UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 ________________________________ 

FORM 10-Q

  ________________________________ 

 

(Mark One)

For the transition period from             to            

 

Commission file number 001-36156

 ________________________________ 

VERACYTE, INC.

(Exact name of registrant as specified in its charter)

________________________________ 

 

 

(Address of principal executive offices, zip code)

 

(Registrant’s telephone number, including area code)

  ________________________________ 

 

 

As of July 28, 2017,April 27, 2018, there were 33,893,56734,346,004 shares of common stock, par value $0.001 per share, outstanding.

VERACYTE, INC.

INDEX

 

PART I. — FINANCIAL INFORMATION

 

Item 1. Condensed Financial Statements

 

VERACYTE, INC.

 

Condensed Balance Sheets

 

(In thousands of dollars, except share and per share amounts)

 

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

VERACYTE, INC.

 

Condensed Statements of Operations and Comprehensive Loss

 

(Unaudited)

 

 

 

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

VERACYTE, INC.

 

Condensed Statements of Cash Flows

 

(Unaudited)

 

(In thousands of dollars) 

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

VERACYTE, INC.

 

Notes to Financial Statements

 

1. Organization and Description of Business

 

Veracyte, Inc. (“Veracyte” or the “Company”) was incorporated in the state of Delaware on August 15, 2006 as Calderome, Inc. Calderome operated as an incubator until early 2008. On March 4, 2008, the Company changed its name to Veracyte, Inc. The Company’s operations are based in South San Francisco, California and Austin, Texas, and it operates in one segment.

 

Veracyte is a leading genomic diagnostics company that is fundamentally improving patient care by resolvingresolves diagnostic uncertainty with evidence that is trustworthy and actionable. The Company's products uniquely combineby combining genomic technology, clinical science and machine learning to provide diagnostic answers that giveto physicians and patients a clear path forward without risky, costly surgery that is often unnecessary.patients.

Since the Company's founding in 2008, it has commercialized three genomic tests that it believes are transforming diagnostics:products:

All of the Company's testing services are made available through its clinical reference laboratories located in South San Francisco, California and Austin, Texas, which are each certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA.1988.

 

 

The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States, (“GAAP”).or GAAP. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The condensed balance sheet as of June 30, 2017,March 31, 2018, the condensed statements of operations and comprehensive loss for the three and six months ended June 30,March 31, 2018 and 2017, and 2016, and the condensed statements of cash flows for the sixthree months ended June 30,March 31, 2018 and 2017 and 2016 are unaudited, but include all adjustments, consisting only of normal recurring adjustments, which the Company considers necessary for a fair presentation of its financial position, operating results and cash flows for the periods presented. The condensed balance sheet at December 31, 20162017 has been derived from audited financial statements. The results for the three and six months ended June 30, 2017March 31, 2018 are not necessarily indicative of the results expected for the full year or any other period.

 

The accompanying interim period condensed financial statements and related financial information included in this Quarterly Report on Form 10-Q should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.2017.

 

 

The preparation of unaudited interim financial statements in conformity with 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 revenue and expenses during the reporting period. Significant items subject to such estimates include: revenue recognition; contractual allowances; the useful lives of property and equipment; the recoverability of long-lived assets; the estimation of the fair value of intangible assets; stock options; income tax uncertainties, including a valuation allowance for deferred tax assets; and contingencies. 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 revenue and expenses that are not readily apparent from other sources. Actual results could differ from those estimates and assumptions.

 

 

The majority of the Company’s cash and cash equivalents are deposited with one major financial institution in the United States. Deposits in this institution may exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on its deposits of cash and cash equivalents.

 

Several of the components of the Company’s sample collection kit and test reagents are obtained from single-source suppliers. If these single-source suppliers fail to satisfy the Company’s requirements on a timely basis, it could suffer delays in being able to deliver its diagnostic solutions, a possible loss of revenue, or incur higher costs, any of which could adversely affect its operating results.

 

The Company is also subject to credit risk from its accounts receivable related to its sales. The Company generally does not perform evaluations of customers’ financial condition and generally does not require collateral.

 

Through June 30, 2017,March 31, 2018, substantially all of the Company’s revenue has been derived from the sale of Afirma. To date, Afirma has been delivered primarily to physicians in the United States. The Company’s third-party payers in excess of 10% of revenue and their related revenue as a percentage of total revenue were as follows:

 

 

The Company’s significant third-party payers and their related accounts receivable balance as a percentage of total accounts receivable were as follows:

 

No other third-party payer represented more than 10% of the Company’s accounts receivable balances as of those dates.

 

 

The Company had deposits of $120,000 included in current assets as of June 30, 2017 and December 31, 2016, pledged for corporate credit cards. The Company also had deposits of $603,000 included in long-term assets as of June 30, 2017March 31, 2018 and December 31, 2016,2017, restricted from withdrawal and held by a bank in the form of collateral for an irrevocable standby letter of credit held as security for the lease of the Company’s South San Francisco facility signed in April 2015.facility.

 

In March 2018, the six months ended December 31, 2016.Company received $0.4 million as a settlement with an institutional investor that was a beneficial owner of the Company's common stock related to the disgorgement of short-swing profits pursuant to Section 16(b) of the Securities Exchange Act of 1934, as amended. The settlement of $0.4 million was recognized as additional paid-in capital.

 

Factors Affecting Our Performance

 

 

Our performance depends on the number of moleculargenomic tests that we perform and report as completed in our CLIA laboratories. Factors impacting the number of tests that we report as completed include, but are not limited to:

We generate substantially all our revenue from genomic testing services, including the rendering of a cytopathology diagnosis as part of the Afirma solution. We do not accrue revenue for tests performed and reported that do not meet our accrual criteria. For the Afirma classifier, we do not accrue revenue for approximately 5%-10% of the tests that we perform and report as complete due principally to insufficient RNA from which to render a result and tests performed for which we do not reasonably expect to be paid. For tests that we perform that doRevenue from Percepta has not meet our accrual criteria, we recognize revenue upon cash receipt.

 

Revenue growth depends on our ability to secure coverage decisions, achieve broader reimbursement at increased levels from third-party payers, expand our base of prescribing physicians and increase our penetration in existing accounts. Because some payers consider our products experimental and investigational, we may not receive payment for tests and payments we receive may not be at acceptable levels. We expect our revenue growth willto increase asif more payers make a positive coverage decision andor as payers enter into contracts with us, which should enhance our accrued revenue and cash collections. To drive increased adoption of Afirma,our products, we increased our sales force over the last several years, along with increasing our marketing efforts. We have hired institutional channel managersOur sales team is structured to focus on the institutional segment, where accounts generally send us fine needle aspirations, or FNAs,sell all of our products; we do not maintain a separate sales force for the Afirma genomic classifier only, and account managers, dedicated to serving existing accounts, thereby freeing up our product specialists to focus on transacting new business.each product. If we are unable to expand the base of prescribing physicians and penetration within these accounts at an acceptable rate, or if we are not able to execute our strategy for increasing reimbursement, we may not be able to effectively increase our revenue. We expect to continue to see pressure from payers to limit the utilization of tests, generally, and we believe more payers are deploying cost containment tactics, such as pre-authorization and employing laboratory benefit managers to reduce utilization rates.

 

Our revenue is generated from the provision of diagnostic services. These services are completed upon the delivery of test results to the prescribing physician, at which time we bill for the services. We recognize revenue related to billings on an accrual basis when we are able to make a reasonable estimate of reimbursement at the time delivery is complete. In the first period in which revenue is accrued for a particular payer or test, there generally is a one-time increase in revenue. Until we have contracts with payers or can reasonably estimate the amount that will ultimately be received, we recognize the related revenuebased on the cash basis. As we commercialize new products, we will need to be able to make a reasonable estimateestimates of the amount that will ultimately be received from eachrealized. In determining the amount to accrue for a delivered test, we consider factors such payment history, payer for each new product offering prior to being able to recognizecoverage, whether there is a reimbursement contract between the relatedpayer and us, payment as a percentage of agreed upon rate (if applicable), amount paid per test and any current developments or changes that could impact reimbursement. These estimates require significant judgment by management. We have not had multiple element revenue on an accrual basis. Because the timing and amount of cash payments received from payers as well as one-time increases in revenue from newly accrued payers are difficult to predict, we expect that our revenue may fluctuate significantly in any given quarter.arrangements through March 31, 2018.

As of June 30,March 31, 2018, cumulative amounts billed at list price for tests processed which were not recognized as revenue upon delivery of a patient report because our accrual revenue recognition criteria were not met and for which we have not collected cash or written off as uncollectible, totaled approximately $159.3 million.

As of December 31, 2017, cumulative amounts billed at list price for tests processed which were not recognized as revenue upon delivery of a patient report because our accrual revenue recognition criteria were not met and for which we have not collected cash or written off as uncollectible, totaled approximately $159.8 million.

Generally, cash we receive is collected within 12 months of the date the test is billed. We cannot provide any assurance as to when, if ever, or to what extent any of these amounts will be collected. Notwithstanding our efforts to obtain payment for these tests, payers may deny our claims, in whole or in part, and we may never receive revenue from previously performed but unpaidpayment for these tests.

Revenue from these tests, if any, may not be equal to the billed amount due to a number of factors that we consider when determining revenue accrual rates, including differences in reimbursement rates, the amounts of patient co-payments and co-insurance, the existence of secondary payers, claims denials and claims denials.the amount we expect to ultimately collect. Finally, when we increase our list price, as we did in July 2015, it will increase the cumulative amounts billed. In addition, payer contracts generally include the right of offset and payers may offset payments prior to resolving disputes over tests performed.

WeGenerally, we calculate the average Afirma genomic classifier reimbursement from all payers, whether they are on the cash or an accrual basis, for tests that are on average a year old, since it can take a significant period of time to collect from some payers. WeExcept in situations where we believe the rate we reasonably expect to collect to vary due to a coverage decision, contract, more recent reimbursement data or evidence to the contrary, we use an average of reimbursement for tests provided over twofour quarters as it reduces the effects of temporary volatility and seasonal effects. Thus, the average reimbursement per Afirma genomic classifier represents the total cash collected to date against Afirma genomic classifier tests, including variants, performed during the relevant period divided by the number of these tests performed during that same period.

The average Afirma genomic classifier reimbursement rate will change over time due to a number of factors, including medical coverage decisions by payers, the effects of contracts signed with payers, changes in allowed amounts by payers, our ability to successfully win appeals for payment, and our ability to collect cash payments from third-party payers and individual patients. Historical average reimbursement is not necessarily indicative of future average reimbursement. For the quarterthree months ended June 30, 2017,March 31, 2018, on average we accrued between $2,400$2,600 and $2,500$2,700 for the Afirma genomic classifier tests, including variants, that met our revenue recognition standard, which was between 90% - 95% of the reported Afirma classifier test volume.

OverFrom the eight quarters ended June 30,first quarter of 2017 to the first quarter of 2018, we generatedaccrued between $1.7 to $2.7million and $2.5 million in revenue per quarter from providing cytopathology services associated with our Afirma solution.

We incur expense for tests in the period in which the test is conducted and recognize revenue for tests in the period in which our revenue recognition criteria are met. Accordingly, any revenue that we recognize as a result of cash collection in respect of previously performed but unpaid tests will favorably impact our liquidity and results of operations in future periods.

 

 

We currently rely on sales of Afirmacontinue to generate all ofadvance our revenue.product portfolio with diagnostic tests that leverage innovations in genomic science, sequencing technology and machine learning methodologies to further improve patient care. In May 2014,2017, we commercially launchedintroduced Afirma GSC, supported by rigorous clinical validation data showing that the RNA sequencing-based test can help significantly more patients avoid unnecessary surgery in thyroid cancer diagnosis, compared to the original Afirma test. In March 2018, we unveiled our Afirma Malignancy Classifiers,Xpression Atlas, which weuses the same RNA sequencing platform as the Afirma GSC and enables us to extract rich genomic content - including gene expression, DNA variants and RNA fusions in over 500 genes that are associated with thyroid cancer - from thyroid FNA samples. We believe enhancesthat this novel offering will provide clinicians with valuable genomic information that may inform surgery strategy and treatment options for patients with suspected thyroid cancer.

Together with our Afirma Thyroid FNA Analysis asGSC and our tests for the BRAF v600E mutation and medullary thyroid cancer (Malignancy Classifiers), the Afirma Xpression Atlas rounds out a comprehensive waysolution for physicians evaluating thyroid nodules. This innovation also enabled our recently announced research collaboration with Loxo Oncology, which is intended to managesupport their development of targeted therapies for genetically defined cancers, including thyroid nodule patients and servecancer.

We have also expanded our current base of prescribing physicians. We are also pursuing development or acquisition of productsability to provide important clinical answers - without the need for additional diseases to increase and diversify our revenue. We launched thesurgery - into pulmonology. Our Percepta classifierBronchial Genomic Classifier, introduced in April 2015.2015, is the first genomic test to receive Medicare coverage for use in lung cancer diagnosis, where it improves the diagnostic performance of bronchoscopy. Additionally, we introduced in October 2016 a solution for diagnosing interstitial lung disease, our Envisia Genomic Classifier launched in October 2016 and is the first commercial test to improve the diagnosis of idiopathic pulmonary fibrosis among patients with a suspected interstitial lung disease.

We are currently exploring opportunities to utilize the same “field of injury” technology that will offer an alternative to surgery by developing a genomic signature to classify samples collected through less invasive bronchoscopy techniques. We expect to continue to invest heavily in research and development in order to expand the capabilities ofpowers our solutions andPercepta classifier to develop additional products. Our successa nasal swab test that can enable earlier lung cancer detection - and ultimately help reduce lung cancer deaths. Additionally, we believe our Xpression Atlas platform can be transferred to our pulmonology indications, to further improve patient care and advance precision medicine in developing or acquiring new products will be important in our efforts to grow our business by expanding the potential market for our productslung cancer and diversifying our sources of revenue.idiopathic pulmonary fibrosis.

 

 

We deploy state-of-the-art and costly genomic technologies in our biomarker discovery experiments, and our spending on these technologies may vary substantially from quarter to quarter. We also spend a significant amount to secure clinical samples that can be used in discovery and product development as well as clinical validation studies. The timing of these research and development activities is difficult to predict, as is the timing of sample acquisitions. If a substantial number of clinical samples are acquired in a given quarter or if a high-cost experiment is conducted in one quarter versus the next, the timing of these expenses can affect our financial results. We conduct clinical studies to validate our new products as well as on-going clinical studies to further the published evidence to support our commercialized tests. As these studies are initiated, start-up costs for each site can be significant and concentrated in a specific quarter. Spending on research and development, for both experiments and studies, may vary significantly by quarter depending on the timing of these various expenses.

Financial Overview

 

 

Through June 30, 2017,March 31, 2018, we derived substantially all of our revenue has been derived from the sale of Afirma. To date, Afirma, has been delivered primarily to physicians in the United States. We generally invoice third-party payers upon delivery of a patient report to the prescribing physician. As such, we take the assignment of benefits and the risk of cash collection from the third-party payer and individual patients. Third-party payers in excess of 10% of revenue and their related revenue as a percentage of total revenue were as follows:

 

 

For tests performed, we recognize the related revenue upon delivery of a patient report to the prescribing physician based on the amount that we expect to ultimately receive. We determineIn determining the amount to accrue for a delivered test, we expect to ultimately receive based onconsider factors such payment history, payer coverage, whether there is a reimbursement contract between the payer and us, payment as a percentage of agreed upon rate (if applicable), amount paid per payer, per contracttest and any current developments or agreement basis.changes that could impact reimbursement. Upon ultimate collection, the amount received where reimbursement was estimated is compared to previous estimates and the amount accrued is adjusted accordingly. In other situations, where we cannot reasonably estimate the amount that will be ultimately received, we recognize revenue on the cash basis. Our ability to increase our revenue will depend on our ability to penetrate the market, obtain positive coverage policies from additional third-party payers, obtain reimbursement and/or enter into contracts with additional third-party payers for our current and new tests, and increase reimbursement rates for tests performed. Finally, should we recognize revenue on an accrual basis and later determine the judgments underlying our estimated reimbursement change, our accrued revenue and financial results could be negatively impacted in future quarters.

 

 

The components of our cost of revenue are materials and service costs, including cytopathology testing services, stock-basedlaboratory expenses, sample collection expenses, compensation expense, direct labor costs,license fees and royalties, depreciation and amortization, other expenses such as equipment and infrastructure expenses associated with testing samples, shipping charges to transport samples,laboratory supplies, and allocated overhead including rent,allocations of facility and information technology equipment depreciation and utilities.expenses. Costs associated with performing tests are recorded as the test is processed regardless of whether and when revenue is recognized with respect to that test. As a result, our cost of revenue as a percentage of revenue may vary significantly from period to period because we do not recognize all revenue in the period in which the associated costs are incurred. We expect cost of revenue in absolute dollars to increase as the number of tests we perform increases. However, we expect that the cost per test will decrease over time due to leveraging fixed costs, efficiencies we may gain as test volume increases and from automation, process efficiencies and other cost reductions. As we introduce new tests, initially our cost of revenue will be high as we expect to run suboptimal batch sizes, run quality control batches, test batches, registry samples and generally incur costs that may suppress or reduce gross margins. This will disproportionately increase disproportionately our aggregate cost of revenue until we achieve efficiencies in processing these new tests.

 

Research and development expenses include costsexpenses incurred to develop our technology, collect clinical samples and conduct clinical studies to develop and support our products.products and pipeline. These costsexpenses consist of personnel costs, including stock-based compensation expense,expenses, direct research and development expenses such as prototype materials, laboratory supplies consulting costs,and costs associated with setting up and conducting clinical studies at domestic and international sites, professional fees, depreciation and allocated overhead including rent,amortization, other miscellaneous expenses and allocation of facility and information technology equipment depreciation and utilities.expenses. We expense all research and development costs in the periods in which they are incurred. We expect to incur significant research and development expenses as we continue to invest in research and development activities related to developing additional products and evaluating various platforms. We incurred research and development expenses in 2016 for the development and launch of Envisia and for the continued development and support of the Afirma and Percepta tests. For the remainder of 2017, we expect to incur research and development expenses on ongoing evidence development for our Afirma, Percepta and Envisia classifiers.classifiers in 2017 and the first quarter of 2018, and expect to continue doing so in the remainder of 2018.

 

 

Selling and marketing expenses consist of personnel costs, including stock-based compensation expense,expenses, direct marketing expenses, consultingprofessional fees, other expenses such as travel and communications costs and allocated overhead including rent,allocation of facility and information technology equipment depreciation and utilities. In addition, co-promotion fees paid to Genzyme, net of amortization of the upfront fee received, are included in selling and marketing expenses through the September 9, 2016 termination date of our U.S. co-promotion agreement.expenses. We have expanded our internal sales force as we invest in our multi-product sales strategy to assign a single of contact to successfully develop and implement relationships with our customers and increased our marketing spending as we transitioned out of the Genzyme relationship, and expect that these costs will be offset by the elimination of the co-promotion fee.spending. We have also incurred increased selling and marketing expense as a result of investments in our lung product portfolio and believe total selling and marketing expenses will continue to increase as we launch and promote our new tests.

 

 

General and administrative expenses include those fromcompensation expenses for executive financeofficers and accounting, human resources, legal,administrative, billing and client service personnel, professional fees for legal and audit services, occupancy costs, depreciation and qualityamortization, and regulatory functions. Theseother expenses include personnel costs, including stock-based compensation expense, audit and legal expenses, consulting costs, costs associated with being a public company, and allocated overhead including rent,such as information technology equipment depreciation and utilities.miscellaneous expenses offset by allocation of facility and information technology expenses to other functions. For the three months ended March 31, 2018, approximately 66% of the headcount classified as general and administrative encompass our billing and customer care teams. We expect thesegeneral and administrative expenses to continue to increase as we build our general and administration infrastructure and to stabilize thereafter.

 

 

Intangible asset amortization began in April 2015 when we launched the Percepta test. The finite-lived intangible asset with a cost of $16.0 million is being amortized over 15 years, using the straight-line method.

 

Interest expense is attributable to our borrowings under our credit agreementdebt agreements and capital leases as well as costs associated with the loan and security agreement that it replaced.pre-payment of debt.

 

 

Other income, (expense), net consists primarily of sublease rental income and interest income received from payers and from our cash equivalents.

 

Results of Operations

 

 

 

Revenue

 

Revenue increased $3.7$3.6 million, or 25%22%, for the three months ended June 30, 2017March 31, 2018 compared to the same period in 2016. The increases were2017, primarily due to additional payers meeting ouran increase in accrued genomic classifiers revenue recognition criteriaof $4.8 million to $17.9 million for accrual andthe three months ended March 31, 2018 compared to $13.1 million for the same period in 2017. The increase in genomic classifiers revenue is due to a volume increase of 18% in reported tests from increased adoption of Afirma and an average accrual rate increase of 11% from higher historical payer collections resulting from more coverage and contracts with payers. During the resultant increasefirst quarter of 2018, cash collections for certain tests delivered in 2017 were coming in at rates higher than originally accrued. As a result, we changed our estimate of the amounts to be recognized for these tests delivered. Revenueand recognized when cash is received has decreased because payers who were previouslyan additional $0.7 million of revenue during the three-months ended March 31, 2018. This change in estimate resulted in a decrease in loss from operations of $0.7 million and a decrease in loss per share of approximately $0.02. For the three months ended March 31, 2018, all of our revenue was recognized on an accrual basis. For the three months ended March 31, 2017, we recognized $16.4 million in revenue, comprised of $15.1 million in revenue recognized on an accrual basis and $1.3 million in revenue recognized on the cash basis have met our revenue recognition criteria and are recognized on an accrual basis.

Cost of revenue

 

Comparison of the three and six months ended June 30,March 31, 2018 and 2017 and 2016 is as follows (in thousands of dollars, except percentages):

 

 

Cost of revenue increased $659,000,$1.6 million or 10%25%, for the three months ended June 30, 2017March 31, 2018 compared to the same period in 2016. Given2017. Reported genomic test volume increased 18% and cytopathology volume declined 6%. Commencing in the second half of 2017, we began transitioning customers to our corporate focus onnext-generation Afirma genomic classifier growth,GSC, while running dual platforms to support the transition from its predecessor, the Afirma classifier tests increasedGEC. As a result, we have experienced higher costs per test to support running dual platforms in our laboratory. Subject to exceptions for select states where we need regulatory approval prior to completing the transition, we expect to be to substantially complete with the transition to the Afirma GSC by 11%, offsetting a 5% decrease in cytopathology tests.June 30, 2018. The increase in reagents, chips, consumables and relatedlaboratory costs is associated primarily with increased Afirma classifier test volume and the related commission expense to a supplier. The decrease in cytopathology fees is relateddue principally to the volume decrease in FNA samples processed.transition to the Afirma GSC. The decreaseincrease in sample collection costs is primarily related to a decreasethe increase in the overall volume of samples. The increase in direct labor is associated withsamples received, including the mix shiftrecent launch of our Percepta Bronchial Genomic Classifier. Compensation expense increased due to relatively more Afirma classifier versus cytopathology tests, as more labor hours are incurred on Afirma classifier tests compared to cytopathology tests and at a higher average employee cost, and an average laboratory headcount increase of 14%, partially offset by a reassignment of certain lab personnel as indirect labor, which is included in other costs. Other costs are primarily indirect costs, such as facilities allocation, depreciation and equipment maintenance, which increased as a result of the reassignment of certain lab personnel as indirect labor, and increased equipment related expenses.

Research and development

 

Comparison of the three and six months ended June 30,March 31, 2018 and 2017 and 2016 is as follows (in thousands of dollars, except percentages):

 

 

Research and development expense decreased $664,000$355,000, or 16%9%, for the three months ended June 30, 2017March 31, 2018 compared to the same period in 2016. Personnel-related2017. The increase in compensation expense increased,was primarily due to a 10% increase in average headcount, and stock-based compensation expense increased, reflecting option grants to new and existing employees. These increases wereseverance costs, partially offset by a 7% decrease in the average headcount. The decrease in direct research and development expense which was primarily due to a lesser amount of materials purchased for research and development experiments following the completion of several major projects.

Selling and marketing

 

Comparison of the three and six months ended June 30,March 31, 2018 and 2017 and 2016 is as follows (in thousands of dollars, except percentages):

 

 

Selling and marketing expense decreased $269,000,increased $4.2 million, or 3%57%, for the three months ended June 30, 2017March 31, 2018 compared to the same period in 2016. The decrease in Genzyme co-promotion expense, net, reflects the termination of the Genzyme co-promotion agreement effective September 9, 2016. The increase in personnel-related expense was primarily2017, principally due to an 18%a 31% increase in average headcount, mainly from increases of our salesincreased incentive compensation and marketing personnel due to the termination of the Genzyme co-promotion agreement, as well asa lesser extent, increased commissions.travel and entertainment expense classified under other expenses. The increase in stock-based compensation expense reflects option grants to new and existing employees. The increasedecrease in direct marketing expense was due to corporate rebranding expenses, and the increase in other expense was mainly due to higher consulting spend on marketing initiatives.

Selling and marketing expense was flat for the six months ended June 30, 2017 compared to the same period in 2016. The decrease in Genzyme co-promotion expense, net, reflects the termination of the Genzyme co-promotion agreement effective September 9, 2016. The increase in personnel-related expense was primarily due to a 22% increasecorporate rebranding initiative in average headcount mainly from increases of our sales and marketing personnel due to the termination of the Genzyme co-promotion agreement, as well as increased commissions.three months ended March 31, 2017. The increase in stock-based compensation expense reflects option grants to new and existing employees. The increase in direct marketing expense wasprofessional fees is due to corporate rebranding expenses, and the increase in other expense was mainly due to higherincreased consulting spend on marketing initiatives.expenses.

General and administrative

 

Comparison of the three and six months ended June 30,March 31, 2018 and 2017 and 2016 is as follows (in thousands of dollars, except percentages):

 

 

General and administrative expense increased $121,000,decreased $375,000, or 2%6%, for the three months ended June 30, 2017March 31, 2018 compared to the same period in 2016.2017. The decrease in personnel-relatedcompensation expense was primarily due to higher employee separation costs in the three months ended June 30, 2016, partially offset by an 8% increasea 2% decrease in average headcount for the three months ended June 30, 2017March 31, 2018 as compared to the same period in 2016. The decrease in stock-based compensation expense was primarily due to higher costs in the three months ended June 30, 2016 from an employee separation-related option modification.2017. The increase in professional fees expense was mainly due to higher legal expenses, and the increase in rent and other facilities expenseoccupancy costs was due to higher utilities costs. The increase in other expenses was mainly from the maintenance of our information technology infrastructure.

 Interest expense

 

Interest expense increased $23,000decreased $352,000 or 44% for the three months ended June 30, 2017March 31, 2018 compared to the same period in 20162017 due to our debt principal increasinga decrease in the effective interest rate to 7.6% under the Loan and Security Agreement from our election to pay interest in-kind for13.6% under the quarters ended June 30, 2016 and September 30, 2016.

Other income, (expense), net

Other income, net, increased $83,000$126,000 for the three months ended June 30, 2017March 31, 2018 compared to the same period in 20162017 primarily due to higher interest incomethe tax benefit from our money market investments.

Liquidity and Capital Resources

 

We have incurred net losses since our inception. For the sixthree months ended June 30, 2017,March 31, 2018, we had a net loss of $15.5$9.2 million, and as of March 31, 2018, we had an accumulated deficit of $220.3 million. We expect to incur additional losses in the remainder of 2017future and at least through 2018. As of June 30, 2017, we had an accumulated deficit of $195.6 million. We may never achieve revenue sufficient to offset our expenses.

We believe our existing cash and cash equivalents of $46.5$27.2 million as of June 30, 2017March 31, 2018, our available revolving line of credit, and our revenue during the next 12 months will be sufficient to meet our anticipated cash requirements for at least the next 12 months.

Agreement and other operating restrictions that could adversely affect our ability to conduct our business. Our current credit agreementLoan and Security Agreement imposes restrictions on our operations, increases our fixed payment obligations and has restrictive covenants. In addition, the issuance of additional equity securities by us, or the possibility of such issuance, may cause the market price of our common stock to decline. In the event that we enter into collaborations or licensing arrangements to raise capital, we may be required to accept unfavorable terms. These agreements may require that we relinquish or license to a third-party on unfavorable terms our rights to technologies or product candidates that we otherwise would seek to develop or commercialize ourselves, or reserve certain opportunities for future potential arrangements when we might be able to achieve more favorable terms. If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate one or more research and development programs or selling and marketing initiatives, or forgo potential acquisitions or investments. In addition, we may have to work with a partner on one or more of our products or development programs, which could lower the economic value of those programs to us.

The following table summarizes our cash flows for the sixthree months ended June 30,March 31, 2018 and 2017 and 2016 (in thousands of dollars): 

 

Cash Flows from Operating Activities

 

Cash used in operating activities for the sixthree months ended June 30, 2017March 31, 2018 was $13.0$7.4 million. The net loss of $15.5$9.3 million was offset primarily by $3.2includes non-cash charges of $1.2 million of stock-based compensation expense and $1.8$1.0 million of depreciation and amortization, which includes $0.3 million of intangible asset amortization. Cash used as a result of changes in operating assets and liabilities of $2.6$0.4 million was primarily due to an increase in accounts receivable of $2.3$0.5 million, and a net decrease in accounts payable accrued liabilities and deferred rent of $0.5 million, primarily fromand an increase in prepaid expenses and other assets of $0.4 million, partially offset by a decrease in supplies inventory of $0.8 million and an increase in accrued liabilities of $0.3 million, which included a commission accrual partially offset by the payment of annual bonuses.

Cash used in operating activities for the sixthree months ended June 30, 2016March 31, 2017 was $16.3$8.1 million. The net loss of $21.3$8.2 million includes non-cash charges of $0.7 million in amortization of the deferred fee received from Genzyme,was offset primarily by $3.2$1.6 million of stock-based compensation expense $1.7and $0.9 million of depreciation and amortization, which includes $0.5$0.3 million of intangible asset amortization, $0.3 million in interest and prepayment penalty relating to the repayment of our borrowings under our previous loan and security agreement, and $0.2 million from the conversion of accrued interest to long-term debt.amortization. Cash generatedused as a result of changes in operating assets and liabilities of $0.3$2.4 million wasis primarily due to a decrease in supplies inventoryaccrued liabilities and deferred rent of $0.3 million.$2.3 million, primarily from the payment of annual bonuses.

Cash Flows from Investing Activities

 

Cash used in investing activities for the sixthree months ended June 30,March 31, 2018 was $0.2 million for the acquisition of property and equipment.

Cash used in investing activities for the three months ended March 31, 2017 was $0.7$0.6 million for the acquisition of property and equipment, partially offset by $0.4 million of proceeds from the sale of property and equipment.

Cash Flows from Financing Activities

 

Cash provided by financing activities for the sixthree months ended June 30,March 31, 2018 was $0.9 million, consisting of $0.6 million in proceeds from the purchase of stock under our Employee Stock Purchase Plan, or ESPP, and exercise of options to purchase our common stock and $0.4 million in proceeds from a legal settlement, partially offset by capital lease payments of $0.1 million during the period.

Cash provided by financing activities for the three months ended March 31, 2017 was $0.5 million, consisting of $0.5$0.4 million in proceeds from the purchase of stock under our ESPP and exercise of options to purchase our common stock and $0.2 million inwere cost reimbursements received related to our issuance of common stock in a public offering in the fourth quarter of 2016, offset by capital lease payments of $0.1 million during the period.

Contractual Obligations

 

There were no material changes during the interim period in the contractual obligations presented in our Form 10-K for the year ended December 31, 20162017 filed with the Securities and Exchange Commission on March 1, 2017.February 27, 2018.

 

Off-balance Sheet Arrangements

 

 

Recent Accounting Pronouncements

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to market risks in the ordinary course of our business. These risks primarily relate to interest rates. We had cash and cash equivalents of $46.5$27.2 million as of June 30, 2017March 31, 2018 which include bank deposits and money market funds. Such interest-bearing instruments carry a degree of risk; however, a hypothetical 10% change in interest rates during any of the periods presented would not have had a material impact on our unaudited interim condensed financial statements. Under our Loan and Security Agreement, we pay interest on any outstanding balances under this agreement based on a variable market rate. A significant change in these market rates may adversely affect our operating results.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

 

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

 

There were no changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation identified above that occurred during the quarterthree months ended June 30, 2017March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. — OTHER INFORMATION

 

ITEM 1A.  RISK FACTORS

 

Risks Related to Our Business

We have incurred net losses since our inception. For the sixthree months ended June 30, 2017,March 31, 2018, we had a net loss of $15.5$9.2 million and we expect to incur additional losses for the remainderas of 2017 and at least through 2018. As of June 30, 2017,March 31, 2018, we had an accumulated deficit of $195.6$220.3 million. We expect to incur additional losses in the future, and we may never achieve revenue sufficient to offset our expenses. Over the next couple of years, we expect to continue to devote substantially all of our resources to increase adoption of, and reimbursement for our Afirma tests, Percepta, our lung cancer test which we launched in April 2015, Envisia, our test for idiopathic pulmonary fibrosis, or IPF, which we launched in October 2016, and the development of additional tests. We may never achieve or sustain profitability, and our failure to achieve and sustain profitability in the future could cause the market price of our common stock to decline.

AllMost of our revenue to date has been derived from the sale of our Afirma tests, which are used in the diagnosis of thyroid cancer. Over the next few years, we expect to continue to derive a substantial portion of our revenue from sales of our Afirma tests. In the second halfthird quarter of 2017, we anticipate that we will beginbegan recognizing revenue from the sale of our Percepta test, used in the diagnosis of lung cancer. However, revenue from Percepta has not been significant to date. We also launched our Envisia test to help improve the diagnosis of interstitial lung disease, specifically IPF, in October 2016.2016, but have not recognized revenue from Envisia to-date. Once genomic tests are clinically validated and commercially available for patient testing, we must continue to develop and publish evidence that our tests are informing clinical decisions in order for them to receive positive coverage decisions by payers. Without coverage policies, our tests may not be reimbursed and we will not be able to recognize revenue. We cannot guarantee that tests we commercialize will gain and maintain positive coverage decisions and therefore, we may never realize revenue from tests we commercialize. In addition, we are in various stages of research and development for other diagnostic solutions that we may offer, but there can be no assurance that we will be able to identify other diseases that can be effectively addressed or, if we are able to identify such diseases, whether or when we will be able to successfully commercialize solutions for these diseases and obtain the evidence and coverage decisions from payers. If we are unable to increase sales and expand reimbursement for our Afirma and Percepta tests, or successfully obtain coverage and reimbursement for our Percepta and Envisia teststest or develop and commercialize other solutions, our revenue and our ability to achieve and sustain profitability would be impaired, and the market price of our common stock could decline.

We are in the process of transitioning our customers to our next-generation Afirma Genomic Sequencing Classifier, or GSC, that uses a new technology platform for the Afirma genomic classifier testing. There are risks associated with this transition that include, but are not limited to, operational implementation, reimbursement, and customer adoption risks. If we are unable to effectively transition to the new platform, our business, financial condition and results of operations could be adversely effected and our reputation and competitive position could be harmed.  

Revenue for tests performed on patients covered by Medicare and UnitedHealthcare was 26%29% and 14%13%, respectively, of our revenue for the sixthree months ended June 30, 2017,March 31, 2018, compared with 30%26% and 12%13%, respectively, for the sixthree months ended June 30, 2016.March 31, 2017. The percentage of our revenue derived from significant payers is expected to fluctuate from period to period as our revenue increases,fluctuates, as additional payers provide reimbursement for our tests or if one or more payers were to stop reimbursing for our tests or change their reimbursed amounts. Effective January 2012, Palmetto GBA, the regional Medicare administrative contractor,Administrative Contractor, or MAC, that handled claims processing for Medicare services withover our jurisdiction at that time, issued coverage and payment determinations for the Afirma Gene Expression Classifier, or GEC. Afirma GSC is now covered by Noridian Healthcare Solutions, the current MAC for our jurisdiction, through the Molecular Diagnostics Services Program, or MolDX program, administered by Palmetto GBA, under a Local Coverage Determination, or LCD.

On a five-year rotational basis, Medicare requests bids for its regional MAC services. Any future changes in the MAC processing or coding for Medicare claims for the Afirma GECclassifier or Afirma GSCPercepta could result in a change in the coverage or reimbursement rates for such products, or the loss of coverage.

On March 1, 2015, a separate CPT code, oran American Medical Association Current Procedural Terminology code, or CPT code, 81545 for the Afirma GEC was issued. In November 2016, The Centers forOn January 1, 2018, the Medicare & Medicaid Services, or CMS, revised its final 2017 gapfillClinical Laboratory Fee Schedule payment rate for the Afirma GECclassifier increased from $3,220 to $3,600. This rate is based on the volume-weighted median of private payer rates based on final payments made between January 1 and determinedJune 30, 2016, which we reported to CMS in 2017 as required under the Protecting Access to Medicare Act of 2014, or PAMA. This payment rate will be effective through December 31, 2020. There can be no assurance that the rate of $3,200 per test would be maintained in 2017. Awill not decrease in the future following the next reporting period under PAMA.

We submit claims to Medicare for Percepta using an unlisted code and were paid at the rate of $3,220 in 2017 under the MolDX program. A specific CPT code assigned to Percepta may be required to go through the national payment determination process, and there can be no assurance that the Medicare payment rate the test receives through this process will not be lower than the current payment rate for Percepta. There can also be no assurance that the Medicare payment rate for Percepta will not be reduced when it is set based on volume-weighted median of private payer rates after the next reporting period under PAMA.

If there is a decrease in the Medicare payment rate for our tests, will decrease our revenue from Medicare will decrease and may also decrease the payment rates for some of our commercial payers may also decrease if they tie their allowable rates to the Medicare rate, whichrate. These changes could have an adverse effect on our business, financial condition and results of operations.

Although we have entered into contracts with certain third-party payers that establish in-network allowable rates of reimbursement for our Afirma tests, payers may suspend or discontinue reimbursement at any time, may require or increase co-payments from patients, or may reduce the reimbursement rates paid to us. Reductions in private payer amounts could decrease the Medicare payment rates for our tests under PAMA. Any such actions could have a negative effect on our revenue.

Physicians might not order our tests unless payers reimburse a substantial portion of the test price. There is significant uncertainty concerning third-party reimbursement of any test incorporating new technology, including our tests. Reimbursement by a payer may depend on a number of factors, including a payer’s determination that these tests are:

Since each payer makes its own decision as to whether to establish a coverage policy or enter into a contract to reimburse our tests, seeking these approvals is a time-consuming and costly process.

 

We do not have a contracted rate of reimbursement with many payers for the Afirma or Percepta tests, and we do not have any contracted reimbursement with any payers with respect to the Envisia test. Without a contracted rate for reimbursement,

our claims are often denied upon submission, and we must appeal the claims. The appeals process is time consuming and expensive, and may not result in payment. In cases where there is no contracted rate for reimbursement, there is typically a greater patient co-insurance or co-payment requirement which may result in further delay or decreased likelihood of collection. Payers may attempt to recoup prior payments after review, sometimes after significant time has passed, which would impact future revenue.

 

We expect to continue to focus substantial resources on increasing adoption, coverage and reimbursement for the Afirma classifiers, the Percepta classifier launched in April 2015, and the Envisia classifier launched in October 2016, as well as any other future tests we may develop. We believe it will take several years to achieve coverage and contracted reimbursement with a majority of third-party payers. However, we cannot predict whether, under what circumstances, or at what payment levels payers will reimburse for our tests. Also, payer consolidation is underway and creates uncertainty as to whether coverage and contracts with existing payers will remain in effect. Finally, if there is a decrease in the Medicare payment rate for our tests, the payment rates for some of our commercial payers may also decrease if they tie their allowable rates to the Medicare rate. Reductions in private payer amounts could decrease the Medicare payment rates and should Medicare reduce their rates as they did with the Afirma test in September 2016, we may be negatively impacted.for our tests under PAMA. Our failure to establish broad adoption of and reimbursement for our tests, or our inability to maintain existing reimbursement from payers, will negatively impact our ability to generate revenue and achieve profitability, as well as our future prospects and our business.

If we are unable to create or maintain demand for our tests in sufficient volume, we may not become profitable. To generate demand, we will need to continue to educate physicians about the benefits and cost-effectiveness of our tests through published papers, presentations at scientific conferences, marketing campaigns and one-on-one education by our sales force. In addition, our ability to obtain and maintain adequate reimbursement from third-party payers will be critical to generating revenue.

The Afirma genomic classifier is included in most physician practice guidelines in the United States for the assessment of patients with thyroid nodules. However, historical practice recommended a full or partial thyroidectomy in cases where cytopathology results were indeterminate to confirm a diagnosis. Our lung products are not yet integrated into practice guidelines and physicians may be reluctant to order tests that are not recommended in these guidelines. Because our diagnostic services are performed by our certified laboratory under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, rather than by the local laboratory or pathology practice, pathologists may be reluctant to support our testing services as well. Guidelines that include our classifiers currently may subsequently be revised to recommend another testing protocol, and these changes may result in physicians deciding not to use our tests. Lack of guideline inclusion could limit the adoption of our tests and our ability to generate revenue and achieve profitability. To the extent international markets have existing practices and standards of care that are different than those in the United States, we may face challenges with the adoption of our tests in international markets.

For tests performed where we have an agreed upon reimbursement rate or we are able to reasonably estimate the amount that will ultimately be realized at the time delivery of a patient report is complete, such as in the case of Medicare and certain other payers, weWe recognize the relatedtest revenue upon delivery of the patient report to the prescribing physician based on the amount we expect to ultimately realize. We determine the amount we expect to ultimately realize based on a per payer per contract or agreement basis. In the first period in which revenue is accrued for a particular payer, a one-time increase in revenue generally occurs.reimbursement history, contracts, and coverage. Upon ultimate collection, the amount received from Medicare and other payers where reimbursement was estimated is compared to previousthe estimates and the amount accrued is adjusted accordingly. In situations where we cannot reasonably estimate the amount that will ultimately be collected, we recognize revenue on the cash basis. We cannot be certain as to when we will receive payment for our diagnostic tests, and we must appeal negative payment decisions, which delays collections. Should we recognize revenue from payers on an accrual basis and later determine the judgments underlying estimated reimbursement change, or were incorrect at the time we accrued such revenue, our financial results could be negatively impacted in future quarters. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. In addition, these fluctuations in revenue may make it difficult for us, for research analysts and for investors to 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 rely on sole suppliers for critical supply of reagents, equipment, chips and other materials that we use to perform our tests. We also purchase components used in our collection kits from sole-source suppliers. Some of these items are unique to these suppliers and vendors. In addition, we utilize a sole source to assemble and distribute our sample collection kits. 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 to perform the tests and for our collection kits, 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 test processing could occur, we may not be able to deliver patient reports 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 test volume decreases or we switch suppliers, we may hold excess inventory with expiration dates that occur before use which would adversely affect our losses and cash flow position. As we introduce any new test, we may experience supply issues as we ramp test volume.

We rely on Thyroid Cytopathology Partners, P.A., or TCP to provide cytopathology professional diagnoses on thyroid fine needle aspiration, or FNA, samples pursuant to a pathology services agreement. Pursuant to this agreement, TCP has the exclusive right to provide the cytopathology diagnoses on FNA samples at a fixed price per test. We have also agreed to allow TCP to co-locate in a portion of our facilities in Austin, Texas. Our agreement with TCP wasis effective through DecemberOctober 31, 20152022, and thereafter automatically renews every year thereafter unless either party provides notice of intent not to renew at least 12 months prior to the end of the then-current term.

 

If TCP were not able to support our current test volume or future increases in test volume or to provide the quality of services we require, or if we were unable to agree on commercial terms and our relationship with TCP were to terminate, our business would be harmed until we were able to secure the services of another cytopathology provider. There can be no assurance

As demand for our tests grows, we will need to continue to scale our testing capacity and processing technology, expand customer service, billing and systems processes and enhance our internal quality assurance program. We will also need additional certified laboratory scientists and other scientific and technical personnel to process higher volumes of our tests. We cannot assure you that any increases in scale, related improvements and quality assurance will be successfully implemented or that appropriate personnel will be available. Failure to implement necessary procedures, transition to new processes or hire the necessary personnel could result in higher costs of processing tests, quality control issues or inability to meet demand. There can be no assurance that we will be able to perform our testing on a timely basis at a level consistent with demand, or that our efforts to scale our operations will not negatively affect the quality of test results. If we encounter difficulty meeting market demand or quality standards, our reputation could be harmed and our future prospects and our business could suffer.

The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act, collectively the ACA, enacted in March 2010, made changes that significantly affected the pharmaceutical and medical device industries and clinical laboratories. Effective January 1, 2013, the ACA included a 2.3% excise tax on the sale of certain medical devices sold outside of the retail setting. Although a moratorium has been imposed on this excise tax for 2016 and 2017,through 2019, the excise tax is scheduled to be restored in 2018.2020.

Other significant measures contained in the ACA include, for example, coordination and promotion of research on comparative clinical effectiveness of different technologies and procedures, initiatives to revise Medicare payment methodologies, such as bundling of payments across the continuum of care by providers and physicians, and initiatives to promote quality indicators in payment methodologies. The ACA also includes significant new fraud and abuse measures, including required disclosures of financial arrangements with physician customers, lower thresholds for violations and increasing potential penalties for such violations. In addition, the ACA establishes an Independent Payment Advisory Board, or IPAB, to reduce the per capita rate of growth in Medicare spending. The IPAB has broad discretion to propose policies to reduce expenditures, which may have a negative effect on payment rates for services. The IPAB proposals could have affected payments for clinical laboratory services beginning in 2016 and may affect those for hospital services beginning in 2020. We are monitoring the effect of the ACA to determine the trends and changes that may be necessitated by the legislation, any of which may potentially affect our business.

 

In the beginning of 2017, the U.S. Congress and the Administration took actions to repeal the ACA and indicated an intent to replace it with another act and efforts to repeal or amend the ACA are ongoing. We cannot predict if, or when, the ACA will be repealed or amended, and cannot quantifypredict the effectimpact that an amendment or repeal of new legislationthe ACA will have on our business.

In addition to the ACA, various healthcare reform proposals have also periodically emerged from federal and state governments. For example, in February 2012, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012, which in part reset the clinical laboratory payment rates on the Medicare Clinical Laboratory Fee Schedule, or CLFS, by 2% in 2013. In addition, under the Budget Control Act of 2011, which is effective for dates of service on or after April 1, 2013, Medicare payments, including payments to clinical laboratories, are subject to a reduction of 2% due to the automatic expense reductions (sequester) until fiscal year 2024. Reductions resulting from the Congressional sequester are applied to total claims payment made; however, they do not currently result in a rebasing of the negotiated or established Medicare or Medicaid reimbursement rates.

State legislation on reimbursement applies to Medicaid reimbursement and managed Medicaid reimbursement rates within that state. Some states have passed or proposed legislation that would revise reimbursement methodology for clinical laboratory payment rates under those Medicaid programs. For example, effective July 2015, California’s Department of Health Care Services implemented a new rate methodology for clinical laboratories and laboratory services. This methodology involves the use of a range of rates that fell between zero and 80% of the calculated California Medicare rate and the calculation of a weighted average (based on units billed) of such rates.

We cannot predict whether future healthcare initiatives will be implemented at the federal or state level or in countries outside of the United States in which we may do business, or the effect any future legislation or regulation will have on us. The taxes imposed by the new federal legislation, cost reduction measures and the expansion in the role of the U.S. government in the healthcare industry may result in decreased revenue, lower reimbursement by payers for our tests or reduced medical procedure volumes, all of which may adversely affect our business, financial condition and results of operations. In addition, sales of our

tests outside the United States subject our business to foreign regulatory requirements and cost-reduction measures, which may also change over time.

 

Ongoing calls for deficit reduction at the federal government level and reforms to programs such as the Medicare program to pay for such reductions may affect the pharmaceutical, medical device and clinical laboratory industries. Currently, clinical laboratory services are excluded from the Medicare Part B co-insurance and co-payment as preventative services. Any requirement for clinical laboratories to collect co-payments from patients may increase our costs and reduce the amount ultimately collected.

 

CMS announced plans to bundlebundles payments for clinical laboratory diagnostic tests together with other services performed during hospital outpatient visits under the Hospital Outpatient Prospective Payment System. For calendar year 2016, CMS maintainedcurrently maintains an exemption for molecular pathology tests from this bundling provision. It is possible that this exemption could be removed by CMS in future rule making, which might result in lower reimbursement for tests performed in this setting.

The Protecting Access to Medicare Act of 2014, or PAMA includes a substantial new payment system for clinical laboratory tests under the CLFS. Under PAMA, laboratories that receive the majority of their Medicare revenues from payments made under the CLFS and the Physician Fee Schedule would report initially and then on a subsequent three year basis thereaftertriennial bases (or annually for advanced diagnostic laboratory tests, or ADLTs), private payer payment rates and volumes for their tests. Thetests with specific CPT codes based final PAMA rulingpayments made during a set data collection period (the first of which was issued June 17, 2016 indicating that data for reporting for the new PAMA process will begin in 2017 and the new market based rates will take effect January 1 2018.through June 30, 2016). We submittedbelieve that PAMA and its implementing regulations are generally favorable to us. We reported to CMS the Afirma genomic classifier data required under PAMA before the March 31, 2017 deadline. We believeThe new payment rate for the Afirma genomic classifier based on the volume-weighted median of private payer rates took effect January 1, 2018, increasing from $3,220 to $3,600 through December 31, 2020. There can be no assurance that the finalpayment rate for Afirma will not decrease in the future or that the payment rates for Percepta or Envisia will not be adversely affected by the PAMA regulations are generally favorable to us. The private payer rate will be calculated based on claims whose adjudication is finallaw and will include patient deductible and co-insurance amounts.  Additionally, weregulations.