topic 606, Revenue from Contracts with Customers (‘‘ASC 606’’). In accordance with ASC 606, the Company follows a five-step process to recognize revenues: (1) identify the contract with the customer, (2) identify the performance obligations, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations and (5) recognize revenues when the performance obligations are satisfied.
All of the Company’s revenues from contracts with customers are associated with the provision of diagnostic and prognostic cancer testing services. Most of the Company’s revenues are attributable to DecisionDx-Melanoma for cutaneous melanoma. The Company also provides a test for uveal melanoma, DecisionDx-UM. Information on the disaggregation of revenues by the Company’s significant third-party payors is included under Payor Concentration below. The Company has determined that it has a contract with the patient when the treating clinician orders the test. The Company’s contracts generally contain a single performance obligation, which is the delivery of the test report, and the Company satisfies its performance obligation at a point in time upon the delivery of the test report to the treating physician, at which point the Company can bill for the report. The amount of revenue recognized reflects the amount of consideration to which the Company expects to be entitled (the ‘‘transaction price’’) and considers the effects of variable consideration, which is discussed further below.
Once the Company satisfies its performance obligations and bills for the service, the timing of the collection of payments may vary based on the payment practices of the third-party payor and the existence of contractually established reimbursement rates. Most of the payments for the Company’s services are made by third-party payors, including Medicare and commercial health insurance carriers. Certain contracts contain a contractual commitment of a reimbursement rate that differs from the Company’s list prices. However, absent a contractually committed reimbursement rate with a commercial carrier or governmental program, the Company’s diagnostic tests may or may not be covered by these entities’ existing reimbursement policies. In addition, patients do not enter into direct agreements with the Company that commit them to pay any portion of the cost of the tests in the event that their insurance provider declines to reimburse the Company. The Company may pursue, on a case-by-case basis, reimbursement from such patients in the form of co-payments and co-insurance, in accordance with the contractual obligations

6

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


that the Company has with the insurance carrier or health plan. These situations may result in a delay in the collection of payments.
The Medicare claims that are covered by policy under a Local Coverage Determination (‘‘LCD’’) are generally paid at the established rate by the Company’s Medicare contractor within 30 days from receipt. Medicare claims that were either submitted to Medicare prior to the LCD coverage commencement date or are not covered by the terms of the LCD but meet the definition of being medically reasonable and necessary pursuant to the controlling Section 1862(a)(1)(A) of the Social Security Act are generally appealed and may ultimately be paid at the first (termed ‘‘redetermination’’), second (termed ‘‘reconsideration’’) or third level of appeal (de novo hearing with an Administrative Law Judge (“ALJ”)). A successful appeal at any of these levels results in payment.
In the absence of LCD coverage or contractually established reimbursements rates, the Company has concluded that its contracts include variable consideration because the amounts paid by Medicare or commercial health insurance carriers may be paid at less than the Company’s standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration attributable to these price concessions is measured at the expected value using the ‘‘most likely amount’’ method under ASC 606. The amounts are determined by historical average collection rates by test type and payor category taking into consideration the range of possible outcomes, the predictive value of the Company’s past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of the Company’s influence, such as the judgment and actions of third parties. Such variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. Variable consideration may be constrained and excluded from the transaction price in situations where there is no contractually agreed upon reimbursement coverage or in the absence of a predictable pattern and history of collectability with a payor. Variable consideration for Medicare claims that are not covered by an LCD, including those claims subject to approval by an ALJ at an appeal hearing, is deemed to be fully constrained due to factors outside the Company’s influence (i.e., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. Included in revenues for the three months ended March 31, 2020 and 2019 were $3,160,000 and $648,000, respectively, of revenue increases associated with changes in estimated variable consideration related to performance obligations satisfied in previous periods. These amounts include (i) adjustments for actual collections versus estimated amounts and (ii) cash collections and the related recognition of revenue in current period for tests delivered in prior periods due to the release of the constraint on variable consideration.
Because the Company’s contracts with customers have an expected duration of one year or less, the Company has elected the practical expedient in ASC 606 to not disclose information about its remaining performance obligations. Any incremental costs to obtain contracts are recorded as selling, general and administrative expense as incurred due to the short duration of the Company’s contracts. Contract balances consisted solely of accounts receivable (both current and noncurrent) as of March 31, 2020 and December 31, 2019.
DecisionDx-Melanoma Claims Consolidation
In June 2017, the Company submitted to the Office of Medicare Hearings and Appeals (‘‘OMHA’’) a formal request to participate in a program that OMHA developed with the intent of providing appellants a means to have large volumes of claim disputes adjudicated at an accelerated rate. The program consolidates outstanding claims at the ALJ level and uses a statistical-sampling approach where five ALJs will determine reimbursement results for a sample of claims which are then extrapolated to the universe of claims. The consolidation includes 2,698 DecisionDx-Melanoma claims dating from 2013 through spring 2017. Hearings were held in April 2019 with a supplemental hearing in May 2019. On March 12, 2020, OMHA issued a decision denying payment on all claims in the consolidation. The Company plans to appeal the decision. In accordance with ASC 606 and consistent with prior periods, the Company has not recognized (fully constrained the variable consideration) any revenues attributable to these claims in its financial statements pending the outcome of this matter.
Payor Concentration
The Company relies upon reimbursements from third-party government payors (primarily Medicare) and private-payor insurance companies to collect accounts receivable related to sales of its diagnostic tests.

7

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


The Company’s significant third-party payors and their related revenues as a percentage of total revenues and accounts receivable balances are as follows:
 
Percentage of Revenues
 
 
 
 
 
Three Months Ended March 31,
 
Percentage of
 Accounts Receivable
 (current)
 
Percentage of
 Accounts Receivable
 (non-current)
 
2020
 
2019
 
March 31, 2020
 
December 31, 2019
 
March 31, 2020
 
December 31, 2019
Medicare
57
%
 
19
%
 
8
%
 
7
%
 
%
 
%
Medicare Advantage plans
30
%
 
25
%
 
42
%
 
41
%
 
16
%
 
18
%
United Healthcare
*

 
9
%
 
4
%
 
9
%
 
%
 
%
BlueCross BlueShield plans
6
%
 
9
%
 
26
%
 
25
%
 
47
%
 
46
%
 
*
Less than 1%
Accounts Receivable and Allowance for Doubtful Accounts
The Company classifies accounts receivable balances that are expected to be paid more than one year from the balance sheet date as non-current assets. The estimated timing of payment utilized as a basis for classification as non-current is determined by analyses of historical payor-specific payment experience, adjusted for known factors that are expected to change the timing of future payments.
The Company accrues an allowance for doubtful accounts against its accounts receivable when it is probable that an account is not collectible, based on write off history, credit risk of specific accounts, aging analysis and other information available on specific accounts. The Company generally does not perform evaluations of customers’ financial condition and generally does not require collateral. Accounts receivable are written off when all efforts to collect the balance have been exhausted. Historically, the Company’s bad debt expense has not been significant. The allowance for doubtful accounts was zero as of March 31, 2020 and December 31, 2019. Adjustments for implicit price concessions attributable to variable consideration, as discussed above, are incorporated into the measurement of the accounts receivable balances and are not part of the allowance for doubtful accounts.
Fair Value of Financial Instruments
The carrying amount of the Company’s long-term debt approximates fair value due to its variable market interest rate and management’s opinion that current rates and terms that would be available to the Company with the same maturity and security structure would be essentially equivalent to that of the Company’s long-term debt. This estimated fair value is a ‘‘Level 3’’ fair value measurement, as defined in Note 8.
Accrued Compensation
The Company accrues for liabilities under discretionary employee and executive bonus plans. These estimated compensation liabilities are based on progress against corporate objectives approved by the Company’s board of directors, compensation levels of eligible individuals, and target bonus percentage levels. The board of directors reviews and evaluates the performance against these objectives and ultimately determines what discretionary payments are made. The Company also accrues for liabilities under employee sales incentive bonus plans with accruals based on performance achieved to date compared to established targets. As of March 31, 2020 and December 31, 2019, the Company accrued $1,794,000 and $4,785,000, respectively, for liabilities associated with these bonus plans. These amounts are classified as current or noncurrent accrued liabilities in the balance sheets based on the expected timing of payment.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as a change in equity during a period from transactions and other events and circumstances from non-owner sources. The Company’s comprehensive income (loss) was the same as its reported net income (loss) for all periods presented.

8

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


Accounting Pronouncements Yet to be Adopted
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which supersedes FASB ASC Topic 840, Leases (Topic 840), and provides principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method for finance leases or on a straight-line basis over the term of the lease for operating leases. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases. For companies that are not emerging growth companies (‘‘EGCs’’), ASU 2016-02 is effective for fiscal years beginning after December 15, 2018. For EGCs, the ASU was to be effective for fiscal years beginning after December 15, 2019. However, in November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective Dates (“ASU 2019-10”), which included a one-year deferral of the effective date of ASU 2016-02 for certain entities. As a result, the ASU is now effective for EGCs for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. The Company expects to adopt the new standard in the fourth quarter of 2021 using the modified retrospective method, under which the Company will apply Topic 842 to existing and new leases as of January 1, 2021, but prior periods will not be restated and will continue to be reported under Topic 840 guidance in effect during those periods. The Company anticipates that the adoption will not have a material impact on its statements of operations and comprehensive income (loss) or its statements of cash flows but expects to recognize right-of-use assets and liabilities for lease obligations associated with its operating leases.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (“ASU 2016-13”), which requires the measurement of expected credit losses for financial instruments carried at amortized cost, such as accounts receivable, held at the reporting date based on historical experience, current conditions and reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. In November 2018, the FASB issued ASU No. 2018-19, Codification Improvements to Topic 326, Financing Instruments—Credit Losses, which included an amendment of the effective date for nonpublic entities. For non-EGCs, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019. For EGCs, the standard was to be effective for fiscal years beginning after December 15, 2021. However, in November 2019, the FASB issued ASU 2019-10, which included a one-year deferral of the effective date of ASU 2016-13 for certain entities. As a result, ASU is now effective for EGCs for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company does not currently believe the adoption of this standard will have a significant impact on its financial statements, given its history of minimal bad debt expense relating to trade accounts receivable.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which eliminates certain exceptions to the general principles in Topic 740 and simplifies other areas of the existing guidance. For non-EGCs, ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For EGCs, the standard is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early adoption is permitted. The Company is currently evaluating the impact of ASU 2019-12 on its financial statements.

3. Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net income (loss) attributable to common stockholders for the period by the weighted-average number of common shares outstanding during the period. The weighted-average number of common shares outstanding includes shares associated with an outstanding warrant, issued in July 2019, to purchase 209,243 shares of common stock, which are deemed to have been issued for purposes of calculating basic and diluted earnings (loss) per share, due to the nominal exercise price. On July 29, 2019, the Company completed the initial public offering of its common stock (the “IPO”), in which it issued and sold 4,600,000 shares of common stock. Also on that date, all of the Company’s outstanding convertible preferred stock and convertible promissory notes automatically converted into 8,181,992 and 1,661,106 shares, respectively, of common stock and certain outstanding warrants to purchase Series F convertible redeemable preferred stock were net exercised for an aggregate of 27,207 shares of common stock. These shares are included in the Company’s weighted-average number of common shares outstanding starting on that date.

9

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


Diluted earnings (loss) per share reflects the additional dilution from potential issuances of common stock, such as stock issuable pursuant to the exercise of stock options or purchases under the 2019 Employee Stock Purchase Plan (“ESPP”), as well as from the possible conversion of the Company’s convertible preferred stock, convertible promissory notes and exercise of outstanding warrants. The treasury stock and if-converted methods are used to calculate the potential dilutive effect of these common stock equivalents. However, potentially dilutive shares are excluded from the computation of diluted loss per share when their effect is antidilutive.
The following table shows the computation of basic and diluted earnings (loss) per share for the three months ended March 31, 2020 and 2019 (in thousands, except per share data):
 
 
Three Months Ended March 31,
 
 
2020
 
2019
 
 
 
 
 
Numerator:
 
 
 
 
Net income (loss) attributable to common stockholders
 
$
570

 
$
(2,342
)
 
 
 
 
 
Denominator:
 


 


Weighted-average common shares outstanding, basic
 
17,372

 
1,917

Assumed exercise of common stock warrants
 
27

 

Assumed exercise of stock options
 
1,310

 

Assumed issuance of shares under the ESPP
 
25

 

Weighted-average common shares outstanding, diluted
 
18,734

 
1,917

 
 
 
 
 
Earnings (loss) per share attributable to common stockholders:
 
 
 
 
Basic
 
$
0.03

 
$
(1.22
)
Diluted
 
$
0.03

 
$
(1.22
)
Due to the Company reporting a net loss attributable to common stockholders for the three months ended March 31, 2019, all potentially dilutive securities are antidilutive and are excluded from the computations of diluted loss per share for such period.
The table below provides the weighted-average number of potential common shares associated with outstanding securities not included in the Company’s calculation of diluted earnings (loss) per share for the three months ended March 31, 2020 and 2019 because to do so would be antidilutive (in thousands):
 
 
Three Months Ended March 31,
 
 
2020
 
2019
Convertible preferred stock
 

 
8,171

Convertible promissory notes(1)
 

 
535

Stock options
 
955

 
1,754

Preferred stock warrants
 

 
141

Employee stock purchase plan
 
14

 

Total
 
969

 
10,601

 
(1)
Based on conversion of the aggregate principal amount, plus accrued interest thereon, of the convertible promissory notes into shares of common stock based on the IPO price of $16.00 per share and assuming the occurrence of such conversion as of the beginning of 2019 or the date of issuance, if later.


10

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


4. Property and Equipment, Net
Property and equipment, net consisted of the following (in thousands):
 
March 31, 2020
 
December 31, 2019
Lab equipment
$
1,571

 
$
1,563

Computer equipment
946

 
887

Leasehold improvements
635

 
635

Furniture and fixtures
209

 
176

Construction in progress
665

 
2

Total
4,026

 
3,263

Less accumulated depreciation
(1,293
)
 
(1,203
)
Property and equipment, net
$
2,733

 
$
2,060

Depreciation expense was recorded in the statements of operations and comprehensive income (loss) as follows (in thousands):
 
Three Months Ended March 31,
 
2020
 
2019
Cost of sales
$
66

 
$
64

Research and development
2

 
2

Selling, general and administrative
23

 
11

Total
$
91

 
$
77


5. Other Accrued Liabilities
Other accrued liabilities consisted of the following (in thousands):
 
March 31, 2020
 
December 31, 2019
Accrued service fees
$
1,123

 
$
1,162

Accrued interest
184

 
184

Employee stock purchase plan contributions
103

 
218

Accrued royalties
92

 
169

Accrued state income taxes
79

 
79

Other
274

 

Total
$
1,855

 
$
1,812


6. Convertible Promissory Notes
In January and February 2019, the Company issued $11,770,000 principal amount of unsecured convertible promissory notes (the “Q1 2019 Notes”), of which $4,756,000 was with related parties (executive officers, members of the Company’s board of directors or entities affiliated with them). The Q1 2019 Notes bore simple interest at a rate of 8% per annum. Originally, the Q1 2019 Notes had a maturity date of January 31, 2020, but on July 3, 2019, the Company entered into an amendment with the holders of the Q1 2019 Notes to extend the maturity to June 30, 2020. The entire amount of the outstanding principal amount plus accrued interest on the Q1 2019 Notes converted into 954,074 shares of common stock in connection with the IPO on July 29, 2019.
The Company determined that certain features of the Q1 2019 Notes were subject to bifurcation and separate accounting under ASC 815-15, Embedded Derivatives. The embedded derivative was recorded at fair value each reporting period, with changes in fair value recorded as “other expense, net” in the statements of operations and comprehensive income (loss). No hedge accounting treatment was applied. The Company also determined the Q1 2019 Notes contained a beneficial conversion feature under ASC 470-20, Debt with Conversion and Other Options, related to the optional conversion of the Q1 2019 Notes into

11

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


Series F redeemable convertible preferred stock at maturity. The debt discounts created from the initial recognition of the embedded derivative and the beneficial conversion feature were being amortized to interest expense over the life of the debt using the effective interest method. Amortization of discounts and issuance costs on the Q1 2019 Notes totaled $204,000 for the three months ended March 31, 2019 and were included in interest expense.
The amounts recognized in net loss for three months ended March 31, 2019 for the embedded derivative liability are as follows (in thousands):
 
 
 
Gain (Loss) Recognized in Net Loss
 
Statement of Operations and Comprehensive Income (Loss) Location
 
Three Months Ended
March 31, 2019
Derivatives Not Classified as Hedging Instruments
 
 
 
Embedded derivative in convertible promissory notes
Other expense, net
 
$
(46
)

7. Long-Term Debt
The Company’s long-term debt balances are presented in the table below (in thousands):
 
March 31, 2020
 
December 31, 2019
Term debt
$
26,688

 
$
26,688

Unamortized discount and issuance costs
(1,342
)
 
(1,566
)
Total long-term debt
25,346

 
25,122

Less: Current portion of long-term debt
(8,333
)
 
(5,833
)
Total long-term debt, less current portion
$
17,013

 
$
19,289

The Company has a Loan and Security Agreement (the ‘‘2018 LSA’’) with Oxford Finance LLC (‘‘Oxford’’), as collateral agent, and Oxford and Silicon Valley Bank (‘‘SVB’’) as equal syndicated lenders (collectively, the ‘‘Lenders’’). The 2018 LSA currently consists of a $25.0 million secured term loan credit facility (the ‘‘2018 Term Loan’’). The Company’s obligations under the 2018 LSA are secured by substantially all of its assets, excluding intellectual property and subject to certain other exceptions and limitations. The Company has the right to prepay the 2018 Term Loan in whole or in part at any time, subject to a prepayment fee of 1.50% prior to November 30, 2020 and 0.75% thereafter. Upon prepayment, the Company is also obligated to pay a non-refundable early termination fee of $497,000. Amounts prepaid or repaid under the 2018 Term Loan may not be reborrowed. Previously, the 2018 LSA contained a financial covenant that required the Company to achieve a monthly trailing three-month revenue target each month throughout the term of the agreement, but the covenant was amended in February 2020 and is now tested quarterly instead of monthly, as discussed further below. As of March 31, 2020 and December 31, 2019, the Company was in compliance with this covenant.
For each month through December 31, 2019, the trailing three-month revenue requirements were calculated as a percentage of the Company’s previously approved applicable monthly revenue projections. In February 2020, the Company entered into an amendment of the 2018 LSA (the “Second Amendment”) that, among other things, changed the covenant from being tested monthly to quarterly testing. In March 2020, the Company entered into an amendment of the 2018 LSA (the “Third Amendment”) with the Lenders to establish revenue targets for the year ending December 31, 2020. For quarterly periods ending after December 31, 2020, the trailing three-month revenue requirements will be determined by the Lenders upon receipt and review of the Company’s quarterly financial projections for the year, subject to certain specified criteria regarding minimum requirements. Revenues, if any, that the Company recognizes as a result of an ALJ appeal process from consolidated claims initiatives for DecisionDx-Melanoma do not count toward the minimum revenue requirements.
On May 10, 2020, the Company entered into an amendment of the 2018 LSA (the “Fourth Amendment”) to modify the covenant structure such that the Company is required to comply with either (i) the trailing three-month revenue target or (ii) a liquidity ratio, in both cases measured quarterly. The liquidity ratio covenant requires that the ratio of (i) unrestricted cash and cash equivalents (as defined in the 2018 LSA) held at SVB or its affiliates to (ii) the outstanding obligations under the 2018 LSA be at least 2.00 to 1.00. The Company requested the Fourth Amendment from the Lenders due to the Company’s anticipated noncompliance with the trailing three-month revenue covenant as of June 30, 2020 as a result of the impacts to its

12

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


business attributable to COVID-19. The liquidity ratio, had it been measured and effective as of March 31, 2020, would have been 3.66 to 1.00.
In addition, the 2018 LSA contains customary conditions of borrowing, events of default and covenants, including covenants that restrict the Company’s ability to dispose of assets, merge with or acquire other entities, incur indebtedness and make distributions to holders of the Company’s capital stock. Should an event of default occur, including the occurrence of a material adverse change, the Company could be liable for immediate repayment of all obligations under the 2018 LSA. The Second Amendment included a waiver, by the Lenders, of an event of default of the Company attributable to maintaining a balance in a certain third-party deposit account, beyond the maximum level permitted, without obtaining a control agreement for such deposit account in favor of the collateral agent, Oxford. In addition to the waiver, the Second Amendment also provided a modification to increase the maximum balance permitted for this deposit account. The Company is currently in compliance with this provision of the 2018 LSA.
The Company’s ability to further amend the terms of the 2018 LSA is subject to the approval of Oxford and SVB. Accordingly, should the Company seek to amend the 2018 LSA, there can be no assurance that an amendment would be available on terms acceptable to the Company or at all.
The 2018 Term Loan bears interest at a floating rate equal to the greater of (1) 8.55% and (2) the 30-day U.S. LIBOR rate as reported in the Wall Street Journal on the last business day of the month that precedes the month in which the interest will accrue, plus 6.48%. The applicable interest rate on the 2018 Term Loan was 8.55% as of March 31, 2020 and December 31, 2019. Interest on the 2018 Term Loan is payable monthly in arrears. The Company is permitted to make interest-only payments on the 2018 Term Loan through May 31, 2020. The principal is required to be repaid in 30 equal monthly installments of $833,333 each beginning on June 1, 2020. All unpaid principal and accrued and unpaid interest are due on November 1, 2022 (the “2018 Term Loan Maturity Date”). The Company is also obligated to make an additional final payment of 6.75% of the aggregate original principal amount, or $1,687,500, upon any prepayment or on the 2018 Term Loan Maturity Date. The final payment amount is being amortized as additional interest expense using the effective interest method over the term of the debt.

8. Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. The fair value hierarchy prioritizes the inputs to valuation techniques used in measuring fair value. There are three levels to the fair value hierarchy based on the reliability of inputs, as follows:
Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 3 – Unobservable inputs in which little or no market data exists, therefore requiring the Company to develop its own assumptions.
Financial instruments measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. The use of different assumptions and/or estimation methodologies may have a material effect on estimated fair values. Accordingly, the fair value estimates disclosed, or amounts recorded may not be indicative of the amount that the Company or holders of the instruments could realize in a current market exchange.

13

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


The table below provides information, by level within the fair value hierarchy, of the Company’s financial assets and financial liabilities that are accounted for at fair value on a recurring basis as of March 31, 2020 and December 31, 2019 (in thousands):
 
As of March 31, 2020
 
Quoted Prices in Active Markets for Identical Items (Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds(1)
$
97,576

 
$

 
$

 
$
97,576

 
As of December 31, 2019
 
Quoted Prices in Active Markets for Identical Items (Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds(1)
$
98,389

 
$

 
$

 
$
98,389

 
(1)
Classified as “Cash and cash equivalents” in the condensed balance sheets.

9. Commitments and Contingencies
From time to time, the Company may be involved in legal proceedings arising in the ordinary course of business. The Company believes there is no threatened litigation or litigation pending that could have, individually or in the aggregate, a material adverse effect on the Company’s financial position, results of operations or cash flows.

10. Stockholders’ Equity
Information about common stock warrants outstanding as of March 31, 2020 and December 31, 2019 are presented in the table below:
Expiration date
 
Number of shares
 
Exercise price
July 12, 2026
 
209,243

 
$
0.001

March 31, 2027
 
26,428

 
$
7.10

November 30, 2028
 
8,809

 
$
7.10

Total
 
244,480

 
 
The common stock warrants are classified as stockholders’ equity and no adjustments are recorded for changes in fair value.


14

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


11. Stock Incentive Plans and Stock-Based Compensation
Stock Incentive Plans
Activity under the Company’s stock plans for the three months ended March 31, 2020 is set forth below:
 
 
 
 
 
Weighted-Average
 
 
 
Shares
Available for
Grant
 
Stock Options
Outstanding
 
Exercise
Price
 
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
(in thousands)
Balance as of December 31, 2019
863,127

 
2,637,966

 
$
13.30

 
 
 
 
Additional options authorized
856,545

 

 

 
 
 
 
Granted
(169,200
)
 
169,200

 
$
31.05

 
 
 
 
Exercised

 
(32,602
)
 
$
2.16

 
 
 
 
Forfeited/Canceled
12,200

 
(12,200
)
 
$
26.59

 
 
 
 
Balance as of March 31, 2020
1,562,672

 
2,762,364

 
$
14.46

 
8.49
 
$
42,704

Exercisable at March 31, 2020 (1)
 
 
716,040

 
$
2.38

 
6.32
 
$
19,643

 
(1)
Vested and exercisable options. Additionally, outstanding unvested options to purchase an aggregate of 111,571 shares of common stock with a weighted-average exercise price of $2.39 per share may be exercised prior to vesting as of March 31, 2020 under early-exercise provisions. In the event of such exercise, the shares obtained upon exercise would be restricted and subject to forfeiture prior to vesting. No such early exercises have occurred as of March 31, 2020.
Employee Stock Purchase Plan
The ESPP provides for certain automatic increases in the number of shares of common stock reserved for issuance, which resulted in an additional 171,309 shares becoming available under the ESPP effective January 1, 2020. On February 28, 2020, the Company issued 39,987 shares of its common stock under a scheduled purchase under the ESPP. As of March 31, 2020, 543,257 shares remained available for issuance under the ESPP.
Determining Fair Value - Summary of Assumptions
The Company uses the Black-Scholes option pricing model to estimate the fair value of each option grant on the date of grant or any other measurement date. The following table sets forth the assumptions used to determine the fair value of stock options:
 
Three Months Ended March 31,
 
2020
 
2019
Average expected term (years)
6
 
6
Expected stock price volatility
59.57% - 60.58%
 
58.22% - 58.84%
Risk-free interest rate
0.80% - 1.66%
 
2.18% - 2.47%
Dividend yield
—%
 
—%
The following table sets forth assumptions used to determine the fair value of the purchase rights issued under the ESPP:
 
Three Months Ended March 31,
 
2020
 
2019
Average expected term (years)
1.2
 
Not applicable
Expected stock price volatility 
56.80% - 63.65%
 
Not applicable
Risk-free interest rate
0.84% - 0.95%
 
Not applicable
Dividend yield
—%
 
Not applicable

15

CASTLE BIOSCIENCES, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)


The fair value of the Company’s common stock is also an assumption used to determine the fair value of stock options and purchase rights under the ESPP. Prior to the IPO, our common stock was not publicly traded, therefore the Company estimated the fair value of its common stock. Following the IPO, the fair value of the Company’s common stock is the closing selling price per share of its common stock as reported on the Nasdaq Global Market on the date of grant or other relevant determination date.
Stock-Based Compensation Expense
Stock-based compensation expense related to stock options and the ESPP is included in the statements of operations and comprehensive income (loss) as follows (in thousands):
 
Three Months Ended March 31,
 
2020
 
2019
Cost of sales
$
206

 
$
10

Research and development
234

 
20

Selling, general and administrative
1,137

 
138

Total stock-based compensation expense
$
1,577

 
$
168

For the three months ended March 31, 2020 and 2019, the weighted-average grant date fair value of options granted was $17.32 and $1.90 per option, respectively, and the weighted-average grant date fair value of the purchase rights granted under the ESPP was $12.70 and nil per share, respectively. As of March 31, 2020, the total unrecognized compensation cost related to stock options and the ESPP was $19,751,000 and $966,000, respectively, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.2 years and 1.6 years, respectively. The total unrecognized compensation costs will be adjusted for forfeitures in future periods as they occur.

12. Subsequent Events
On April 1, 2020, the Company granted to a new member of the Company’s board of directors an option to purchase 16,000 shares of common stock at an exercise price of $28.77 per share. The option was granted pursuant to the 2019 Equity Incentive Plan (the “2019 Plan”), has a ten-year term and vests over a three-year period (with one-third vesting on April 15, 2021 and the remaining shares vesting in 24 equal monthly installments thereafter). On April 15, 2020, the Company granted to various employees, options to purchase an aggregate of 10,400 shares of our common stock at an exercise price of $29.69 per share. The option awards were granted pursuant to the 2019 Plan, have a ten-year term and vest over a four-year period (with 25% vesting after one year from the vesting start date and the remainder vesting in 36 equal monthly installments thereafter).
On April 10, 2020, the Company received an automatic payment of $1.9 million from the U.S. Department of Health and Human Services (“HHS”) pursuant to the Coronavirus Aid, Relief and Economic Security Act enacted on March 27, 2020, also known as the CARES Act, out of relief funds allocated by HHS to healthcare providers to reimburse healthcare related expenses or lost revenues attributable to COVID-19. This automatic payment was calculated by HHS in proportion to the providers’ share of Medicare fee-for-service reimbursements in 2019 and was applicable to all facilities and providers that received Medicare fee-for-service reimbursements in 2019. As determined by HHS, the funds will not need to be repaid.
On April 16, 2020, the Company received an advance payment of $8.3 million (the “Advance Payment”) from the Centers for Medicare & Medicaid Services (“CMS”) under its Accelerated and Advance Payment Program, which was recently expanded to provide increased cash flow to service providers during the COVID-19 pandemic. Starting on August 14, 2020 (120 days after the issuance of the Advance Payment), the recoupment process will begin and claims the Company submits for reimbursement will be applied against the balance of the Advance Payment. If the Advance Payment is not fully recovered by CMS by November 12, 2020 (210 days from the issuance of the Advance Payment), the Company will make arrangements with its Medicare Administrative Contractor for CMS to recoup the remaining balance. The Company expects to reflect the receipt of the Advance Payment as a liability on its balance sheet in the second quarter of 2020 and the Company will reduce the balance as it is applied to new claims or is otherwise recouped by CMS.
On May 10, 2020, the Company and the Lenders amended the 2018 LSA, as discussed in Note 7.

16


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of financial condition and results of operations together with our unaudited condensed financial statements and the related notes and other financial information included in this Quarterly Report on Form 10-Q and our audited financial statements and notes thereto as of and for the years ended December 31, 2019 and 2018 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, including Critical Accounting Policies and Significant Judgments and Estimates, included in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission, or the SEC, on March 10, 2020. Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “we,” “us,” and “our” refer to Castle Biosciences, Inc.

Forward-Looking Statements
The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning the impacts of COVID-19 on our business, our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the SEC. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements, except as may be required by law.

Overview
We are a commercial-stage dermatological cancer company focused on providing physicians and their patients with personalized, clinically actionable genomic information to make more accurate treatment decisions. We believe that the traditional approach to developing a treatment plan for certain cancers using clinical and pathology factors alone is inadequate and can be improved by incorporating personalized genomic information. Our non-invasive products utilize proprietary algorithms to provide an assessment of a patient’s specific risk of metastasis or recurrence of their cancer, allowing physicians to identify patients who are likely to benefit from an escalation of care as well as those who may avoid unnecessary medical and surgical interventions. Our lead product, DecisionDx-Melanoma, is a proprietary multi-gene expression profile, or GEP, test that predicts the risk of metastasis or recurrence for patients diagnosed with invasive cutaneous melanoma, a deadly skin cancer. We estimate more than 130,000 patients are diagnosed with invasive cutaneous melanoma each year in the United States. We launched DecisionDx-Melanoma in May 2013. We also market DecisionDx-UM, which is a proprietary GEP test that predicts the risk of metastasis for patients with uveal melanoma, a rare eye cancer. We launched DecisionDx-UM in January 2010. Based on the substantial clinical evidence that we have developed, we have received Medicare coverage for both of our products, which represents approximately 50% of our addressable patient population.
We also have two late-stage proprietary products in development that address cutaneous squamous cell carcinoma, or SCC, and suspicious pigmented lesions. We expect to commercially launch our SCC proprietary GEP test, DecisionDx-SCC, in the third quarter of 2020. As it relates to our proprietary GEP test for suspicious pigmented lesions, we believe we remain on track to launch this test in the second half of 2020. These indications are areas of high clinical need in dermatological cancer and, together, represent an additional addressable market of approximately 500,000 patients in the United States.
We have processed over 60,000 clinical samples since commercial launch and our annual revenue increased from $22.8 million in 2018 to $51.9 million in 2019. For the three months ended March 31, 2020, year-over-year growth in new ordering clinicians for our DecisionDx-Melanoma test was 43%.

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The numbers of DecisionDx-Melanoma and DecisionDx-UM test reports delivered by us during the three months ended March 31, 2020 and for the year ended December 31, 2019 are presented in the table below:
 
DecisionDx-
Melanoma
 
DecisionDx-UM
 
Total
Q1 2020
4,574

 
361

 
4,935

 
 
 
 
 
 
Q1 2019
3,232

 
360

 
3,592

Q2 2019
3,691

 
376

 
4,067

Q3 2019
4,126

 
356

 
4,482

Q4 2019
4,480

 
434

 
4,914

For the year ended December 31, 2019
15,529

 
1,526

 
17,055

For additional information on the metrics we disclose, refer to “Information about certain metrics” below.
Since our inception in 2008, we have devoted substantially all of our resources to organizing and staffing our company, business planning, raising capital, discovering product candidates, conducting clinical study activities to generate evidence demonstrating the clinical validity, clinical utility, economic benefits, and patient outcomes of our products, and commercialization activities for those products. We currently market two proprietary GEP products and generate substantially all of our revenue from those activities.
The principal focus of our current commercial efforts is to distribute our molecular diagnostic testing products through our direct sales force in the U.S. The number of test reports we generate is a key indicator that we use to assess our business. A test report is generated when we receive a sample in our laboratory, the relevant information relating to that test is entered into our Laboratory Information Management System, the genomic profile of the sample is performed and a report providing the results of that profile is sent to the physician who ordered the test.
We bill third-party payors and patients for the tests we perform. The majority of our revenue collections is paid by third-party insurers, including Medicare. We have received Local Coverage Determinations, or LCDs, which provide coverage for our tests that meet certain criteria for Medicare and Medicare Advantage beneficiaries, representing approximately 60 million covered lives. As it relates to DecisionDx-UM, we have contracts or have received positive medical policy decisions from additional payors representing approximately 83 million covered lives. A ‘‘covered life’’ means a subscriber, or a dependent of a subscriber, who is insured under an insurance policy for such an insurance carrier.
On May 17, 2019, the Centers for Medicare & Medicaid Services, or CMS, determined that DecisionDx-UM meets the criteria for existing advanced diagnostic laboratory test, or ADLT, status, also referred to as “existing ADLT” status. This means that beginning in 2021, the DecisionDx-UM Medicare rate will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. Specifically, the median private payor rate from January 1 to June 30, 2019 will be used to set the Medicare rate for the calendar year 2021. We submitted this data in January 2020. Note that our rate for 2020 will be set by Noridian Healthcare Solutions, LLC, or Noridian, our local Medicare Administrative Contractor, or MAC.
Also, on May 17, 2019, CMS determined that DecisionDx-Melanoma meets the criteria for ‘‘new ADLT’’ status. This means that from July 1, 2019 through March 31, 2020 the Medicare reimbursement rate equaled the initial list price of $7,193.00, subject to the possible recoupment provision described below. The rate for April 1, 2020 through December 31, 2021 was calculated based upon the median private payor rate from July 1, 2019 to November 30, 2019. We submitted this data in December 2019 and CMS has notified us that the rate for April 1, 2020 through December 31, 2021 will be $7,193.00.
Beginning in 2022, the rate for both DecisionDx-UM and DecisionDx-Melanoma will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. For example, the rate for 2022 will be set using median private payor rate data from January 1, 2020 to June 30, 2020.
To date, in addition to the revenue generated from the sale of our products, we have financed our operations through our initial public offering of common stock, or the IPO, private placements of preferred stock, convertible promissory notes and bank debt. We believe that our existing cash and cash equivalents and anticipated cash generated from sales of our products will be sufficient to fund our operations for the foreseeable future. However, we have based these estimates on assumptions, including those related to the impact of COVID-19 on our financial condition, that may prove to be wrong, and we could utilize our available capital resources sooner than we expect.

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Our net income (losses) may fluctuate significantly from period to period, depending on the timing of our planned development activities, the growth of our sales and marketing activities and the timing of revenue recognition under Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, or ASC 606. We expect our expenses will increase substantially over time as we:
execute clinical studies to generate evidence supporting our current and future product candidates;
execute our commercialization strategy for our current and future products;
continue our ongoing and planned development of new products;
seek to discover and develop additional product candidates;
hire additional scientific and research and development staff; and
add additional operational, financial and management information systems and personnel.
Furthermore, we expect to continue to incur additional costs associated with operating as a public company, including significant legal, accounting, investor relations and other expenses.

Impact of COVID-19 Pandemic
In December 2019, a novel strain of coronavirus, SARS-CoV-2, which causes coronavirus disease 2019, or COVID-19, surfaced in Wuhan, China. Since then, COVID-19 has spread to multiple countries, including the United States. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. We are providing the following update with respect to the impact of COVID-19 on our business:
To date, we have maintained uninterrupted business operations with normal turnaround times for our delivery of test reports. We have implemented adjustments to our operations designed to keep employees safe and comply with federal, state and local guidelines, including those regarding social distancing.
We have recently experienced a decline in orders, which we believe is linked to delays and/or cancellations in patient visits, resulting in reduced diagnostic biopsies and thus reduced diagnoses of cutaneous melanoma in response to COVID-19. For example, from April 1, 2020 to May 6, 2020, orders for our lead product, DecisionDx-Melanoma, declined 43% from the same period in 2019. We have observed a stabilization in the decline in orders beginning in the second week of April 2020, which parallel the stabilization of the melanoma diagnosis rate seen in weekly, third-party new melanoma claims data. As it relates to the impact of COVID-19 on our uveal melanoma test, DecisionDx-UM, order volume has exhibited some softening since early April 2020.
Our future results will be dependent upon the extent and duration of the COVID-19 crisis as well as the timing and occurrence of rescheduled patient visits. While we anticipate that a majority of these delayed and/or canceled patient visits will be subsequently rescheduled as state and local government restrictions and guidelines are eased, we are unable to predict the pace, timing or occurrence of any rescheduled patient visits.

Based upon an analysis of our supply channel and current inventory levels, we believe we have adequate access to reagents and consumables needed for testing patient samples, and we expect to continue providing normal turnaround times for delivery of our test reports.
We continue to believe our cash and cash equivalents and anticipated cash generated from sales of our products will be sufficient to fund our operations for the foreseeable future.
In response to COVID-19, the United States government has passed legislation and taken other actions to provide financial relief to companies and other organizations affected by the pandemic. We have received the following payments, which are summarized below:
On April 10, 2020, we received an automatic payment of $1.9 million from the U.S. Department of Health and Human Services, or HHS, pursuant to the Coronavirus Aid, Relief and Economic Security Act enacted on March 27, 2020, or the CARES Act, out of relief funds allocated by HHS to healthcare providers to reimburse for healthcare related expenses or lost revenues attributable to COVID-19. This automatic payment was calculated by HHS in proportion to the providers’ share of Medicare fee-for-service reimbursements in 2019 and was applicable to all facilities and providers that received Medicare fee-for-service reimbursements in 2019. As determined by HHS, the funds will not need to be repaid.

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On April 16, 2020, we received an advance payment of $8.3 million, or the Advance Payment, from CMS under its Accelerated and Advance Payment Program, which was recently expanded to provide increased cash flow to service providers during the COVID-19 pandemic. The Advance Payment will be applied to future Medicare claims we submit for reimbursement beginning August 14, 2020 (120 days after the Advance Payment was issued). If the Advance Payment is not fully recovered by CMS by November 12, 2020 (within 210 days of the issuance of the Advance Payment), we will make arrangements with our MAC for CMS to recoup the remaining balance.
The effects of COVID-19 on our business caused us to anticipate noncompliance with our trailing three-month revenue covenant under our loan agreement at the next scheduled measurement date of June 30, 2020. In response, on May 10, 2020, we entered into an amendment to our loan agreement to modify the structure of the covenant so that we are now required to comply with either the existing trailing three-month revenue target or a new liquidity ratio calculation. For further discussion regarding the covenant, see “Long-Term Debt” under the Liquidity and Capital Resources section below.
As the overall effect of COVID-19 on our business is continuing to evolve, we cannot predict the extent to which our results of operations, financial condition or cash flows will be impacted by COVID-19. Accordingly, the April 1 through May 6, 2020 order data presented above is not necessarily indicative of our results of operations that can be expected for the three months ending June 30, 2020, or any other interim period, or for the year ending December 31, 2020. For more information on the potential impact of the COVID-19 pandemic on our business, see the risk factors included under “Risks Related to Our Business” and the other risk factors included in Part II, Item 1A., “Risk Factors,” of this Quarterly Report on Form 10-Q.

Factors affecting our performance
We believe there are several important factors that have impacted and that we expect will impact our operating performance and results of operations, including:
Report volume. We believe that the number of reports we deliver to physicians is an important indicator of growth of adoption among the healthcare provider community. Our revenue and costs are affected by the volume of testing and mix of customers. Our performance depends on our ability to retain and broaden adoption with existing prescribing physicians, as well as attract new physicians. In the near term, we expect our report volume to be negatively impacted by the effects of the COVID-19 pandemic, as discussed above.
Reimbursement. We believe that expanding reimbursement is an important indicator of the value of our products. Payors require extensive evidence of clinical utility, clinical validity, patient outcomes and health economic benefits in order to provide reimbursement for diagnostic products. Our revenue depends on our ability to demonstrate the value of our products to these payors.
Gross margin. We believe that our gross margin is an important indicator of the operating performance of our business. Higher gross margins reflect the average selling price of our tests, as well as the operating efficiency of our laboratory operations.
New product development. A significant aspect of our business is our investment in research and development activities, including activities related to the development of new products. In addition to the development of new product candidates, we believe these studies are critical to gaining physician adoption of new products and driving favorable coverage decisions by payors for such products.

Information about certain metrics
The following provides additional information about certain metrics we have disclosed in this Management’s Discussion and Analysis of Financial Condition and Results of Operation.
Test reports delivered for DecisionDx-Melanoma and DecisionDx-UM represents the number of completed test reports delivered by us during the reporting period indicated. The period in which a test report is delivered does not necessarily correspond with the period the related revenue, if any, is recognized, due to the timing and amount of adjustments for variable consideration under ASC 606. We use this metric to evaluate the growth in adoption of our tests and to measure against our internal performance objectives. We believe this metric is useful to investors in evaluating the volume of our business activity from period to period that may not be discernible from our reported revenues under ASC 606.
New ordering clinicians for DecisionDx-Melanoma represents the number of clinicians who ordered the DecisionDx-Melanoma test for the first time during the reporting period specified. We believe this metric is useful in evaluating the effectiveness of our sales and marketing efforts in establishing new relationships with clinicians and increasing the adoption of our DecisionDx-Melanoma test. We also believe this metric provides useful information to investors in assessing our ability to expand the use of

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the DecisionDx-Melanoma test. Since this metric is based upon the reporting period in which an order is placed, it does not necessarily correspond to the reporting period in which a test report was delivered or in which any revenue was recognized.
Components of the Results of Operations
Net Revenues
We generate revenues from the sale of our products, primarily from the sale of DecisionDx-Melanoma and DecisionDx-UM. We bill third-party payors and patients for the tests we perform.
Under ASC 606, we recognize revenue at the amount we expect to be entitled, subject to a constraint for variable consideration, in the period in which our tests are delivered to the treating physicians. We have determined that our contracts contain variable consideration under ASC 606 because the amounts paid by third-party payors may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration is recognized only to the extent it is probable that a significant reversal of revenue will not occur in future periods when the uncertainties are resolved. Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. Variable consideration for Medicare claims that are not covered by an LCD, including those claims subject to approval by an Administrative Law Judge, or ALJ, at an appeal hearing, is deemed to be fully constrained due to factors outside the Company’s influence (i.e., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. For these fully constrained claims, we generally recognize revenue upon receipt of a favorable appeal decision. Due to potential future changes in Medicare coverage policies and appeal cycles, insurance coverage policies, contractual rates and other trends in the reimbursement of our tests, our revenues may fluctuate significantly from period to period.
Our ability to increase our revenues will depend on our ability to further penetrate our target market, and, in particular, generate sales through our direct sales force, develop and commercialize additional tests, obtain reimbursement from additional third-party payors and increase our reimbursement rate for tests performed. In the near term, our financial performance will be highly dependent on reimbursement for DecisionDx-Melanoma. The use of DecisionDx-Melanoma is not yet broadly covered under positive coverage policies, although many third-party payors have begun to reimburse for this test.
Cost of Sales
The components of our cost of sales are material and service costs, personnel costs, which includes stock-based compensation expense, equipment and infrastructure expenses associated with testing samples, electronic medical records, order and delivery systems, shipping charges to transport samples, third-party test fees, and allocated overhead including rent, information technology costs, equipment depreciation and utilities. Costs associated with performing tests are recorded when the test is processed regardless of whether and when revenues are recognized with respect to that test. As a result, our cost of sales as a percentage of revenues may vary significantly from period to period because we do not recognize all revenues in the period in which the associated costs are incurred. We expect cost of sales in absolute dollars to increase as the number of tests we perform increases.
Gross margin, calculated as net revenue minus cost of sales, and gross margin percentage, calculated as gross margin divided by net revenue, are key indicators we use to assess our business.
Research and Development
Research and development expenses include costs incurred to develop our genomic tests, collect clinical samples and conduct clinical studies to develop and support our products. These costs consist of personnel costs, including stock-based compensation expense, prototype materials, laboratory supplies, consulting costs, regulatory costs, electronic medical records set up costs, costs associated with setting up and conducting clinical studies and allocated overhead, including rent, information technology, equipment depreciation and utilities. We expense all research and development costs in the periods in which they are incurred. We expect our research and development expenses to increase in absolute dollars as we continue to invest in research and development activities related to developing enhanced and new products.
Selling, General and Administrative
Selling, general and administrative, or SG&A, expenses include executive, selling and marketing, legal, finance and accounting, human resources, billing and client services. These expenses consist of personnel costs, including stock-based compensation expense, direct marketing expenses, audit and legal expenses, consulting costs, training and medical education activities, payor outreach programs and allocated overhead, including rent, information technology, equipment depreciation, and utilities. We expect continued increases in SG&A expenses related to compliance with the rules and regulations of the SEC

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and The Nasdaq Stock Market LLC, or Nasdaq, investor relations activities, and additional insurance expenses. Other administrative and professional services expenses within SG&A are expected to increase with the scale of our business, but selling and marketing-related expenses are expected to increase significantly, consistent with our growth strategy. In the near term, we expect these increases to be partially offset by temporarily reduced spending on travel and field-based sales activities as a result of COVID-19.
Interest Income
Interest income consists primarily of earnings on cash and cash equivalents, including money market funds.
Interest Expense
Interest expense is attributable to borrowings under our term debt, revolving line of credit and the convertible promissory notes issued in January and February of 2019, or the Q1 2019 Notes, and also includes the amortization of debt discount and issuance costs.
Other Expense, Net
Other expense, net reflects changes in the fair value of (i) our convertible preferred stock warrant liability and (ii) the embedded derivative associated with the Q1 2019 Notes.
Income Tax Expense
Our financial statements do not reflect any federal or state income tax benefits attributable to the net losses we have incurred, due to the uncertainty of realizing a benefit from those items. As of December 31, 2019, we had federal net operating loss carryforwards of $57.4 million, of which $43.5 million will begin to expire in 2028 if not utilized to offset taxable income, and $13.9 million may be carried forward indefinitely. Also, as of December 31, 2019, we had state net operating loss carryforwards of $42.2 million, which begin to expire in 2028 if not utilized to offset state taxable income.

Results of Operations

Comparison of the three months ended March 31, 2020 and 2019
The following table summarizes our results of operations for the periods indicated (in thousands, except percentages):
 
Three Months Ended March 31,
 
Increase (Decrease)
 
2020
 
2019
 
 
(unaudited)
 
 
 
 
Net revenues
$
17,418

 
$
8,717

 
$
8,701

 
99.8
%
Cost of sales
2,391

 
1,598

 
793

 
49.6
%
Gross margin
15,027

 
7,119

 
7,908

 
111.1
%
Gross margin percentage
86.3
%
 
81.7
%
 


 
 
Operating expenses:
 
 
 
 
 
 
 
Research and development
2,913

 
1,394

 
1,519

 
109.0
%
Selling, general and administrative
11,078

 
6,047

 
5,031

 
83.2
%
Total operating expenses
13,991

 
7,441

 
6,550

 
88.0
%
Operating income (loss)
1,036

 
(322
)
 
1,358

 
421.7
%
Interest income
298

 
21

 
277

 
1,319.0
%
Interest expense
(764
)
 
(1,024
)
 
260

 
25.4
%
Other expense, net

 
(33
)
 
33

 
100.0
%
Income (loss) before income taxes
570

 
(1,358
)
 
1,928

 
142.0
%
Income tax expense

 

 

 
%
Net income (loss)
$
570

 
$
(1,358
)
 
$
1,928

 
142.0
%


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Net Revenues
Net revenues increased by $8.7 million, or 99.8%, to $17.4 million due to a combination of increased test volume and higher per-unit revenues. Essentially all of the increase is attributable to DecisionDx-Melanoma test revenues. For the three months ended March 31, 2020, we experienced an increase in DecisionDx-Melanoma and DecisionDx-UM test volume of 37.4%, compared to the three months ended March 31, 2019. Our 2020 per-unit revenues also benefited from the attainment of “new ADLT” status for our DecisionDx-Melanoma test, effective July 1, 2019, which resulted in a higher Medicare reimbursement rate for the test, as described above. Additionally, for the three months ended March 31, 2020 and 2019, we recorded net positive revenue adjustments of $3.2 million and $0.6 million, respectively, related to tests delivered in previous periods, associated with changes in estimated variable consideration. The additional positive revenue adjustments in the current year primarily relate to recognition of revenue for certain tests delivered in prior periods for which no revenue was recognizable originally, but was recognized upon cash collection of payments for the tests in the current-year period.

Cost of Sales
Cost of sales for the three months ended March 31, 2020 increased by $0.8 million, or 49.6%, compared to the three months ended March 31, 2019, primarily due to higher personnel costs associated with additional headcount in our laboratory testing operations and increases in expenses for supplies and services, which were attributable to the higher activity levels. Our gross margin percentage was 86.3% for the three months ended March 31, 2020, compared to 81.7% for the same period in 2019, with the improvement principally a result of the increased operating leverage on the higher revenues. Due to the nature of our business, a significant portion of our cost of sales expenses represent fixed costs associated with our testing operations. Accordingly, our cost of sales expense will not necessarily increase or decrease commensurately with the change in net revenues from period to period.

Research and Development
Research and development expenses increased by $1.5 million, or 109.0%, for the three months ended March 31, 2020, compared to the three months ended March 31, 2019, primarily associated with increases in personnel costs attributable to additional headcount as well as higher expenses for clinical trials.

Selling, General and Administrative
SG&A expense increased by $5.0 million, or 83.2%, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. Approximately 60% of the increase is attributable to higher personnel costs, particularly due to increased headcount, which includes salaries, bonuses, benefits and stock-based compensation. In early 2019, we expanded our sales organization from 14 territories to 23 territories and implemented an additional expansion to 32 territories beginning in December 2019. The higher personnel costs also reflect expanded headcount in our administrative support functions. The remainder of the increase was primarily associated with higher professional fees (principally attributable to reimbursement and accounting), higher insurance expense, increased travel costs, increased spending for events and conferences and other general increases.

Interest Income
Interest income increased by $0.3 million for the three months ended March 31, 2020, compared to the three months ended March 31, 2019, as a result of higher balances of cash and cash equivalents. The higher cash and cash equivalents were primarily attributable to proceeds from the IPO in July 2019.

Interest Expense
Interest expense decreased by $0.3 million, or 25.4%, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019. The decrease is primarily attributable to interest expense on the Q1 2019 Notes during the three months ended March 31, 2019. The outstanding principal amount and accrued interest on the Q1 2019 Notes converted into shares of common stock in connection with the IPO in July 2019.

Liquidity and Capital Resources
Sources of Liquidity
Our principal sources of liquidity are our cash and cash equivalents and cash generated from sales of our products. As of March 31, 2020 and December 31, 2019, we had cash and cash equivalents of $98.7 million and $98.8 million, respectively. To

23


date, in addition to the revenue generated from the sale of our products, we have financed our operations through the IPO, private placements of preferred stock, convertible promissory notes and bank debt. Our long-term debt is described further below.
On April 10, 2020, we received an automatic payment of $1.9 million from HHS pursuant to the CARES Act out of relief funds allocated by HHS to healthcare providers to reimburse for healthcare related expenses or lost revenues attributable to COVID-19. This automatic payment was calculated by HHS in proportion to the providers’ share of Medicare fee-for-service reimbursements in 2019 and was applicable to all facilities and providers that received Medicare fee-for-service reimbursements in 2019. As determined by HHS, the funds will not need to be repaid. On April 16, 2020, we received an advance payment of $8.3 million from CMS under its Accelerated and Advance Payment Program, which was recently expanded to provide increased cash flow to service providers during the COVID-19 pandemic. The Advance Payment will be applied to future Medicare claims we submit for reimbursement beginning August 14, 2020 (120 days after the Advance Payment was issued). If the Advance Payment is not fully recovered by CMS within November 12, 2020 (210 days of the issuance of the Advance Payment), we will make arrangements with our MAC for CMS to recoup the remaining balance.
Funding Requirements
Our primary uses of capital are, and we expect will continue to be, compensation and related expenses, clinical research and development services, laboratory and related supplies, legal and other regulatory expenses, general administrative costs, and interest and principal payments on our debt. We anticipate that a substantial portion of our capital resources and efforts in the foreseeable future will be focused on the commercialization of our existing products, the development of our future product candidates, the potential commercialization of our product candidates, should their development be successful, and general administrative costs. Additionally, we anticipate using a portion of our capital resources to fund the expansion of our facilities in support of our growth strategy.
Since our inception, we have incurred significant operating losses and negative cash flows. We had an accumulated deficit of $51.6 million as of March 31, 2020. Our ability to generate revenue sufficient to achieve sustained profitability will depend heavily on the successful commercialization of our currently marketed products and the products we plan to launch in the future as well as our spending on research and development activities. Although we generated positive operating income during the year ended December 31, 2019 and for the three months ended March 31, 2020, we expect to incur additional expenses and operating losses in the future as we invest in the commercialization of our existing products, the development of our future product candidates and the commercialization of our product candidates. We believe that our existing cash and cash equivalents and anticipated cash generated from sales of our products will be sufficient to fund our operations for the foreseeable future. However, we have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. There are numerous risks and uncertainties associated with developing genomic tests, including, among others, the uncertainty of:
successful commencement and completion of clinical study protocols;
successful identification and acquisition of tissue samples;
the development and validation of genomic classifiers; and
acceptance of new genomic tests by physicians, patients and third-party payors.
Because of the numerous risks and uncertainties associated with research, development and commercialization of product candidates, we are unable to estimate our exact working capital requirements. Our future funding requirements will depend on and could increase significantly as a result of many factors, including those listed above as well as those listed in Part II, Item 1A., “Risk Factors,” of this Quarterly Report on Form 10-Q.
We do not currently have any committed external source of funds. In the event additional funding is required, we expect that we would use a combination of equity and debt financings, which may not be available to us when needed, on terms that we deem to be favorable or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of common stockholders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends. As a result of the COVID-19 crisis and actions taken to slow its spread, the global credit and financial markets have experienced extreme volatility, including diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates and uncertainty about economic stability. There can be no assurance that further deterioration in credit and financial markets and confidence in economic conditions will not occur. If equity and credit markets deteriorate, it may make

24


any necessary debt or equity financing more difficult to obtain, more costly and/or more dilutive. If we are unable to raise additional funds through equity or debt financings or other arrangements when needed, we may be required to delay, limit, reduce or terminate our product discovery and development activities or future commercialization efforts.
Long-Term Debt
Our long-term debt balances are presented in the table below (in thousands):
 
March 31, 2020
 
December 31, 2019
 
(unaudited)
 
 
Term debt
$
26,688

 
$
26,688

Unamortized discount and issuance costs
(1,342
)
 
(1,566
)
Total long-term debt
25,346

 
25,122

Less: Current portion of long-term debt
(8,333
)
 
(5,833
)
Long-term debt, less current portion
$
17,013

 
$
19,289

We have a Loan and Security Agreement, or the 2018 LSA, with Oxford Finance LLC, or Oxford, as collateral agent, and Oxford and Silicon Valley Bank, or SVB, as equal syndicated lenders, or the Lenders. The 2018 LSA currently consists of a $25.0 million secured term loan credit facility, or the Term Loan. Our obligations under the 2018 LSA are secured by substantially all of our assets, excluding intellectual property and subject to certain other exceptions and limitations. We have the right to prepay the 2018 Term Loan in whole or in part at any time, subject to a prepayment fee of 1.50% prior to November 30, 2020 and 0.75% thereafter. Upon prepayment, we are also obligated to pay a non-refundable early termination fee of $497,000. Amounts prepaid or repaid under the 2018 Term Loan may not be reborrowed. Previously, the 2018 LSA contained a financial covenant that required us to achieve a monthly trailing three-month revenue target each month throughout the term of the agreement, but the covenant was amended in February 2020 and is now tested quarterly instead of monthly, as discussed further below. As of March 31, 2020 and December 31, 2019, we were in compliance with this covenant.
For each month through December 31, 2019, the trailing three-month revenue requirements were calculated as a percentage of our previously approved applicable monthly revenue projections. In February 2020, we entered into an amendment of the 2018 LSA, or the Second Amendment, that, among other things, changed the covenant from being tested monthly to quarterly testing. In March 2020, we entered into an amendment of the 2018 LSA, or the Third Amendment, with the Lenders to establish revenue targets for the year ending December 31, 2020. Such requirements, for the quarterly periods from January to December 2020, are equal to generally increasing dollar amounts, in millions, in the low double digits. For quarterly periods ending after December 31, 2020, the trailing three-month revenue requirements will be determined by the Lenders upon receipt and review of our quarterly financial projections for the year, subject to certain specified criteria regarding minimum requirements. Revenues, if any, that we recognize as a result of an ALJ appeal process from consolidated claims initiatives for DecisionDx-Melanoma do not count toward the minimum revenue requirements.
On May 10, 2020, we entered into an amendment of the 2018 LSA, or the Fourth Amendment, to modify the covenant structure such that we are required to comply with either (i) the trailing three-month revenue target or (ii) a liquidity ratio, in both cases measured quarterly. The liquidity ratio covenant requires that the ratio of (i) unrestricted cash and cash equivalents (as defined in the 2018 LSA) held at SVB or its affiliates to (ii) the outstanding obligations under the 2018 LSA be at least 2.00 to 1.00. We requested the Fourth Amendment from the Lenders due to our anticipated noncompliance with the trailing three-month revenue covenant as of June 30, 2020 as a result of the impacts to our business attributable to COVID-19. The liquidity ratio, had it been measured and effective as of March 31, 2020, would have been 3.66 to 1.00.
In addition, the 2018 LSA contains customary conditions of borrowing, events of default and covenants, including covenants that restrict our ability to dispose of assets, merge with or acquire other entities, incur indebtedness and make distributions to holders of our capital stock. Should an event of default occur, including the occurrence of a material adverse change, we could be liable for immediate repayment of all obligations under the 2018 LSA. The Second Amendment included a waiver, by the Lenders, of an event of default by us attributable to maintaining a balance in a certain third-party deposit account, beyond the maximum level permitted, without obtaining a control agreement for such deposit account in favor of the collateral agent, Oxford. In addition to the waiver, the Second Amendment also provided a modification to increase the maximum balance permitted for this deposit account. We are currently in compliance with this provision of the 2018 LSA. While we were able to obtain a waiver and amendment in this instance, there can be no assurance that the Lenders would agree to provide any future waivers or amendments if another event of default were to occur as result of noncompliance with this or any other covenant under the 2018 LSA.

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Our ability to further amend the terms of the 2018 LSA is subject to the approval of Oxford and SVB. Accordingly, should we seek to amend the 2018 LSA, there can be no assurance that an amendment would be available on terms acceptable to us or at all.
The 2018 Term Loan bears interest at a floating rate equal to the greater of (1) 8.55% and (2) the 30-day U.S. LIBOR rate as reported in The Wall Street Journal on the last business day of the month that precedes the month in which the interest will accrue, plus 6.48%. The applicable interest rate on the 2018 Term Loan was 8.55% as of March 31, 2020 and December 31, 2019. Interest on the 2018 Term Loan is payable monthly in arrears. We are permitted to make interest-only payments on the 2018 Term Loan through May 31, 2020. The principal is required to be repaid in 30 equal monthly installments of $833,333 each beginning on June 1, 2020. All unpaid principal and accrued and unpaid interest are due on November 1, 2022, or the 2018 Term Loan Maturity Date. We are also obligated to make an additional final payment of 6.75% of the aggregate original principal amount, or $1,687,500, upon any prepayment or on the 2018 Term Loan Maturity Date. The final payment amount is being amortized as additional interest expense using the effective interest method of the term of the debt.
Cash Flows
The following table summarizes our sources and uses of cash and cash equivalents for each of the periods presented (in thousands):
 
Three Months Ended March 31,
 
2020
 
2019
 
(unaudited)
Net cash (used in) provided by operating activities
$
(251
)
 
$
1,288

Net cash used in investing activities
(500
)
 
(244
)
Net cash provided by financing activities
559

 
10,707

Net change in cash and cash equivalents
$
(192
)
 
$
11,751

Operating Activities
Net cash used in operating activities was $0.3 million for the three months ended March 31, 2020 and was primarily attributable to a decrease in accrued compensation of $2.6 million and other minor variations, partially offset by non-cash charges of $1.9 million and net income of $0.6 million. Non-cash charges consisted of stock compensation expense of $1.6 million, amortization of debt discount and issuance costs of $0.2 million and depreciation expense of $0.1 million.
Net cash provided by operating activities was $1.3 million for the three months ended March 31, 2019 and was primarily attributable to decreases in accounts receivable of $3.8 million and net non-cash charges of $0.6 million, partially offset by decreases in accrued compensation of $1.8 million and the net loss of $1.4 million. Non-cash charges primarily consisted of $0.3 million in amortization of debt discount and issuance costs, stock compensation expense of $0.2 million and depreciation expense of $0.1 million.
Investing Activities
Net cash used in investing activities for the three months ended March 31, 2020 and 2019 consisted entirely of purchases of property and equipment.
Financing Activities
Net cash provided by financing activities was $0.6 million for the three months ended March 31, 2020 and consisted of cash received from contributions to the employee stock purchase plan and proceeds from the exercise of stock options.
Net cash provided by financing activities was $10.7 million for the three months ended March 31, 2019 and consisted primarily of $11.7 million in net proceeds from the issuance of the Q1 2019 Notes, partially offset by $1.0 million in repayments on our line of credit.

Off-Balance Sheet Arrangements
We do not currently have, nor did we have any off-balance sheet arrangements, as defined in the rules and regulations of the SEC, during the periods presented.


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Critical Accounting Policies and Significant Judgments and Estimates
During the three months ended March 31, 2020, there were no significant changes to the information discussed under “Critical Accounting Policies and Significant Judgments and Estimates” included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended December 31, 2019.

Recent Accounting Pronouncements
Refer to Note 2, ‘‘Summary of Significant Accounting Policies,’’ in the accompanying notes to our unaudited condensed financial statements included in this Quarterly Report on Form 10-Q for a discussion of recent accounting pronouncements.

JOBS Act Accounting Election
We are an emerging growth company within the meaning of the Jumpstart Our Business Startups Act, as amended, or the JOBS Act, enacted in April 2012. Section 107(b) of the JOBS Act provides that an emerging growth company can leverage the extended transition period, provided in Section 102(b) of the JOBS Act, for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. We have elected to use this extended transition period and, as a result, our financial statements may not be comparable to companies that comply with public company effective dates. We also intend to rely on other exemptions provided by the JOBS Act, including without limitation, not being required to comply with the auditor attestation requirements of Section 404(b) of Sarbanes-Oxley Act of 2002, as amended, or Sarbanes-Oxley.
We will remain an emerging growth company until the earliest of (1) December 31, 2024, (2) the last day of the fiscal year (a) in which we have total annual gross revenue of at least $1.07 billion or (b) in which we are deemed to be a ‘‘large accelerated filer’’ as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock held by non-affiliates exceeded $700.0 million as of the prior June 30th, and (3) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period.

Item 3. Qualitative and Quantitative Disclosures About Market Risk.
As a smaller reporting company, we are not required to provide the information required by this Item.

Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2020. Based upon the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the first quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.
From time to time, we may be involved in legal proceedings arising in the ordinary course of business. We believe there is no threatened litigation or litigation pending that could have, individually or in the aggregate, a material adverse effect on our financial position, results of operations or cash flows.

Item 1A. Risk Factors.
You should consider carefully the risks described below, as well as the other information in this Quarterly Report on Form 10‑Q, before deciding whether to purchase, hold or sell shares of our common stock. The occurrence of any of the following risks could harm our business, financial condition, results of operations and/or growth prospects or cause our actual results to differ materially from those contained in forward-looking statements we have made in this report and those we may make from time to time. You should consider all of the factors described as well as the other information in this Quarterly Report on Form 10-Q, including our unaudited condensed financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” when evaluating our business. The risk factors set forth below that are marked with an asterisk (*) are new or contain changes to the similarly titled risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2019. If any of the following risks actually occur, our business, financial condition, results of operations and future growth prospects could be materially and adversely affected. In these circumstances, the market price of our common stock could decline and you may lose all or part of your investments. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations.

Risks Related to Our Financial Condition
Our reliance upon a small number of third-party payors for a significant portion of our revenue may materially adversely affect our financial condition and results of operations.
We receive a substantial portion of our revenue from a small number of third-party payors, primarily Medicare and United Healthcare. Our revenue for our test reports provided for patients covered by Medicare and United Healthcare as a percentage of total revenue, was 49% and 6%, respectively, for the year ended December 31, 2019, and 36% and 12%, respectively, for the year ended December 31, 2018. In addition, our current accounts receivable balances for Medicare and United Healthcare, as a percentage of our total current accounts receivable, were 7% and 9%, respectively, as of December 31, 2019, and 54% and 7%, respectively, as of December 31, 2018. There were no long-term accounts receivable balances for Medicare and United Healthcare as of December 31, 2019, but long-term accounts receivable for Medicare and United Healthcare as a percentage of total long-term accounts receivable were and 0% and 15%, respectively, as of December 31, 2018. If our largest current payors were to significantly reduce, or cease to pay, the amount they reimburse for our products, or if they do not reach favorable coverage and reimbursement decisions for our products, or attempt to recover amounts they had already paid, it could have a material adverse effect on our business, financial condition and results of operations and cause significant fluctuations in our results of operations.
Due to how we recognize revenue, our quarterly revenues may not reflect our underlying business.*
We have concluded that our contracts include variable consideration because the amounts paid by Medicare or commercial health insurance carriers may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration attributable to these price concessions is measured at the expected value using the ‘‘most likely amount’’ method under ASC 606. The amounts are determined by historical average collection rates by test type and payor category taking into consideration the range of possible outcomes, the predictive value of our past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as the judgment and actions of third parties. Such variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. Variable consideration may be constrained and excluded from the transaction price in situations where there is no contractually agreed upon reimbursement coverage or in the absence of a predictable pattern and history of collectability with a payor. Variable consideration for Medicare claims that are not covered by an LCD, including those claims subject to approval by an ALJ at an appeal hearing, is deemed to be fully constrained due to factors outside our influence (i.e., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. As a result of the timing and amount of adjustments for variable consideration, our operating results and comparisons of such results on a period-to-period basis may be difficult to understand and may not be meaningful. In addition, these fluctuations in revenue may make it difficult for us, for research analysts and for investors to

28


accurately forecast our revenue and operating results. If our revenue or operating results fall below expectations, the price of our common stock would likely decline.
We have incurred significant losses since inception, and we may never achieve sustained profitability.*
Since our inception, we have had a history of net losses. As of March 31, 2020, we had a cash and cash equivalents balance of $98.7 million and an accumulated deficit of $51.6 million. We cannot predict if we will achieve sustained profitability in the near future or at all. We expect to incur losses in the future as we plan to invest significant additional funds toward the expansion of our commercial organization, the conduct of clinical utility and validity studies to support adoption of our products and the development or acquisition of additional products. Additionally, our performance could be impacted by the ongoing impacts of COVID-19. As a public company, we expect to continue to incur additional legal, accounting and other expenses that we did not incur as a private company. These increased expenses will make it harder for us to achieve sustained future profitability. We may also incur significant losses in the future for a number of reasons, many of which are beyond our control, including the other risks described in this Quarterly Report on Form 10‑Q, adoption of our products, coverage of and reimbursement rates for our products from third-party payors, and future research and development activities. Our failure to achieve sustained profitability in the future could cause the market price of our common stock to decline.
We are an early, commercial-stage company and have a limited operating history, which may make it difficult to evaluate our current business and predict our future performance.*
We are an early commercial-stage company and have a limited operating history. Our limited operating history may make it difficult to evaluate our current business and this makes predictions about our future success or viability subject to significant uncertainty. In particular, we intend to use a portion of our working capital to increase our headcount, including through the expansion of our sales and marketing and research and development teams, which will increase our operating costs in a manner not historically reflected in our financial statements. In combination with our other anticipated increased operating expenses in connection with being a public company, these anticipated changes in our operating expenses may make it difficult to evaluate our current business, assess our future performance relative to prior performance and accurately predict our future performance.
We will continue to encounter risks and difficulties frequently experienced by early commercial-stage companies, including those associated with increasing the size of our organization and the prioritization of our commercial, research and business development activities. If we do not address these risks successfully, our business could suffer.
Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported operating results.*
Accounting principles generally accepted in the United States of America are subject to interpretation by the Financial Accounting Standards Board, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. For example, in response to the COVID-19 crisis, accounting standard setters may issue additional guidance or interpretations of existing guidance to address the financial reporting and accounting issues that have arisen or that may arise from the pandemic. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.
Our quarterly and annual operating results and cash flows may fluctuate in the future, which could cause the market price of our stock to decline substantially.*
Numerous factors, many of which are outside our control, such as the COVID-19 pandemic, may cause or contribute to significant fluctuations in our quarterly and annual operating results. These fluctuations may make financial planning and forecasting uncertain. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively affect our business and prospects. In addition, one or more of such factors may cause our revenue or operating expenses in one period to be disproportionately higher or lower relative to the others. As a result, comparing our operating results on a period-to-period basis may be difficult to understand and may not be meaningful. You should not rely on our past results as indicative of our future performance.
In addition, a significant portion of our operating expense is relatively fixed in nature, and planned expenditures are based in part on expectations regarding future revenue. Accordingly, unexpected revenue shortfalls could decrease our gross margins and cause significant changes in our operating results from quarter to quarter. If this occurs, the trading price of our stock could fall substantially.

29


This variability and unpredictability caused by factors such as those described above could also result in our failing to meet the expectations of industry or financial analysts or investors for any period. If our revenue or operating results fall below the expectations of analysts or investors or below any guidance we may provide, or if the guidance we provide is below the expectations of analysts or investors, the price of our common stock could decline substantially. Such a stock price decline could occur even when we have met any previously publicly stated guidance we may provide.
We previously identified material weaknesses in our internal control over financial reporting. If our internal control over financial reporting is not effective, we may not be able to accurately report our financial results or file our periodic reports in a timely manner, which may cause adverse effects on our business and may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price.
Effective internal control over financial reporting is necessary for us to provide reliable financial reports in a timely manner. In connection with the audits of our financial statements for the years ended December 31, 2018 and 2017, we concluded that there were material weaknesses in our internal control over financial reporting. However, as of December 31, 2019, we concluded that these material weaknesses have been remediated.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
These material weaknesses related to a lack of (i) appropriately designed and implemented controls over the review and approval of manual journal entries and the related supporting journal entry calculations, (ii) personnel with appropriate knowledge, experience and training commensurate with accounting and reporting requirements and (iii) appropriately designed and implemented controls to evaluate variable consideration and the related constraint in accordance with ASC 606, and resulted in certain material corrections to the financial statements.
To remediate these weaknesses, we hired a full-time director of SEC reporting and technical accounting and another full-time accounting resource, both certified public accountants with active licenses, to augment our accounting staff and to provide more resources for complex accounting matters and financial reporting. We also commenced development of a new information technology tool designed to improve the efficiency of our processes with respect to revenue recognition under ASC 606 and hired a full-time financial analyst to support our revenue accounting and related activities under ASC 606. Further, we selected a third party to assist us with formalizing our internal control documentation and implementation of enhancements to our internal control over financial reporting.
If we identify any future significant deficiencies or material weaknesses, the accuracy and timing of our financial reporting may be adversely affected, a material misstatement in our financial statements could occur, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports, which may adversely affect our business and our stock price may decline as a result.
Nevertheless, we will be required to expend significant time and resources to further improve our internal controls over financial reporting, including by further expanding our finance and accounting staff to meet the demands that are placed upon us as a public company, including the requirements of Sarbanes-Oxley. If we fail to adequately staff our accounting and finance function, or fail to maintain adequate internal control over financial reporting, any new or recurring material weaknesses could prevent our management from concluding our internal control over financial reporting is effective and impair our ability to prevent material misstatements in our financial statements, which could cause our business to suffer.
The terms of our credit facility place restrictions on our operating and financial flexibility, and failure to comply with covenants or to satisfy certain conditions of the agreement governing the credit facility may result in acceleration of our repayment obligations and foreclosure on our pledged assets, which could significantly harm our liquidity, financial condition, operating results, business and prospects and cause the price of our securities to decline.*
The 2018 LSA, which we amended in June 2019, February 2020, March 2020 and May 2020, with Oxford and SVB, is secured by a lien covering substantially all of our assets, excluding intellectual property. The 2018 LSA provides for a five-year $25.0 million term-loan facility, all of which has been disbursed to us.
Following the Fourth Amendment to the 2018 LSA in May 2020, the 2018 LSA requires us to comply with either (i) a trailing three-month revenue target or (ii) a liquidity ratio, in both cases measured quarterly. The liquidity ratio requires that the ratio of (i) unrestricted cash and cash equivalents (as defined in the 2018 LSA) held at SVB or its affiliates to (ii) the principal outstanding on the 2018 Term Loan be at least 2.00 to 1.00. We were in compliance with the trailing three-month revenue target at March 31, 2020. The liquidity ratio, had it been measured and effective as of March 31, 2020, would have been 3.66 to 1.00. However, there can be no assurance of our ability to maintain compliance with the revenue covenant or the liquidity ratio

30


covenant as of any future date. For example, prior to the amendment of the 2018 LSA in June 2019, our projections indicated that we were at risk of noncompliance with the financial covenant existing under the 2018 LSA prior to such amendment. Among other things, the June 2019 amendment revised our financial covenant to be more aligned with our revenue projections after taking into account the impact of ASC 606 on our revenue recognition following our early adoption of ASC 606. We requested the Fourth Amendment from the Lenders due to our anticipated noncompliance with the trailing three-month revenue covenant as of June 30, 2020 as a result of the impacts to our business attributable to COVID-19.
Our ability to further amend the terms of the 2018 LSA is subject to the approval of Oxford and SVB. Accordingly, should we seek to amend the 2018 LSA, there can be no assurance that an amendment would be available on terms acceptable to us or at all. In the event we are unable to comply with the trailing three-month revenue requirement or the liquidity ratio covenant and we are unable to obtain an amendment of the 2018 LSA or a waiver, the Lenders could accelerate our payment obligations under the 2018 LSA. If an acceleration had occurred as of March 31, 2020, our total payment obligation under the 2018 LSA would have been $27.7 million, which consists of the outstanding unpaid principal balance (including the additional final payment), accrued interest, the early termination penalty and the prepayment penalty. If an acceleration were to occur, we expect we would seek financing from other sources and/or utilize a portion of our existing cash and cash equivalents on hand, which totaled $98.7 million as of March 31, 2020, to satisfy our obligations.
The 2018 LSA also requires us to comply with a number of other covenants (affirmative and negative), including restrictive covenants that limit our ability to: incur additional indebtedness; encumber the collateral securing the loan; acquire, own or make investments; repurchase or redeem any class of stock or other equity interest; declare or pay any cash dividend or make a cash distribution on any class of stock or other equity interest; transfer a material portion of our assets; maintain certain levels of cash balances in third-party deposit accounts, acquire other businesses; and merge or consolidate with or into any other organization or otherwise suffer a change in control, in each case subject to exceptions. In February 2020, in connection with an amendment to the 2018 LSA, our lenders agreed to provide a waiver of an event of default by us that resulted from us maintaining a cash balance in a third-party deposit account beyond the maximum level permitted. Such amendment also provided a modification to increase the maximum balance permitted for this deposit account. While we were able to obtain a waiver and amendment in this instance, there can be no assurance that the lenders would agree to provide any future waivers or amendments if another event of default were to occur as result of noncompliance with this or any other covenant under the 2018 LSA.
In addition to other specified events of default, and subject to limited exceptions, the lenders could declare an event of default upon the occurrence of any event that they interpret as having a material impairment in their lien on the collateral under the agreement, a material adverse change in our business, operations or condition (financial or otherwise) or a material impairment in the prospect of repayment of our obligations under the agreement. If we default under the credit facility, the lenders may accelerate all of our repayment obligations, which may require us to seek additional or alternate financing and/or modify our operational plans. If we were to seek additional or alternative financing, there can be no assurance that any such financing would be available to us on commercially reasonable terms or at all. If we are unable to access funds to meet those obligations or to renegotiate our agreement, the lenders could take control of our pledged assets and we would have to immediately cease operations. During the continuance of an event of default, the then-applicable interest rate on the then-outstanding principal balance will increase by 5.0%. Upon an event of default, the lenders could also require us to repay the loan immediately, together with a prepayment charge of up to 1.5% of the then-outstanding principal balance, together with other fees. If we were to renegotiate the agreement under such circumstances, the terms may be significantly less favorable to us. If we were liquidated, the lenders’ right to repayment would be senior to the rights of our stockholders to receive any proceeds from the liquidation. Any declaration by the lenders of an event of default could significantly harm our liquidity, financial condition, operating results, business, and prospects and cause the price of our securities to decline.
We may incur additional indebtedness in the future. The debt instruments governing such indebtedness may contain provisions that are as, or more, restrictive than the provisions governing our existing indebtedness. If we are unable to repay, refinance or restructure our indebtedness when payment is due, the lenders could proceed against the collateral or force us into bankruptcy or liquidation.
We may need to raise additional capital to fund our existing operations, commercialize new products or expand our operations.*
We believe our existing cash and cash equivalents and anticipated cash generated from sales of our products will be sufficient to fund our operations for the foreseeable future. If our available cash balances and anticipated cash generated from sales of our products are insufficient to satisfy our liquidity requirements including because of lower demand for our products, lower than currently expected rates of reimbursement from third-party payors or other risks described in this Quarterly Report on Form 10‑Q, we may finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements. We do not currently have any committed external source of

31


funds. In addition, we may seek additional capital due to favorable market conditions or strategic considerations, even if we believe we have sufficient funds for our current or future operating plans.
We may consider raising additional capital in the future to expand our business, to pursue strategic investments, to take advantage of financing opportunities or for other reasons, including to:
increase our sales and marketing efforts for DecisionDx-Melanoma and address competitive developments;
fund ongoing development of our pipeline products, including for SCC and suspicious pigmented lesions, in addition to other programs in development;
expand our laboratory testing facility and related testing capacity;
expand our technologies into other types of skin cancer management and detection products;
acquire, license or invest in technologies;
acquire or invest in complementary businesses or assets; and
finance capital expenditures and general and administrative expenses.
Our present and future funding requirements will depend on many factors, including:
our ability to achieve revenue growth;
our rate of progress in establishing payor coverage and reimbursement arrangements with third-party payors;
our rate of progress in, and cost of the sales, marketing, coverage and reimbursement activities associated with, establishing adoption of DecisionDx-Melanoma, among our other products;
the cost of expanding our laboratory operations and offerings, including our sales, marketing, coverage and reimbursement efforts;
our rate of progress in, and cost of research and development activities associated with, diagnostic products in research and early development;
the potential cost of, and delays in, the development of new products as a result of changes in regulatory oversight applicable to our products;
the effects of the COVID-19 pandemic; and
the effect of competing technological and market developments.
To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends.
If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or products, or grant licenses on terms that may not be favorable to us.

In addition, the COVID-19 crisis continues to rapidly evolve and has already resulted in a significant disruption of global financial markets. Our ability to raise additional capital may be adversely impacted by potential worsening global economic conditions and the recent disruptions to, and volatility in, the credit and financial markets in the U.S. and worldwide resulting from the crisis. If the disruption persists and deepens, we could experience an inability to access additional capital. If we are unable to raise additional funds through equity or debt financings or other arrangements when needed, we may be required to delay, limit, reduce or terminate our commercialization, research and development efforts or grant rights to third parties to market and/or develop products that we would otherwise prefer to market and develop ourselves.


32


Risks Related to Our Business
The COVID-19 pandemic has adversely impacted and could continue to adversely impact our business, including the demand for our test reports, as well as the business or operations of physicians and other healthcare providers who order our test reports and the third-party payors responsible for reimbursement for our tests, customers and other third parties with whom we conduct business.*
Public health crises such as pandemics or similar outbreaks have adversely impacted and could continue to adversely impact our business. In December 2019, a novel strain of coronavirus, SARS-CoV-2, which causes COVID-19, surfaced in Wuhan, China. Since then, COVID-19 has spread to multiple countries, including the United States. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. As a result of the COVID-19 outbreak, or similar pandemics, and federal, state and local government responses to pandemics, we have and/or may in the future experience disruptions that could adversely impact our business, including, but not limited to:
decreased test report volume due to a decline in orders of DecisionDx-Melanoma and DecisionDx-UM tests as patient visits for routine examinations and biopsies are being delayed and/or canceled;
disruption of our sales and commercialization activities due to limitations on our ability to communicate with physicians as a result of travel restrictions and hindered means of communicating with physicians;
delays or disruptions by third parties in the collection, preparation or delivery of the tumor samples that we test;
delays or difficulties in delivering test reports, interruptions in research and development and other limitations of key business activities due to members of our workforce becoming ill and/or stay-at-home or other similar orders imposed by or that may be imposed by state and local governments, including at our Phoenix, Arizona and Friendswood, Texas locations;
delayed reimbursement from third party payors, disruption in our supply channel and other adverse impacts on our business resulting from the negative effects of the COVID-19 pandemic on our suppliers, service providers and other third parties on whom we rely; and
delayed or postponed interactions with regulators and other important agencies and contractors, due to limitations in employee resources, travel restrictions or forced furlough of government employees.
We have recently experienced a decline in orders, which we believe is linked to delays and/or cancellations in patient visits, resulting in reduced diagnostic biopsies and thus reduced diagnoses of cutaneous melanoma in response to COVID-19. For example, from April 1, 2020 to May 6, 2020, orders for our lead product, DecisionDx-Melanoma, declined 43% from the same period in 2019. As it relates to the impact of COVID-19 on our uveal melanoma test, DecisionDx-UM, order volume has exhibited some softening since early April 2020. Our future results will be dependent upon the extent and duration of the COVID-19 impacts as well as the timing and occurrence of rescheduled patient visits. We are unable to predict the pace, timing or occurrence of any rescheduled patient visits, which may be impacted by continued apprehension regarding possible exposure to the virus, even after the easing of state and local restrictions and guidelines. Accordingly, the April 1 through May 6, 2020 order data presented above is not necessarily indicative of our results of operations that can be expected for the three months ending June 30, 2020, or any other interim period, or for the year ending December 31, 2020.
The effects of COVID-19 on our business could affect our ability to comply with the covenants or other requirements under the 2018 LSA. For more information on risks associated with the 2018 LSA, see above under “—Risks Related to Our Financial Condition—The terms of our credit facility place restrictions on our operating and financial flexibility, and failure to comply with covenants or to satisfy certain conditions of the agreement governing the credit facility may result in acceleration of our repayment obligations and foreclosure on our pledged assets, which could significantly harm our liquidity, financial condition, operating results, business and prospects and cause the price of our securities to decline.
Under legislation enacted (or that may be enacted) by the United States federal government to respond to COVID-19, we have received and may receive in the future, cash payments or other forms of assistance allocated to healthcare and other companies. The eligibility requirements for any such payments or other assistance may be subject to restrictive terms and conditions, which may be ambiguous or subject to further interpretation and guidance issued by government agencies on an ongoing basis. In the event we fail to comply with any of the terms or conditions associated with a payment we receive, we may be required to return it. Additionally, the receipt of government payments or other assistance during the COVID-19 crisis has generated negative publicity for some companies and may continue to generate negative publicity for companies in the future. If we receive any negative publicity as a result of receiving or accepting a government payment or other assistance, it could harm our reputation, trigger a review or audit by applicable government agencies and/or adversely impact our stock price.

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The COVID-19 crisis continues to rapidly evolve. The extent to which COVID-19 will impact our business will depend on future developments, which are highly uncertain and cannot be predicted with confidence, such as the ultimate geographic spread of the disease, the duration of the crisis, resurgences of the virus, the use of telemedicine, travel restrictions, stay-at-home or other similar orders and social distancing in the United States and other countries, business closures or business disruptions and the effectiveness of actions taken in the United States and other countries to contain and treat the virus. Any of these factors, individually or in combination, could materially and adversely affect our business, results of operations, financial condition or cash flows. In addition, the current and potential adverse impacts of the COVID-19 crisis on our business, financial condition, results of operations and growth prospects, may also have the effect of heightening many of the other risks and uncertainties described elsewhere in this “Risk Factors” section.
Our revenue currently depends primarily on sales of DecisionDx-Melanoma, and we will need to generate sufficient revenue from this and other products to grow our business.*
Most of our revenue in 2019 and 2018 was derived from the sale of our lead product, DecisionDx-Melanoma. While we also derive revenue from DecisionDx-UM, we expect that the majority of our revenue for the foreseeable future will be derived from sales of DecisionDx-Melanoma. Further, we believe that our long-term commercial success will depend on our ability to develop and market additional products, such as our pipeline products for SCC and suspicious pigmented lesions. Our ability to derive revenue from DecisionDx-Melanoma, DecisionDx-UM and any future products that we commercialize is uncertain and depends on favorable coverage and reimbursement policies from government payors, like Medicare, and from private payors, like insurance companies. Without positive coverage policies, our products may not be reimbursed and we may not be able to recognize revenue. If we are unable to increase sales and expand coverage and reimbursement for DecisionDx-Melanoma, develop and commercialize other products, and successfully obtain coverage and adequate reimbursement for such products, our revenue and our ability to achieve sustained profitability would be impaired, and the market price of our stock could decline substantially.
Billing for our products is complex and requires substantial time and resources to collect payment.*
Billing for clinical laboratory testing services is complex, time-consuming and expensive. Depending on the billing arrangement and applicable law, we bill various payors, including Medicare, Medicaid, private insurance companies, private healthcare institutions, and patients, all of which have different billing requirements. We generally bill third-party payors for products and pursue reimbursement on a case-by-case basis where pricing contracts are not in place. To the extent laws or contracts require us to bill patient co-payments or co-insurance, we must also comply with these requirements. We may also face increased risk in our collection efforts, including potential write-offs of accounts receivable and long collection cycles, which could adversely affect our business, results of operations and financial condition.
Several factors make the billing process complex, including:
differences between the billing rates and reimbursement rates for our products;
compliance with complex federal and state regulations related to billing government healthcare programs, including Medicare, Medicaid and TRICARE;
risk of government audits related to billing;
disputes among payors as to which party is responsible for payment;
differences in coverage and information and billing requirements among payors, including the need for prior authorization and/or advanced notification;
the effect of patient co-payments or co-insurance and our ability to collect such payments from patients;
changes to billing codes used for our products;
changes to requirements related to our current or future clinical studies, including our registry studies, which can affect eligibility for payment;
ongoing monitoring provisions of LCDs for our products, which can affect the circumstances under which a claim would be considered medically necessary;
incorrect or missing billing information; and
the resources required to manage the billing and claims appeals process.

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We use standard industry billing codes, known as Current Procedural Terminology, or CPT, codes, to bill for our products. If these codes were to change, there is a risk of an error being made in the claim adjudication process. Such errors can occur with claims submission, third-party transmission or in the processing of the claim by the payor. Claim adjudication errors may result in a delay in payment processing or a reduction in the amount of the payment we receive.
As we introduce new products, we may need to add new codes to our billing process as well as our financial reporting systems. Failure or delays in effecting these changes in external billing and internal systems and processes could negatively affect our collection rates, revenue and cost of collecting.
Additionally, our billing activities require us to implement compliance procedures and oversight, train and monitor our employees, and undertake internal audits to evaluate compliance with applicable laws and regulations as well as internal compliance policies and procedures. When payors deny our claims, we may challenge the reason, low payment amount or payment denials. Payors also conduct external audits to evaluate payments, which add further complexity to the billing process. If the payor makes an overpayment determination, there is a risk that we may be required to return all or some portion of prior payments we have received.
Additionally, the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, collectively the ACA, requires providers and suppliers to report and return any overpayments received from government payors under the Medicare and Medicaid programs within 60 days of identification. Failure to identify and return such overpayments exposes the provider or supplier to liability under federal false claims laws. These billing complexities, and the related uncertainty in obtaining payment for our products, could negatively affect our revenue and cash flow, our ability to achieve sustained profitability, and the consistency and comparability of our results of operations.
We rely on third parties for tumor sample collection, preparation and delivery. Any defects in sample collection or preparation by such third parties and any delays in delivery of such samples could cause errors in our test reports and delay our ability to deliver test reports in a timely manner, which could significantly harm our business.*
The tumor tissue samples that we test are biopsied, preserved, prepared and delivered to us by third parties, including dermatopathologists and laboratory facilities. As such, we rely on these third parties to prepare, label and deliver the tissue samples that we test in compliance with applicable laws and guidelines, and in a timely manner. Therefore, the accuracy and correctness of the test reports that we deliver are dependent on proper chain of custody and appropriate methods of sample collection or preparation utilized by these third parties, and our ability to timely deliver reports is dependent upon the ability of these third parties to provide these samples to us in a timely manner. The ability of these third parties to provide these samples to us in a timely manner could be delayed by events beyond our control, including but not limited to natural disasters and public health epidemics, such as the COVID-19 crisis. Any errors in any part of the sample collection or preparation process could cause us to deliver incorrect test reports, potentially resulting in harm to patients whose physicians implement a change in treatment decisions based upon our test report. If we are unable to timely deliver test reports, physicians may be less likely to recommend and order our products. The occurrence of any of the foregoing could significantly harm our reputation and our results of operations, causing significant harm to our business.
We rely on our database of tumor samples for the development and improvement of our products. Depletion or loss of our tumor samples could significantly harm our business.
The development and validation of accurate products is a complex process that requires access to tumor tissue specimens and long-term outcomes data. Our research and development efforts to improve our existing products and develop new products may require the depletion of our existing database of tumor samples. If our tumor samples are lost or destroyed, or substantially depleted before we are able to generate meaningful data, we may be unable to improve our existing products, continue the development of pipeline products or validate product candidates. While we have historically been able to create and maintain a large sample bank to expand the clinical use of our products and develop new products, we may be unable to do so in the future. If we were unable to maintain or replenish our sample bank, we may be unable to improve our products or develop new products.
If our sole laboratory facility becomes damaged or inoperable or we are required to vacate our existing facility, our ability to conduct our laboratory analysis and pursue our research and development efforts may be jeopardized.*
We currently perform all of our testing and store our database of tumor samples at a single laboratory facility in Phoenix, Arizona. Our facility and equipment could be harmed or rendered inoperable by natural or man-made disasters, including war, fire, earthquake, power loss, communications failure, terrorism, burglary, public health crises (including restrictions that may be imposed on businesses by state and local governments under stay-at-home or similar orders and mandates) or other events, which may make it difficult or impossible for us to perform our testing services for some period of time or to receive and store samples. The inability to perform tests or to reduce the backlog of sample analysis that could develop if our facility becomes

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inoperable, for even a short period of time, may result in the loss of revenue, loss of customers or harm to our reputation, and we may be unable to regain that revenue, those customers or repair our reputation in the future. Furthermore, integral parties in our supply chain are operating from single sites, increasing their vulnerability to natural disasters and man-made disasters or other sudden, unforeseen and severe adverse events.
In addition, the loss of our tumor samples due to such events could limit or prevent our ability to conduct research and development analysis on existing tests as well as tests in active pipeline development.
While we have a business continuity plan in place and we are completing a build-out of a second laboratory facility located near our existing laboratory facility, our facilities and the equipment we use to perform our testing and research and development could be unavailable or costly and time-consuming to repair or replace. It would be difficult, time-consuming and expensive to rebuild our facilities, to locate and qualify a new facility, replace certain pieces of equipment or license or transfer our proprietary technology to a third-party, particularly in light of licensure and accreditation requirements. Even in the unlikely event that we are able to find a third party with such qualifications to enable us to resume our operations, we may be unable to negotiate commercially reasonable terms.
We carry insurance for damage to our property and the disruption of our business, but this insurance may not cover all of the risks associated with damage or disruption to our business, may not provide coverage in amounts sufficient to cover our potential losses and may not continue to be available to us on acceptable terms, if at all.
Our current or future products may not achieve or maintain significant commercial market acceptance.
We believe our commercial success is dependent upon our ability to continue to successfully market and sell our products, to continue to expand our current relationships and develop new relationships with healthcare providers, to expand and maintain coverage for our products, and to develop and commercialize new products. Our ability to achieve and maintain commercial market acceptance of our existing and future products will depend on a number of factors, including:
our ability to increase awareness of our products through successful clinical utility and validity studies;
the rate of adoption of our products by physicians and other healthcare providers;
our ability to achieve guideline inclusion for our products;
the timeliness with which we can provide our clinical reports to the ordering physician;
the timing and scope of any regulatory approval for our products, if such approvals become required, and maintaining ongoing compliance with regulatory requirements;
our ability to obtain and maintain positive coverage decisions for our products from government and commercial payors;
our ability to obtain and maintain adequate reimbursement from third-party payors, including Medicare, Medicare Advantage plans, United Healthcare and BlueCross BlueShield plans, which accounted for an aggregate of approximately 90% and 83% of our total revenue for the years ended December 31, 2019 and 2018, respectively;
the impact of our investments in research and development and commercial growth;
negative publicity regarding our or our competitors’ products resulting from scientific publications, or defects or errors in the products; and
our ability to further validate our products through clinical research and accompanying publications.
We cannot assure you that we will be successful in addressing each of these factors or other factors that might affect the market acceptance of our products. If we are unsuccessful in achieving and maintaining market acceptance of our products, our business and results of operations will suffer.
New product development involves a lengthy and complex process, and we may be unable to develop and commercialize, or receive reimbursement for, on a timely basis, or at all, new products.
We continually seek to develop new product offerings, which requires us to devote considerable resources to research and development. For example, before we can commercialize our pipeline products for SCC and suspicious pigmented lesions, we will need to expend significant resources in order to conduct substantial research and development, including clinical utility and validity studies, and further develop and scale our laboratory processes and infrastructure to accommodate additional products.

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Our product development process takes time and involves a high degree of risk, and such development efforts may fail for many reasons, including failure of the product to perform as expected, failure to successfully complete analytic and clinical validation, or failure to demonstrate the clinical utility of the product.
As we develop new products, we will have to make significant investments in research and development, marketing, selling, coverage and reimbursement activities. Typically, few research and development projects result in a commercialized product, and there can be no assurance that we will be able to successfully develop new products that can be commercialized. At any point, we may abandon development of a product or we may be required to expend considerable resources conducting research, which would adversely affect the timing for generating potential revenue from a new product and our ability to invest in other products in our pipeline. If a clinical validation study fails to demonstrate the prospectively defined endpoints of the study or if we fail to sufficiently demonstrate analytical validity or clinical utility, we might choose to abandon the development of the product, which could harm our business. In addition, competitors may develop and commercialize competing products or technologies faster than us or at a lower cost.
We may experience limits on our revenue if we are unable to increase and support adoption of our products by physicians and other healthcare providers.*
Physicians and other healthcare providers may be unwilling to adopt our products due to their reliance on existing traditional clinical and pathology staging criteria and our ability to generate revenue from our products would be significantly impaired if we were unable to educate physicians, healthcare providers, patients and third-party payors about the benefits and advantages of our products. Recently, the COVID-19 crisis has impacted our in-person healthcare interactions, such as field-based sales and medical affairs, and we have had to convert visits, programs and projects to be performed online and by telephone. Due to the uncertainties surrounding the duration and extent of the COVID-19 outbreak, our in-person healthcare interactions may continue to be limited and this may impact the effectiveness of our efforts. We will need to continue to educate physicians and pathologists about the benefits and cost-effectiveness of our products through published papers, presentations at scientific conferences, one-on-one marketing efforts by our sales force and one-on-one education by our medical affairs team. However, physicians and other healthcare providers may be reluctant to adopt our products in circumstances where our products are not incorporated into the current standard of care or practice guidelines. For example, while clinical utility of DecisionDx-Melanoma has been demonstrated in peer reviewed publications, the sentinel lymph node biopsy, or SLNB, surgery is the most widely used staging tool for determining a cutaneous melanoma patient’s metastatic risk. Whether healthcare providers adopt DecisionDx-Melanoma as a complementary or triage diagnostic method relative to the SLNB surgery will depend on our ability to increase awareness of DecisionDx-Melanoma and its clinical validation.
In addition, our testing services are performed by our certified laboratory located in Phoenix, Arizona, under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, rather than by local laboratory or pathology practices. Accordingly, it may be difficult for us to collect samples from pathologists, and pathologists may be reluctant to support our testing services.
We rely on limited or sole suppliers for some of the reagents, equipment, chips and other materials used by our products, and we may not be able to find replacements or transition to alternative suppliers.
We rely on limited or sole suppliers for certain reagents and other materials and components that we use for our products. Some of these items are unique to these suppliers and vendors. While we have developed alternate sourcing strategies for these materials and vendors, we cannot be certain whether these strategies will be effective or the alternative sources will be available when we need them. If these suppliers can no longer provide us with the materials we need, if the materials do not meet our quality specifications or are otherwise unusable, if we cannot obtain acceptable substitute materials, or if we elect to change suppliers, an interruption in laboratory operations could occur, we may not be able to deliver patient reports on a timely basis, or at all, and we may incur higher one-time switching costs. Any such interruption may significantly affect our future revenue, cause us to incur higher costs, and harm our customer relationships and reputation. In addition, in order to mitigate these risks, we maintain inventories of these supplies at higher levels than would be the case if multiple sources of supply were available. If our testing volume decreases or we switch suppliers, we may hold excess supplies with expiration dates that occur before use which would adversely affect our losses and cash flow position. As we introduce any new products, we may experience supply issues as we ramp test volume. If we should encounter delays or difficulties in securing, reconfiguring or revalidating the equipment, reagents or other materials we require for our products, our business, financial condition, results of operations and reputation could be adversely affected.
If our products do not meet the expectations of physicians and patients, our operating results, reputation and business could suffer.
Our success depends on physician and patient confidence that we can provide reliable, high-quality information that will improve treatment outcomes, lower healthcare costs and enable better patient care. We believe that patients, physicians and

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other healthcare providers are likely to be particularly sensitive to defects and errors in our products, including if our products fail to accurately predict risk of metastasis with high accuracy from samples, and there can be no guarantee that our products will meet their expectations. As a result, the failure of our products to perform as expected could significantly impair our operating results and our reputation, including if we become subject to legal claims arising from any defects or errors in our products or reports.
If we are unable to compete successfully, our business will suffer and we may be unable to increase or sustain our revenue or achieve sustained profitability.*
We face competition from companies and academic institutions that have either developed or may seek to develop products intended to compete with our products. Potential competitors within the broader genomics profiling space based on tissue sample collection include laboratory companies such as Laboratory Corporation of America and Myriad Genetics, and other companies which have strong infrastructures capable of supporting the commercialization of diagnostic services.
In addition, competitors may develop their own versions of our solutions in countries where we do not have patents or where our intellectual property rights are not recognized and compete with us in those countries, including encouraging the use of their solutions by physicians in other countries.
Some potential competitors may have longer operating histories, larger customer bases, greater brand recognition and market penetration, substantially greater financial, technological and research and development resources and selling and marketing capabilities, and more experience dealing with third-party payors. As a result, they may be able to respond more quickly to changes in customer requirements, devote greater resources to the development, promotion and sale of their products than we do or sell their products at prices designed to win significant levels of market share. We may not be able to compete effectively against these organizations. Increased competition and cost-saving initiatives on the part of governmental entities and other third-party payors are likely to result in pricing pressures, which could harm our sales, profitability or ability to gain market share. In addition, competitors may be acquired by, receive investments from or enter into other commercial relationships with larger, well-established and well-financed companies. Certain potential competitors may be able to secure key inputs from vendors on more favorable terms, devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing policies and devote substantially more resources to test development than we can. In addition, companies or governments that control access to testing through umbrella contracts or regional preferences could promote our competitors or prevent us from performing certain services. If we are unable to compete successfully against current and future competitors, our business will suffer and we may be unable to increase market acceptance and sales of our products, which could prevent us from increasing our revenue or achieving sustained profitability and could cause our stock price to decline. As we add new tests and services, we will face many of these same competitive risks for these new tests.
The sizes of the markets for our current and future products have not been established with precision and may be smaller than we estimate.
Our estimates of the total addressable markets for DecisionDx-Melanoma, DecisionDx-UM and our products in development are based on a number of internal and third-party estimates, including, without limitation, the annual rate of patients with the applicable form of skin cancer, the list price of our products relative to the reimbursement we expect to receive from third-party payors and the assumed prices at which we can sell our products in markets that have not been established. For example, we estimate that the total addressable market for DecisionDx-Melanoma is approximately $540 million, which is based, in part, on our review of multiple recent publications which show that diagnosis of melanoma is underreported by 30% to 40%. While we believe our assumptions and the data underlying our estimates are reasonable, these assumptions and estimates may not be correct and the conditions supporting our assumptions or estimates may change at any time, thereby reducing the predictive accuracy of these underlying factors. As a result, our estimates of the annual total addressable market for our current or future products may prove to be incorrect. If the actual number of patients who would benefit from our products, the price at which we can sell future products, or the annual total addressable market for our products is smaller than we have estimated, it may impair our sales growth and have an adverse impact on our business.
The diagnostic testing industry is subject to rapid change, which could make our current or future products obsolete.
Our industry is characterized by rapid changes, including technological and scientific breakthroughs, frequent new product introductions and enhancements and evolving industry standards, all of which could make our current products and the other products we are developing obsolete. Our future success will depend on our ability to keep pace with the evolving needs of physicians and patients on a timely and cost-effective basis and to pursue new market opportunities that develop as a result of scientific and technological advances. In recent years, there have been numerous advances in technologies relating to the diagnosis and treatment of cancer. There have also been advances in methods used to analyze very large amounts of molecular information. We must continuously enhance our existing products and develop new products to keep pace with evolving

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standards of care. If we do not update our products to reflect new scientific knowledge about cancer biology, information about new cancer therapies or relevant clinical studies, our products could become obsolete and sales of our current products and any new products we develop could decline or fail to grow as expected.

Risks Related to Reimbursement and Government Regulation
We currently have limited reimbursement coverage for our lead product, DecisionDx-Melanoma, and if third-party payors, including government and commercial payors, do not provide sufficient coverage of, or adequate reimbursement for, our products, our commercial success will be negatively affected.*
Our revenue depends on achieving broad coverage and adequate reimbursement for our products from third-party payors, including both government and commercial third-party payors. If third-party payors do not provide coverage of, or do not provide adequate reimbursement for, a substantial portion of the list price of our products, we may need to seek additional payment from the patient beyond any co-payments and deductibles, which may adversely affect demand for our products. Coverage determinations by a third-party payor may depend on a number of factors, including, but not limited to, a third-party payor’s determination of whether our products are appropriate, medically necessary or cost-effective. If we are unable to provide third-party payors with sufficient evidence of the clinical utility and validity of our products, they may not provide coverage, or may provide limited coverage, which will adversely affect our revenues and our ability to succeed. To the extent that more competitors enter our markets, the availability of coverage and the reimbursement rate for our products may decrease as we encounter pricing pressure from these competitors.
Since each third-party payor makes its own decision as to whether to establish a policy to cover our products, enter into a contract with us and set the amount it will reimburse for a product, these negotiations are a time-consuming and costly process, and they do not guarantee that the third-party payor will provide coverage or adequate reimbursement for our products. In addition, the determinations by a third-party payor whether to cover our products and the amount it will reimburse for them are often made on an indication-by-indication basis.
In cases where there is no coverage policy or we do not have a contracted rate for reimbursement as a participating provider, the patient is typically responsible for a greater share of the cost of the product, which may result in further delay of our revenue, increase our collection costs or decrease the likelihood of collection.
Our claims for reimbursement from third-party payors may be denied upon submission, and we may need to take additional steps to receive payment, such as appealing the denials. Such appeals and other processes are time-consuming and expensive, and may not result in payment. Third-party payors may perform audits of historically paid claims and attempt to recoup funds years after the funds were initially distributed if the third-party payors believe the funds were paid in error or determine that our products were medically unnecessary. If a third-party payor audits our claims and issues a negative audit finding, and we are not able to overturn the audit findings through appeal, the recoupment may result in a material adverse effect on our revenue. Additionally, in some cases commercial third-party payors for whom we are not a participating provider may elect at any time to review claims previously paid and determine the amount they paid was too much. In these situations, the third-party payor will typically notify us of their decision and then offset whatever amount they determine they overpaid against amounts they owe us on current claims. We cannot predict when, or how often, a third-party payor might engage in these reviews and we may not be able to dispute these retroactive adjustments.
Under ASC 606, we recognize revenue at the amount we expect to be entitled, subject to a constraint for variable consideration, in the period in which our tests are delivered to the treating physician. We have determined that our contracts contain variable consideration under ASC 606 because the amounts paid by third-party payors may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration is recognized only to the extent it is probable that a significant reversal of revenue will not occur in future periods when the uncertainties are resolved. Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. Variable consideration for Medicare claims that are not covered by an LCD, including those claims subject to approval by an ALJ at an appeal hearing, is deemed to be fully constrained due to factors outside the Company’s influence (i.e., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. For these fully constrained claims, we generally recognize revenue upon receipt of a favorable appeal decision. In June 2017 we submitted to the Office of Medicare Hearings and Appeals, or OMHA, a request to participate in an appeal program developed with the intent of providing appellants a means to have large volumes of claim disputes adjudicated at an accelerated rate. We submitted 2,698 DecisionDx-Melanoma claims dating from 2013 through spring 2017 for adjudication on a consolidated basis. In March 2020, OMHA issued a decision denying payment on all of these claims. In accordance with ASC 606 and consistent with prior periods, the Company has not recognized (fully constrained the variable consideration) any revenues attributable to these claims in its financial statements pending the outcome of this matter. Although we plan to appeal the decision, there can be no assurances regarding the timing or the outcome of this or any other appeal decision. Due to potential future changes in

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Medicare coverage policies and appeal cycles, insurance coverage policies, contractual rates and other trends in the reimbursement of our tests, our revenues may fluctuate significantly from period to period.
Although we are an in-network participating provider with some commercial third-party payors, including several Blue Cross Blue Shield plans, and certain large, national commercial third-party payors, including Aetna, other commercial third-party payors have issued non-coverage policies that currently categorize DecisionDx-UM and DecisionDx-Melanoma as experimental or investigational. If we are not successful in obtaining coverage from third-party payors, in reversing existing non-coverage policies, or if other third-party payors issue similar non-coverage policies, this could have a material adverse effect on our business and operations.
Palmetto, the MAC responsible for administering MolDX, the program that assesses molecular diagnostic technologies, issued a final LCD for DecisionDx-Melanoma, which became effective on December 3, 2018. This LCD provides for coverage of DecisionDx-Melanoma for certain SLNB-eligible patients with cutaneous melanoma tumors with clinically negative sentinel node basins who are being considered for SLNB to determine eligibility for adjuvant therapy. Similarly, Palmetto issued a final LCD for DecisionDx-UM effective July 10, 2017. This LCD provides for coverage of DecisionDx-UM to determine metastatic risk in connection with the management of a patient’s newly diagnosed uveal melanoma and to guide surveillance and referral to medical oncology for those patients. We worked with Palmetto to obtain these positive coverage decisions through the submission of a detailed dossier of analytical and clinical data to substantiate that the tests meet Medicare’s medical necessity requirements. Per their joint operating agreement, Noridian, the MAC responsible for administering claims for laboratory services performed in Arizona, has adopted the same coverage policy as Palmetto for DecisionDx-UM and DecisionDx-Melanoma. This coverage process is lengthy, time-consuming, has changed over time, may change in the future and requires significant dedication of resources, and as we develop new products, we may be unsuccessful in receiving LCD determinations for those products or in maintaining our current LCDs. On a periodic basis, CMS requests bids for its MAC services, and MAC jurisdictions have changed in the past. A change in our MAC, or future changes in the MolDX program, the elimination of the program, or a change in the administrator of that program, may affect our ability to obtain Medicare coverage and reimbursement for products for which we have coverage, for products for which we do not yet have coverage, or for any products we may launch in the future, or delay payments for our tests.
Under Medicare, payment for products like ours is generally made under the Clinical Laboratory Fee Schedule, or CLFS, with payment amounts assigned to specific procedure billing codes. In April 2014, Congress passed the Protecting Access to Medicare Act of 2014, or PAMA, which included substantial changes to the way in which clinical laboratory services are paid under Medicare. Under PAMA, certain laboratories were required to report to CMS, beginning in 2017 and every three years thereafter (or annually for advanced diagnostic laboratory tests, or ADLTs), commercial third-party payor payment rates and volumes for each test they perform. CMS uses this data to calculate a weighted median payment rate for each test, which will be used to establish revised Medicare CLFS reimbursement rates for the test. Laboratories that fail to report the required payment information may be subject to substantial civil monetary penalties. We bill Medicare for our products, and therefore we are subject to reporting requirements under PAMA.
On May 17, 2019, CMS determined that DecisionDx-UM meets the criteria for “existing ADLT” status. This means that beginning in 2021, the DecisionDx-UM Medicare rate will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. Specifically, the median private payor rate from January 1 to June 30, 2019 will be used to set the Medicare rate for the calendar year 2021. Note that our rate for 2020 will be set by Noridian, our local MAC.
Also, on May 17, 2019, CMS determined that DecisionDx-Melanoma meets the criteria for “new ADLT” status. This means that from July 1, 2019 through March 31, 2020 the Medicare reimbursement rate will equal the initial list price of $7,193.00. The rate for April 1, 2020 through December 31, 2021 was calculated based upon the median private payor rate from July 1, 2019 to November 30, 2019. We submitted this data in December 2019 and CMS has notified us that the rate for April 1, 2020 through December 31, 2021 will be $7,193.00.
Beginning in 2022, the rate for both DecisionDx-UM and DecisionDx-Melanoma will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. For example, the rate for 2022 will be set using median private payor rate data from January 1, 2020 to June 30, 2020.
If we are unable to obtain and maintain adequate reimbursement rates from commercial third-party payors, this may adversely affect our Medicare rate. It is unclear what impact new pricing structures, such as those adopted under PAMA, may have on our business, financial condition, results of operations or cash flows.
The U.S. federal government continues to show significant interest in pursuing health care reform and reducing health care costs. Similarly, commercial third-party payors may seek to reduce costs by limiting coverage or reducing reimbursement for our products. Any government-adopted reform measures or changes to commercial third-party payor coverage and

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reimbursement policies could cause significant pressure on the pricing of, and reimbursement for, health care products and services, including our products, which could decrease demand for our products, and adversely affect our sales and revenue.
In addition, some third-party payors have implemented, or are in the process of implementing, laboratory benefit management programs, often using third-party benefit managers to manage these programs. The stated goals of these programs are to help improve the quality of outpatient laboratory services, support evidence-based guidelines for patient care and lower costs. The impact on laboratories, such as ours, of active laboratory benefit management by third parties is unclear, and we expect that it could have a negative impact on our revenue in the short term. It is possible that third-party payors will resist reimbursement for the products that we offer, in favor of less expensive products, may require pre-approval for our products or may impose additional pricing pressure on and substantial administrative burden for reimbursement for our products.
We expect to continue to focus substantial resources on increasing coverage and reimbursement for our current products and any future products we may develop. We believe it may take several years to achieve broad coverage and adequate contracted reimbursement with a majority of third-party payors for our products.
However, we cannot predict whether, under what circumstances, or at what payment levels third-party payors will cover and reimburse our products. If we fail to establish and maintain broad adoption of, and coverage and reimbursement for, our products, our ability to generate revenue could be harmed and our future prospects and our business could suffer.
Our products are currently marketed as laboratory developed tests, and any changes in regulations or the U.S. Food and Drug Administration’s enforcement discretion for laboratory developed tests, or violations of regulations by us, could adversely affect our business, prospects, results of operations or financial condition.
The diagnostics industry is highly regulated, and we cannot assure you that the regulatory environment in which we operate will not change significantly and adversely in the future. In many instances, there are no significant regulatory or judicial interpretations of these laws and regulations. Although the U.S. Food and Drug Administration, or FDA, has statutory authority to assure that medical devices are safe and effective for their intended uses, the FDA has generally exercised its enforcement discretion and not enforced applicable regulations with respect to in vitro diagnostics that are designed, manufactured and used within a single laboratory. These tests are referred to as laboratory developed tests, or LDTs. We currently market our products as LDTs.
The FDA has adopted a policy of enforcement discretion with respect to LDTs whereby the FDA does not actively require premarket review of LDTs or otherwise impose its requirements applicable to other medical devices on LDTs. However, the FDA has stated its intention to modify its enforcement discretion policy with respect to LDTs. The FDA could ultimately modify its current approach to LDTs in a way that would subject our products marketed as LDTs to the enforcement of additional regulatory requirements. Moreover, legislative measures have recently been proposed in Congress that, if ultimately enacted, could provide the FDA with additional authority to require premarket review of and regulate LDTs. If and when such changes to the regulatory framework occur, we could for the first time be subject to enforcement of regulatory requirements as a device manufacturer such as registration and listing requirements, medical device reporting requirements and the requirements of the FDA’s Quality System Regulation. We may be required to conduct clinical trials prior to continuing to sell our existing products or launching any other products we may develop. This may increase the cost of conducting, or otherwise harm, our business.
Moreover, even if the FDA does not modify its policy of enforcement discretion, the FDA may disagree that we are marketing our LDTs within the scope of its policy of enforcement discretion and may impose significant regulatory requirements. While we believe that we are currently in material compliance with applicable laws and regulations as historically enforced by the FDA, we cannot assure you that the FDA will agree with our determination. A determination that we have violated these laws and regulations, or a public announcement that we are being investigated for possible violations, could adversely affect our business, prospects, results of operations or financial condition.
If the FDA begins to actively regulate our diagnostic products, we may be required to obtain premarket clearance under Section 510(k) of the U.S. Federal Food, Drug and Cosmetic Act, or FDCA, or a premarket approval, or PMA. The process for submitting a 510(k) premarket notification and receiving FDA clearance usually takes from three to 12 months, but it can take significantly longer and clearance is never guaranteed. The process for submitting and obtaining FDA approval of a PMA is much more costly, lengthy and uncertain. It generally takes from one to three years or even longer, and approval is not guaranteed. PMA approval typically requires extensive clinical data and can be significantly longer, more expensive and more uncertain than the 510(k) clearance process. Despite the time, effort and expense expended, there can be no assurance that a particular device ultimately will be cleared or approved by the FDA through either the 510(k) clearance process or the PMA process on a timely basis, or at all. Moreover, there can be no assurance that any cleared or approved labeling claims will be consistent with our current claims or adequate to support continued adoption of and reimbursement for our products. If

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premarket review is required for some or all of our products, the FDA may require that we stop selling our products pending clearance or approval, which would negatively impact our business. Even if our products are allowed to remain on the market prior to clearance or approval, demand or reimbursement for our products may decline if there is uncertainty about our products, if we are required to label our products as investigational by the FDA, or if the FDA limits the labeling claims we are permitted to make for our products. As a result, we could experience significantly increased development costs and a delay in generating additional revenue from our products, or from other products now in development.
If the FDA imposes significant changes to the regulation of LDTs it could reduce our revenues or increase our costs and adversely affect our business, prospects, results of operations or financial condition.
We conduct business in a heavily regulated industry, and failure to comply with federal, state and foreign laboratory licensing requirements and the applicable requirements of the FDA or any other regulatory authority, could cause us to lose the ability to perform our tests, experience disruptions to our business, or become subject to administrative or judicial sanctions.
The diagnostics industry is highly regulated, and the laws and regulations governing the marketing of diagnostic tests are extremely complex. Areas of the regulatory environment that may affect our ability to conduct business include, without limitation:
federal and state laws applicable to test ordering, documentation of tests ordered, billing practices and claims payment and/or regulatory agencies enforcing those laws and regulations;
federal and state fraud and abuse laws;
federal and state laboratory anti-mark-up laws;
coverage and reimbursement levels by Medicare, Medicaid, other governmental payors and private insurers;
restrictions on coverage of and reimbursement for tests;
federal and state laws governing laboratory testing, including CLIA, and state licensing laws;
federal and state laws and enforcement policies governing the development, use and distribution of diagnostic medical devices, including LDTs;
federal, state and local laws governing the handling and disposal of medical and hazardous waste;
federal and state Occupational Safety and Health Administration rules and regulations; and
the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and similar state data privacy laws.
In particular, the FDCA defines a medical device to include any instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including a component, part, or accessory, intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals. Our products are considered by the FDA to be subject to regulation as medical devices, and marketed under FDA’s policy of enforcement discretion for LDTs. Among other things, pursuant to the FDCA and its implementing regulations, the FDA regulates the research, testing, manufacturing, safety, labeling, storage, recordkeeping, premarket clearance or approval, marketing and promotion, and sales and distribution of medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intended uses. In addition, the FDA regulates the import and export of medical devices manufactured between the United States and international markets.
We are also subject to CLIA, a federal law that regulates clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. CLIA regulations establish specific standards with respect to personnel qualifications, facility administration, proficiency testing, quality control, quality assurance and inspections. Any testing subject to CLIA regulation must be performed in a CLIA certified or accredited lab. CLIA certification or accreditation is also required in order for us to be eligible to bill state and federal healthcare programs, as well as commercial third-party payors, for our products. We have a current CLIA accreditation under the College of American Pathologists, or CAP, program to conduct our tests at our clinical reference laboratory in Phoenix, Arizona.
To maintain our CLIA accreditation, we have elected to be subject to survey and inspection every two years by CAP. Moreover, CLIA inspectors may make random inspections of our laboratory from time to time.

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In addition, certain states require our laboratory to be licensed in such states in order to test specimens from those states. Accordingly, our laboratory is also licensed by California, Maryland, New York, Pennsylvania and Rhode Island. Other states may have similar requirements or may adopt similar requirements in the future.
Although we have obtained licenses from states where we believe we are required to be licensed, we may become aware of other states that require out-of-state laboratories to obtain licensure in order to accept specimens from the state, and it is possible that other states currently have such requirements or will have such requirements in the future.
In order to test specimens from New York, LDTs must be approved by the New York State Department of Health, or NYSDOH, on a test-by-test basis before they are offered. Our laboratory director must also be separately qualified to be a laboratory director in New York. DecisionDx-UM, DecisionDx-PRAME and DecisionDx-Melanoma have each been approved and our laboratory director has been qualified by NYSDOH. We are subject to periodic inspection by the NYSDOH and are required to demonstrate ongoing compliance with NYSDOH regulations and standards. To the extent NYSDOH identified any non-compliance and we are unable to remedy such non-compliance, the State of New York could withdraw approval for our products. We will need to seek NYSDOH approval of any future LDTs we develop and want to offer for clinical testing to New York residents, and there can be no assurance that we will be able to obtain such approval.
We may also be subject to regulation in foreign jurisdictions as we seek to expand international utilization of our products or such jurisdictions adopt new licensure requirements, which may require review of our products in order to offer them or may have other limitations such as restrictions on the transport of human tissue samples necessary for us to perform our tests that may limit our ability to make our products available outside of the United States. Complying with licensure requirements in new jurisdictions may be expensive, time-consuming and subject us to significant and unanticipated delays.
CAP maintains a clinical laboratory accreditation program. While not required for the operation of a CLIA-certified laboratory, many private insurers require CAP accreditation as a condition to contracting with clinical laboratories to cover their tests. In addition, some countries outside the United States require CAP accreditation as a condition to permitting clinical laboratories to test samples taken from their citizens. CAP accredited laboratories are surveyed for compliance with CAP standards every two years in order to maintain accreditation. Failure to maintain CAP accreditation could have a material adverse effect on the sales of our products and the results of our operations. Our most recent CAP inspection occurred in the fourth quarter of 2018 and our CLIA accreditation certificate expires on December 20, 2020.
Failure to comply with applicable clinical laboratory licensure requirements may result in a range of enforcement actions, including suspension, limitation or revocation of our CLIA accreditation and/or state licenses, imposition of a directed plan of action, onsite monitoring, civil monetary penalties, criminal sanctions and revocation of the laboratory’s approval to receive Medicare and Medicaid payment for its services, as well as significant adverse publicity. Any sanction imposed under CLIA, its implementing regulations, or state or foreign laws or regulations governing clinical laboratory licensure or our failure to renew our CLIA accreditation, or a state or foreign license, could have a material adverse effect on our business, financial condition and results of operations. Even if we were able to bring our laboratory back into compliance, we could incur significant expenses and potentially lose revenue in doing so.
The FDA may modify its enforcement discretion policy with respect to LDTs in a risk-based manner, and we may become subject to extensive regulatory requirements and may be required to conduct additional clinical trials prior to continuing to sell our existing tests or launching any other tests we may develop, which may increase the cost of conducting, or otherwise harm, our business.
If the FDA changes or ends its policy of enforcement discretion with respect to LDTs, and our products become subject to the FDA’s requirements for premarket review of medical devices, we may be required to cease commercial sales of our products and conduct clinical trials prior to making submissions to the FDA to obtain premarket clearance or approval. If we are required to conduct such clinical trials, delays in the commencement or completion of clinical trials could significantly increase our product development costs and delay commercialization of any currently marketed testing that we may be required to cease selling or the commercialization of any future tests that we may develop. Many of the factors that may cause or lead to a delay in the commencement or completion of clinical trials may also ultimately lead to delay or denial of regulatory clearance or approval. The commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the eligibility criteria for the clinical trial.
The FDA requires medical device manufacturers to comply with, among other things, current good manufacturing practices for medical devices, known as the Quality System Regulation, which requires manufacturers to follow elaborate design, testing, control, documentation and other quality assurance procedures during the manufacturing process; the medical device reporting regulation, which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or

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serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur; labeling regulations, including the FDA’s general prohibition against promoting products for unapproved or ‘‘off-label’’ uses; and the reports of corrections and removals regulation, which requires manufacturers to report to the FDA if a device correction or removal was initiated to reduce a risk to health posed by the device or to remedy a violation of the FDCA caused by the device which may present a risk to health.
Even if we were able to obtain FDA clearance or approval for one or more of our products, if required, a diagnostic test may be subject to limitations on the indications for which it may be marketed or to other regulatory conditions. In addition, such clearance or approval may contain requirements for costly post-market testing and surveillance to monitor the safety or efficacy of the test.
In addition, the FDA’s and other regulatory authorities’ policies may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approvals. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may lose any marketing authorization that we may have obtained and we may not achieve or sustain profitability, which would adversely affect our business, prospects, financial condition and results of operations.
Interim, topline and preliminary data from our clinical studies that we announce or publish from time to time may change as more data become available and are subject to audit and verification procedures that could result in material changes in the final data.
From time to time, we may publicly disclose preliminary or topline or data from our clinical studies, which is based on a preliminary analysis of then-available data, and the results and related findings and conclusions are subject to change following a more comprehensive review of the data related to the particular study. We also make assumptions, estimations, calculations and conclusions as part of our analyses of data, and we may not have received or had the opportunity to fully and carefully evaluate all data. As a result, the topline results that we report may differ from future results of the same studies, or different conclusions or considerations may qualify such results, once additional data have been received and fully evaluated. Topline data also remain subject to audit and verification procedures that may result in the final data being materially different from the preliminary data we previously published. As a result, topline data should be viewed with caution until the final data are available. From time to time, we may also disclose interim data from our clinical studies. Interim data from clinical studies that we may complete are subject to the risk that one or more of the clinical outcomes may materially change as more patient data become available. Adverse differences between preliminary or interim data and final data could significantly harm our reputation and marketing efforts.
Further, others, including healthcare providers or payors, may not accept or agree with our assumptions, estimates, calculations, conclusions or analyses or may interpret or weigh the importance of data differently, which could impact the value of the particular program, the approvability or commercialization of the particular product candidate or product and our company in general. In addition, the information we choose to publicly disclose regarding a particular study is based on what is typically extensive information, and you or others may not agree with what we determine is the material or otherwise appropriate information to include in our disclosure, and any information we determine not to disclose may ultimately be deemed significant with respect to future decisions, conclusions, views, activities or otherwise regarding our business. If the topline or interim data that we report differ from actual results, or if others, including healthcare providers or payors, disagree with the conclusions reached, our ability to commercialize, our product candidates may be harmed, which could harm our business, operating results, prospects or financial condition.
Changes in health care policy could increase our costs, decrease our revenues and impact sales of and reimbursement for our products.*
In March 2010, the ACA became law. This law substantially changed the way health care is financed by both government and commercial third-party payors, and significantly impacted our industry. The ACA contains a number of provisions that are expected to impact our business and operations, some of which in ways we cannot currently predict, including those governing enrollment in state and federal health care programs, reimbursement changes and fraud and abuse, which impact existing state and federal health care programs and will result in the development of new programs. Among other things, the ACA required medical device manufacturers to pay a sales tax equal to 2.3% of the price for which such manufacturer sells its medical devices, and began to apply to sales of taxable medical devices after December 31, 2012, but was suspended in 2016. Further, the 2020 federal spending package permanently eliminated, effective January 1, 2020, the medical device tax and “Cadillac” tax on high-cost employer-sponsored health coverage and, effective January 1, 2021, also eliminates the health insurer tax.

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Since 2016 there have been efforts to repeal all or part of the ACA, and the current administration and the U.S. Congress have taken action to roll back certain provisions of the ACA. The current administration and the U.S. Congress may take further action regarding the ACA, including, but not limited to, repeal or replacement.
Additionally, on December 14, 2018, a Texas U.S. District Court Judge ruled that the ACA is unconstitutional in its entirety because the tax penalty on certain individuals who fail to maintain qualifying health coverage for all or part of a year, commonly referred to as the ‘‘individual mandate,’’ was repealed by Congress as part of the Tax Cuts and Jobs Act of 2017, or the TCJA. Additionally, on December 18, 2019, the U.S. Court of Appeals for the 5th Circuit ruled that the individual mandate was unconstitutional and remanded the case back to the District Court to determine whether the remaining provisions of the ACA are invalid as well. On March 2, 2020, the United States Supreme Court granted the petitions for writs of certiorari to review this case and has allotted one hour for oral arguments. It is unclear when such oral arguments are to be held and when a decision is expected to be made. It is also unclear how such litigation and other efforts to repeal and replace the ACA will impact the ACA and our business.
On August 2, 2011, the Budget Control Act of 2011 was signed into law, which, among other things, reduced Medicare payments to providers by 2% per fiscal year, effective on April 1, 2013 and, due to subsequent legislative amendments to the statute, will remain in effect through 2030, unless additional Congressional action is taken. The CARES Act, which was signed into law in March 2020 and is designed to provide financial support and resources to individuals and business affected by the COVID-19 pandemic, suspended the 2% Medicare sequester from May 1, 2020 through December 31, 2020, and extended the sequester by one year, through 2030.
We anticipate there will continue to be proposals by legislators at both the federal and state levels, regulators and commercial third-party payors to reduce costs while expanding individual healthcare benefits. For example, it is possible that additional governmental action is taken to address the COVID-19 crisis. Certain of these changes could impose additional limitations on the prices we will be able to charge for our products, the coverage of or the amounts of reimbursement available for our products from third-party payors, including government and commercial payors.
We are subject to numerous federal and state healthcare statutes and regulations, and complying with laws pertaining to our business is an expensive and time-consuming process. If we are unable to comply, or have not fully complied, with such laws, we could face substantial penalties and a material adverse effect to our business and operations.
Physicians, other healthcare providers and third-party payors play a primary role in the recommendation of our products. Our arrangements with healthcare providers, third-party payors and customers may expose us to broadly applicable fraud and abuse and other healthcare laws and regulations that affect the business and financial arrangements and relationships through which we market and sell our products. The laws that affect our ability to operate include, but are not limited to:
the federal Anti-Kickback Statute, or the AKS, which prohibits, among other things, any person or entity from knowingly and willfully soliciting, receiving, offering or paying any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, to induce or reward either the referral of an individual for, or the purchase, order or recommendation of an item or service reimbursable, in whole or in part, under a federal healthcare program, such as the Medicare and Medicaid programs. The term ‘‘remuneration’’ has been broadly interpreted to include anything of value, such as specimen collection materials or test kits. There are a number of statutory exceptions and regulatory safe harbors protecting some common activities from prosecution, however these are drawn narrowly. Additionally, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. Violations are subject to civil and criminal fines and monetary penalties of up to $100,000 for each violation, plus up to three times the remuneration involved, imprisonment of up to ten years and exclusion from government healthcare programs. In addition, the ACA codified case law that a claim including items or services resulting from a violation of the AKS constitutes a false or fraudulent claim for purposes of the federal False Claims Act, or the FCA;
the Stark Law, which prohibits a physician from making a referral for certain designated health services covered by the Medicare or Medicaid program, including laboratory and pathology services, if the physician or an immediate family member of the physician has a financial relationship with the entity providing the designated health services and prohibits that entity from billing, presenting or causing to be presented a claim for the designated health services furnished pursuant to the prohibited referral, unless an exception applies. Sanctions for violating the Stark Law include denial of payment, civil monetary penalties and exclusion from the federal health care programs. Failure to refund amounts received as a result of a prohibited referral on a timely basis may constitute a false or fraudulent claim and may result in civil penalties and additional penalties under the FCA;

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federal civil and criminal false claims laws and civil monetary penalty laws, such as the FCA, which can be enforced by private citizens through civil qui tam actions, prohibits individuals or entities from, among other things, knowingly presenting, or causing to be presented through distribution of template medical necessity language or other coverage and reimbursement information, false, fictitious or fraudulent claims for payment or approval by the federal government, including federal health care programs, such as Medicare and Medicaid, and knowingly making, using or causing to be made or used a false record or statement material to a false or fraudulent claim, or knowingly making a false statement to improperly avoid, decrease or conceal an obligation to pay money to the federal government. In addition, a claim including items or services resulting from a violation of the AKS constitutes a false or fraudulent claim for purposes of the FCA. Private individuals can bring False Claims Act ‘‘qui tam’’ actions, on behalf of the government and such individuals, commonly known as ‘‘whistleblowers,’’ may share in amounts paid by the entity to the government in fines or settlement. When an entity is determined to have violated the federal civil False Claims Act, the government may impose civil fines and penalties, plus treble damages, and exclude the entity from participation in Medicare, Medicaid and other federal healthcare programs;
HIPAA, which, among other things, imposes criminal liability for executing or attempting to execute a scheme to defraud any healthcare benefit program, including private third-party payors, knowingly and willfully embezzling or stealing from a healthcare benefit program, willfully obstructing a criminal investigation of a healthcare offense, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation, in connection with the delivery of or payment for healthcare benefits, items or services. Like the AKS, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation;
HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and their implementing regulations, which imposes privacy, security and breach reporting obligations with respect to individually identifiable health information upon entities subject to the law, such as health plans, healthcare clearinghouses and certain healthcare providers, known as covered entities, and their respective business associates, individuals or entities that perform services for them that involve individually identifiable health information. Failure to comply with the HIPAA privacy and security standards can result in civil monetary penalties, and, in certain circumstances, criminal penalties. HITECH also created new tiers of civil monetary penalties, amended HIPAA to make civil and criminal penalties directly applicable to business associates, and gave state attorneys general new authority to file civil actions for damages or injunctions in U.S. federal courts to enforce HIPAA and seek attorneys’ fees and costs associated with pursuing federal civil actions;
state laws that prohibit other specified practices, such as billing physicians for tests that they order or providing tests at no or discounted cost to induce physician or patient adoption; insurance fraud laws; waiving coinsurance, copayments, deductibles, and other amounts owed by patients; billing a state Medicaid program at a price that is higher than what is charged to one or more other third-party payors employing, exercising control over or splitting professional fees with licensed professionals in violation of state laws prohibiting fee splitting or the corporate practice of medicine and other professions; and
federal and state consumer protection and unfair competition laws, which broadly regulate marketplace activities and activities that potentially harm consumers;
the federal transparency requirements under the Physician Payments Sunshine Act, created under the ACA, which requires, among other things, certain manufacturers of drugs, devices, biologics and medical supplies reimbursed under Medicare, Medicaid, or the Children’s Health Insurance Program to annually report to CMS information related to payments and other transfers of value provided to physicians, certain other healthcare professionals, and teaching hospitals and physician ownership and investment interests, including such ownership and investment interests held by a physician’s immediate family members. Failure to submit required information may result in civil monetary penalties for all payments, transfers of value or ownership or investment interests that are not timely, accurately, and completely reported in an annual submission, and may result in liability under other federal laws or regulations. We believe that we are exempt from these reporting requirements. We cannot assure you, however, that our regulators, principally the federal government, will agree with our determination, and a determination that we have violated these laws and regulations, or a public announcement that we are being investigated for possible violations, could adversely affect our business;
the prohibition on reassignment of Medicare claims, which, subject to certain exceptions, precludes the reassignment of Medicare claims to any other part;

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state and foreign law equivalents of each of the above federal laws, such as anti-kickback and false claims laws, that may impose similar or more prohibitive restrictions, and may apply to items or services reimbursed by any non-governmental third-party payors, including private insurers; and
federal, state and foreign