Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 September 30, 2018
OR
o
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: 001-38683
_____________________
GUARDANT HEALTH, INC.
(Exact Name of Registrant as Specified in its Charter)
_____________________
Delaware
 
45-4139254
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
505 Penobscot Dr.
Redwood City, California
 
94063
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (855) 698-8887
_____________________
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  o    No  x
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  o
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
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
x  (Do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
 
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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
As of November 16, 2018, the registrant had 85,754,101 shares of common stock, $0.00001 par value per share, outstanding.
 




GUARDANT HEALTH, INC.
FORM 10-Q
TABLE OF CONTENTS
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 




Table of Contents

PART I—FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Guardant Health, Inc.
Condensed Consolidated Balance Sheets (unaudited)
(in thousands, except share and per share data)
 
September 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
113,957

 
$
72,280

Short-term marketable securities
157,385

 
149,040

Accounts receivable
14,640

 
12,787

Inventory
7,075

 
7,287

Prepaid expenses and other current assets
4,024

 
1,541

Total current assets
297,081

 
242,935

Long-term marketable securities
2,963

 
73,254

Property and equipment, net
30,318

 
16,036

Capitalized license fees
8,044

 
8,739

Deferred offering costs
4,257

 

Other assets
1,936

 
1,974

Total Assets
$
344,599

 
$
342,938

LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
13,081

 
$
4,998

Accrued compensation
7,430

 
4,911

Accrued expenses
7,482

 
6,406

Capital lease, current
102

 
199

Deferred revenue
3,955

 
3,113

Total current liabilities
32,050

 
19,627

Capital lease, net of current portion
137

 
460

Deferred rent, net of current portion
7,623

 
6,537

Obligation related to royalty
7,446

 
7,708

Other long-term liabilities
206

 

Total Liabilities
47,462

 
34,332

Commitments and contingencies (Note 8)


 


Redeemable noncontrolling interest
41,950

 





Stockholders’ equity:
 
 
 
Convertible preferred stock, par value of $0.00001 per share; 80,104,464 shares authorized as of September 30, 2018 and December 31, 2017; 78,627,369 shares issued and outstanding as of September 30, 2018 and December 31, 2017 with aggregate liquidation preference of $501,410 as of September 30, 2018
499,974

 
499,974

Common stock, par value of $0.00001 per share; 111,853,396 shares authorized as of September 30, 2018 and December 31, 2017; 13,002,822 and 11,896,882 shares issued and outstanding as of September 30, 2018 and December 31, 2017

 

Additional paid-in capital
11,421

 
4,900

Accumulated other comprehensive loss
(531
)
 
(532
)
Accumulated deficit
(255,677
)
 
(195,736
)
Total Stockholders’ Equity
255,187

 
308,606

Total Liabilities, Redeemable Noncontrolling Interest and Stockholders’ Equity
$
344,599

 
$
342,938

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



Table of Contents

Guardant Health, Inc.
Condensed Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Precision oncology testing
$
18,298

 
$
10,253

 
$
50,311

 
$
27,927

Development services
3,394

 
879

 
7,455

 
1,913

Total revenue
21,692

 
11,132

 
57,766

 
29,840

Costs and operating expenses:
 
 
 
 
 
 
 
Cost of precision oncology testing
9,671

 
7,603

 
27,222

 
20,928

Cost of development services
380

 
1,058

 
2,041

 
1,542

Research and development expense
14,253

 
7,246

 
34,062

 
17,442

Sales and marketing expense
13,464

 
7,808

 
36,351

 
22,941

General and administrative expense
8,129

 
16,095

 
23,645

 
27,982

Total costs and operating expenses
45,897

 
39,810

 
123,321

 
90,835

Loss from operations
(24,205
)
 
(28,678
)
 
(65,555
)
 
(60,995
)
Interest income
958

 
657

 
2,932

 
1,222

Interest expense
(304
)
 
(303
)
 
(952
)
 
(2,398
)
Loss on debt extinguishment

 

 

 
(5,075
)
Other income (expense), net
43

 
(266
)
 
4,587

 
(915
)
Loss before provision for income taxes
(23,508
)
 
(28,590
)
 
(58,988
)
 
(68,161
)
Provision for income taxes

 

 
3

 

Net loss
(23,508
)
 
(28,590
)
 
(58,991
)
 
(68,161
)
Fair value adjustment of redeemable noncontrolling interest
(950
)
 

 
(950
)
 

Net loss attributable to Guardant Health, Inc.
$
(24,458
)
 
$
(28,590
)
 
$
(59,941
)
 
$
(68,161
)
Deemed dividend related to repurchase of Series A convertible preferred stock

 
(4,716
)
 

 
(4,716
)
Deemed dividend related to change in conversion rate of Series D convertible preferred stock

 

 

 
(1,058
)
Net loss attributable to Guardant Health, Inc. common stockholders
$
(24,458
)
 
$
(33,306
)
 
$
(59,941
)
 
$
(73,935
)
Net loss per share attributable to Guardant Health, Inc. common stockholders, basic and diluted
$
(1.94
)
 
$
(2.76
)
 
$
(4.87
)
 
$
(5.76
)
Weighted-average shares used in computing net loss per share attributable to Guardant Health, Inc. common stockholders, basic and diluted
12,582

 
12,073

 
12,300

 
12,831

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



Table of Contents

Guardant Health, Inc.
Condensed Consolidated Statements of Comprehensive Loss (unaudited)
(in thousands)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Net loss
$
(23,508
)
 
$
(28,590
)
 
$
(58,991
)
 
$
(68,161
)
Other comprehensive loss, net of tax impact:
 
 
 
 
 
 
 
Unrealized loss on available-for-sale securities
188
 
6
 
28
 
(55
)
Foreign currency translation adjustments
(27)
 

 
(27)
 

Other comprehensive loss
161

 
6

 
1
 
(55)
Comprehensive loss
$
(23,347
)
 
$
(28,584
)
 
$
(58,990
)
 
$
(68,216
)
Comprehensive loss attributable to redeemable noncontrolling interest
(950
)
 

 
(950
)
 

Comprehensive loss attributable to Guardant Health, Inc.
$
(24,297
)
 
$
(28,584
)
 
$
(59,940
)
 
$
(68,216
)
The accompanying notes are an integral part of these condensed consolidated financial statements.



Table of Contents

Guardant Health, Inc.
Condensed Consolidated Statements of Cash Flows (unaudited)
(in thousands)
 
Nine Months Ended September 30,
 
2018
 
2017
 
 
 
 
OPERATING ACTIVITIES:
 
Net loss
$
(58,991
)
 
$
(68,161
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
4,967

 
3,814

Unrealized translation losses on obligation related to royalty
(251
)
 
854

Non-cash stock-based compensation
4,288

 
2,098

Non-cash interest expense
(10
)
 
573

Loss on debt extinguishment

 
5,075

Amortization of premium or discounts on marketable securities
41

 
329

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(1,853
)
 
(3,849
)
Inventory
212

 
(2,620
)
Prepaid expenses and other current assets
(2,483
)
 
(247
)
Other assets
97

 
(22
)
Accounts payable
3,348

 
3,289

Accrued compensation
2,519

 
1,240

Accrued expenses and other current liabilities
541

 
1,807

Deferred rent
1,086

 
(456
)
Deferred revenue
842

 
2,030

Net cash used in operating activities
(45,647
)
 
(54,246
)
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
Purchase of marketable securities
(48,693
)
 
(119,714
)
Maturity of marketable securities
110,625

 
49,944

Purchase of property and equipment
(17,272
)
 
(3,719
)
Payment in connection with a license agreement

 
(1,102
)
Net cash provided by (used in) investing activities
44,660

 
(74,591
)
 
 
 
 
FINANCING ACTIVITIES:
 
 
 
Payment related to settlement of debt and buyout of royalty obligations

 
(25,844
)
Payments made on capital lease obligations
(420
)
 
(199
)
Proceeds from issuance of convertible preferred stock, net of issuance costs

 
319,536

Proceeds from issuance of common stock upon exercise of stock options
2,572

 
669

Proceeds from issuance of common stock upon the exercise of warrants
38

 
7

Repurchase of convertible preferred stock

 
(5,335
)
Repurchase of common stock
(172
)
 
(7,222
)
Payment of offering costs related to initial public offering
(221
)
 

Net proceeds from issuance of equity interests in redeemable noncontrolling interest
41,000

 

Net cash provided by financing activities
42,797

 
281,612

Net effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash
(27
)
 

Net increase in cash, cash equivalents and restricted cash
41,783

 
152,775


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Table of Contents

Cash, cash equivalents and restricted cash - Beginning of period
72,596

 
33,591

Cash, cash equivalents and restricted cash - End of period
$
114,379

 
$
186,366

Supplemental Disclosures of Cash Flow Information:
 
 
 
Cash paid for interest
$
67

 
$
1,318

Cash paid for income taxes
$

 
$
26

Supplemental Disclosures of Noncash Investing and Financing Activities:
 
 
 
Capitalized license fees financed through future royalty payment
$

 
$
6,302

Issuance of Series D convertible preferred stock in exchange for a technology license agreement
$

 
$
1,060

Increase in purchases of property and equipment included in accounts payable and accrued expenses
$
1,234

 
$
2,243

Purchases of capitalized license fee included in accrued expenses
$

 
$
1,200

Vesting of common stock exercised early
$

 
$
36

Property and equipment acquired under capital leases
$

 
$
346

Deferred offering costs included in accounts payable and accrued expenses
$
4,036

 
$

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

8

Table of Contents

 Guardant Health, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
1.
Description of Business
Guardant Health, Inc. (the “Company”) is a leading precision oncology company focused on helping conquer cancer globally through use of its proprietary blood tests, vast data sets and advanced analytics. The key to conquering cancer is unprecedented access to its molecular information throughout all stages of the disease, which it enables by a routine blood draw, or liquid biopsy. The Guardant Health Oncology Platform is designed to leverage the Company’s capabilities in technology, clinical development, regulatory, reimbursement and commercial adoption to improve patient clinical outcomes, lower healthcare costs and accelerate biopharmaceutical drug development. In pursuit of its goal to manage cancer across all stages of the disease, it has launched multiple liquid biopsy-based tests, Guardant360 and GuardantOMNI for advanced stage cancer patients, which fuel its development programs for recurrence and early detection, LUNAR-1 and LUNAR-2, respectively. Guardant360, which the Company launched in 2014, has been used by oncologists, biopharmaceutical companies and National Comprehensive Cancer Network cancer centers. GuardantOMNI, a purpose-built comprehensive genomic profiling tool to enable the Company’s biopharmaceutical customers to accelerate clinical development programs in both the immuno-oncology and targeted therapy areas, was launched in 2017.
The Company was incorporated in Delaware in December 2011 and is headquartered in Redwood City, California. In April 2018, the Company established Guardant Health AMEA, Inc. (the “Joint Venture”) in the United States with an entity affiliated with SoftBank. Under the terms of the joint venture agreement, the Company held a 50% ownership interest in the Joint Venture. As of September 30, 2018, the Joint Venture has branch offices in Singapore and Japan (see Note 3).
Approval of Amended and Restated Certificate of Incorporation
In September 2018, the Company’s Board of Directors and its stockholders approved a 0.7378-for-one reverse stock split of the Company’s common stock. The reverse stock split became effective on September 19, 2018. The par value of the common stock was not adjusted as a result of the reverse stock split. Adjustments corresponding to the reverse stock split were made to the ratio at which the convertible preferred stock was convertible into common stock immediately prior to the closing of the IPO. All share and per share amounts in the financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to this reverse split.
Initial Public Offering
On October 3, 2018, the Company completed its initial public offering (the “IPO”) in which it issued and sold 14,375,000 shares of its common stock at a public offering price of $19.00 per share. The Company received net proceeds of $249.5 million after deducting underwriting discounts and commissions and offering expenses. All outstanding common stock warrants were exercised prior to the completion of the IPO. In addition, in connection with the IPO, all shares of the Company’s then-outstanding convertible preferred stock were automatically converted into 58,264,577 shares of its common stock at their respective conversion ratios, and all shares of the Company's then-outstanding warrants to purchase preferred stock were automatically converted into warrants to purchase 7,636 shares of its common stock.
2.
Summary of Significant Accounting Policies
Basis of Presentation
The Company’s condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying condensed consolidated financial statements include the accounts of Guardant Health, Inc. and its consolidated Joint Venture. Other stockholders’ interests in the Joint Venture are shown in the condensed consolidated financial statements as redeemable noncontrolling interests. All significant intercompany balances and transactions have been eliminated in consolidation.

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Table of Contents

The Company believes that its existing cash and cash equivalents and marketable securities as of September 30, 2018 will be sufficient to allow the Company to fund its current operating plan through at least a period of one year after the date the condensed consolidated financial statements are issued. As the Company continues to incur losses, its transition to profitability is dependent upon a level of revenues adequate to support the Company’s cost structure. If the Company’s transition to profitability is not consistent with its current operating plan, the Company may have to seek additional capital.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the related disclosures at the date of the condensed consolidated financial statements, as well as the reported amounts of revenues and expenses during the periods presented. The Company bases its estimates on historical experience and other market-specific or other relevant assumptions that it believes to be reasonable under the circumstances. Estimates are used in several areas including, but not limited to, best estimate of selling price used in the accounting for multiple-element revenue arrangements, estimation of potential credit losses on accounts receivable, the valuation of inventory, recovery of long-lived assets, stock-based compensation, fair value of common stock and warrants, contingencies, the provision for income taxes, including related reserves, valuation of redeemable noncontrolling interest, among others. These estimates generally involve complex issues and require judgments, involve the analysis of historical results and prediction of future trends, can require extended periods of time to resolve and are subject to change from period to period. Actual results may differ materially from management’s estimates.
Unaudited Interim Condensed Financial Statements
The accompanying condensed consolidated balance sheet as of September 30, 2018, the condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2018 and 2017, and cash flows for the nine months ended September 30, 2018 and 2017, and the related interim condensed consolidated disclosures are unaudited. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Securities Act of 1933, as amended (the “Securities Act”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. These unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring accruals that the Company believes are necessary to fairly state the financial position and the results of the Company’s operations and cash flows for interim periods in accordance with GAAP. Interim-period results are not necessarily indicative of results of operations or cash flows for a full year or any subsequent interim period.
The accompanying condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Registration Statement on Form S-1 declared effective by the SEC on October 3, 2018.
JOBS Act Accounting Election
The Company is an “emerging growth company” within the meaning of the Jumpstart Our Business Act of 2012, or JOBS Act. 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. The Company has elected to use this extended transition period and, as a result, the financial statements may not be comparable to companies that comply with public company effective dates. The Company also intends 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 the Sarbanes-Oxley Act of 2002.

10

Table of Contents

Foreign Currency Translation
The functional currency of the branch offices of the consolidated Joint Venture is the local currency. The assets and liabilities of the subsidiaries are translated into U.S. dollars at exchange rates in effect at each balance sheet date, with the resulting translation adjustments recorded to a separate component of accumulated other comprehensive loss within stockholders’ equity. Income and expense accounts are translated at average exchange rates during the period. Foreign currency transaction gains and losses resulting from transactions denominated in a currency other than the functional currency are recognized in the consolidated statements of operations. For the three and nine months ended September 30, 2018, foreign currency translation adjustment was immaterial as the branch offices of the Company’s consolidated Joint Venture has limited operations.
Cash and Cash Equivalents and Restricted Cash
Cash equivalents consist of highly liquid investments with original maturities at the time of purchase of three months or less. Cash equivalents include bank demand deposits and money market accounts that invest primarily in U.S. government-backed securities and treasuries. Cash equivalents are carried at cost, which approximates their fair value.
Restricted cash consists of deposits related to the Company’s corporate credit card. Restricted cash balance as of September 30, 2018 and December 31, 2017 was $422,000 and $316,000, respectively, which is included in other assets in the accompanying condensed consolidated balance sheets.
The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same amounts shown in the condensed consolidated statements of cash flows:
 
September 30, 2018
 
December 31, 2017
 
(unaudited)
 
 
 
(in thousands)
Cash and cash equivalents
$
113,957

 
$
72,280

Restricted cash
422

 
316

Total cash and cash equivalents and restricted cash
$
114,379

 
$
72,596

Concentration of Risk
The Company is subject to credit risk from its portfolio of cash equivalents held at one commercial bank and investments in marketable securities. The Company limits its exposure to credit losses by investing in money market funds through a U.S. bank with high credit ratings. The Company’s cash may consist of deposits held with banks that may at times exceed federally insured limits, however, its exposure to credit risk in the event of default by the financial institution is limited to the extent of amounts recorded on the condensed consolidated balance sheets. The Company performs evaluations of the relative credit standing of these financial institutions to limit the amount of credit exposure.
The Company also invests in investment‑grade debt instruments and has policy limits for the amount it can invest in any one type of security, except for securities issued or guaranteed by the U.S. government. The goals of the Company’s investment policy, in order of priority, are as follows: safety and preservation of principal and diversification of risk; liquidity of investments sufficient to meet cash flow requirements; and a competitive after‑tax rate of return. Under its investment policy, the Company limits amounts invested in such securities by credit rating, maturity, investment type and issuer, as a result, the Company is not exposed to any significant concentrations of credit risk from these financial instruments.
The Company is also subject to credit risk from its accounts receivable. The majority of the Company’s accounts receivable arises from the provision of precision oncology services in the United States and are primarily with biopharmaceutical companies with high credit ratings. The Company has not experienced any material losses related to receivables from individual customers, or groups of customers. The Company does not require collateral. Accounts receivable are recorded at the invoiced amount and do not bear interest.

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Significant customers are those which represent more than 10% of the Company’s total revenue or accounts receivable balance at each respective condensed consolidated balance sheet date. For each significant customer, revenue as a percentage of revenue and accounts receivable as a percentage of accounts receivable are as follows:
 
Revenue
 
Accounts Receivable
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
September 30, 2018
 
December 31, 2017
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(unaudited)
 
(unaudited)
 
 
Customer A
*

 
16
%
 
10
%
 
15
%
 
*

 
*

Customer B
18
%
 
13
%
 
14
%
 
13
%
 
30
%
 
24
%
Customer C
*

 
*

 
*

 
*

 
*

 
23
%
Customer D
*

 
*

 
*

 
*

 
10
%
 
13
%
*
less than 10%
Accounts Receivable
Accounts receivable represent valid claims against biopharmaceutical companies, research institutes and international distributors. The Company evaluates the collectability of its accounts receivable and provides for an allowance for potential credit losses based on management’s best estimate of the amount of probable credit losses. As of September 30, 2018 and December 31, 2017, the Company had no allowance for doubtful accounts.
Revenue Recognition
The Company derives revenue from the provision of precision oncology testing services provided to its ordering physicians and biopharmaceutical customers, as well as from biopharmaceutical research and development services provided to its biopharmaceutical customers. Precision oncology services include genomic profiling and the delivery of other genomic information derived from the Company’s platform. Development services include the development of new platforms and information solutions, including companion diagnostic development and laboratory services. The Company currently receives payments from commercial third-party payers, certain hospitals and oncology centers and individual patients, as well as biopharmaceutical companies and research institutes.
The Company recognizes revenue when all of the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred; (iii) the fee is fixed or determinable; and (iv) collectability is reasonably assured. Criterion (i) is satisfied when the Company has an arrangement or contract in place. Criterion (ii) is satisfied when the Company delivers a test report corresponding to each sample, without further commercial obligations. Determination of criteria (iii) and (iv) are based on management’s judgments regarding whether the fee is fixed or determinable, and whether the collectability of the fee is reasonably assured. The Company recognizes revenue from the sale of its precision oncology tests for clinical customers, including certain hospitals, cancer centers, other institutions and patients, at the time results of the test are reported to physicians, if criteria (i) through (iv) above are met. The Company recognizes revenue on a cash basis when it cannot conclude that criteria (iii) and (iv) have been met. Most of precision oncology tests requested by clinical customers are sold without a contracted engagement with a third-party payer; therefore, the Company experiences significant variability in collections and does not have sufficient history to establish a predictable pattern of payment. Because the price is not fixed or determinable and collectability is not reasonably assured, the Company recognizes revenue on a cash basis for sales of its liquid biopsy tests to clinical customers where collection depends on a third-party payer or the individual patient. The Company uses judgment in its assessment of whether the fee is fixed or determinable and whether collectability is reasonably assured in determining when to recognize revenue. Accordingly, the Company expects to recognize revenue on a cash basis for these clinical customers until it has sufficient history to reliably estimate payment patterns. In August 2018, the Company received positive coverage decision under Medicare and is in the process of evaluating whether this impacts its assessment of when revenue recognition criteria are satisfied for clinical customers with Medicare coverage. The Company’s precision oncology information services are delivered electronically, and as such there are no shipping or handling fees incurred by the Company or billed to customers.
Revenue from sales of the Company’s tests to biopharmaceutical customers are based on a negotiated price per test or on the basis of an agreement to provide certain testing volume, data access or biopharmaceutical research and development services over a defined period. The Company recognizes revenue upon delivery of the test results, or over the period in which biopharmaceutical research and development services are provided, as appropriate.

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Multiple-element arrangements
The Company performs development services for its biopharmaceutical customers utilizing its precision oncology information platform. Contracts with biopharmaceutical customers are primarily analyzed as multiple-element arrangements given the nature of the service deliverables. For development services performed, the Company is compensated in various ways, including (i) through non-refundable regulatory and other developmental milestone payments; and (ii) through royalty and sales milestone payments. The Company performs development services as part of its normal activities. The Company records these payments as development services revenue in the condensed consolidated statements of operations using a proportional performance model over the period which the unit of accounting is delivered or based on the level of effort expended to date over the total expected effort, whichever is considered the most appropriate measure of performance. For development of new products or services under these arrangements, costs incurred before technological feasibility is assured are included as research and development expenses in the Company’s condensed consolidated statements of operations, while costs incurred thereafter are recorded as cost of development services.
The Company collaborates with pharmaceutical companies in the development and clinical trials of new drugs. As part of these collaborations, the Company provides services related to regulatory filings with the FDA to support companion diagnostic device submissions for the Company’s liquid biopsy panels. Under these collaborations the Company generates revenue from achievement of milestones, as well as provision of on-going support. These collaboration arrangements include no royalty obligations.
For revenue arrangements with multiple deliverables, the Company evaluates each deliverable to determine whether it qualifies as a separate unit of accounting. This determination is based on whether the deliverable has stand-alone value to the customer and whether a general right of return exists. In assessing whether an item has standalone value, the Company considers factors such as the research, development and commercialization capabilities of a third party and the availability of the associated expertise in the general marketplace. In addition, the Company considers whether the other party in the arrangement can use the other deliverables for their intended purpose without the receipt of the remaining elements, whether the value of the deliverable is dependent on the undelivered items and whether there are other vendors that can provide the undelivered elements.
The consideration that is fixed or determinable is then allocated to each separate unit of accounting based on the relative selling price of each deliverable. The Company allocates the arrangement consideration following a hierarchy to determine the relative selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”), and (iii) best estimate of the selling price (“BESP”) if neither VSOE nor TPE is available. The Company typically uses BESP to estimate the selling price, since it generally does not have VSOE or TPE of selling price for its units of accounting under multiple-element arrangements. In developing the BESP for a unit of accounting, the Company considers applicable market conditions and estimated costs. The Company validates the BESP for units of accounting by evaluating whether changes in the key assumptions used to determine the BESP will have a significant effect on the allocation of arrangement consideration between multiple units of accounting. The consideration allocated to each unit of accounting is recognized as the related goods or services are delivered, limited to the consideration that is not contingent upon future deliverables. The Company uses judgment in identifying the deliverables in its arrangements, assessing whether each deliverable is a separate unit of accounting and in determining the best estimate of selling price for certain deliverables. The Company also uses judgment in determining the period over which the deliverables are recognized in certain of its arrangements. Any amounts received that do not meet the criteria for revenue recognition are recorded as deferred revenue until such criteria are met.
The Company performed laboratory installation and maintenance services for one of its customers as part of a multiple-element arrangement entered into in 2017. The Company recognized certain revenue from its construction service deliverables in a multiple-element collaboration arrangement based on the completed-contract method. This method was used as the Company determined that it did not have the basis for estimating performance under the contract. Other construction service deliverables under that contract were recognized under the percentage-of-completion method due to the Company’s ability to make reasonably dependable estimates of the extent of progress toward contract completion. Construction services were completed in March 2018.

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Milestones
The Company recognizes payments that are contingent upon achievement of a substantive milestone in their entirety in the period in which the milestone is achieved. Milestones are defined as events that can only be achieved based on the Company’s performance and there is substantive uncertainty about whether the event will be achieved at the inception of the arrangement. Events that are contingent only on the passage of time or only on counterparty performance are not considered substantive milestones. Further, the amounts received must relate solely to prior performance, be reasonable relative to all of the deliverables and payment terms within the agreement and commensurate with the Company’s performance to achieve the milestone after commencement of the agreement. Any contingent payment that becomes payable upon achievement of events that are not considered substantive milestones are allocated to the units of accounting previously identified at the inception of an arrangement when the contingent payment is received and revenue is recognized based on the revenue recognition criteria for each unit of accounting. Revenue from commercial milestone payments are recorded as revenue upon achievement of the milestone, assuming all other revenue recognition criteria are met.
As of September 30, 2018 and December 31, 2017, the deferred revenue balance was $4.0 million and $3.1 million, respectively, which included $1.0 million and $1.5 million, respectively, related to GuardantOMNI panel collaboration development efforts to be recognized as the Company performs research and development in the future periods.
Costs of Precision Oncology Testing
Cost of precision oncology testing generally consists of cost of materials, direct labor including bonus, benefit and stock-based compensation, equipment and infrastructure expenses associated with processing liquid biopsy test samples (including sample accessioning, library preparation, sequencing, quality control analyses and shipping charges to transport blood samples), freight, curation of test results for physicians and license fees due to third parties. Infrastructure expenses include depreciation of laboratory equipment, rent costs, amortization of leasehold improvements and information technology costs. Costs associated with performing the Company’s tests are recorded as the tests are processed regardless of whether revenue was recognized with respect to that test. Royalties for licensed technology calculated as a percentage of revenues generated using the associated technology are recorded as expense at the time the related revenues are recognized. One-time royalty payments related to signing of license agreements or other milestones, such as issuance of new patents, are amortized to expense over the expected useful life of the patents.
Cost of Development Services
Cost of development service includes costs incurred for the performance of development services requested by the Company’s customers. For development of new products, costs incurred before technological feasibility has been achieved are reported as research and development expenses, while costs incurred thereafter are reported as cost of development services.
Deferred Offering Costs
Deferred offering costs consist of fees and expenses incurred in connection with the anticipated sale of the Company’s common stock in the IPO, including the legal, accounting, printing and other IPO-related costs. Deferred offering costs of $4.3 million are capitalized and classified within noncurrent assets on the condensed consolidated balance sheet as of September 30, 2018. In October 2018, upon completion of the IPO, the Company reclassified these costs into additional paid-in capital as a reduction of the net proceeds received from the IPO. During the nine months ended September 30, 2018, $0.2 million of the deferred offering costs were paid.
Stock‑Based Compensation
Stock‑based compensation related to stock options granted to the Company’s employees is measured at the grant date based on the fair value of the award. The fair value is recognized as expense over the requisite service period, which is generally the vesting period of the respective awards. Starting January 1, 2017, upon adoption of Accounting Standards Update (“ASU”) 2016 -09, Compensation – Stock Compensation (Topic 718), forfeitures are accounted for as they occur. The Company uses the Black‑Scholes option‑pricing model to estimate the fair value of its stock options. The Black-Scholes option-pricing model requires assumptions to be made related to the estimated fair value of the Company’s common stock at the applicable measurement date, expected term of an award, expected volatility, risk-free rate and expected dividend yield.

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The Company accounts for stock options issued to non-employees based on the estimated fair value at the grant date and re-measured at each reporting period using the Black-Scholes option-pricing model. The measurement of stock-based compensation is subject to periodic adjustments as the underlying equity instruments vest, and the resulting change in value, if any, is recognized in the Company’s condensed consolidated statements of operations during the period that the related services are rendered.
Net Loss Per Share Attributable to Common Stockholders
The Company calculates its basic and diluted net loss per share attributable to common stockholders in conformity with the two-class method required for companies with participating securities. The Company considers its convertible preferred stock to be participating securities. In the event a dividend is declared or paid on the Company’s common stock, holders of preferred stock are entitled to a share of such dividend in proportion to the holders of common stock on an as-if converted basis. Under the two-class method, basic net loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Net loss attributable to common stockholders is determined by allocating undistributed earnings between common and preferred stockholders. The diluted net loss per share attributable to common stockholders is computed by giving effect to all potential dilutive common stock equivalents outstanding for the period determined using the treasury stock method. The net loss attributable to common stockholders was not allocated to the preferred stock under the two-class method as the preferred stock does not have a contractual obligation to share in the Company’s losses. For purposes of this calculation, convertible preferred stock, common stock warrants and stock options are considered common stock equivalents but have been excluded from the calculation of diluted net loss per share attributable to common stockholders as their effect is anti-dilutive.
Recent Accounting Pronouncements Not Yet Adopted
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC606”). The new standard is based on the principle that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Since its initial release, the FASB has issued several amendments to the standard, which include clarification of accounting guidance related to identification of performance obligations, intellectual property licenses and principal vs. agent considerations. The new guidance and all subsequent amendments will be effective for the Company beginning on January 1, 2019 and may be applied using either the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. Early adoption is permitted.
The Company identified certain differences in accounting for revenue recognition as a result of developing an adoption plan for ASC 606. For precision oncology testing revenue, the Company identified a difference in accounting for certain revenue arrangements from the application of the new revenue accounting standard as compared to the previous revenue accounting standards. Historically, for certain clinical customers, the Company deferred revenue recognition until cash receipt when the price pursuant to the underlying customer arrangement was not fixed and determinable and collectability was not reasonably assured. Under the new standard, this is considered variable consideration. For these arrangements, the Company will record an estimate of the transaction price, subject to the constraint in the new standard for variable consideration, as revenue at the time of delivery. This estimate will be monitored in subsequent periods and adjusted as necessary based on actual collection experience. This will result in earlier revenue recognition as compared to previous revenue recognition. The Company is still in the process of quantifying the impact of new guidance on its condensed consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new standard requires lessees to recognize most leases on their balance sheets as lease liabilities with corresponding right-of-use assets and eliminates certain real estate-specific provisions. The new guidance will be effective for the Company beginning in 2020, at which time, the new guidance will be adopted on a modified retrospective transition basis for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements. The Company is currently evaluating the impact of new guidance on its condensed consolidated financial statements and anticipates the recognition of additional assets and corresponding liabilities on its condensed consolidated balance sheet related to leases. The adoption of the standard is also expected to materially impact the Company’s condensed consolidated financial statement disclosures related to leases.

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In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which amends the impairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables and available for sale debt securities. The new guidance is effective for the Company beginning in 2021, with early adoption permitted. The Company is currently evaluating the impact of the new guidance on its condensed consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The new guidance is effective for the Company beginning in 2019, with early adoption permitted. The Company is currently evaluating the impact of the new guidance on its condensed consolidated financial statements.
On December 22, 2017, the U.S. federal government enacted the Tax Cuts and Jobs Act (“the Tax Act”). The Tax Act contains, among other things, significant changes to corporate taxation, including reduction of the corporate tax rate from a top marginal rate of 35% to a flat rate of 21% for tax years beginning after December 31, 2017, limitation of the deduction for net operating losses to 80% of current year taxable income and elimination of net operating loss carrybacks, implementing a territorial tax system, and requiring a mandatory one-time tax on U.S. owned undistributed foreign earnings and profits known as the transition tax. In December 2017, SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”) to address the accounting implications of recently enacted U.S. federal tax reform. SAB 118 allows companies to record provisional amounts during a measurement period not to extend beyond one year of the enactment date to address ongoing guidance and tax interpretations that are expected over the next 12 months. The Company has adopted SAB 118 and currently considers its accounting of the impact of U.S. federal tax reform to be incomplete but continues to make a reasonable estimate of the effects on our existing deferred tax assets. The Company expects to complete the remainder of the analysis within the measurement period in accordance with SAB 118. Adjustments, if any, are not expected to impact the statement of operations due to the full valuation allowance on the Company’s deferred tax assets.
3.
Investment in Joint Venture
Variable Interest Entity (“VIE”)
In connection with SoftBank’s purchase of its Series E convertible preferred stock, the Company entered into a joint venture agreement with an entity affiliated with SoftBank, a related party. In May 2018, the Company and SoftBank formed and capitalized Guardant Health AMEA, Inc. (the “Joint Venture”) for the sale, marketing and distribution of the Company’s tests in all areas worldwide, outside of North America, Central America, South America, the United Kingdom, all other member states of the European Union as of May 2017, Iceland, Norway, Switzerland and Turkey. The Company expects to rely on the Joint Venture to accelerate commercialization of its products in Asia, the Middle East and Africa, with an initial focus on Japan.
Under the terms of the joint venture agreement, the Company paid $9.0 million for 40,000 shares of common stock, or 50% ownership interest, of the Joint Venture, and the affiliate of SoftBank contributed $41.0 million for 40,000 shares of common stock, or the other 50% ownership interest, of the Joint Venture. Neither party has the obligation to provide additional financial support to the Joint Venture. Each party holds two seats on the board of the Joint Venture and has to cast at least one vote for any board resolution of the Joint Venture to pass. The representatives of the Company on the Joint Venture’s board of directors have the right to appoint and remove a chief executive officer and a legal representative for the Joint Venture, in each case, subject to the approval of the full Joint Venture board of directors. The Joint Venture’s board of directors has the right to appoint and remove all other members of the Joint Venture’s senior management reporting to its chief executive officer and to approve the compensation of all foregoing individuals, including the compensation of the chief executive officer and legal representative.
At the inception of the arrangement and at the end of each reporting period, the Company assesses whether the Joint Venture is a variable interest entity (“VIE”), and if so, who is the primary beneficiary of the VIE. As of September 30, 2018, the Company and SoftBank had equal ownership interests and equal voting rights in the Joint Venture, and the Joint Venture’s board consisted of an equal number of directors representing the interest of the Company and SoftBank, respectively. As of September 30, 2018, the Joint Venture’s board had the right to vote on all critical matters that most significantly impact the Joint Venture’s economic performance, except that the Company had the unilateral right to make pricing decisions. As of September 30, 2018, the Company had responsibility for the Joint Venture’s daily operations, while SoftBank served as a financing partner. The Company also entered into various ancillary agreements with the Joint Venture necessary to operate its business. The Joint Venture is deemed to be a VIE and considering the power and benefits criterion, the Company and SoftBank,

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collectively as a related party group, has the characteristics of the primary beneficiary of the Joint Venture as the related party group has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Because the Company is most closely associated with the Joint Venture within the related party group, it has been identified as the VIE’s primary beneficiary. As the primary beneficiary, the Company has consolidated the financial position, results of operations and cash flows of the Joint Venture in its financial statements and all intercompany balances have been eliminated in consolidation. The Company concluded the Joint Venture did not meet the definition of a business upon consolidation as it lacked the processes required to generate outputs. Upon consolidation no liabilities were assumed and other than cash, and any identifiable assets were related to intellectual property rights that the Company transferred to the Joint Venture shortly before it became its primary beneficiary and therefore such transfer was treated as a common control transaction. Upon consolidation, the non-controlling interest of the affiliate of SoftBank was recorded at its estimated fair value of $41.0 million, which is equal to the original investment made by the affiliate of SoftBank.
As of September 30, 2018, the Joint Venture had total assets of approximately $49.5 million, which was primarily comprised of cash and security deposits. Although the Company consolidates the Joint Venture, the legal structure of the Joint Venture limits the recourse that its creditors will have over the Company’s general credit or assets.  Similarly, the assets held in the Joint Venture can be used only to settle obligations of the Joint Venture. As of September 30, 2018, the Company has not provided financial or other support to the Joint Venture that was not previously contracted or required.
Put-call arrangements
The joint venture agreement includes a put-call arrangement with respect to the shares of the Joint Venture held by SoftBank and its affiliates. Under certain specified circumstances and on terms specified in the joint venture agreement, SoftBank will have the right to cause the Company to purchase all shares of the Joint Venture held by SoftBank and its affiliates, or the put right, and the Company will have a similar right to purchase all such shares, or the call right.
If the Company’s business model were to change such that the sale, marketing and distribution of its tests in the territory covered by the joint venture agreement was no longer economical, SoftBank would have the right to cause the Company to purchase, or the Company would have the right to purchase, all of the shares of the Joint Venture held by SoftBank and its affiliates. In this instance, the Company would be required to repurchase the shares at an aggregate purchase price of $41.0 million, the original purchase price paid by SoftBank to the Joint Venture for the shares.
Additionally, both the Company and SoftBank may exercise its respective put-call rights for the Company to purchase all shares of the Joint Venture held by SoftBank in the event of (i) certain material disagreement relating to the Joint Venture or its business that may seriously affect the ability of the Joint Venture to perform its obligations under the joint venture agreement or may otherwise seriously impair the ability of the Joint Venture to conduct its business in an effective matter, other than one relating to the Joint Venture’s business plan or to factual matters that may be capable of expert determination; (ii) the effectiveness of the Company’s initial public offering, a change in control of the Company, the seventh anniversary of the formation of the Joint Venture, or each subsequent anniversary of each of the foregoing events; or (iii) a material breach of the joint venture agreement by the other party that goes unremedied within 20 business days. The purchase price per share of the Joint Venture will be equal to the average closing price of the shares for the 20 trading days ending on the business day immediately preceding the date of the put or call notice, if the shares of the Joint Venture are publicly traded and listed on a national exchange; or determined by a third-party valuation firm on the assumption that the sale is on an arm’s-length basis on the date of the put or call notice. Upon the effectiveness of the Company's IPO on October 3, 2018, the put-call rights for the Company to purchase all shares of the Joint Venture held by SoftBank are exercisable on each subsequent anniversary of the IPO by the Company or SoftBank.
In the event the Company exercises its call right, the fair value of the Joint Venture will be deemed to be no less than an amount that yields a 20% internal rate of return on each tranche of capital invested by SoftBank and its affiliates in the Joint Venture, taking into account all proceeds received by SoftBank and its affiliates arising from their shares through such date.
In the event SoftBank exercises its put right and the fair value of the Joint Venture is determined to be greater than 40% of the fair value of the Company, the Company will only be required to purchase the number of shares of the Joint Venture held by SoftBank and its affiliates having an aggregate value equal to the product of 40% and the pro rata portion of the outstanding shares of the Joint Venture held by SoftBank and its affiliates.

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The Company may pay the purchase price for the shares of the Joint Venture, in its sole discretion, in cash, in shares of its capital stock (which may be a non-voting security with senior preferences to all other classes of its equity or, if its common stock is publicly traded on a national exchange, its common stock), or in a combination thereof.
The noncontrolling interest held by SoftBank contains embedded put-call redemption features that are not solely within the Company’s control and has been classified outside of permanent equity in the condensed consolidated balance sheets. The put-call feature embedded in the redeemable noncontrolling interest do not currently require bifurcation as it does not meet the definition of a derivative and is considered to be clearly and closely related to the redeemable noncontrolling interest. The noncontrolling interest is considered probable of becoming redeemable as SoftBank has the option to exercise its put right to sell its equity ownership in the Joint Venture to the Company on or after the seventh anniversary of the formation of the Joint Venture. The Company elected to recognize the change in redemption value immediately as they occur as if the put-call redemption feature were exercisable at the end of the reporting period. The carrying value of the redeemable noncontrolling interest is first adjusted for the earnings or losses attributable to the redeemable noncontrolling interest based on the percentage of the economic or ownership interest retained in the consolidated VIE by the noncontrolling parties, and then adjusted to equal to its redemption amount, or the fair value of the noncontrolling interest held by SoftBank, as if the redemption were to occur at the end of the reporting date. As of September 30, 2018, the fair value of the noncontrolling interest held by SoftBank approximates $42.0 million, and a fair value adjustment to redeemable noncontrolling interest of $950,000 was recorded in the Company’s condensed consolidated statements of operations during the three and nine months ended September 30, 2018.
4.
Condensed Consolidated Balance Sheet Components
Property and Equipment, Net
Property and equipment, net consist of the following:
 
September 30, 2018
 
December 31, 2017
 
(unaudited)
 
 
 
(in thousands)
Machinery and equipment
$
19,470

 
$
15,676

Computer hardware
4,237

 
1,939

Leasehold improvements
13,888

 
6,766

Furniture and fixtures
1,423

 
1,347

Computer software
656

 
656

Construction in progress
5,413

 
349

Property and equipment, gross
45,087

 
26,733

Less: accumulated depreciation and amortization
(14,769
)
 
(10,697
)
Property and equipment, net
$
30,318

 
$
16,036

Depreciation and amortization expense related to property and equipment was $1.7 million and $1.1 million for the three months ended September 30, 2018 and 2017, and $4.2 million and $3.1 million for the nine months ended September 30, 2018 and 2017, respectively.
As of September 30, 2018 and December 31, 2017, total property and equipment financed under capital leases was $504,000 and $1.1 million, net of accumulated amortization of $265,000 and $349,000, respectively. Amortization expense related to total property and equipment financed under capital leases was $30,000 and $64,000 for the three months ended September 30, 2018 and 2017, and $135,000 and $164,000, for the nine months ended September 30, 2018 and 2017, respectively.

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Accrued Expenses
Accrued expenses consist of the following:
 
September 30, 2018
 
December 31, 2017
 
(unaudited)
 
 
 
(in thousands)
Accrued royalty obligations
$
527

 
$
766

Accrued litigation settlement expense

 
3,000

Accrued legal expenses
1,683

 
561

Accrued tax liabilities
1,142

 
905

Accrued information technology expenses
183

 
316

Accrued professional services
2,205

 
336

Accrued clinical trials and studies
223

 
59

Purchases of property and equipment included in accrued expenses
431

 

Other
1,088

 
463

Total accrued expenses
$
7,482

 
$
6,406

5.
Fair Value Measurements, Cash Equivalents and Marketable Securities
Financial instruments consist of cash equivalents, marketable securities, prepaid expenses and other current assets, accounts payable, accrued expenses and debt. Cash equivalents and marketable securities are stated at fair value. Prepaid expenses and other current assets, accounts payable and accrued expenses are stated at their carrying value, which approximates fair value due to the short time to the expected receipt or payment date.
Fair value is defined as the exchange price that would be received from sale of an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The identification of market participant assumptions provides a basis for determining what inputs are to be used for pricing each asset or liability. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
A fair value hierarchy has been established which gives precedence to fair value measurements calculated using observable inputs over those using unobservable inputs. This hierarchy prioritized the inputs into three broad levels as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

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The Company’s financial assets and liabilities subject to fair value measurements on a recurring basis and the level of inputs used in such measurements were as follows:
 
September 30, 2018
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands)
Financial Assets:
 
 
 
 
 
 
 
Money market funds
$
360

 
$
360

 
$

 
$

Total cash equivalents
360

 
360

 

 

 
 
 
 
 
 
 
 
Corporate bonds
48,365

 

 
48,365

 

U.S. government debt securities
104,044

 

 
104,044

 

U.S. government agency bonds
4,976

 

 
4,976

 

Total short-term marketable securities
157,385

 

 
157,385

 

 
 
 
 
 
 
 
 
U.S. government debt securities
2,963

 

 
2,963

 

Total long-term marketable securities
2,963

 

 
2,963

 

Total
$
160,708

 
$
360

 
$
160,348

 
$

 
December 31, 2017
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
(in thousands)
Financial Assets:
 
 
 
 
 
 
 
Money market funds
$
33,485

 
$
33,485

 
$

 
$

Total cash equivalents
33,485
 
33,485
 

 

 
 
 
 
 
 
 
 
Corporate bonds
48,075
 

 
48,075
 

U.S. government debt securities
100,965
 

 
100,965
 

Total short-term marketable securities
149,040
 

 
149,040
 

 
 
 
 
 
 
 
 
Corporate bonds
6,698
 

 
6,698
 

U.S. government debt securities
66,556
 

 
66,556
 

Total long-term marketable securities
73,254
 

 
73,254
 

Total
$
255,779

 
$
33,485

 
$
222,294

 
$

The Company measures the fair value of money market funds based on quoted prices in active markets for identical securities. Corporate bonds, U.S. government debt securities and U.S. government agency bonds are valued taking into consideration valuations obtained from third-party pricing services. The pricing services utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities, issuer credit spreads; benchmark securities; prepayment/default projections based on historical data; and other observable inputs.
The significant unobservable inputs used in the fair value measurement of the Company’s contingent consideration liability include the estimated amount and timing of projected cash flows, and the risk-adjusted discount rate used to present value the cash flows. The use of different inputs in the valuation of the contingent consideration liability could result in materially different fair value estimates.

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There were no transfers between Level 1, Level 2 and Level 3 during the periods presented.
The Company’s term loan and royalty obligations are measured at fair value on a non-recurring basis. The fair value of the term loan and royalty obligations is estimated based upon the achievement of certain revenue targets over the life of the contract. The fair value of the liability was determined using valuation methodologies such as the discounted cash-flow model, with significant Level 3 inputs that included discount rate, projected revenues and projected royalty payments. The carrying value of the Company’s term loan and royalty obligations approximate its fair value as the stated interest rate approximates market rates. As further disclosed in Note 7, the Company paid off the outstanding principal balance and interest on its term loan and exercised its buyout option of the associated royalty obligation prior to its maturity in June 2017, and recognized loss on debt extinguishment of $5.1 million in the accompanying condensed consolidated statements of operations.
Cash Equivalents and Marketable Securities
The following tables summarizes the Company’s cash equivalents and marketable securities’ amortized costs, gross unrealized gains, gross unrealized losses and estimated fair values by significant investment category:
 
September 30, 2018
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Estimated Fair Value
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands)
Money market fund
$
360

 
$

 
$

 
$
360

Corporate bond
48,434

 
1

 
(70
)
 
48,365

U.S. government debt securities
107,434

 

 
(427
)
 
107,007

U.S. government agency bonds
$
4,984

 
$

 
$
(8
)
 
$
4,976

Total
$
161,212

 
$
1

 
$
(505
)
 
$
160,708

 
December 31, 2017
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Estimated Fair Value
 
 
 
 
 
 
 
 
 
(in thousands)
Money market fund
$
33,485

 
$

 
$

 
$
33,485

Corporate bond
54,879

 

 
(106
)
 
54,773

U.S. government debt securities
167,947

 

 
(426
)
 
167,521

Total
$
256,311

 
$

 
$
(532
)
 
$
255,779

There have been no material realized gains or losses on marketable securities for the periods presented. None of the Company’s investments in marketable securities has been in an unrealized loss position for more than one year. The Company determined that it did have the ability and intent to hold all marketable securities that have been in a continuous loss position until maturity or recovery, thus there has been no recognition of any other-than-temporary impairment in the three or nine months ended September 30, 2018 and 2017. The Company’s long-term marketable securities have a weighted average maturities of 1.0 years as of September 30, 2018.

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6.
Patent License Agreement
In January 2017, the Company entered into a license agreement with a biotechnology company for an exclusive, non-transferable right to use proprietary technology related to high-throughput screening and identification of mutations in targeted gene sequences. The terms of the license agreement included (i) a one-time upfront payment of €1.0 million; (ii) issuance of 141,774 shares of Series D convertible preferred stock; (iii) a milestone payment of €1.0 million associated with the achievement of a specified milestone event; and (iv) future royalty payments at the minimum of €13.4 million in the aggregate based on annual net sales in which the licensed technology are used. The Company made a one-time upfront payment of $1.1 million in January 2017 and a milestone payment of $1.2 million in August 2017 upon achievement of the specified milestone event. The Series D convertible preferred stock issued under the license agreement had a fair value of $1.1 million on the date of issuance. The transaction was treated as an acquisition of an asset and the Company capitalized the upfront payment, milestone payments and fair value of Series D convertible preferred stock in addition to license fees of $6.3 million related to the future minimum royalty payments discounted to the present value. The Company recorded the obligation at the estimated present value of the future payments using a discount rate of 15% (Level 3 input), the Company’s estimate of its effective borrowing rate for similar obligations.
As of September 30, 2018 and December 31, 2017, unamortized capitalized license fees plus one-time upfront and milestone payments totaled $8.0 million and $8.7 million, respectively, which will be amortized over the remaining useful life of 8.3 and 9.0 years, respectively. Amortization of capitalized license fees plus one-time upfront and milestone payments totaled $266,000 and $232,000 for the three months ended September 30, 2018 and 2017, and $694,000 and $674,000 for the nine months ended September 30, 2018 and 2017, respectively.
7.
Senior Term Loan and Royalty Purchase Agreement
In 2015, the Company entered into a credit agreement with a financial institution for a senior term loan (the “Credit Agreement”). The Credit Agreement provided for up to $40.0 million in borrowing capacity. The Company borrowed $20.0 million on the effective date of the Credit Agreement. The Credit Agreement provided for an interest rate equal to the greater of (i) three-month LIBOR or (ii) 1% per annum plus 8.75% on the outstanding balance of the term loan not exceeding $20.0 million.
Concurrent with the Credit Agreement, the Company also entered into a Royalty Purchase Agreement (the “Royalty Agreement”) with the same financial institution, which obligated the Company to make quarterly royalty payments of (i) 1.5% applied to total Company fiscal year revenues of up to $50 million and (ii) 2.45% applied to fiscal year revenues in excess of $50 million. The Royalty Agreement included a buyout option, by which the Company had the right, exercisable in its sole discretion, to buy out the obligation to make future royalty payments. The price of this buyout option was calculated based on a table with axes of principal balance outstanding and time, less the cumulative sum of royalty payments at the time the buy-out option is exercised.
In June 2017, the Company exercised its prepayment right under the Credit Agreement and repaid the outstanding principal balance of $19.8 million and accrued interest of $0.7 million. The prepayment option also required the Company to pay a prepayment penalty of $1.5 million. Concurrent with the early repayment of the senior term loan, the Company also excised its royalty buyout option for $4.5 million. The transaction was accounted for as a debt extinguishment. The net carrying amount of the debt and royalty liabilities immediately before the extinguishment was $20.7 million. As a result, the difference between the reacquisition price and the net carrying amount of $5.1 million was recorded as loss on debt extinguishment in the accompanying condensed consolidated statements of operations.

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8.
Commitments and Contingencies
Operating Leases
As of September 30, 2018, future minimum payments under the non-cancelable operating lease are as follows:
Year Ending December 31,
 
 
(unaudited)
 
(in thousands)
Remainder of 2018
$
911

2019
4,091

2020
5,272

2021
5,358

2022
5,557

2023 and thereafter
21,891

Total
$
43,080

Rent expense for the facility leases was $1.2 million and $243,000 for the three months ended September 30, 2018 and 2017, and $3.4 million and $724,000 for the nine months ended September 30, 2018 and 2017, respectively.
Capital Leases
In September 2016 and April 2017, the Company entered into capital lease arrangements to finance the purchase of manufacturing equipment of $554,000 and $346,000, respectively. Both lease agreements have a contractual term of four years and do not include any bargain purchase option at the end of the lease term. In May 2018, the Company exercised its buyout option for one item of manufacturing equipment financed under a capital lease of $554,000, net of accumulated amortization of $219,000. The buyout resulted in a reduction of the Company’s capital lease obligations by $323,000.
As of September 30, 2018, future minimum capital lease payments are as follows:
Year Ending December 31,
 
 
(unaudited)
 
(in thousands)
Remainder of 2018
$
37

2019
141

2020
108

2021
36

Total minimum capital lease payments
322

Less: amount representing interest
(83
)
Present value of net minimum capital lease payments
239

Less: current installments of obligations under capital lease
(102
)
Obligations under capital lease, excluding current installments
$
137

License Agreements
The Company has patent license agreements with four separate parties. Under these agreements, the Company has made one-time and milestone license fee payments, which it has capitalized and is amortizing to expense ratably over the useful life of the underlying patent(s). Under certain of these agreements, the Company is obligated to pay royalties ranging from 2.5% to 3.0% of future sales in which the patents are used in the product or service sold, subject to minimum annual royalties or fees in certain agreements.

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Royalty expenses were included in cost of precision oncology testing on the accompanying condensed consolidated statements of operations. The Company recognized royalty expenses of $319,000 and $205,000, or 2% and 2% of precision oncology testing revenue in each period, for the three months ended September 30, 2018 and 2017, and $936,000 and $754,000, or 2% and 3% of precision oncology testing revenue in each period, for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, future minimum royalty payments are due as follows regardless of sales amounts:
Year Ending December 31,
 
 
(unaudited)
 
(in thousands)
Remainder of 2018
$
290

2019
1,451

2020
1,451

2021
1,451

2022
1,741

2023 and thereafter
7,545

Total future minimum royalty payments
13,929

Less: amount representing interest
(6,483
)
Present value of future minimum royalty payments
$
7,446

Indemnification Agreements
The Company has entered into indemnification agreements with certain directors and officers that require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. To date, no such matters have arisen and the Company does not believe that the outcome of any claims under indemnification arrangements will have a material adverse effect on its financial positions, results of operations or cash flows. Accordingly, the Company has not recorded a liability related to such indemnifications as of September 30, 2018.
Legal Proceedings
The Company is subject to claims and assessments from time to time in the ordinary course of business. The Company will accrue a liability for such matters when it is probable that a liability has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be established, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. The accrual for a litigation loss contingency might include, for example, estimates of potential damages, outside legal fees and other directly related costs expected to be incurred.
In May 2016, Foundation Medicine, Inc. (“Foundation Medicine”) filed a lawsuit for patent infringement against the Company in the United States District Court for the Eastern District of Texas, alleging that the Company infringed Foundation Medicine’s patent relating to its tissue biopsy assay technology and seeking compensatory damages and attorneys’ fees. The Company filed three petitions for inter partes review (“IPR”) with the Patent Trial and Appeal Board (“PTAB”) at the U.S. Patent Office, challenging the patentability of Foundation Medicine’s patent. In July 2018, the Company reached an agreement with Foundation Medicine to settle the lawsuit and resolve the IPRs. As part of the settlement agreement, which was accepted by the PTAB and the United States District Court, the Company made a one-time payment of $3.0 million to Foundation Medicine. The Company recorded $3.0 million as litigation settlement expense, a component of general and administrative expenses, at December 31, 2017.
In November 2017, the Company filed separate lawsuits against Personal Genome Diagnostics, Inc. (“Personal Genome Diagnostics”) and Foundation Medicine in the United States District Court for the District of Delaware, alleging that each has infringed a patent relating to our Digital Sequencing technology. The Company subsequently amended its original complaints in each case to assert infringement of three additional patents relating to its Digital Sequencing technology. In each lawsuit, the Company is seeking compensatory damages, injunctive relief and attorneys’ fees. In March 2018, Personal Genome Diagnostics filed two petitions for post-grant review with the PTAB, challenging the patentability of two of the asserted patents.
In the first quarter of 2018, the Company settled a commercial legal dispute. In connection with the settlement, the Company received a payment of $4.25 million, which was reported as other income in the condensed consolidated statements of operations for the nine months ended September 30, 2018.

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Table of Contents

9.
Common Stock
Common stockholders are entitled to dividends if and when declared by the Company’s Board of Directors (the “Board of Directors”) subject to the prior rights of the preferred stockholders. As of September 30, 2018 and December 31, 2017, no dividends on common stock had been declared by the Board of Directors.
Common stock has been reserved for the following potential future issuances:
 
September 30, 2018
 
December 31, 2017
 
(unaudited)

 
 
Conversion of outstanding convertible preferred stock
58,264,577

 
58,264,577
Shares underlying outstanding stock options
7,717,070
 
7,391,052
Shares available for future stock option grants
509,584
 
1,698,790
Exercise and conversion of preferred stock warrants
7,636
 
7,636
Exercise of common stock warrants
40,538
 
313,741
Total
66,539,405
 
67,675,796
Repurchase of Common Stock
In April 2018, the Company repurchased 30,451 shares of outstanding common stock from certain employees at $10.80 per share for total consideration of $329,000. These shares were repurchased at a price that exceeded the fair value of the shares. The difference between the repurchase amount and the fair value of these shares were recorded as compensation expense of $157,000.
10.
Warrants
In connection with a bank loan agreement with a financial institution in September 2013, the Company issued warrants to purchase 5,386 shares of Series A convertible preferred stock at an exercise price of $0.93 per share. In October 2014, the Company issued additional warrants to the same financial institution to purchase 4,965 shares of Series B convertible preferred stock at an exercise price of $3.16 per share. Both preferred stock warrants expire in ten years from issuance and are outstanding as of September 30, 2018 and December 31, 2017. These preferred stock warrants were converted to warrants to purchase common stock upon the consummation of IPO in October 2018.
In 2012, the Company issued to investors warrants to purchase 495,775 shares of common stock. The exercise price of the warrants is $0.14 per share and the warrants have a contractual term through September 2023. For the three and nine months ended September 30, 2018, 229,568 and 273,203 shares, respectively, were issued upon the exercise of warrants. For the three and nine months ended September 30, 2017, 49,284 shares were issued upon the exercise of warrants. As of September 30, 2018 and December 31, 2017, warrants to purchase 40,538 and 313,741 shares of common stock, respectively, remained outstanding. These common stock warrants were fully exercised prior to the consummation of IPO in October 2018.
11.
Convertible Preferred Stock
In May 2017, in accordance with the certificate of incorporation then in effect, the Company adjusted the conversion price of Series D convertible preferred stock from $10.1338 per share to $9.8329 per share. The Company accounted for the transaction as a modification. A deemed dividend of $1.1 million, calculated as the additional 253,361 shares of common stock to be received upon the conversion of the Series D convertible preferred stock after the conversion ratio adjustment, multiplied by the then current fair value of the Company’s common stock, was reported as an increase to net loss attributable to common stockholders for the three and nine months ended September 30, 2017.

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Table of Contents

The Company’s convertible preferred stock consisted of the following:
 
September 30, 2018
 
Shares Authorized
 
Shares Issued and Outstanding
 
Aggregate Liquidation Preference
 
Net Carrying Value
 
 
 
 
 
 
 
 
 
(unaudited)
 
 
 
(in thousands)
Series A
9,935,864

 
9,263,558

 
$
8,598

 
$
8,531

Series B
10,320,952

 
10,297,182

 
32,490

 
32,428

Series C
8,873,996

 
8,873,996

 
55,999

 
55,921

Series D
11,222,041

 
11,222,041

 
83,904

 
83,559

Series E
39,751,611

 
38,970,592

 
320,419

 
319,535

Total convertible preferred stock
80,104,464

 
78,627,369

 
$
501,410

 
$
499,974

 
December 31, 2017
 
Shares Authorized
 
Shares Issued and Outstanding
 
Aggregate Liquidation Preference
 
Net Carrying Value
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Series A
9,935,864
 
9,263,558
 
$
8,598

 
$
8,531

Series B
10,320,952
 
10,297,182
 
32,490
 
32,428
Series C
8,873,996
 
8,873,996
 
55,999
 
55,921
Series D
11,222,041
 
11,222,041
 
83,904
 
83,559
Series E
39,751,611
 
38,970,592
 
320,419
 
319,535
Total convertible preferred stock
80,104,464
 
78,627,369
 
$
501,410

 
$
499,974

12.
Stock-Based Compensation
Approval of the 2018 Incentive Award Plan
In September 2018, the Company’s Board of Directors adopted and its stockholders approved the 2018 Incentive Award Plan (the “2018 Plan”), under which the Company may grant cash and equity incentive awards to employees and non-employees. The 2018 Plan becomes effective immediately prior to the completion of the IPO. An aggregate of 3,658,602 shares of common stock are initially available for issuance under awards granted pursuant to the 2018 Plan. The number of shares may be increased in accordance with the terms of the 2018 Plan. Shares issued under the 2018 Plan may be authorized but unissued shares, or shares purchased in the open market or treasury shares. As of September 30, 2018, no shares were issued under the 2018 Plan.
Approval of the 2018 Employee Stock Purchase Plan
In September 2018, the Company’s Board of Directors adopted and its stockholders approved the 2018 Employee Stock Purchase Plan (the “ESPP”). A total of 922,250 shares of common stock are initially reserved for issuance under the ESPP. The number of shares may be increased in accordance with the terms of the ESPP.

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Table of Contents

Stock Option Activity
A summary of the Company’s stock option activity under the 2012 Plan and related information is as follows:
 
 
 
Options Outstanding
 
Shares
Available for Grant 
 
Shares Subject to Options Outstanding
 
Weighted-Average Exercise Price 
 
Weighted-Average Remaining Contractual Life (Years)
 
Aggregate Intrinsic Value
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Balance as of December 31, 2017
1,698,790

 
7,391,052

 
$
3.63

 
8.8
 
$
7,595

Granted
(1,966,069
)
 
1,966,069

 
6.45

 
 
 
 
Exercised

 
(864,418
)
 
2.98

 
 
 
 
Canceled
775,633

 
(775,633
)
 
4.10

 
 
 
 
Repurchase of early exercised shares
1,230

 

 
 
 
 
 
 
Balance as of September 30, 2018
509,584

 
7,717,070

 
$
4.38

 
8.5
 
$
91,809

Vested and Exercisable as of September 30, 2018
 
 
2,797,623

 
$
3.38

 
7.7
 
$
36,085

Aggregate intrinsic value represents the difference between the estimated fair value of the underlying common stock and the exercise price of outstanding, in-the-money options. The total intrinsic value of the options exercised was $2.2 million and $346,000 for the three months ended September 30, 2018 and 2017, and $3.9 million and $594,000 for the nine months ended September 30, 2018 and 2017, respectively.
The weighted-average grant date fair value of options granted was $5.45 and $2.90 per share for the three months ended September 30, 2018 and 2017, and $4.65 and $2.87 per share for the nine months ended September 30, 2018 and 2017, respectively.
Future stock-based compensation for unvested options granted to employees as of September 30, 2018 and December 31, 2017 was $16.1 million and $15.0 million, which is expected to be recognized over a weighted-average period of 2.9 years and 2.9 years, respectively.
Stock‑Based Compensation Expense
The following table presents the effect of employee and non‑employee option-related stock‑based compensation expense:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(in thousands)
Cost of precision oncology testing
$
112

 
$
(25
)
 
$
254

 
$
104

Research and development expense
617

 
17

 
1,035

 
307

Sales and marketing expense
428

 
(526
)
 
1,061

 
14

General and administrative expense
674

 
1,342

 
1,938

 
1,673

Total stock-based compensation expense
$
1,831

 
$
808

 
$
4,288

 
$
2,098


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Table of Contents

Valuation of Stock Options
The grant date fair value of employee stock options was estimated using a Black-Scholes option-pricing model with the following weighted-average assumptions:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Expected term (in years)
5.87 – 6.09
 
6.02 – 6.08
 
5.01 – 6.51
 
6.02 – 6.08
Expected volatility
69.7% – 70.2%
 
74.3% – 75.1%
 
68.7% – 72.5%
 
74.3% – 75.1%
Risk-free interest rate
2.7% – 2.9%
 
2.0% – 2.0%
 
2.5% – 2.9%
 
1.9% – 2.0%
Expected dividend yield
—%
 
—%
 
—%
 
—%
The determination of the fair value of stock options on the date of grant using a Black-Scholes option-pricing model is affected by the estimated fair value of the Company’s common stock, as well as assumptions regarding a number of variables that are complex, subjective and generally require significant judgment to determine. The valuation assumptions were determined as follows:
Fair Value of Common Stock
The grant date fair value of the Company’s common stock has been determined by the Company’s Board of Directors with the assistance of management and an independent third-party valuation specialist. The grant date fair value of the Company’s common stock was determined using valuation methodologies which utilizes certain assumptions including probability weighting of events, volatility, time to liquidation, a risk-free interest rate and an assumption for a discount for lack of marketability (Level 3 inputs). In determining the fair value of the Company’s common stock, the methodologies used to estimate the enterprise value of the Company were performed using methodologies, approaches, and assumptions consistent with the American Institute of Certified Public Accountants Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation.
Expected Term
The expected term represents the period that the options granted are expected to be outstanding and is determined using the simplified method (based on the mid-point between the vesting date and the end of the contractual term) as the Company has concluded that its stock option exercise history does not provide a reasonable basis upon which to estimate expected term.
Expected Volatility
The Company derived the expected volatility from the average historical volatilities over a period approximately equal to the expected term of comparable publicly traded companies within its peer group that were deemed to be representative of future stock price trends as the Company does not have any trading history for its common stock. The Company will continue to apply this process until a sufficient amount of historical information regarding the volatility of its own stock price becomes available.
Risk-Free Interest Rate
The risk-free interest rate is based on the U.S. Treasury rate, with maturities similar to the expected term of the stock options.
Expected Dividend Yield
The Company does not anticipate paying any dividends in the foreseeable future and, therefore, uses an expected dividend yield of zero.

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Table of Contents

Valuation of Stock Option Grants to Non-Employees
Total options outstanding as of September 30, 2018 and December 31, 2017 included 495,867 and 651,801 shares of options, respectively, that were granted to non-employees, of which 16,830 and 18,446 shares were granted during the nine months ended September 30, 2018 and 2017, respectively. Stock-based compensation expense related to stock options granted to non-employees is recognized as the stock option is earned and the services are rendered. The fair value of stock options granted to non-employees was estimated on the date of grant using the Black-Scholes option pricing model. The valuation assumptions used were substantially consistent with the assumption used to value the employee options with the exception of the expected term which was based on the contractual term of the award. The fair value of the stock options granted to non-employees is calculated at each reporting date using the Black-Scholes options-pricing model with the following assumptions:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Expected term (in years)
5.4 – 9.5
 
6.0 – 10.0
 
5.4 – 10.0
 
6.0 – 10.0
Expected volatility
64.9% – 71.5%
 
72.3% – 72.8%
 
64.9% – 71.5%
 
66.3% – 73.4%
Risk-free interest rate
2.8% – 3.1%
 
1.8% – 2.0%
 
2.3% – 3.1%
 
1.8% – 2.1%
Expected dividend yield
—%
 
—%
 
—%
 
—%
Stock-based compensation related to grant of options to non-employees was $434,000 and $69,000 for the three months ended September 30, 2018 and 2017, and $658,000 and $225,000 for the nine months ended September 30, 2018 and 2017, respectively.
Liabilities for Early Exercise of Employee Options
The Company allowed certain stock option holders to exercise unvested options to purchase shares of common stock. Shares received from such early exercises are subject to repurchase in the event of the optionee’s employment termination, at the original issuance price, until the options are fully vested. As of September 30, 2018 and December 31, 2017, 44,268 and 18,600 shares of common stock were subject to repurchase at weighted-average prices of $4.66 and $2.82 per share, respectively. As of September 30, 2018, the cash proceeds received for unvested shares of common stock of $206,000 was recorded within long-term liabilities on the condensed consolidated balance sheet. As of December 31, 2017, the cash proceeds received for unvested shares of common stock recorded within other current and long-term liabilities on the condensed consolidated balance sheet were insignificant. The shares issued pursuant to unvested options have been included in shares issued and outstanding on the condensed consolidated balance sheet and condensed consolidated statement of redeemable noncontrolling interest and stockholders’ equity as such shares are considered legally outstanding.


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Table of Contents

13.
Net Loss Per Share Attributable to Guardant Health, Inc. Common Stockholders
The following table sets forth the computation of the basic and diluted net loss per share attributable to Guardant Health, Inc. common stockholders:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands, except per share data)
Net loss
$
(23,508
)
 
$
(28,590
)
 
$
(58,991
)
 
$
(68,161
)
Fair value adjustment of redeemable noncontrolling interest
(950
)
 

 
(950
)
 

Net loss attributable to Guardant Health, Inc.
(24,458
)
 
(28,590
)
 
(59,941
)
 
(68,161
)
Deemed dividend related to repurchase of Series A convertible preferred stock

 
(4,716
)
 

 
(4,716
)
Deemed dividend related to change in conversion rate of Series D convertible preferred stock

 

 

 
(1,058
)
Net loss attributable to Guardant Health, Inc. common stockholders, basic and diluted
$
(24,458
)
 
$
(33,306
)
 
$
(59,941
)
 
$
(73,935
)
Net loss per share attributable to Guardant Health, Inc. common stockholders, basic and diluted
$
(1.94
)
 
$
(2.76
)
 
$
(4.87
)
 
$
(5.76
)
Weighted-average shares used in computing net loss per share attributable to Guardant Health, Inc. common stockholders, basic and diluted
12,582

 
12,073

 
12,300

 
12,831

Since the Company was in a loss position for all periods presented, basic net loss per share attributable to Guardant Health, Inc. common stockholders is the same as diluted net loss per share attributable to Guardant Health, Inc. common stockholders, as the inclusion of all potential shares of common stock outstanding would have been anti-dilutive. The following weighted-average common stock equivalents were excluded from the calculation of diluted net loss per share attributable to Guardant Health, Inc. common stockholders for the periods presented as they had an anti-dilutive effect:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands)
Convertible preferred stock (on an as if converted basis)
58,265

 
54,757

 
58,265

 
40,286

Stock options issued and outstanding
7,675

 
6,489

 
7,460

 
4,540

Preferred stock warrants (on an as if converted basis)
8

 
8

 
8

 
8

Common stock warrants
203

 
399

 
237

 
402

Common stock subject to repurchase
54

 
26

 
43

 
32

Total
66,205

 
61,679

 
66,013

 
45,268


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Table of Contents

14.
Segment and Geographic Information
The following table sets forth the Company’s revenue by geographic areas based on the customers’ locations:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands)
United States
$
17,932

 
$
9,607

 
$
47,389

 
$
26,224

International(1)
3,760

 
1,525

 
10,377

 
3,616

Total revenue
$
21,692

 
$
11,132


$
57,766

 
$
29,840

(1)
No single country outside of the United States accounted for more than 10% of total revenue during three and nine months ended September 30, 2018 and 2017, except for Germany which accounted for 10% of total revenue during the three months ended September 30, 2018.
As of September 30, 2018 and December 31, 2017, all of the Company’s long-lived assets are located in the United States.
15.
Related Party Transactions
For the three and nine months ended September 30, 2017, the Company recognized revenue of $142,000 and $458,000 from an entity affiliated with a member of the Company’s Board of Directors, who serves on the board of both the aforementioned entity and the Company. The individual was appointed to the Company’s board in January 2017.

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 the unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion and other parts of this report contain forward-looking statements that involve risk and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk factors.”
Overview
We are a leading precision oncology company focused on helping conquer cancer globally through use of our proprietary blood tests, vast data sets and advanced analytics. We believe that the key to conquering cancer is unprecedented access to its molecular information throughout all stages of the disease, which we intend to enable by a routine blood draw, or liquid biopsy. Our Guardant Health Oncology Platform is designed to leverage our capabilities in technology, clinical development, regulatory and reimbursement to drive commercial adoption, improve patient clinical outcomes and lower healthcare costs. In pursuit of our goal to manage cancer across all stages of the disease, we have launched our liquid biopsy tests, Guardant360 and GuardantOMNI, for advanced stage cancer, which fuel our programs developing tests for recurrence and early detection, LUNAR-1 and LUNAR-2, respectively. Guardant360, which we launched in 2014, has been used by more than 5,000 oncologists, over 40 biopharmaceutical companies and all 27 National Comprehensive Cancer Network, or NCCN, Centers. We launched GuardantOMNI in 2017 as a comprehensive genomic profiling tool to enable our biopharmaceutical customers to accelerate clinical development programs in both immuno-oncology and targeted therapy.
Since our inception, we have devoted substantially all of our resources to research and development activities related to Guardant360 and GuardantOMNI and our LUNAR-1 and LUNAR-2 programs, including clinical and regulatory initiatives to obtain approval by the FDA and sales and marketing activities. We are pioneering the clinical comprehensive liquid biopsy market with Guardant360 and GuardantOMNI. Guardant360 is a molecular diagnostic test measuring 73 cancer-related genes and GuardantOMNI is a broader 500-gene panel, both of which analyze circulating tumor DNA in blood. Guardant360 has been used over 70,000 times by clinicians to help inform which therapy may be effective for advanced stage cancer patients with solid tumors. It is also used by biopharmaceutical companies for a range of applications, including identifying target patient populations to accelerate translational science research, clinical trial enrollment, and drug development, and commercialization post-drug approval.
The analytical and clinical data that we have generated in our efforts to establish clinical utility, combined with the support we have developed with key opinion leaders, or KOLs, in the oncology community have led to positive coverage decisions by a number of commercial payers. Guardant360 is currently covered by Cigna and several Blue Cross Blue Shield plans, which have adopted reimbursement policies that specifically cover Guardant360 for non-small cell lung cancer, or NSCLC, which we believe gives us a competitive advantage with these payers. We anticipate approval by the FDA, if obtained, may support improvements in coverage and reimbursement for Guardant360. In July 2018, Palmetto GBA, the Medicare Administrative Contractor, or MAC, responsible for administering Medicare’s molecular diagnostic services program, MolDx, issued a local coverage determination, or LCD, for Guardant360 for NSCLC patients who meet certain clinical criteria. We worked with Palmetto GBA to obtain this positive coverage decision through the submission of a detailed dossier of analytical and clinical data to substantiate that the test meets Medicare’s medical necessity requirements. Noridian Healthcare Solutions, the MAC responsible for adjudicating claims in California, where our laboratory is located, is a participant in MolDx and recently finalized its LCD for Guardant360. In September 2018, we began to submit claims to Medicare for reimbursement for clinical tests for Medicare beneficiaries covered under the LCD and in October 2018 we began to receive payments from Medicare for these clinical tests
In the United States, we market our tests to clinical customers through our targeted sales organization, which as of September 30, 2018 included 41 sales representatives that are engaged in sales efforts and promotional activities primarily to oncologists and cancer centers. Outside the United States, we market our tests to clinical customers through distributors and direct contracts with health care institutions. We market our tests to biopharmaceutical customers globally through our business development team, which promotes the broad utility of our tests throughout drug development and commercialization. Additionally, we have established a joint venture with SoftBank to

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accelerate commercialization of our products in Asia, the Middle East and Africa, with our initial focus being on Japan. Our products are currently marketed in 39 countries.
We perform Guardant360 and GuardantOMNI tests in our clinical laboratory located in Redwood City, California. The laboratory is accredited by CLIA, permitted under the New York State Department of Health, or NYSDOH, and licensed in many other states including California, Florida, Maryland, Pennsylvania and Rhode Island. In January 2018, the FDA granted Guardant360 expedited access pathway designation, which offers potentially faster review for breakthrough medical devices that address unmet medical needs.
We generated total revenue of $21.7 million and $11.1 million for the three months ended September 30, 2018 and 2017, and $57.8 million and $29.8 million for the nine months ended September 30, 2018 and 2017, respectively. We also incurred net losses of $23.5 million and $28.6 million for the three months ended September 30, 2018 and 2017, and $59.0 million and $68.2 million for the nine months ended September 30, 2018 and 2017, respectively. We have funded our operations to date principally from the sale of convertible preferred stock, revenue from precision oncology testing and development services, and the incurrence of indebtedness. In 2017, we raised $320.4 million through the sale of our Series E convertible preferred stock. As of September 30, 2018, we had cash, cash equivalents and marketable securities of $274.3 million. In October 2018, we completed our initial public offering, or IPO, selling 14,375,000 shares of common stock and raising $249.5 million net of underwriting discounts and commissions and other expenses payable by us.
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:
Precision oncology testing volume and customer mix. Our revenue and costs are affected by the volume of testing and mix of customers from period to period. We evaluate both the volume of our clinical sample tests, or the number of tests that we perform for patients on behalf of clinicians, as well as tests for biopharmaceutical companies. Our performance depends on our ability to retain and broaden adoption with existing customers, as well as attract new customers. We believe that the test volume we receive from clinicians and biopharmaceutical companies are indicators of growth in each of these customer verticals. Customer mix for our tests has the potential to significantly affect our results of operations, as the average selling price for biopharmaceutical sample testing is currently significantly greater than our average selling price for clinical tests since we are not a contracted provider for or our tests are not covered by clinical patients’ insurance for the majority of the tests that we perform for patients on behalf of clinicians. For instance, approximately 38% and 38% of our U.S. clinical tests for the nine months ended September 30, 2018 and 2017, respectively, were for Medicare beneficiaries. Prior to the third quarter of 2018, Medicare did not cover our tests and we did not submit claims for reimbursement. In July 2018, Palmetto GBA, the Medicare Administrative Contractor, or MAC responsible for administering Medicare’s molecular diagnostic services program, or MolDx, issued a local coverage determination, or LCD, for Guardant360 for non-small cell lung cancer, or NSCLC, patients who meet certain clinical criteria. Approximately 45% of our U.S. clinical tests for the three months ended September 30, 2018 and 2017 were for patients tested for NSCLC. We estimate that approximately 75% of Medicare patients tested for NSCLC would be covered by the LCD. In September 2018, Palmetto GBA notified us that the contractor had set the reimbursement rate for Guardant360 at $3,500 per test. In September 2018, we began to submit claims to Medicare for reimbursement for clinical tests for Medicare beneficiaries covered under the LCD and in October 2018 we began to receive payments from Medicare for these clinical tests.

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Regulatory (FDA) approval for liquid biopsy. Guardant360 was the first comprehensive liquid biopsy approved by NYSDOH. In addition, we believe our facility was the first comprehensive liquid biopsy laboratory to be CLIA-certified, CAP-accredited and NYSDOH-permitted. While FDA approval is currently not required to market our tests in the United States, we intend to seek a pre-market approval, or PMA, for Guardant360. In January 2018, the FDA granted Guardant360 expedited access pathway designation, which offers faster review for breakthrough medical devices that address unmet medical needs. In March 2018, the Centers for Medicare and Medicaid Services, or CMS, published a Decision Memorandum for next-generation sequencing tests for patients with advanced cancer who meet certain clinical criteria, or the NGS Decision Memorandum. The NGS Decision Memorandum states that coverage would be available for next-generation sequencing FDA-approved tests offered within the FDA-approved labeling. FDA approval now provides a path to reimbursement by Medicare through the NGS Decision Memorandum. We plan to submit our PMA application to the FDA in the first half of 2019. We believe that this establishes a competitive advantage for tests receiving FDA approval and that FDA approval will be increasingly necessary for diagnostic tests to gain adoption, both in the United States and abroad. We believe FDA approval, if obtained, will help increase adoption of our tests and facilitate favorable reimbursement decisions by Medicare and commercial payers. Any negative regulatory decisions or changes in regulatory requirements affecting our business could adversely impact our operations and financial results.
Reimbursement for clinical sample testing. Our revenue depends on achieving broad coverage and reimbursement for our tests from third-party payers, including both commercial and government payers. Payment from third-party payers differs depending on whether we have entered into a contract with the payers as a “participating provider” or do not have a contract and are considered a “non-participating provider.” Payers will often reimburse non-participating providers, if at all, at a lower amount than participating providers. We have received a substantial portion of our revenue from a limited number of third-party commercial payers, most of which have not contracted with us to be a participating provider. We have received reimbursement for tests of patients with a variety of cancers, though for amounts that on average are significantly lower than for participating providers. Historically, we have experienced situations where commercial payers proactively reduced the amounts they were willing to reimburse for our tests, and in other situations, commercial payers have determined that the amounts they previously paid were too high and have sought to recover those perceived excess payments by deducting such amounts from payments otherwise being made. When we contract to serve as a participating provider, reimbursements are made pursuant to a negotiated fee schedule and are limited to only covered indications. Becoming a participating provider generally results in higher reimbursement for covered indications and lack of reimbursement for non-covered indications. As a result, the impact of becoming a participating provider with a specific payer will vary based on historical reimbursement as a non-participating provider for that payer, and in some situations, the benefit of increased reimbursement for covered testing could be offset by the loss of reimbursement on other tests previously received when we served as a non-participating provider. Recently, Cigna and multiple Blue Cross Blue Shield plans adopted reimbursement policies that cover Guardant360 for the majority of NSCLC patients we test. If their reimbursement policies were to change in the future to cover additional cancer indications, we anticipate that our total reimbursement would increase. If we are not able to obtain or maintain coverage and adequate reimbursement from third-party payers, we may not be able to effectively increase our testing volume and revenue as expected. Additionally, retrospective reimbursement adjustments can negatively impact our revenue and cause our financial results to fluctuate.
Investment in clinical studies and product innovation to support commercial growth. A significant aspect of our business is our investment in research and development, including the development of new products, such as those being developed as part of our LUNAR-1 and LUNAR-2 programs, and our investments in clinical utility studies. In particular, we have invested heavily in clinical studies, including 29 clinical outcomes studies, the largest-ever liquid-to-tissue concordance study, and a prospective interventional clinical utility study demonstrating clinical overall response rates in line with tissue biopsy approaches. Our clinical research has resulted in 80 peer-reviewed publications for Guardant360. In addition to clinical studies, we are collaborating with investigators from multiple academic cancer centers, including MD Anderson Cancer Center, the University of Colorado, Memorial Sloan Kettering Cancer Center, Massachusetts General Cancer Center, Wake Forest Cancer Center and the University of California San Francisco, as well as several international institutions. We believe these studies are critical to gaining physician adoption and driving favorable coverage decisions by payers, and expect our investments to increase. We expect to increase our research and development expense with the goal of fueling further innovation.

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Ability to attract new biopharmaceutical customers and maintain and expand relationships with existing customers. Our business development team promotes the broad utility of our products for biopharmaceutical companies in the United States and internationally. Our revenue and business opportunities depend in part on our ability to attract new biopharmaceutical customers and to maintain and expand relationships with existing customers, and we expect to increase our sales and marketing expense in furtherance of this goal. As we continue to develop these relationships, we expect to support a growing number of clinical trials both in the United States and internationally. If our relationships expand, we believe we may have opportunities to offer our platform for companion diagnostic development, novel target discovery and validation efforts, and to grow into other commercial opportunities. For example, we believe genomic data, in combination with clinical outcomes or claims data, has revenue-generating potential, including for novel target identification.
International expansion. A component of our long-term growth strategy is to expand our commercial footprint internationally, and we expect to increase our sales and marketing expense to execute on this strategy. We currently offer our tests in 38 countries outside the United States, primarily through distributor relationships or direct contracts with hospitals. In May 2018, we formed and capitalized a joint venture, Guardant Health AMEA, Inc., which we refer to as the Joint Venture, with SoftBank relating to the sale, marketing and distribution of our tests in all areas worldwide outside of North America, Central America, South America, the United Kingdom, all other member states of the European Union as of May 2017, Iceland, Norway, Switzerland and Turkey, or the JV Territory. Depending on the market opportunity in a country, the Joint Venture may create direct operations, sell through a distribution model or license to a third party. Direct operations would entail full operations including a laboratory, sales and marketing and regulatory among other functions. Under the distribution model, our tests would be marketed and sold by the Joint Venture or third-party distributors in relevant countries within the JV Territory, and the tests would be performed by or on behalf of us or our affiliates outside of such countries on samples obtained by the Joint Venture or third-party distributors in such countries. Following a determination by the board of directors of the Joint Venture on the appropriate model for an individual country, we will enter into agreements with the Joint Venture with respect to the individual country based on the license or distribution model. We expect to rely on the Joint Venture to accelerate commercialization of our products in Asia, the Middle East and Africa, with our initial focus being on Japan.
While each of these areas present significant opportunities for us, they also pose significant risks and challenges that we must address. See “Part II, Item 1A. Risk factors” for more information.
Components of results of operations
Revenue
We derive our revenue from two sources: (i) precision oncology testing and (ii) development services.
Precision oncology testing. Precision oncology testing revenue is generated from sales of our tests. In the United States, we generally perform tests as an out-of-network service provider without contracts with health insurance companies. We submit claims for payment for U.S. test from patients covered by private insurance payers. Tests for patients covered by Medicare represented approximately 39% and 38% of U.S. tests processed for the three months ended September 30, 2018 and 2017, respectively, and approximately 38% and 38% of U.S. tests processed for the nine months ended September 30, 2018 and 2017, respectively. Prior to the third quarter of 2018, Medicare did not cover our tests and we did not submit claims for reimbursement for these tests. Our MAC issued an LCD for Guardant360 for NSCLC patients in July 2018 and set the reimbursement rate in September 2018 after which we began to submit claims to Medicare for reimbursement. Due to the general lack of contracts with U.S. insurance payers and variability in payments received for claims submitted to them, as well as the limited claims experience to date with Medicare, revenue is not recognized at the time the service is performed as the price of the transaction is not fixed and determinable and collectability is not reasonably assured. We expect to recognize revenue on a cash basis for testing of U.S. clinical samples until we have sufficient history to reliably estimate payment patterns. We provided precision oncology testing to biopharmaceutical companies under contracts, therefore we recognized revenue on an accrual basis for those services.

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Development services. Development services revenue represents services, other than precision oncology testing, that we provide to biopharmaceutical companies and large medical institutions. It includes companion diagnostic development and regulatory approval services, clinical trial referrals and liquid biopsy testing development and support. We collaborate with biopharmaceutical companies in the development and clinical trials of new drugs. As part of these collaborations, we provide services related to regulatory filings with the FDA to support companion diagnostic device submissions for our liquid biopsy panels. Under these collaborations we generate revenue from achievement of milestones, as well as provision of on-going support. Development services revenue can vary over time as different projects start and complete.
Costs and operating expenses
Cost of precision oncology testing. Cost of precision oncology testing generally consists of cost of materials, direct labor, including bonus, benefit and stock-based compensation; equipment and infrastructure expenses associated with processing liquid biopsy test samples, including sample accessioning, library preparation, sequencing, quality control analyses and shipping charges to transport blood samples; freight; curation of test results for physicians; and license fees due to third parties. Infrastructure expenses include depreciation of laboratory equipment, rent costs, amortization of leasehold improvements and information technology costs. Costs associated with performing our tests are recorded as the tests are processed regardless of whether revenue was recognized with respect to the tests. Royalties for licensed technology are calculated as a percentage of revenues generated using the associated technology and recorded as expense at the time the related revenue is recognized. One-time royalty payments related to signing of license agreements or other milestones, such as issuance of new patents, are amortized to expense over the expected useful life of the patents. While we do not believe the technologies underlying these licenses are necessary to permit us to provide our tests, we do believe these technologies are potentially valuable and of possible strategic importance to us or our competitors. Under these license agreements, we are obligated to pay aggregate royalties ranging from 2.5% to 3.0% of sales in which the patents are used in the product or service sold, subject to minimum annual royalties or fees in certain agreements. Cost of precision oncology testing revenue included royalty expense of $0.3 million and $0.2 million for the three months ended September 30, 2018 and 2017, respectively, and $0.9 million and $0.8 million for the nine months ended September 30, 2018 and 2017, respectively.
We expect the cost of precision oncology testing to generally increase in line with the increase in the number of tests we perform, but the cost per test to decrease modestly over time due to the efficiencies we may gain as test volume increases, and from automation and other cost reductions.
Cost of development services. Cost of development services includes costs incurred for the performance of development services requested by our customers. For development of new products, costs incurred before technological feasibility has been achieved are reported as research and development expenses, while costs incurred thereafter are reported as cost of revenue. Cost of development services will vary depending on the nature, timing and scope of customer projects.
Research and development expense. Research and development expenses consist of costs incurred to develop technology and include salaries and benefits, reagents and supplies used in research and development laboratory work, infrastructure expenses, including allocated facility occupancy and information technology costs, contract services, other outside costs and costs to develop our technology capabilities. Research and development expenses also include costs related to activities performed under contracts with biopharmaceutical companies. Research and development costs are expensed as incurred. Payments made prior to the receipt of goods or services to be used in research and development are deferred and recognized as expense in the period in which the related goods are received or services are rendered. Costs to develop tour technology capabilities are recorded as research and development unless they meet the criteria to be capitalized as internal-use software costs.
We expect that our research and development expenses will continue to increase in absolute dollars as we continue to innovate and develop additional products, expand our genomic and medical data management resources and conduct our ongoing and new clinical trials. This expense, though expected to increase in absolute dollars, is expected to decrease modestly as a percentage of revenue in the long term, though it may fluctuate as a percentage from period to period due to the timing and extent of these expenses.

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Sales and marketing expense. Our sales and marketing expenses are expensed as incurred and include costs associated with our sales organization, including our direct sales force and sales management, client services, marketing and reimbursement, as well as business development personnel who are focused on our biopharmaceutical customers. These expenses consist primarily of salaries, commissions, bonuses, employee benefits, travel and stock-based compensation, as well as marketing and educational activities and allocated overhead expenses.
We expect our sales and marketing expenses to increase in absolute dollars as we expand our sales force, increase our presence within and outside of the United States, and increase our marketing activities to drive further awareness and adoption of Guardant360 and GuardantOMNI and our future products. These expenses, though expected to increase in absolute dollars, are expected to decrease modestly as a percentage of revenue in the long term, though they may fluctuate as a percentage from period to period due to the timing and extent of these expenses.
General and administrative expense. Our general and administrative expenses include costs for our executive, accounting and finance, legal and human resources functions. These expenses consist principally of salaries, bonuses, employee benefits, travel and stock-based compensation, as well as professional services fees such as consulting, audit, tax and legal fees, and general corporate costs and allocated overhead expenses.
We expect that our general and administrative expenses will continue to increase in absolute dollars in 2018, primarily due to increased headcount and costs associated with operating as a public company, including expenses related to legal, accounting, regulatory, maintaining compliance with exchange listing and requirements of the SEC, director and officer insurance premiums and investor relations. These expenses, though expected to increase in absolute dollars, are expected to decrease modestly as a percentage of revenue in the long term, though they may fluctuate as a percentage from period to period due to the timing and extent of these expenses.
Interest income
Interest income consists of interest earned on our cash, cash equivalents and marketable securities. We expect our interest income to continue to increase primarily as we invest the net proceeds from the IPO.
Interest expense
Interest expense consists primarily of interest from a loan, capital leases and royalty obligations. For 2018, we expect our interest expense to decrease as compared to 2017, as we repaid the outstanding principal balance and interest on our term loan in June 2017.
Loss on debt extinguishment
In June 2017, we repaid a loan prior to maturity which resulted in an extinguishment of the debt for accounting purposes. The difference between the reacquisition price and the net carrying amount of the debt and related royalty liabilities of $5.1 million was recognized as a one-time charge for the year ended December 31, 2017.
Other income (expense), net
In the first quarter of 2018, we settled a commercial legal dispute. In connection with the settlement, we received a payment of $4.25 million, which was recognized as one-time other income for the nine months ended September 30, 2018.
Other income (expense), net also consists of foreign currency exchange gains and losses. Foreign currency exchange gains and losses relate to transactions and asset and liability balances denominated in currencies other than the U.S. dollar, primarily comprised of an obligation related to a royalty denominated in Euros. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.

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Series E convertible preferred stock financing
In May 2017 we entered into a Series E convertible preferred stock purchase agreement with SoftBank and certain of our existing stockholders. Pursuant to the purchase agreement, we issued and sold an aggregate of 38,174,246 shares of Series E convertible preferred stock at a purchase price of $8.3936 per share, for an aggregate purchase price of $320.4 million. The purchase agreement also provided that we would issue additional shares of Series E convertible preferred stock to the investors in such an amount as to cause SoftBank’s equity ownership to equal 35% of our outstanding fully-diluted capital stock measured 70 days after the initial closing. The purpose of this gross-up was to cause SoftBank’s equity ownership to reach 35% following various repurchases of our equity from existing stockholders. As a result, in July 2017, we repurchased an aggregate of 1,588,065 shares of common stock from certain of our directors and executive officers for a purchase price of $10.23887 per share, which represented a price equal to 90% of the original price per share for the Series E convertible preferred stock, as adjusted to reflect the 0.7378-for-one reverse stock split effected on September 19, 2018. We also engaged in a tender offer pursuant to which we repurchased 131,243 shares of common stock from certain employees at the same per share price paid for the Series E convertible preferred stock, as adjusted to reflect the 0.7378-for-one reverse stock split effected on September 19, 2018, and 666,920 shares of Series A convertible preferred stock from existing stockholders at a purchase price of $8.00 per share of Series A convertible preferred stock. Following these repurchases, in October 2017, we issued an additional 796,346 shares of Series E convertible preferred stock to the Series E investors for a purchase price of $0.00001 per share pursuant to the terms of the gross-up provision.
In addition, in connection with SoftBank’s purchase of Series E convertible preferred stock, we also agreed to enter into a joint venture agreement with Softbank relating to the commercialization and distribution of products throughout the JV Territory. Upon the incorporation of the Joint Venture (Guardant Health AMEA, Inc.) in May 2018, SoftBank purchased 40,000 shares of common stock of the Joint Venture in exchange for $41.0 million in cash and we purchased 40,000 shares of common stock of the Joint Venture in exchange for $9.0 million in cash. We also entered into various ancillary agreements with the Joint Venture necessary to operate its business. Under the terms of the joint venture agreement, neither we nor SoftBank is obligated to make any further capital contribution, in cash or otherwise, to the Joint Venture. In the event the Joint Venture requires any additional funding for its operations, the Joint Venture may seek debt financing from third parties, or may seek additional financing from its major shareholders, which will be on a pro rata basis among major shareholders unless such shareholders agree otherwise.

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Results of operations
The following table set forth the significant components of our results of operations for the periods presented.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands)
Revenue:
 
 
 
 
 
 
 
Precision oncology testing
$
18,298

 
$
10,253

 
$
50,311

 
$
27,927

Development services
3,394

 
879

 
7,455

 
1,913

Total revenue
21,692

 
11,132

 
57,766

 
29,840

Costs and operating expenses:
 
 
 
 
 
 
 
Cost of precision oncology testing(1)(2)
9,671

 
7,603

 
27,222

 
20,928

Cost of development services
380

 
1,058

 
2,041

 
1,542

Research and development expense(1)(2)
14,253

 
7,246

 
34,062

 
17,442

Sales and marketing expense(1)(2)
13,464

 
7,808

 
36,351

 
22,941

General and administrative expense(1)(2)
8,129

 
16,095

 
23,645

 
27,982

Total costs and operating expenses
45,897

 
39,810

 
123,321

 
90,835

Loss from operations
(24,205
)
 
(28,678
)
 
(65,555
)
 
(60,995
)
Interest income
958

 
657

 
2,932

 
1,222

Interest expense
(304
)
 
(303
)
 
(952
)
 
(2,398
)
Loss on debt extinguishment

 

 

 
(5,075
)
Other income (expense), net
43

 
(266
)
 
4,587

 
(915
)
Loss before provision for income taxes
(23,508
)
 
(28,590
)
 
(58,988
)
 
(68,161
)
Provision for income taxes

 

 
3

 

Net loss
$
(23,508
)
 
$
(28,590
)
 
$
(58,991
)
 
$
(68,161
)
(1)
Amounts include stock-based compensation expense as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands)
Cost of precision oncology testing
$
112

 
$
(25
)
 
$
254

 
$
104

Research and development expense
617

 
17

 
1,035

 
307

Sales and marketing expense
428

 
(526
)
 
1,061

 
14

General and administrative expense
674

 
1,342

 
1,938

 
1,673

Total stock-based compensation expense
$
1,831

 
$
808

 
$
4,288

 
$
2,098


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(2)
Amounts include compensation expenses associated with repurchase of common stock as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(unaudited)
 
(in thousands)
Cost of precision oncology testing
$

 
$
72

 
$

 
$
72

Research and development expense

 
250

 

 
250

Sales and marketing expense

 
659

 

 
659

General and administrative expense

 
9,672

 
157

 
9,672

Total compensation expense associated with repurchase of common stock
$

 
$
10,653

 
$
157

 
$
10,653

Comparison of the Three Months Ended September 30, 2018 and 2017
Revenue
 
Three Months Ended September 30,
 
Change
 
2018
 
2017
 
$
 
%
 
(unaudited)
 
 
 
 
 
(in thousands)
 
 
Precision oncology testing
$
18,298

 
$
10,253

 
$
8,045

 
78
%
Development services
3,394

 
879

 
2,515

 
286
%
Total revenue
$
21,692

 
$
11,132

 
$
10,560

 
95
%
Total revenue was $21.7 million for the three months ended September 30, 2018 compared to $11.1 million for the three months ended September 30, 2017, an increase of $10.6 million, or 95%.
Precision oncology testing revenue increased to $18.3 million for the three months ended September 30, 2018 from $10.3 million for the three months ended September 30, 2017, an increase of $8.0 million, or 78%. This increase in precision oncology testing revenue was primarily due to an increase in tests processed. Tests for clinical customers increased to 7,027 for the three months ended September 30, 2018 from 6,147 for the three months ended September 30, 2017 (excluding 459 tests in the three-month period ended September 2017 from a customer that in March 2018 began processing tests in-house) mainly due to an increase in the number of physicians ordering Guardant360 tests. Precision oncology revenue from tests for clinical customers, which we have generally recognized as cash payments as received, was $9.6 million for the three months ended September 30, 2018 and $6.1 million for the three months ended September 30, 2017, respectively. Cash receipts increased due to increases in tests for clinical customers and increases in commercial payer payments that were beneficially affected by the Protecting Access to Medicare Act of 2014. Tests for biopharmaceutical customers increased to 2,505 for the three months ended September 30, 2018 from 1,502 for the three months ended September 30, 2017 due to an increase in the number of biopharmaceutical customers and their contracted projects. The average selling price of biopharmaceutical tests was $3,491 for the three months ended September 30, 2018, up from $2,734 for the three months ended September 30, 2017 due to introduction at the end of 2017 of the GuardantOMNI test, which has a higher selling price than the Guardant360 test.
Development services revenue increased to $3.4 million for the three months ended September 30, 201