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(EDGAR Online via COMTEX) -- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains certain forward-looking statements that involve risk and uncertainties. Our actual results may differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those set forth under the Section entitled "Risk Factors" in Item 1A, and other documents we file with the Securities and Exchange Commission. Historical results are not necessarily indicative of future results.

Overview and Recent Highlights

We are a global transplant diagnostics company with product and service offerings along the pre- and post-transplant continuum. We focus on discovery, development and commercialization of clinically differentiated, high-value diagnostic solutions for transplant patients.

Testing Services

AlloMap

Our first commercialized testing solution, the AlloMap heart transplant molecular test, or 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, we have sought to expand the adoption and utilization of our 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 our 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. We believe 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, we believe 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. In 2008, AlloMap received 510(k) clearance from the U.S. Food and Drug Administration, or 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.

AlloMap has received positive coverage decisions for reimbursement from Medicare. The 2018 reimbursement rate for AlloMap was $3,240, which represented a 14% increase over the 2017 reimbursement rate. AlloMap has also received positive coverage decisions for reimbursement from many of the largest U.S. private payers, including Aetna, Anthem, Cigna, Health Care Services Corporation (HCSC), Humana, Kaiser Foundation Health Plan, Inc., TRICARE and UnitedHealthcare.

We have also successfully completed a number of landmark clinical trials in the transplant field demonstrating the clinical utility of AlloMap for surveillance of heart transplant recipients. We initially established the analytical and clinical validity of AlloMap on the basis of our Cardiac Allograft Rejection Gene Expression Observational (Deng, M. et al., Am J Transplantation 2006), or CARGO, study, which was published in the American Journal of Transplantation. A subsequent clinical utility trial, Invasive Monitoring Attenuation through Gene Expression (Pham MX et al., N. Eng. J. Med., 2010), or IMAGE, published in The New England Journal of Medicine, demonstrated that clinical outcomes in recipients managed with AlloMap surveillance were equivalent (non-inferior) to outcomes in recipients managed with biopsies. The results of our clinical trials have also been presented at major medical society congresses.

Since the launch of AlloMap in January 2005, we have performed more than 123,000 commercial AlloMap tests, including 16,116 tests during 2018. During the year ended December 31, 2018, AlloMap was used in 133 of the approximately 138 heart transplant centers in the United States.

AlloSure

AlloSure, our transplant surveillance solution which was commercially launched in October 2017, applies proprietary next generation sequencing technology to measure donor-derived cell-free DNA, or dd-cfDNA, in the blood stream emanating from the donor kidney. We believe AlloSure may help clinicians determine rejection-specific activity manifested as cell damage in the transplanted heart, kidney, or other solid organ, irrespective of the type of organ transplanted. We also believe 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, we believe AlloSure can improve patient care by helping healthcare providers to reduce the use of invasive biopsies and determine the appropriate dosage levels of immunosuppressants. Effective October 9, 2017, AlloSure became available for commercial testing with Medicare coverage and reimbursement. The Medicare reimbursement rate for AlloSure is $2,841. AlloSure has also received payment from private payers on a case-by-case basis, but no positive coverage decisions have been made to the date of this filing.

Prior to the commercialization of AlloSure, we generated a strong body of clinical evidence. In late 2015, we announced the completion of analytical validation of AlloSure. A report describing the analytical validation of AlloSure including clinical validation detailing the quality, reality and consistency of analytical results information for heart transplant, appeared in the November 2016 issue of The Journal of Molecular Diagnostics. The Circulating Donor-Derived Cell-Free DNA in Blood for Diagnosing Acute Rejection in Kidney Transplant Recipients, or DART, trial, sponsored by us, was conducted between April 2015 and January 2018. DART is a 14 center observational study of kidney transplant recipients where blood specimens are drawn periodically after transplant during follow up visits and also after treatment for acute rejection. By the time of completion of the first analysis, 384 patients were followed in DART for up to 24 months. The results demonstrated that increased levels of dd-cfDNA, determined by the AlloSure assay, discriminated active rejection of a kidney transplant more effectively than serum creatinine values. In collaboration with clinical investigators, we published these findings in the scientific peer-reviewed Journal of the American Society of Nephrology and the Journal Applied Laboratory Medicine in March 2017. A total of 2,109 patient visits had been accrued in DART by January 2019. We plan to analyze and report on additional findings from this dataset in 2019 and into the future.

In 2018, we initiated the Kidney Allograft Outcomes AlloSure Registry, or K-OAR study, to develop further data on the clinical utility of AlloSure for surveillance of kidney transplant recipients. As of December 31, 2018, 47 centers have been initiated as K-OAR study sites.

During the year 2018, there were 11,634 AlloSure patient test results provided. In the fourth quarter of 2018, AlloSure was ordered by 100 kidney transplant centers in the United States.

HeartCare

In September, 2018, we initiated the Surveillance HeartCare Outcomes Registry ("SHORE"). SHORE is a prospective, multi-center, observational, registry of patients receiving HeartCare for surveillance.

HeartCare combines the gene expression profiling technology of AlloMap with the dd-cfDNA analysis of AlloSure-Heart in one surveillance solution. An approach to surveillance using HeartCare provides information from the two complementary measures: (i) AlloMap - a measure of immune activation, and (ii) AlloSure-Heart(R)

Products

We develop, manufacture, market and sell products that increase the chance of successful transplants by facilitating a better match between a donor and a recipient of stem cells and organs. We also help clinicians manage transplant patients after the transplant has occurred.

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. Olerup SSP is used to type Human Leukocyte Antigen, or HLA alleles, based on the sequence specific primer, or SSP technology. Olerup SBT is a complete product range for sequence-based typing of HLA alleles.

On May 4, 2018, we entered into a License Agreement with Illumina, which provides us with worldwide distribution, development and commercialization rights to Illumina's NGS product line for use in transplantation diagnostic testing.

As a result, on June 1, 2018, we became the exclusive worldwide distributor of Illumina's TruSight HLA product line. TruSight HLA is high resolution solution that uses NGS methodology. In addition, we were granted the exclusive right to develop and commercialize other NGS product lines for use in the field of bone marrow and solid organ transplantation diagnostic testing.

Fourth Quarter 2018 Highlights

Continued the acceleration of AlloSure penetration

- In the fourth quarter of 2018, 100 U.S. transplant centers provided 4,575 AlloSure tests to approximately 3,400 patients

- Continued progress in AlloSure Registry (K-OAR) enrollment, with 47 centers initiated and 748 patients enrolled as of December 31, 2018

Achieved total revenue of $23.5 million for the fourth quarter of 2018, increasing 88% year-over-year

- Testing services revenue of $18.9 million, with 4,575 AlloSure and 4,057 AlloMap patient results provided

- Product revenue of $4.6 million

Generated a net loss of $3.8 million, positive adjusted EBITDA of $0.8 million and positive net cash from operations of $2.0 million in the fourth quarter of 2018

Strengthened balance sheet through public equity offering and repayment of all outstanding debt

- Cash and cash equivalents of $64.6 million at December 31, 2018

Financial Operations Overview

Revenue

We derive our revenue from testing services, products sales and license and other revenues. On January 1, 2018, we adopted the new revenue accounting standard Revenue from Contracts with Customers (Topic 606), or ASC 606, using the modified retrospective method. Under the new accounting standard, 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. The adoption of ASC 606 resulted in a one-time adjustment of $2.9 million to accounts receivable and accumulated deficit. This adjustment reflected the estimated payments to be received for tests where the result had been delivered at December 31, 2017, but the associated revenue had not been recognized by December 31, 2017, because payments had not been received. As of December 31, 2018, we had received payments of $3.4 million for these tests and recorded a change in estimate of $0.5 million as additional testing services revenue during 2018 year. Adoption of ASC 606 did not have any impact on product and license revenue recognized in prior periods.

Testing Services Revenue

Our testing services revenue is derived from AlloMap and AlloSure tests, which represented 79%, 69% and 73% of our total revenues for the years ended December 31, 2018, 2017 and 2016, respectively. Our testing services revenue depends on a number of factors, including (i) the number of tests performed;

histories; (v) our ability to expand into markets outside of the United States; and (vi) how quickly we can successfully commercialize new product offerings.

We currently market testing services to healthcare providers through our direct sales force that targets transplant centers and their physicians, coordinators and nurse practitioners. The healthcare providers that order the tests and on whose behalf we provide our testing services are generally not responsible for the payment of these services. Amounts received by us vary from payer to payer based on each payer's internal coverage practices and policies. We generally bill third-party payers upon delivery of a test result report to the ordering physician. As such, we take the assignment of benefits and the risk of collection from the third-party payer and individual patients.

During 2018 we performed 16,116 commercial AlloMap tests that are included in our estimated testing revenue. We also recognized additional $0.5 million in revenue related to tests performed in prior period due to the change in estimated transaction price in accordance with new revenue recognition standard ASC 606.

Since October 2017, when we launched AlloSure, we performed 282 commercial AlloSure tests as of December 31, 2017. During 2018 we performed 11,634 commercial AlloSure tests. All tests were performed from our Brisbane, California laboratory.

Product Revenue

Our product revenue is derived primarily from sales of Olerup SSP, QTYPE, Olerup SBT and TruSight products. Product revenue represented 20%, 30% and 26% of total revenue for the years ended December 31, 2018, 2017 and 2016, respectively. We recognize product revenue from the sale of products to end-users, distributors and strategic partners when all revenue recognition criteria are satisfied. We generally have 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

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. Our performance obligations under the collaboration and license 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 with the collaboration partners. We make judgments that affect the periods over which we recognize revenue. We review our estimated periods of performance based on the progress under each arrangement and account for the impact of any change in estimated revenues.

Segment Reporting

We changed our segment reporting from two reportable segments: Post-Transplant and Pre-Transplant to one reportable segment. In the third quarter of 2018, we completed a business reorganization to support our strategy to become a global transplant care leader. The position of the head of the former Pre-Transplant segment was eliminated, and global functional leaders were identified to manage sales and marketing, research and development, manufacturing and quality and other global functions. These changes resulted in changes to the presentation of financial information provided to our chief operating decision maker (the "CODM"), who is our chief executive officer, for resource allocation and management performance assessment. The CODM continues to review revenue and cost of sales by testing services and products, as reported in the consolidated statements of operations. Earnings before interests, tax, depreciation and amortization, and operating results are reviewed at the consolidated level only. Effective September 30, 2018, we report a single operating segment.

Goodwill Impairment

We test goodwill and indefinite-lived intangibles for impairment at least annually and more frequently if impairment indicators are present. We recorded goodwill impairment charges related to our former Pre-Transplant reporting unit

of $13.0 million and $2.0 million as of December 31, 2016 and March 31, 2017, respectively. Goodwill allocated to our former Pre-Transplant reporting unit was fully impaired at March 31, 2017. The remaining goodwill of $12.0 million relates to our former Post-Transplant reporting unit and it was not impaired. No impairment charges were recorded in 2018.

Change in Estimated Fair Value of Contingent Consideration

We revalued our contingent consideration obligation liability in connection with our acquisition of IMX in 2014 at the end of each reporting period through the settlement date. Changes in the fair value of our contingent consideration obligation were recognized as a component of operating expense within our consolidated statements of operations. We achieved the contingent consideration obligation milestone of 2,500 commercial AlloSure tests and issued 227,848 shares of our common stock in the three month period ended June 30, 2018. We recorded $1.0 million expense related to changes in fair value of contingent consideration from January 1, 2018 to the date of the shares issuance. There is no contingent consideration obligation outstanding as of December 31, 2018.

Debt Extinguishment Expenses

In connection with the repayment and conversion to shares of common stock of all outstanding debt obligations during 2018, we recorded $2.8 million loss on the conversion of the convertible debt financing with JGB (the "JGB Debt") as the difference between the value of the shares of common stock issued on the days of conversion and the amount of principal debt converted on those days, net of the allocated debt discount and derivative liability balances. During the same period we also recorded a $3.0 million loss on debt extinguishment of the credit agreement with Perceptive Credit Holdings II, LP, or Perceptive, or the Perceptive Credit Agreement.

Other Expense, Net

Other expense includes gains and losses on foreign currency transactions and other miscellaneous expenses. During the year ended December 31, 2018, the other expense charge of $0.2 million primarily consisted franchise taxes paid.

Change in Estimated Fair Value of Common Stock Warrant and Derivative Liabilities

We recorded $23.0 related to changes in fair value of common stock warrants and derivative liabilities, as these financial instruments are classified in liabilities during the year ended December 31, 2018. Common stock warrants issued in connection with our debt and equity financings are considered freestanding financial instruments and are analyzed as to whether they meet equity or liability classification in accordance with United States generally accepted accounting principles, or US GAAP. Warrants that meet liability classification are remeasured at each period end with changes in fair value recorded in our consolidated statements of operations until these warrants are exercised or expire. On January 1, 2018, we adopted Accounting Standards Update 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, and this resulted in the liability balance for our warrants issued to JGB being reclassified to equity on the date of adoption.

The JGB Debt included certain embedded derivatives that required bifurcation, including settlement and penalty provisions. The 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 consolidated statements of operations. As of March 27, 2018, the JGB Debt was fully converted to shares of our common stock and the derivative was extinguished.

On April 17, 2018, we entered into the Perceptive Credit Agreement for an initial term loan of $15.0 million, which included an embedded derivative that required bifurcation related to early repayment provision. We recorded changes in the fair value of the derivative liabilities in the change in estimated value of common stock warrant liability and derivative liability in our consolidated statements of operations. All amounts owing under the Perceptive Credit Agreement were fully paid off on November 20, 2018 and the derivative was extinguished.

Critical Accounting Policies and Significant Judgments and Estimates

Our management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 of the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information. Some of these accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We believe that the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of our consolidated financial statements.

Revenue Recognition

We recognize 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

Patient tests are ordered by healthcare providers. We receive a test requisition form with payer information along with a collected patient blood sample. We consider the patient to be our customer and the test requisition form a contract. Testing services are performed in our 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 we provide testing services are generally not responsible for the payment of these services. The first and second revenue recognition criteria are satisfied when we receive a test requisition form with payer information from the healthcare provider. Generally, we bill third-party payers upon delivery of test result to the healthcare provider. Amounts received may vary amongst payers based on coverage practices and policies of the payer. We determine an estimate of a transaction price by financial class 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. We estimate 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 process for determining the appropriate transaction price involves judgment, and considers such factors as, historical payment trends, current economic conditions and regulatory changes. The ultimate amounts of collections could be different from the amounts we estimate.

During 2018, we recognized $0.5 million additional revenue related to the change in estimate of reimbursement of testing services as we collected more than we estimated for tests performed in prior year.

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. We generally have 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

We generate 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. Our 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. We make 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. We periodically review our 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. We constrain variable consideration, such as milestones, if it is probable that a significant portion of revenue would be reversed. Our deferred revenue relates to one performance obligation, which should be recognized over time.

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Mar 06, 2019

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