CareDx, Inc. - Quarter Report: 2018 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2018

or

For the transition period from           to           

Commission file number: 001-36536

CAREDX, INC.

(Exact name of registrant as specified in its charter)

3260 Bayshore Boulevard

Brisbane, California 94005

(Address of principal executive offices and zip code)

(415) 287-2300

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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 ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

There were 36,346,124 shares of the registrant’s Common Stock issued and outstanding as of August 6, 2018.

CareDx, Inc.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

CareDx, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except share data)

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

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CareDx, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except share and per share data)

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

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CareDx, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

(In thousands)

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

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CareDx, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

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

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CareDx, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

CareDx, Inc. (“CareDx” or the “Company”) together with its subsidiaries, is a global transplant diagnostics company with product offerings along the pre- and post-transplant continuum.  The Company focuses on discovery, development and commercialization of clinically differentiated, high-value diagnostic surveillance solutions for transplant patients.  In diagnostic testing services, the Company offers AlloMap®, which is a gene expression solution for heart transplant patients and AlloSure®, which is a donor-derived cell free DNA (“dd-cfDNA”) solution initially used for kidney transplant patients.  The Company also offers high quality products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs.

AlloMap is a gene expression test that helps clinicians monitor and identify heart transplant recipients with stable graft function who have a low probability of moderate to severe acute cellular rejection.  Since 2008, the Company has sought to expand the adoption and utilization of its AlloMap solution through ongoing studies to substantiate the clinical utility and actionability of AlloMap, secure positive reimbursement decisions for AlloMap from large private and public payers, develop and enhance its relationships with key members of the transplant community, including opinion leaders at major transplant centers, and explore opportunities and technologies for the development of additional solutions for post-transplant surveillance.  The Company believes the use of AlloMap, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a heart transplant. In particular, the Company believes AlloMap can improve patient care by helping healthcare providers avoid the use of unnecessary, invasive surveillance biopsies and determine the appropriate dosage levels of immunosuppressants. AlloMap has received 510(k) clearance from the U.S. Food and Drug Administration (the “FDA”) for marketing and sale as a test to aid in the identification of recipients with a low probability of moderate or severe acute cellular rejection.  A 510(k) submission is a premarketing submission made to the FDA. Clearance may be granted by the FDA if it finds the device or test provides satisfactory evidence pertaining to the claimed intended uses and indications for the device or test.

On October 9, 2017, the Company commercially launched AlloSure, its proprietary next-generation sequencing-based test to measure dd-cfDNA after transplantation. The Company believes the use of AlloSure, in conjunction with other clinical indicators, can help healthcare providers and their patients better manage long-term care following a kidney transplant. In particular, the Company believes AlloSure can improve patient care by helping healthcare providers to reduce the use of invasive biopsies and determine the appropriate dosage levels of immunosuppressants.

The Company also develops, manufactures, markets and sells products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs.  Olerup SSP® is used to type Human Leukocyte Antigen (“HLA”) alleles, based on the sequence specific primer (“SSP”) technology.  Olerup SBT^TM is a complete product range for sequence-based typing of HLA alleles. Olerup QTYPE® enables speed and precision in HLA typing at a low to intermediate resolution for samples that require a fast turn-around-time and uses real-time polymerase chain reaction, or PCR methodology. QTYPE received CE mark certification on April 10, 2018.  

On May 4, 2018, the Company entered into a License and Commercialization Agreement with Illumina, Inc. (“Illumina”), which provides the Company with worldwide distribution, development and commercialization rights to Illumina’s next generation sequencing (“NGS”) product line for use in transplantation diagnostic testing.

The Company’s headquarters are in Brisbane, California; primary operations are in Brisbane, U.S. and Stockholm, Sweden; and the Company operates in two reportable segments.

Liquidity and Going Concern

The Company has incurred significant losses and negative cash flows from operations since its inception and had an accumulated deficit of $288.1 million at June 30, 2018. As of June 30, 2018, the Company had cash and cash equivalents of $16.2 million, and $13.3 million of debt outstanding, net of debt discount, under its debt obligations, of which none is current.

On April 17, 2018, the Company entered into a credit agreement with Perceptive Credit Holdings II, LP (“Perceptive”) for an initial term loan of $15.0 million (“the Perceptive Credit Agreement”) and repaid the outstanding indebtedness of the promissory notes previously issued to FastPartner AB and Mohammed Al Amoudi and the term loan and credit facility with Danske Bank A/S (“Danske”).  A second tranche of $10.0 million will be available at the Company’s option subject to the satisfaction of customary conditions. Refer to Note 10 for additional details.

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The Company may require additional financing in the future to fund working capital and pay its obligations as they come due.  Additional financing might include issuance of equity securities, debt, cash from collaboration agreements or a combination of these.  However, there can be no assurance that the Company will be successful in acquiring additional funding at levels sufficient to fund its operations or on terms favorable to the Company. The Company believes its existing cash balance and expected revenues will be sufficient to meet its anticipated cash requirements for at least the next 12 months.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies and estimates used in preparation of the unaudited condensed consolidated financial statements are described in the Company’s audited consolidated financial statements as of and for the year ended December 31, 2017, and the notes thereto, which are included in the Company’s Annual Report on Form 10-K. Material changes to the significant accounting policies previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 are reflected below.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and follow the requirements of the Securities and Exchange Commission (the “SEC”) for interim reporting.  As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted.  These financial statements have been prepared on the same basis as the Company’s annual financial statements and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments that are necessary for a fair statement of the Company’s financial information.  The condensed consolidated balance sheet as of December 31, 2017 has been derived from audited financial statements as of that date but does not include all of the financial information required by U.S. GAAP for complete financial statements.  Operating results for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany transactions have been eliminated.  The Company acquired CareDx International AB, formerly Allenex AB “Allenex”, on April 14, 2016.  Since the acquisition of Allenex through March 15, 2018, the Company owned less than 100% of the shares of Allenex and recorded a net loss attributable to noncontrolling interest in its condensed consolidated statements of operations equal to the percentage of the economic or ownership interest retained by the respective noncontrolling parties in such entities.  On March 15, 2018, the Company acquired the remaining noncontrolling interest in Allenex and has not reported any noncontrolling interest balances since this date.

Use of Estimates

The preparation of unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses in the unaudited condensed consolidated financial statements and accompanying notes.  On an ongoing basis, management evaluates its estimates, including those related to (i) variable transaction price consideration related to contracts with customers, (ii) the determination of the accruals for clinical studies, (iii) the fair value of assets and liabilities acquired in business combinations, including contingent consideration, (iv) inventory valuation, (v) the valuation of common stock warrant liability, (vi) the fair value of embedded derivatives, (vii) measurement of stock-based compensation expense, (viii) the determination of the valuation allowance and estimated tax benefit associated with deferred tax assets and net deferred tax liability, (ix) any impairment of long-lived assets, including in-process technology and goodwill, and (x) legal contingencies.  Actual results could differ from those estimates.

Concentrations of Credit Risk and Other Risks and Uncertainties

For the six months ended June 30, 2018 and 2017, approximately 45% and 28%, respectively, of total revenue was derived from Medicare. No other payers or customers represented more than 10% of total revenue for these periods.

At June 30, 2018 and December 31, 2017, approximately 24% and 16%, respectively, of accounts receivable was due from Medicare.  No other payer or customer represented more than 10% of accounts receivable on either June 30, 2018 or December 31, 2017.

Restricted Cash

A restricted cash balance of $9.4 million was released upon the full conversion of the debt obligation to JGB Collateral LLC and certain of its affiliates (“JGB”) (refer to Note 10) during the three months ended March 31, 2018 and is no longer classified as restricted cash.

As a condition of the lease agreements for certain facilities and an agreement with the State of Florida Medicaid, the Company must maintain letters of credit, minimum collateral requirements and a surety bond.  These agreements are collateralized by cash.  The cash

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used to support these arrangements is classified as long-term restricted cash on the accompanying condensed consolidated balance sheets.

Common Stock Warrant Liability and Derivative Liability

Common Stock Warrant Liability

On January 1, 2018, the Company adopted Accounting Standard Update (“ASU”) No. 2017-11, Accounting for Certain Financial Instruments with Down Round Features and Replacement of the Indefinite Deferral of Mandatorily Redeemable Financial Instruments of Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception.  The Company determined that the common stock warrants issued to JGB (the “JGB Warrants”) meet equity classification criteria under the new standard and reclassified $6.6 million (the fair value of the JGB warrants as of January 1, 2018) from warrant liability to equity (additional paid in capital). The warrant issued to Perceptive (the “Perceptive Tranche A Warrant”), on April 17, 2018, also met the equity classification as noted in Note 13.The new standard did not impact the classification of the other warrants included in the warrant liability balance as these financial instruments have other than down-round anti-dilution adjustments features.

Derivative Liability

The convertible debt financing with JGB (the “JGB Debt”), included certain embedded derivatives that required bifurcation, including settlement and penalty provisions.  The combined embedded derivative was remeasured at each reporting period with changes recorded in change in estimated fair value of common stock warrant liability and derivative liability in the condensed consolidated statements of operations.  As of March 27, 2018, the JGB Debt was fully converted to shares of the Company’s common stock.  The change in the fair market value of the derivative liability through March 27, 2018 was recorded in change in estimated fair value of common stock warrant liability and derivative liability in the condensed consolidated statements of operations.

On April 17, 2018, the Company entered into the Perceptive Credit Agreement, which included an embedded derivative that required bifurcation related to early repayment provision. This embedded derivative fair value of $0.2 million was recorded as debt issuance discount. Refer to Note 10 for additional details.  The derivative is remeasured at the end of each reporting period if debt remains outstanding with changes recorded in change in estimated fair value of common stock warrant liability and derivative liability in the condensed consolidated statements of operations.

Revenue

The Company recognizes revenue from testing services, products, and license and other revenue in the amount that reflects the consideration which it expects to be entitled in exchange for goods or services as it transfers control to its customers.  Revenue is recorded considering a five-step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when, or as, an entity satisfies a performance obligation.

Testing Services Revenue

AlloMap and AlloSure patient tests are ordered by healthcare providers.  The Company receives a test requisition form with payer information along with a collected patient blood sample. The Company considers the patient to be its customer and the test requisition form a contract. Testing services are performed in the Company’s laboratory. Testing services represent one performance obligation in a contract and are performed when results of the test are provided to the healthcare provider, at a point of time.

The healthcare providers that order the tests and on whose behalf CareDx provides testing services are generally not responsible for the payment of these services.  The first and second revenue recognition criteria are satisfied when the Company receives a test requisition form with payer information from the healthcare provider.  Generally, the Company bills third-party payers upon delivery of an AlloMap or AlloSure test result to the healthcare provider. Amounts received may vary amongst payers based on coverage practices and policies of the payer.  The Company has used the portfolio approach, a practical expedient under Accounting Standards Codifications (“ASC”) Topic 606, to identify financial classes of payers. Transaction prices are determined for each financial class using history of reimbursements, including analysis of an average reimbursement per test and a percentage of tests reimbursed. The Company estimates revenue for non-contracted payers and self-payers using this methodology.  The estimate requires significant judgment. Revenue recognized for Medicare and other contracted payers is based on the agreed current reimbursement rate per test, adjusted for historical collection trends where applicable.

The Company monitors revenue estimates at each reporting period based on actual cash collections in order to assess whether a revision to the estimate is required. Changes in transaction price estimates are updated quarterly based on actual cash collected or changes made to contracted rates.

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Product Revenue

Product revenue is recognized from the sale of products to end-users, distributors and strategic partners when all revenue recognition criteria are satisfied.  The Company generally has a contract or a purchase order from a customer with the specified required terms of order, including the number of products ordered. Transaction prices are determinable and products are delivered and risk of loss passed to the customer upon either shipping or delivery, as per the terms of the agreement. There are no further performance obligations related to a contract and revenue is recognized at the point of delivery consistent with the terms of the contract or purchase order.

License and Other Revenue

The Company generates revenue from license agreements.  License agreements may include non-refundable upfront payments, partial or complete reimbursement of research and development costs, contingent payments based on the occurrence of specified events under the agreements, license fees and royalties on sales of products or product candidates if they are successfully commercialized.  The Company’s performance obligations under the agreements may include the transfer of intellectual property rights in the form of licenses, obligations to provide research and development services and obligations to participate on certain development committees.  The Company makes judgments to determine if performance obligations are distinct or should be combined and the transaction price allocated to each performance obligation, which affect the periods over which revenue is recognized.  The Company periodically reviews its estimated periods of performance based on the progress under each arrangement and accounts for the impact of any change in estimated periods of performance on a prospective basis. The Company constrains variable consideration, such as milestones, if it is probable that a significant portion of revenue would be reversed. The Company’s deferred revenue relates to one performance obligation, which should be recognized over time.

The Company did not recognize any revenue connected with milestones during the three or six months ended June 30, 2018 or 2017.

Cost of Testing Services

Cost of testing services reflects the aggregate costs incurred in delivering the Company’s testing services.  The components of cost of testing are materials and service costs, direct labor costs, stock-based compensation, equipment and infrastructure expenses associated with testing samples, shipping, logistics and specimen processing charges to collect and transport samples, and allocated overhead including rent, information technology, equipment depreciation, utilities and royalties.  Prior to adoption of the new revenue guidance, the Company recorded costs of testing associated with performing tests (except royalties) in the period when tests were performed without consideration of whether revenue was recognized in the same period.  With the adoption of the new revenue standard on January 1, 2018, revenue and cost of testing for tests performed are recognized in the same period. Royalties for licensed technology, calculated as a percentage of test revenues, are recorded as license fees in cost of testing services at the time the test revenues are recognized.

Recent Accounting Pronouncements

On January 1, 2018, the Company adopted the new revenue accounting standard Revenue from Contracts with Customers (Topic 606) ("ASC 606") using the modified retrospective method. The adoption of ASC 606 resulted in a one-time adjustment of $2.9 million to accounts receivable and retained earnings on January 1, 2018.  The adjustment reflects the estimated payments to be received for tests where the result had been delivered at December 31, 2017, but associated revenue had not been recognized by December 31, 2017, because payment had not been received. The new standard did not impact the Company’s product revenue or license and other revenue, nor did it impact contract assets or contract liabilities.

The following table summarizes the impact of the ASC 606 adoption on accounts receivable as of June 30, 2018 (in thousands):

The following table summarizes the impact to the statement of operations in accordance with the new revenue standard requirements for the three and six months ended June 30, 2018 (in thousands):

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In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842), which, for operating leases, requires the lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet.  The guidance also requires a lessee to recognize single lease costs, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis.  In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases. Additionally, the FASB issued ASU, No. 2018-11, Leases (Topic 842): Targeted Improvements, which offers a practical expedient for transitioning at the adoption date. These ASUs will be effective for the Company on January 1, 2019 and the Company has chosen to use the practical expedient and recognize a cumulative-effect adjustment to the opening balance of the retained earnings.  The Company has created an implementation plan and is in the early stages of assessing the impact of the guidance on its consolidated financial statements.  

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) (“ASU 2016-15”), to reduce the diversity in practice with respect to the presentation of certain cash flows.  The ASU is effective for interim and annual periods beginning after December 15, 2017.  The Company adopted ASU 2016-15 on January 1, 2018 on a retrospective basis.  The adoption of ASU 2016-15 did not have a material impact on the Company’s condensed consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force) (“ASU 2016-18”).  This guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents.  Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for all interim and annual reporting periods beginning after December 15, 2017.  The Company adopted ASU 2016-18 on January 1, 2018 on a retrospective basis and included restricted cash together with cash and cash equivalents in its condensed consolidated statements of cash flows.

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”).  The amendments provide guidance about how to account for changes to terms or conditions of a share-based payment award required under modification accounting.  ASU 2017-09 is effective for all interim and annual reporting periods beginning after December 15, 2017. The Company adopted ASU 2017-09 on January 1, 2018 on a prospective basis and the adoption of ASU 2017-09 did not have a material impact to the condensed consolidated financial statements.

In July 2017, the FASB issued ASU No. 2017-11, Accounting for Certain Financial Instruments with Down Round Features and Replacement of the Indefinite Deferral of Mandatorily Redeemable Financial Instruments of Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (“ASU 2017-11”). ASU 2017-11 is effective for all interim and annual reporting periods beginning on or after December 15, 2018 with early adoption permitted.  The Company adopted ASU 2017-11 on January 1, 2018, and the adoption resulted in the JGB common stock warrant liability balance being reclassified to additional paid in capital (Refer to Note 13).  

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In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220):  Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”).  The amendments in ASU 2018-02 allow a reclassification from accumulated other comprehensive income to retained earnings for certain tax effects resulting from the Tax Cuts and Jobs Act (the “Tax Act”).  The Company is still reviewing the Tax Act and its impact to the condensed consolidated financial statements. ASU 2018-02 will become effective for all interim and annual reporting periods beginning after December 15, 2018 and may be applied retrospectively or as of the beginning of the period of adoption.

In June 2018, the FASB issued ASU No. 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share Based Payment Accounting (“ASU 2018-07”). ASU 2018-07 is effective for all interim and annual reporting periods beginning on or after December 15, 2018. The Company will adopt ASU 2018-07 on January 1, 2019 and does not expect the adoption to have a material impact to the condensed consolidated financial statements.      

3. NET LOSS PER SHARE

Basic and diluted net loss per share have been computed by dividing the net loss by the weighted-average number of common shares outstanding during the period, without consideration of common share equivalents as their effect would have been antidilutive.

The following tables set forth the computation of the Company’s basic and diluted net loss per share (in thousands, except shares and per share data):

The following potentially dilutive securities have been excluded from diluted net loss per share, because their effect would be antidilutive:

On October 10, 2017, the Company completed an underwritten public offering (the “2017 Public Offering”), pursuant to which the Company issued and sold an aggregate of 4,992,840 shares.  During 2017 and the three months ended March 31, 2018, 6,415,039 shares of common stock subject to convertible notes were issued due to the conversion of the JGB Debt.  In the three months ended June 30, 2018, the Company achieved the milestone of performing 2,500 commercial AlloSure tests; therefore, the Company issued 227,845 shares of common stock to the former owners of ImmuMetrix, Inc. (“IMX”) that was previously considered contingent consideration.  

The Perceptive Credit Agreement includes a Tranche B loan of $10.0 million available at the Company’s option at any time from April 17, 2018 to April 17, 2019 (the “Tranche B Term Loan”). If the Tranche B Term Loan is funded, the Company will issue to Perceptive an additional warrant to purchase up to 93,333 shares of common stock.

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4. FAIR VALUE MEASUREMENTS

The Company records its financial assets and liabilities at fair value except for its debt, which was recorded at amortized cost.  The carrying amounts of certain financial instruments of the Company, including cash and cash equivalents, prepaid expenses and other current assets, accounts payable and accrued liabilities, approximate fair value due to their relatively short maturities.  Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date.  The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value as follows:

The following table sets forth the Company’s financial assets and liabilities measured at fair value on a recurring basis, as of June 30, 2018 and December 31, 2017 (in thousands):

The following table presents the issuances, changes in fair value and reclassifications of the Company’s Level 3 financial instruments that are measured at fair value on a recurring basis (in thousands):

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The Company recognizes transfers between levels of the fair value hierarchy as of the end of the reporting period.  There were no transfers between Level 1, Level 2 and Level 3 categories during the periods presented.

In determining fair value, the Company uses various valuation approaches within the fair value measurement framework.  The valuation methodologies used for the Company’s instruments measured at fair value and their classification in the valuation hierarchy are summarized below:

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Common Stock Warrant Liability and Derivative Liability Valuation Assumptions

5. BUSINESS COMBINATIONS AND ASSET ACQUISITIONS

Business Combinations

Allenex

On April 14, 2016, the Company acquired 98.3% of the outstanding common stock of Allenex, a transplant diagnostic company based in Stockholm, Sweden that developed, manufactured and sold products that help match donor organs with potential recipients prior to transplantation.  Allenex had a presence and direct distribution channels in the United States and Europe, with additional third party distributors in Europe and other markets around the world. Under the terms of the Conditional Share Purchase Agreements entered into on December 16, 2015, as amended, and the tender offer prospectus dated March 7, 2016, and as a result of the tender offer, the aggregate purchase consideration paid by the Company was approximately $34.1 million and consisted of (i) $26.9 million of cash, of which $5.7 million (which represents SEK 50,620,000 as of the acquisition date) was deferred purchase consideration originally payable to Midroc Invest AB, FastPartner AB and Xenella Holding AB, the former majority shareholders of Allenex (the “Former Majority Shareholders”) by no later than March 31, 2017, subject to certain contingencies being met, and (ii) the issuance of 1,375,029 shares of the Company’s common stock valued at $7.2 million.

Of the total cash consideration, $8.0 million of cash payable to the Former Majority Shareholders was deposited into an escrow account by the Company and subsequently invested in the Company by the Former Majority Shareholders through a purchase of the Company’s equity securities in a private placement.  Upon the completion of such private placement, certain contingencies in the Conditional Share Purchase Agreements were waived. On June 8, 2016, the Company delisted Allenex’s common stock from Nasdaq Stockholm.  

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The date by which the deferred purchase consideration was due to the Former Majority Shareholders was subsequently extended to July 1, 2017.  In addition, interest began accruing on the Company’s obligations to the Former Majority Shareholders (the “Deferred Obligation”) at a rate of 10.0% per year commencing on January 1, 2017.  On July 1, 2017, the Deferred Obligation totaled $6.3 million.  On July 1, 2017, the Conditional Share Purchase Agreements were amended in order to, among other things: (i) convert approximately $1.1 million of the Deferred Obligation into 1,022,544 shares of the Company’s common stock at a per share price equal to $1.12; (ii) require that the Company make an immediate cash payment of $0.5 million thereby reducing the Deferred Obligation by $0.5 million; (iii) extend the maturity date of a portion of the obligations, totaling approximately $2.9 million, under the Conditional Share Purchase Agreements to March 31, 2019; and (iv) provide that approximately $2.1 million of the Deferred Obligation would become payable on December 31, 2017 unless converted into shares of the Company’s common stock prior to that date, which issuance of shares was subject to approval by the Company’s stockholders.  Interest began to accrue on the Deferred Obligation at a rate of 10% per annum commencing on July 1, 2017.  On November 14, 2017, the Company further amended the Conditional Share Purchase Agreements with the Former Majority Shareholders, and, as a result, the Company paid the total remaining deferred purchase consideration of $4.7 million, plus accrued interest.  

The Company has accounted for the Allenex transaction as a business combination in exchange for total consideration of approximately $34.1 million.  Under business combination accounting, the total purchase price was allocated to Allenex’s net tangible and identifiable intangible assets based on their estimated fair values as of April 14, 2016.

The fair value of the remaining 1.7% of noncontrolling interest in Allenex was purchased on March 15, 2018.  The fair value of the noncontrolling interest was determined based on the number of outstanding shares comprising the noncontrolling interest and Allenex’s stock price of SEK 2.48 per share as of the acquisition date.  The noncontrolling interest was presented as a component of stockholders’ equity on the Company’s condensed consolidated balance sheets at December 31, 2017.

Conexio

On January 20, 2017, the Company acquired the business assets of Conexio Genomics Pty. Ltd (“Conexio”). Prior to the acquisition, the Company was the exclusive distributor of the Conexio SBT^TM product line for all countries excluding Australia.  The Company purchased rights to many of the assets, such as machinery, facilities leases, know-how and the opportunity to retain key Conexio employees to continue producing and selling SBT products.  The Company paid $0.4 million in cash and will make quarterly payments of 20% of the gross revenue from the sale of SBT products up to an aggregate total of $0.7 million.  During each of the six months ended June 30, 2018, and June 30, 2017, the Company paid less than $0.1 million.  The Company accounted for this transaction as a business combination.

Asset Acquisition

Illumina License and Commercialization Agreement

On May 4, 2018, the Company entered into a License and Commercialization Agreement (the “License Agreement”) with Illumina, which provides the Company with certain worldwide distribution, development and commercialization rights to Illumina’s NGS product line for use in the field of bone marrow and solid organ transplantation diagnostic testing (the “Field”).  As a result, from June 1, 2018, the Company is the exclusive worldwide distributor of Illumina’s TruSight HLA v1 and v2 product line. In addition, the Company was also granted the exclusive right to develop and commercialize other NGS product lines for use in the Field.

The License Agreement required the Company to make a $5.0 million initial cash payment to Illumina and further requires the Company to pay royalties in the mid-single to low-double digits on sales of future commercialized products. Pursuant to the License Agreement, the Company is obligated to complete timely development and commercialization of other NGS product lines for use in the Field, and has agreed to minimum purchase commitments of finished products and raw materials from Illumina through 2023.

As the License Agreement did not meet the definition of a business combination under FASB ASC Topic 805, Business Combinations, the Company accounted for the transaction as an asset acquisition. In an asset acquisition goodwill is not recognized, but rather any excess consideration transferred over the fair value of the net assets acquired is allocated on a relative fair value basis to the identifiable assets acquired.

Costs relating to the assets acquired were $5.2 million, comprising of the cash consideration of $5.0 million and associated transaction costs of $0.2 million. A deferred tax balance was not required to be established on the License Agreement date as the book and tax basis of the intangible assets was equivalent to the amount paid.

The allocation of the purchase price to identified intangible assets acquired was based on the Company's best estimate of the fair value of such assets as of the acquisition date. Significant assumptions utilized in the valuation of identified intangible assets were based on company specific information and projections, which are not observable in the market and are thus considered Level 3 measurements

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as defined by U.S. GAAP. The Company determined the estimated fair values using Level 3 inputs after review and consideration of relevant information, including discounted cash flows, quoted market prices and estimates made by management.

Customer relationships represent the fair value of future projected revenue that is expected to be derived from sales of TruSight HLA products to existing customers of Illumina. The customer contracts and related relationships value has been estimated utilizing a multi-period excess earnings method under income approach, which reflects the present value of the projected cash flows that are expected to be generated by the customer relationships less charges representing the contribution of other assets to those cash flows that use projected cash flows with and without the intangible asset in place. The economic useful life was determined based on the life of the products, assuming that the existing customers will remain with the Company until the products becomes obsolete. The Company utilized a discount rate of 18% in estimating the fair value of the customer relationships.

The acquired in-process technology represents the fair value of products in development that have not reached commercial production at the date of acquisition. The fair value of the products was also determined using the multi-period excess earnings method under income approach. A rate of 30% and 40% for the AlloSeq HLA acquired in-process technology and the AlloSeq BMT acquired in-process technology, respectively, was utilized to discount the cash flows to the present value. The acquired in-process technology will not be amortized until completion of the related products, which is determined by when the products commence commercial production. Upon completion, each acquired in-process technology product will be amortized over its estimated useful life.

The following table summarizes the fair values of the intangible assets acquired as of the closing date (in thousands):

6. GOODWILL AND INTANGIBLE ASSETS

Goodwill

Goodwill is recorded when the purchase price of an acquisition exceeds the fair value of the net tangible and identified intangible assets acquired.  The Company reported $12.0 million of goodwill on the condensed consolidated balance sheet as of each of June 30, 2018 and December 31, 2017.

Goodwill is tested annually for impairment at the reporting unit level during the fourth quarter or earlier upon the occurrence of certain events or substantive changes in circumstances.  On January 1, 2017, the Company adopted ASU 2017-04, which eliminated the Step 2 requirement of the goodwill impairment test. Instead, the goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount.  The Company determined that the decrease in its market capitalization in the first quarter of 2017 constituted an indicator of impairment and therefore a goodwill impairment test was completed as of March 31, 2017.  The goodwill impairment test determined that the fair value of the Pre-Transplant reporting unit was $3.5 million, which was lower than its carrying value.  Accordingly, the Company recorded a goodwill impairment charge of $2.0 million as of March 31, 2017, which represented the remaining goodwill balance in the Pre-Transplant reporting unit.  The significant assumptions utilized in the March 31, 2017 discounted cash flow analysis for the Pre-Transplant reporting unit were a discount rate of 16.6%, a terminal growth rate of 3.2% and a capitalization multiple of 7.48.  

There were no indicators of impairment in the three and six months ended June 30, 2018.

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Intangible Assets

The following tables present details of the Company’s intangible assets as of June 30, 2018 (in thousands):

The following tables present details of the Company’s intangible assets as of December 31, 2017 (in thousands):

Amortization expense was $0.6 million and $0.6 million for the three months ended June 30, 2018 and 2017, respectively.  For the three months ended June 30, 2018, expenses of $0.4 million and $0.2 million were amortized to cost of product and sales and marketing expense, respectively.  For the three months ended June 30, 2017, expenses of $0.4 million and $0.2 million were amortized to cost of product and sales and marketing expense, respectively.  Amortization expense was $1.2 million for each of the six months ended June 30, 2018 and 2017. For the six months ended June 30, 2018, expenses of $0.7 million and $0.5 million were amortized to cost of product and sales and marketing, expense, respectively.  For the six months ended June 30, 2017, expenses of $0.7 million and $0.5 million were amortized to cost of product and sales and marketing expense, respectively.  

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The following table summarizes the Company’s estimated future amortization expense of intangible assets with finite lives as of June 30, 2018 (in thousands):

The Company evaluates the carrying value of the intangible assets, not subject to amortization, related to in‑process research and development (“IPR&D”) assets, which are considered to be indefinite‑lived until the completion or abandonment of the associated research and development efforts. Accordingly, amortization of the IPR&D assets will not occur until the products reach commercialization. During the period the assets are considered indefinite‑lived, they are tested for impairment on an annual basis, as well as between annual tests if the Company becomes aware of any events occurring or changes in circumstances that would indicate that the fair values of the IPR&D assets are less than their carrying amounts. An impairment loss would be recorded when the fair value of an IPR&D asset is less than its carrying value. If and when development is complete, which generally occurs when the products are made commercially available, the associated IPR&D asset will be deemed definite‑lived and will then be amortized based on its estimated useful life.

7. BALANCE SHEET COMPONENTS

Inventory

Inventory consisted of the following (in thousands):

Accrued and other liabilities

Accrued and other liabilities consisted of the following (in thousands):