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OFFON

GUARDANT HEALTH, INC.

(GH)
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GUARDANT HEALTH : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

05/06/2021 | 05:12pm EDT
You should read the following discussion and analysis of our 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 Quarterly Report on
Form 10-Q contain forward-looking statements that involve risk and
uncertainties, such as statements of our plans, objectives, beliefs,
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 Part I, Item 1A, "Risk Factors," of our Annual Report on Form 10-K for the
year ended December 31, 2020 and in Part II, Item 1A, "Risk Factors" of this
Quarterly Report on Form 10-Q.
Overview
We are a leading precision oncology company focused on helping conquer cancer
globally through use of our proprietary blood-based 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, accelerate drug development, 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 Guardant360, Guardant360
LDT, Guardant360 CDx, and GuardantOMNI liquid biopsy-based tests for advanced
stage cancer. In February 2021, we launched our Guardant Reveal liquid
biopsy-based tests for residual and recurring cancer to first address the need
in Stage II-III colorectal cancer. We are developing tests under our Guardant360
tissue program which aims to address challenges with tissue genotyping products
currently available in the market and tests from our LUNAR program which aims to
address the needs of early stage cancer patients with neoadjuvant and adjuvant
treatment selection, cancer survivors with surveillance, asymptomatic
individuals eligible for cancer screening, and individuals at a higher risk for
developing cancer with early detection. We have also developed our
GuardantINFORM platform to further accelerate precision oncology drug
development by biopharmaceutical companies by offering them an in-silico
research platform to unlock further insights into tumor evolution and treatment
resistance across various biomarker-driven cancers.
We perform our tests in our clinical laboratory located in Redwood City,
California. Our laboratory is certified pursuant to the Clinical Laboratory
Improvement Amendments of 1988, or CLIA, accredited by the College of American
Pathologists, or CAP, permitted by the New York State Department of Health, or
NYSDOH, and licensed in California and four other states. In September 2020, we
dual-launched our Guardant360 CDx and Guardant360 LDT tests. Our Guardant360 CDx
test was the first comprehensive liquid biopsy test approved by the U.S. Food
and Drug Administration, or the FDA, to provide tumor mutation profiling for
cancer patients with solid tumors and to be used as a companion diagnostic
initially in connection with one therapeutic product of a biopharmaceutical
customer.
We generated total revenue of $78.7 million and $67.5 million for the three
months ended March 31, 2021 and 2020, respectively. We also incurred net losses
of $107.4 million and $31.8 million for the three months ended March 31, 2021
and 2020, respectively. We have funded our operations to date principally from
the sale of our stock, convertible senior notes, and revenue from our precision
oncology testing and development services and other. As of March 31, 2021, we
had cash, cash equivalents and marketable securities of $1.9 billion.
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:
•Testing volume, pricing 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 tests that we perform for patients on behalf of clinicians
and the number of tests we perform 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 higher than our
average reimbursement for clinical tests because 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.
Approximately 35% and 38% of our U.S. clinical tests for the three months ended
March 31, 2021 and 2020, respectively, were for Medicare beneficiaries.
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•Payer coverage and reimbursement. Our revenue depends on achieving broad
coverage and reimbursement for our tests from third-party payers, including both
commercial and government payers. Precision oncology revenue from tests for
clinical customers is calculated based on our expected cash collections, using
the estimated variable consideration. The variable consideration is estimated
based on historical collection patterns as well as the potential for changes in
future reimbursement behavior by one or more payers. Estimation of the impact of
the potential for changes in reimbursement requires significant judgment and
considers payer' past patterns of changes in reimbursement as well as any stated
plans to implement changes. Any cash collections over the expected reimbursement
period exceeding the estimated variable consideration is recorded in future
periods based on actual cash received. Payment from commercial payers can vary
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 often reimburse non-participating
providers, if at all, at a lower amount than participating providers. Because we
are not contracted with these payers, they determine the amount that they are
willing to reimburse us for any of our tests and they can prospectively and
retrospectively adjust the amount of reimbursement, adding to the complexity in
estimating the variable consideration. When we contract with a payer to serve as
a participating provider, reimbursements by the payer are generally made
pursuant to a negotiated fee schedule and are limited to only covered
indications or where prior approval has been obtained. Becoming a participating
provider can result in higher reimbursement amounts for covered uses of our
tests and, potentially, no reimbursement for non-covered uses identified under
the payer's policies or the contract. As a result, the potential for more
favorable reimbursement associated with becoming a participating provider may be
offset by a potential loss of reimbursement for non-covered uses of our tests.
Current Procedural Terminology, or CPT, coding plays a significant role in how
our Guardant360 test is reimbursed both from commercial and governmental payers.
In addition, Z-Code Identifiers are used by certain payers, including under
Medicare's Molecular Diagnostic Services Program, or MolDx, to supplement CPT
codes for molecular diagnostics tests such as our Guardant360 test. Changes to
the codes used to report the Guardant360 test to payers may result in
significant changes in its reimbursement. If a coding change were to occur,
including as a result of the FDA approval of our Guardant360 test, payments for
certain uses of the Guardant360 test could be reduced, put on hold, or
eliminated by such payers. Cigna, Priority Health, multiple Blue Cross Blue
Shield plans as well as the health plans associated with eviCore adopted
policies that cover our Guardant360 test for the majority of NSCLC patients we
test. If their policies were to change in the future to cover additional cancer
indications, we anticipate that our total reimbursement would increase. For the
three months ended March 31, 2021 and 2020, respectively, approximately 41% and
43% of our U.S. clinical tests were for patients tested for NSCLC. In March
2020, we began to receive reimbursement from Medicare for claims submitted, with
respect to Guardant360 clinical tests performed for qualifying patients
diagnosed with solid tumor cancers of non-central nervous system origin other
than NSCLC. Following the FDA approval of our Guardant360 CDx test, a new Z-Code
Identifier was issued in August 2020. A proprietary laboratory analyses, or PLA
code was issued for our Guardant360 CDx in January 2021 with an effective date
in April 2021. Once the code is effective, all Guardant360 CDx services will be
billed with this new code. Additionally, based on this new PLA code, we applied
to the Centers for Medicare and Medicaid Services or CMS for our Guardant360 CDx
test to become an advanced diagnostic laboratory test, or ADLT. In March 2021,
CMS approved ADLT status to the Guardant360 CDx test, which would allow us to
bill Medicare at the lowest available commercial rate for the first three
quarters at the launch of the test. After the initial three quarters, we can
bill Medicare for Guardant360 CDx services at the median rate of claims paid by
commercial payers. We are in the process of negotiating reimbursement for our
Guardant Reveal test from commercial and governmental payers. Due to the
inherent variability and unpredictability of the reimbursement landscape,
including related to the amount that payers reimburse us for any of our tests,
previously recorded revenue adjustments are not indicative of future revenue
adjustments from actual cash collections, which may fluctuate significantly.
This variability and unpredictability could increase the risk of future revenue
reversal and result in our failing to meet any previously publicly stated
guidance we may provide.
•Biopharmaceutical customers. Our revenue also depends on our ability to
attract, maintain and expand relationships with biopharmaceutical customers. As
we continue to develop these relationships, we expect to support a growing
number of clinical trials globally and continue to have opportunities to offer
our platform to such customers for development services, including companion
diagnostic development, novel target discovery and validation, as well as
clinical trial enrollment. For example, our Guardant360, Guardant360 CDx, and
GuardantOMNI tests are being developed as companion diagnostics under
collaborations with biopharmaceutical companies, including AstraZeneca, Amgen,
Daiichi Sankyo, Janssen Biotech, and Radius Health.
•Research and development. A significant aspect of our business is our
investment in research and development, including the development of new
products. In particular, we have invested heavily in clinical studies as we
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believe these studies are critical to gaining physician adoption and driving
favorable coverage decisions by payers. With respect to our LUNAR program, we
initiated a prospective screening study, which we refer to as the ECLIPSE trial,
aiming to recruit approximately 10,000 patients and evaluate the performance of
our LUNAR-2 assay in detecting colorectal cancer in average-risk adults. In
addition, we are investing very heavily in establishing clinical utility of our
Guardant Reveal test in adjuvant treatment settings. In 2020, we launched three
trials in collaboration with key cancer researchers: COBRA, a randomized
controlled study, comprising over 1,400 low-risk stage-II colon cancer patients,
ACT-3, comprising over 500 stage-III colorectal cancer patients, and PEGASUS for
the de-escalation of therapy, encompassing over 140 high-risk stage-II and
stage-III colon cancer patients. We have expended considerable resources, and
expect to increase such expenditures over the next few years, to support our
research and development programs with the goal of fueling further innovation.
•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 countries outside the United States primarily through distributor
relationships or direct contracts with hospitals or partnerships with research
organizations. 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 generally outside
the Americas and Europe. We expect to rely on the Joint Venture to accelerate
commercialization of our products in Asia, the Middle East and Africa.
•Sales and marketing expense. Our financial results have historically, and will
likely continue to, fluctuate significantly based upon the impact of our sales
and marketing expense, increase in headcount, and in particular, our various
marketing programs around existing and new product introductions.
•General and administrative expense. Our financial results have historically,
and will likely continue to, fluctuate significantly based upon the impact of
our general and administrative expense, and in particular, our stock-based
compensation expense. Our equity awards, including market-based and
performance-based restricted stock units, are intended to retain and incentivize
employees to lead us to sustained, long-term superior financial and operational
performance.
•COVID-19 Global Pandemic. The global outbreak of coronavirus 2019, or COVID-19,
has disrupted, and we expect will continue to disrupt, our operations. To
protect the health and well-being of our workforce, partners, vendors and
customers, we have provided free COVID-19 testing for all of our employees,
contractors and their dependents, implemented social distance and building entry
policies at work, restricted travel and facility visits, and followed
California's "shelter in place" public health orders and the guidance from the
Centers for Disease Control and Prevention. The COVID-19 global pandemic also
has started to negatively affect, and we expect will continue to negatively
affect, our revenue and our clinical studies. For example, our biopharmaceutical
customers are facing challenges in recruiting patients and in conducting
clinical trials to advance their pipelines, for which our tests could be
utilized. We launched our Guardant-19 test and received the FDA's emergency use
authorization for use in the detection of the novel coronavirus. The test is
being offered to our employees and select partner organizations our
CLIA-certified clinical laboratory. We cannot predict the extent to which the
Guardant-19 test will be used by third parties.
While each of these areas presents significant opportunities for us, they also
pose significant risks and challenges that we must address. See Part I, Item
1A, "Risk Factors" of our Annual Report on Form 10-K for the year ended
December 31, 2020, and Part II, Item 1A, "Risk Factors" of this Quarterly Report
on Form 10-Q, for more information.
Components of results of operations
Revenue
We derive our revenue from two sources: (i) precision oncology testing and (ii)
development services and other.
Precision oncology testing. Precision oncology testing revenue is generated from
sales of our tests to clinical and biopharmaceutical customers. In the United
States, through March 31, 2021, we generally performed tests as an
out-of-network service provider without contracts with health insurance
companies. We submit claims for payment for tests performed for patients covered
by U.S. private payers. We submit claims to Medicare for reimbursement for
Guardant360 clinical testing performed for qualifying patients diagnosed with
solid tumor cancers of non-central nervous system origin who meet the criteria
of Medicare's National Coverage Determination for Next Generation Sequencing
established in March 2018. Tests for patients covered by Medicare represented
approximately 35% and
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38% of U.S. tests performed during the three months ended March 31, 2021 and
2020, respectively. We also provide precision oncology testing to
biopharmaceutical customers under contracts for which all recognition criteria
are met, and we have recognized revenue on an accrual basis for those services.
Development services and other. Development services and other revenue primarily
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 setup, monitoring and maintenance, referrals, liquid biopsy testing
development and support, as well as GuardantConnect, GuardantINFORM,
Guardant-19, and kits fulfillment related revenues. 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 to support companion diagnostic device submissions for our liquid biopsy
panels. Under these arrangements, we generate revenue from progression of our
collaboration efforts, as well as from provision of on-going support.
Development services and other 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, inventory write-downs, direct labor, including
bonus, employee benefits 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, depreciation of leasehold improvements and information technology costs.
Costs associated with performing our tests are recorded as the tests are
performed 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.
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 and other. Cost of development services and other
primarily includes costs incurred for the performance of development services
requested by our customers comprising of direct labor and material costs
including any inventory write-downs. 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 and other 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 including
stock-based compensation, 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 before technological feasibility has been achieved.
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 our 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.
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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, medical affairs, as well as business development personnel who
are focused on our biopharmaceutical customers. These expenses consist primarily
of salaries, commissions, bonuses, employee benefits, travel expenses and
stock-based compensation, as well as marketing, sales incentives, 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 our tests.
General and administrative expense. Our general and administrative expenses
include costs for our executive, accounting and finance, information technology,
legal and human resources functions. These expenses consist principally of
salaries, bonuses, employee benefits, travel expenses 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, primarily due to increased stock-based compensation
expense, including resulting from the market-based restricted stock units
granted to our Chief Executive Officer and our President and Chief Operating
Officer in May 2020. 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 of revenue from period to
period due to the timing and extent of these expenses being incurred.
Interest income
Interest income consists of interest earned on our cash, cash equivalents and
marketable securities.
Interest expense
Interest expense consists primarily of charges relating to amortization of debt
issuance costs.
Other income (expense), net
Other income (expense), net consists of foreign currency exchange gains and
losses, payments due and received in relation to the settlement of a patent
dispute, net of credit losses, and the relief fund grant from the Department of
Health and Human Services, or HHS, under the U.S. Coronavirus Aid, Relief, and
Economic Security Act, or the CARES Act. 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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Results of operations
The following table set forth the significant components of our results of
operations for the periods presented.
                                                               Three Months Ended
                                                                   March 31,
                                                                             2021           2020

                                                                                 (unaudited)
                                                                               (in thousands)
      Revenue:
      Precision oncology testing                                         $ 

63,729 $ 60,246

      Development services and other                                       

14,936 7,264

      Total revenue                                                        

78,665 67,510

Costs and operating expenses:

      Cost of precision oncology testing(1)                                

23,590 18,191

      Cost of development services and other                               

5,157 2,315

      Research and development expense(1)                                  

55,508 37,016

      Sales and marketing expense(1)                                       

34,338 25,115

      General and administrative expense(1)                                

67,935 19,785

      Total costs and operating expenses                                    186,528        102,422
      Loss from operations                                                 (107,863)       (34,912)
      Interest income                                                         1,551          3,318
      Interest expense                                                         (646)           (12)
      Other income (expense), net                                              (290)          (209)
      Loss before provision for income taxes                              

(107,248) (31,815)

      Provision for (benefit from) income taxes                            
    110             14
      Net loss                                                           $ (107,358)     $ (31,829)

(1)Amounts include stock-based compensation expense as follows:

                                                              Three Months Ended
                                                                  March 31,
                                                                             2021         2020

                                                                                (unaudited)
                                                                              (in thousands)
        Cost of precision oncology testing                                $    767      $   303
        Research and development expense                                     4,300        2,364
        Sales and marketing expense                                          2,880        1,798
        General and administrative expense                                  47,122        1,873
        Total stock-based compensation expense                            $ 55,069      $ 6,338



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Comparison of the Three Months Ended March 31, 2021 and 2020
Revenue
                                        Three Months Ended March 31,                   Change
                                             2021                    2020           $            %

                                                 (unaudited)
                                                      (in thousands)
Precision oncology testing       $        63,729                  $ 60,246      $  3,483         6  %
Development services and other            14,936                     7,264         7,672       106  %
Total revenue                    $        78,665                  $ 67,510      $ 11,155        17  %


Total revenue was $78.7 million for the three months ended March 31, 2021
compared to $67.5 million for the three months ended March 31, 2020, an increase
of $11.2 million, or 17%.
Precision oncology testing revenue increased to $63.7 million for the three
months ended March 31, 2021 from $60.2 million for the three months ended March
31, 2020, an increase of $3.5 million, or 6%. This increase in precision
oncology testing revenue was due to an increase in sample volume. Precision
oncology revenue from tests for clinical customers was $49.8 million in the
three months ended March 31, 2021 and $38.0 million in the three months ended
March 31, 2020, respectively. Tests for clinical customers increased to 18,390
for the three months ended March 31, 2021 from 15,257 for the three months ended
March 31, 2020 mainly due to an increase in the number of physicians ordering
Guardant360 tests. In March 2020, we began to receive reimbursement from
Medicare for claims submitted with respect to Guardant360 clinical tests
performed for qualifying patients diagnosed with solid tumor cancers of
non-central nervous system origin other than NSCLC.
Precision oncology revenue from tests for biopharmaceutical customers was $13.9
million in the three months ended March 31, 2021 and $22.3 million in the three
months ended March 31, 2020, respectively. Tests for biopharmaceutical customers
decreased to 3,522 for the three months ended March 31, 2021 from 5,266 for the
three months ended March 31, 2020 primarily due to the timing and progression of
clinical trials and studies which resulted in fluctuation in the number of
samples received for testing. As a result of the COVID-19 pandemic, beginning in
the latter half of March 2020, we began receiving fewer samples for testing on a
daily average basis from our clinical and biopharmaceutical customers than
before the outbreak of the COVID-19 pandemic. Our future sample volumes and
precision oncology revenue may be adversely impacted by the COVID-19 pandemic
depending on the duration and severity of the pandemic.
Development services and other revenue increased to $14.9 million for the three
months ended March 31, 2021 from $7.3 million for the three months ended March
31, 2020, an increase of $7.7 million, or 106%. This increase in development
services and other revenue was primarily due to new collaboration projects from
biopharmaceutical customers for companion diagnostic development and regulatory
approval services during the three months ended March 31, 2021. Our development
services arrangements with biopharmaceutical customers and development services
revenue may be adversely impacted by the COVID-19 pandemic in future periods.
Costs and operating expenses
Cost of revenue
                         Three Months Ended March 31,                  Change
                        2021                        2020            $           %

                                 (unaudited)
                                      (in thousands)
Cost of revenue   $      28,747                  $ 20,506       $ 8,241        40  %
Gross profit      $      49,918                  $ 47,004
Gross margin                 63   %                    70  %


Cost of revenue was $28.7 million for the three months ended March 31, 2021
compared to $20.5 million for the three months ended March 31, 2020, an increase
of $8.2 million, or 40%.
Cost of precision oncology testing revenue was $23.6 million for the three
months ended March 31, 2021 compared to $18.2 million for the three months ended
March 31, 2020, an increase of $5.4 million, or 30%. This increase in cost of
precision oncology testing was primarily due to a $2.8 million increase in
material costs, $1.7 million
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increase in labor and manufacturing overhead costs, a $1.0 million increase in
other costs including costs related to freight and curation of test results for
physicians, partially offset by a $0.2 million decrease in royalties.
Cost of development services and other was $5.2 million for the three months
ended March 31, 2021 compared to $2.3 million for the three months ended March
31, 2020, an increase of $2.8 million, or 123%. This increase in cost of
development services and other was primarily due to an increase in material and
labor costs related to companion diagnostic development and regulatory approval
service contracts.
Gross margin for the three months ended March 31, 2021 was 63% compared to 70%
for the three months ended March 31, 2020. The decrease in gross margin is
primarily due to higher average cost per test resulting from varied product mix
and lower average selling price. Our gross margin may be adversely impacted by
the COVID-19 pandemic for the affected periods.
Research and development expense
                                  Three Months Ended March 31,                   Change
                                       2021                    2020           $            %

                                           (unaudited)
                                                (in thousands)
Research and development   $        55,508                  $ 37,016      $ 18,492        50  %


Research and development expenses were $55.5 million for the three months ended
March 31, 2021 compared to $37.0 million for the three months ended March 31,
2020, an increase of $18.5 million, or 50%. This increase in research and
development expense was primarily due to an increase of $12.0 million in
personnel-related costs for employees in our research and development group,
including a $1.9 million increase in stock-based compensation, as we increased
our headcount to support continued investment in our technology. The increase is
also attributable to an increase of $1.3 million in development consulting fees,
an increase of $8.6 million in material costs, and an increase of $4.2 million
related to allocated facilities and information technology infrastructure costs
offset by a decrease of $8.5 million relating to in-process research and
development (IPR&D) technology expensed in connection with a patent license
acquisition that occurred in March 2020. Our research and development expenses
are expected to increase in absolute dollars in coming years as the Company
continues to innovate and invest in new product initiatives with a particular
focus on LUNAR program.
Sales and marketing expense
                               Three Months Ended March 31,                   Change
                                    2021                    2020           $           %

                                        (unaudited)
                                             (in thousands)
Sales and marketing     $        34,338                  $ 25,115      $ 9,223        37  %


Selling and marketing expenses were $34.3 million for the three months ended
March 31, 2021 compared to $25.1 million for the three months ended March 31,
2020, an increase of $9.2 million, or 37%. This increase was primarily due to an
increase of $4.5 million in personnel-related costs, including a $1.1 million
increase in stock-based compensation, associated with the expansion of our
commercial organization. The increase is also attributable to an increase of
$2.2 million related to allocated facilities and information technology
infrastructure costs, and an increase of $2.6 million in professional service
expenses related to marketing activities. 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 our tests.
General and administrative expense
                                     Three Months Ended March 31,                   Change
                                          2021                    2020           $            %

                                              (unaudited)
                                                   (in thousands)
General and administrative    $        67,935                  $ 19,785      $ 48,150       243  %

General and administrative expenses were $67.9 million for the three months ended March 31, 2021 compared to

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$19.8 million for the three months ended March 31, 2020, an increase of $48.2
million, or 243%. This increase was primarily due to an increase of $48.2
million in personnel-related costs, including a $45.2 million increase in
stock-based compensation primarily in connection with the issuance of
market-based restricted stock units to our Chief Executive Officer and our
President and Chief Operating Officer as well as an increase in our headcount,
an increase of $0.9 million in professional service expenses related to outside
legal, accounting, consulting and IT services, and an increase of $0.3 million
related to allocated facilities and information technology infrastructure cost,
offset by a decrease of $1.2 million related to settlement costs in connection
with a patent license acquisition that occurred in March 2020, and a decrease of
$0.3 million in office administrative costs. Our general and administrative
expenses may increase in the near term due to increase in stock-based
compensation expense associated with increase headcount as well as expense
recognition associated with the market-based restricted stock units.
Interest income
                         Three Months Ended March 31,                   Change
                               2021                   2020           $            %

                                  (unaudited)
                                       (in thousands)
Interest income   $        1,551                    $ 3,318      $ (1,767)      (53) %


Interest income was $1.6 million for the three months ended March 31, 2021
compared to $3.3 million for the three months ended March 31, 2020, a decrease
of $1.8 million, or 53%. This decrease was primarily due to a significant
decrease in interest rate as the U.S. Federal Reserve lowered the risk-free
interest rate to nearly zero.
Interest expense
                              Three Months Ended March 31,                    Change
                                    2021                     2020         $            %

                                      (unaudited)
                                           (in thousands)
Interest expense     $           (646)                      $ (12)     $ (634)      5,283  %


Interest expense was $0.6 million for the three months ended March 31, 2021,
primarily due to the amortization of debt issuance costs. Interest expense was
immaterial for the three months ended March 31, 2020.
Other income (expense), net
                                      Three Months Ended March 31,                 Change
                                            2021                     2020         $         %

                                               (unaudited)
                                                   (in thousands)
Other income (expense), net   $          (290)                     $ (209)     $  (81)      *



Other income (expense), net included foreign currency exchange gains of $0.3
million and $0.2 million for the three months ended March 31, 2021 and 2020.
Provision for (benefit from) income taxes
                                             Three Months Ended March 31,                         Change
                                              2021                    2020                  $                 %

                                                     (unaudited)
                                                             (in thousands)
Provision for (benefit from) income
taxes                                 $             110          $         14          $      96              *


*  Not meaningful
Provision for income taxes was immaterial for the three months ended March 31,
2021 and 2020.
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Liquidity and capital resources
We have incurred losses and negative cash flows from operations since our
inception, and as of March 31, 2021, we had an accumulated deficit of $711.8
million. We expect to incur additional operating losses in the near future and
our operating expenses will increase as we continue to invest in clinical trials
and develop new products, expand our sales organization, and increase our
marketing efforts to drive market adoption of our tests. As demand for our tests
are expected to continue to increase from physicians and biopharmaceutical
companies, we anticipate that our capital expenditure requirements could also
increase if we require additional laboratory capacity.
We have funded our operations to date principally from the sale of stock,
convertible debt and through revenue from precision oncology testing and
development services and other. As of March 31, 2021, we had cash and cash
equivalents of $869.4 million and marketable securities of $1.1 billion. Cash in
excess of immediate requirements is invested in accordance with our investment
policy, primarily with a view to provide liquidity while ensuring capital
preservation. Currently, our funds are held in marketable securities consisting
of United States treasury securities.
Based on our current business plan, we believe our current cash, cash
equivalents and marketable securities and anticipated cash flows from
operations, will be sufficient to meet our anticipated cash requirements for
more than 12 months from the date of this report. We may consider raising
additional capital to expand our business, to pursue strategic investments, to
take advantage of financing opportunities or for other reasons. As revenue from
precision oncology testing and development services and other is expected to
grow long-term, we expect our accounts receivable and inventory balances to
increase. Any increase in accounts receivable and inventory may not be
completely offset by increases in accounts payable and accrued expenses, which
could result in greater working capital requirements.
If our available cash, cash equivalents and marketable securities and
anticipated cash flows from operations are insufficient to satisfy our liquidity
requirements including because of lower demand for our products as a result of
lower than currently expected rates of reimbursement from our customers or other
risks described in our Form 10-K for the year ended December 31, 2020, we may
seek to sell additional common or preferred equity or convertible debt
securities, enter into a credit facility or another form of third-party funding
or seek other debt financing. The sale of equity and convertible debt securities
may result in dilution to our stockholders and, in the case of preferred equity
securities or convertible debt, those securities could provide for rights,
preferences or privileges senior to those of our common stock. The terms of debt
securities issued or borrowings pursuant to a credit agreement could impose
significant restrictions on our operations. If we raise funds through
collaborations and licensing arrangements, we might be required to relinquish
significant rights to our platform technologies or products or grant licenses on
terms that are not favorable to us. Additional capital may not be available to
us on reasonable terms, or at all.
Cash flows
The following table summarizes our cash flows for the periods presented:
                                                                   Three Months Ended March 31,
                                                                     2021                   2020

                                                                            (unaudited)
                                                                          (in thousands)
Net cash used in operating activities                         $       (16,291)         $   (13,282)
Net cash provided by investing activities                     $       123,870          $    20,804
Net cash (used in) provided by financing activities           $       

(69,953) $ 1,466



Operating activities
Cash used in operating activities during the three months ended March 31, 2021
was $16.3 million, which resulted from a net loss of $107.4 million, partially
offset by non-cash charges of $67.9 million and net change in our operating
assets and liabilities of $23.2 million. Non-cash charges primarily consisted of
$55.1 million of stock-based compensation, $5.0 million of depreciation and
amortization, $3.9 million of non-cash operating lease costs, and $3.3
million of amortization of premium on investment. The net change in our
operating assets and liabilities was primarily the result of a $12.0 million
increase in accounts payable, a $8.9 million increase in accrued compensation
due to increased personnel, a $5.3 million decrease in accounts receivables and
a $4.4 million increase in accrued expenses and other liabilities, partially
offset by a $6.2 million increase in inventory due to higher testing volumes and
a $2.8 million payment of operating lease liabilities net of receipt of tenant
improvement allowance.
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Cash used in operating activities during the three months ended March 31, 2020
was $13.3 million, which resulted from a net loss of $31.8 million and net
change in our operating assets and liabilities of $1.5 million, partially offset
by non-cash charges of $20.1 million. Non-cash charges primarily consisted of
$8.5 million of charge of in-process research and development costs with no
alternative future use, $6.3 million of stock-based compensation, $3.3 million
of depreciation and amortization, $1.5 million of non-cash operating lease
costs, and $0.6 million of amortization of premium on investment. The net change
in our operating assets and liabilities was primarily the result of a $10.0
million increase in inventory due to higher testing volumes, a $2.6 million
increase in prepaid expenses and other current assets, a $1.9 million payment of
operating lease liabilities and a $0.6 million decrease in accrued expenses and
other liabilities, partially offset by a $9.5 million increase in accounts
payable and a $4.4 million increase in accrued compensation due to increased
personnel.
Investing activities
Cash provided by investing activities during the three months ended March 31,
2021 was $123.9 million, which resulted primarily from maturities of marketable
securities of $204.1 million, partially offset by purchases of marketable
securities of $70.7 million and purchases of property and equipment of $9.6
million.
Cash provided by investing activities during the three months ended March 31,
2020 was $20.8 million, which resulted primarily from maturities of marketable
securities of $104.0 million, partially offset by purchases of marketable
securities of $55.8 million, purchases of intangible assets and capitalized
license obligations of $17.9 million and purchases of property and equipment of
$9.6 million.
Financing activities
Cash used in financing activities during the three months ended March 31, 2021
was $70.0 million, which was primarily due to taxes paid related to net share
settlement of restricted stock units of $73.6 million, partially offset by
proceeds from exercise of stock options of $4.5 million.
Cash provided by financing activities during the three months ended March 31,
2020 was $1.5 million, which was primarily due to proceeds from exercise of
stock options.
Contractual obligations and commitments
Except as set forth in Note 10, Commitments and Contingencies, of the notes to
our condensed consolidated financial statements included elsewhere in this
Quarterly Report on Form 10-Q, there have been no material changes outside the
ordinary course of business to our contractual obligations and commitments as
described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in our Annual Report on Form 10-K for the year ended
December 31, 2020.
Off-balance sheet arrangements
As of March 31, 2021, we have not had any off-balance sheet arrangements as
defined in the rules and regulations of the SEC.
Critical accounting policies and estimates
We have prepared our consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America
("GAAP"). Our preparation of these consolidated financial statements requires us
to make estimates, assumptions and judgments that affect the reported amounts of
assets, liabilities, expenses and related disclosures at the date of the
consolidated financial statements, as well as revenue and expenses recorded
during the reporting periods. We evaluate our estimates and judgments on an
ongoing basis. We base our estimates on 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 could therefore differ materially from these estimates under different
assumptions or conditions.
While our significant accounting policies are described in more detail in Note 2
to our unaudited condensed consolidated financial statements included elsewhere
in this Quarterly Report on Form 10-Q, we believe the following accounting
policies to be critical to the judgments and estimates used in the preparation
of our consolidated financial statements.
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Revenue recognition
We derive revenue from the provision of precision oncology testing services
provided to our ordering physicians and biopharmaceutical customers, as well as
from biopharmaceutical research and development services provided to our
biopharmaceutical customers. Precision oncology services include genomic
profiling and the delivery of other genomic information derived from our
platform. Development services and other include companion diagnostic
development, clinical trial set up, monitoring and maintenance, information
solutions and laboratory services, and other miscellaneous revenue streams. We
currently receive payments from commercial third-party payers, certain hospitals
and oncology centers and individual patients, as well as biopharmaceutical
companies and research institutes.
Revenues are recognized when control of services is transferred to customers, in
an amount that reflects the consideration we expect to be entitled to in
exchange for those services. ASC 606 provides for 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.
Precision oncology testing
We recognize revenue from the sale of our 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. Most
precision oncology tests requested by clinical customers are sold without a
written agreement; however, we determine an implied contract exists with our
clinical customers. We identify each sale of our liquid biopsy test to clinical
customer as a single performance obligation. With the exception of certain
limited contracted arrangements with insurance carriers and other institutions
where the transaction price is fixed, a stated contract price does not exist and
the transaction price for each implied contract with our clinical customers
represents variable consideration. We estimate the variable consideration under
the portfolio approach and consider the historical reimbursement data from
third-party payers and patients, as well as known current or anticipated
reimbursement trends not reflected in the historical data. We monitor the
estimated amount to be collected in the portfolio at each reporting period based
on actual cash collections in order to assess whether a revision to the estimate
is required. Both the estimate and any subsequent revision contain uncertainty
and require the use of judgment in the estimation of the variable consideration
and application of the constraint for such variable consideration. We analyze
actual cash collections over the expected reimbursement period and compare it
with the estimated variable consideration for each portfolio and any difference
is recognized as an adjustment to estimated revenue after the expected
reimbursement period, subject to assessment of the risk of future revenue
reversal.
Revenue from sales of precision oncology tests to biopharmaceutical customers
are based on a negotiated price per test or on the basis of an agreement to
provide certain testing volume over a defined period. We identify our promise to
transfer a series of distinct liquid biopsy tests to biopharmaceutical customers
as a single performance obligation. Precision oncology tests to
biopharmaceutical customers are generally billed at a fixed price for each test
performed. For agreements involving testing volume to be satisfied over a
defined period, revenue is recognized over time based on the number of tests
performed as the performance obligation is satisfied over time.
Results of our precision oncology services are delivered electronically, and as
such there are no shipping or handling fees incurred by us or billed to
customers.
Development services and other
We perform development services for our biopharmaceutical customers utilizing
our precision oncology information platform. Development services typically
represent a single performance obligation as we perform a significant
integration service, such as analytical validation and regulatory submissions.
The individual promises are not separately identifiable from other promises in
the contracts and, therefore, are not distinct. However, under certain
contracts, a biopharmaceutical customer may engage us for multiple distinct
development services which are both capable of being distinct and separately
identifiable from other promises in the contracts and, therefore, distinct
performance obligations.
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We collaborate with pharmaceutical companies in the development and clinical
trials of new drugs. As part of these collaborations, we provide services
related to regulatory filings 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. These
collaboration arrangements include no royalty obligations. For development
services performed, we are compensated through a combination of an upfront fee
and performance-based non-refundable regulatory and other developmental
milestone payments. The transaction price of our development services contracts
typically represents variable consideration. Application of the constraint for
variable consideration to milestone payments is an area that requires
significant judgment. We evaluate factors such as the scientific, clinical,
regulatory, commercial, and other risks that must be managed to achieve the
respective milestone and the level of effort and investment required to achieve
the respective milestone. In making this assessment, we consider our historical
experience with similar milestones, the degree of complexity and uncertainty
associated with each milestone, and whether achievement of the milestone is
dependent on parties other than us. The constraint for variable consideration is
applied such that it is probable a significant reversal of revenue will not
occur when the uncertainty associated with the contingency is resolved.
Application of the constraint for variable consideration is updated at each
reporting period as a revision to the estimated transaction price.
We recognize development services revenue over the period in which
biopharmaceutical research and development services are provided. Specifically,
we recognize revenue using an input method to measure progress, utilizing costs
incurred to-date relative to total expected costs as its measure of progress. We
also assess the changes to the total expected cost estimates as well as any
incremental fees negotiated resulting from changes to the scope of the original
contract in determining the revenue recognition at each reporting period. For
development of new products or services under these arrangements, costs incurred
before technological feasibility is reached are included as research and
development expenses in our condensed consolidated statements of operations,
while costs incurred thereafter are recorded as cost of development services.
We also have other miscellaneous revenue streams that are recognized in addition
to development services noted above such as clinical trial setup, monitoring and
maintenance, referral fees, liquid biopsy testing development and support,
GuardantConnect, GuardantINFORM and Guardant-19, and kits fulfillment related
revenues.
Contracts with multiple performance obligations
Contracts with biopharmaceutical customers may include multiple distinct
performance obligations, such as provision of precision oncology testing,
biopharmaceutical research and development services, and clinical trial
enrollment assistance, among others. We evaluate the terms and conditions
included within our contracts with biopharmaceutical customers to ensure
appropriate revenue recognition, including whether services are considered
distinct performance obligations that should be accounted for separately versus
together. We first identify material promises, in contrast to immaterial
promises or administrative tasks, under the contract and then evaluates whether
these promises are both capable of being distinct and distinct within the
context of the contract. In assessing whether a promised service is capable of
being distinct, we consider whether the customer could benefit from the service
either on its own or together with other resources that are readily available to
the customer, including 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 assessing whether a promised
service is distinct within the context of the contract, we consider whether we
provide a significant integration of the services, whether the services
significantly modify or customize one another, or whether the services are
highly interdependent or interrelated.
For contracts with multiple performance obligations, the transaction price is
allocated to the separate performance obligations on a relative standalone
selling price basis. We determine standalone selling price by considering the
historical selling price of these performance obligations in similar
transactions as well as other factors, including, but not limited to, the price
that customers in the market would be willing to pay, competitive pricing of
other vendors, industry publications and current pricing practices, and expected
costs of satisfying each performance obligation plus appropriate margin.
Variable interest entity
We review agreements we enter into with third party entities, pursuant to which
we may have a variable interest in the entity, in order to determine if the
entity is a variable interest entity, or VIE. If the entity is a VIE, we assess
whether or not we are the primary beneficiary of that entity. In determining
whether we are the primary beneficiary of an entity, we apply a qualitative
approach that determines whether we have both (1) the power to direct the
economically significant activities of the entity and (2) the obligation to
absorb losses of, or the right to receive benefits from, the entity that could
potentially be significant to that entity. If we determine we are the primary
beneficiary of a VIE, we consolidate the statements of operations and financial
condition of the VIE into our consolidated financial statements. Accounting for
the consolidation is based on our determination if the VIE meets
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the definition of a business or and asset. Assets, liabilities and
noncontrolling interests, excluding goodwill, of VIEs that are not determined to
be businesses are recorded at fair value in our financial statements upon
consolidation. Assets and liabilities that we have transferred to a VIE, after,
or shortly before the date we became the primary beneficiary are recorded at the
same amount at which the assets and liabilities would have been measured if they
had not been transferred. Our determination about whether we should consolidate
such VIEs is made continuously as changes to existing relationships or future
transactions may result in a consolidation or deconsolidation event.
In May 2018, we and an affiliate of SoftBank formed and capitalized the Joint
Venture for the sale, marketing and distribution of our tests in the JV
Territory. We expect to rely on the Joint Venture to accelerate
commercialization of our products in Asia, the Middle East and Africa. The Joint
Venture is deemed to be a VIE and we are identified as the primary beneficiary
of the VIE. Consequently, we have consolidated the financial position, results
of operations and cash flows of the Joint Venture in our financial statements
and all intercompany balances have been eliminated in consolidation.
The joint venture agreement also includes a put-call arrangement with respect to
the shares of the Joint Venture held by SoftBank and its affiliates. SoftBank
will have a put right to cause us to purchase all shares of the Joint Venture
held by SoftBank and its affiliates, and we will have a call right to purchase
all such shares 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 our initial public offering, a change in control, 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. Unless the shares of the Joint Venture are publicly
traded and listed on a nationally recognized stock exchange, the purchase price
per share of the Joint Venture in these situations will be 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. The third-party valuation firm may
evaluate a range of factors and employ assumptions that are subjective in
nature, which could result in the fair value of SoftBank's interest in the Joint
Venture being determined to be materially different from what has been recorded
in our condensed consolidated financial statements, including those included
elsewhere in this Quarterly Report on Form 10-Q.
In the event we exercise our 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 our fair value, we 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% of our
fair value and the pro rata portion of the outstanding shares of the Joint
Venture held by SoftBank and its affiliates.
We may pay the purchase price for the shares of the Joint Venture in cash, in
shares of our common stock, or in a combination thereof. In the event we
exercise the call right, SoftBank will choose the form of consideration. In the
event SoftBank exercises the put right, we will choose the form of
consideration.
The noncontrolling interest held by SoftBank contains embedded put-call
redemption features that are not solely within our control and has been
classified outside of permanent equity in our 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 us on or after the seventh
anniversary of the formation of the Joint Venture, on each subsequent
anniversary of the IPO and under certain other circumstances. We 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.
Stock-based compensation
After the adoption of Accounting Standards Update 2018-07, Compensation-Stock
Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment
Accounting on January 1, 2019, we measure stock-based compensation expense for
stock options granted to our employees, directors, and nonemployee consultants
on the date of grant and recognize the corresponding compensation expense of
those awards over the period that the related services are rendered, which is
generally the vesting period of the respective award. Compensation expense for
stock
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options with performance metrics is calculated based upon expected achievement
of the metrics specified in the grant.
We estimate the fair value of stock options granted under the 2012 Stock Plan,
the 2018 Incentive Award Plan, and under the Guardant Health AMEA, Inc.'s 2020
Equity Incentive Plan for the Joint Venture, and stock purchase rights granted
under our 2018 Employee Stock Purchase Plan on the grant date using the
Black-Scholes option-pricing model. The Black-Scholes option-pricing model
requires the use of assumptions regarding a number of variables that are
complex, subjective and generally require significant judgment to determine. The
assumptions used to calculate the fair value of our stock options were:
Fair Value of Common Stock
The fair value of our common stock is determined by the closing price, on the
date of grant, of its common stock, which is traded on the Nasdaq Global Select
Market. The board of directors of the Joint Venture has determined the fair
value of common stock of the Joint Venture. The grant date fair value of the
Joint Venture'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. In determining the fair value of the Joint
Venture's common stock, the methodologies used to estimate the enterprise value
of the Joint Venture 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
Our expected term represents the period that our stock options are expected to
be outstanding. After the adoption of Accounting Standards Update 2018-07,
Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee
Share-Based Payment Accounting on January 1, 2019, the expected term of stock
options issued to employees, directors and nonemployee consultants is determined
using the simplified method (based on the mid-point between the vesting date and
the end of the contractual term), as we do not have sufficient historical data
to use any other method to estimate expected term.
Expected volatility
Prior to the commencement of trading of our common stock on the Nasdaq Global
Select Market on October 4, 2018 in connection with the IPO, there was no active
trading market for our common stock. Due to limited historical data for the
trading of our common stock, expected volatility is estimated based on the
average volatility for comparable publicly traded peer group companies in the
same industry plus our expected volatility for the available periods. The
comparable companies are chosen based on their similar size, stage in the life
cycle or area of specialty.
The Joint Venture derived the expected volatility from the average historical
volatility 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 Joint Venture does not have
any trading history for its common stock. The Joint Venture 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 zero coupon issues in
effect at the time of grant for periods corresponding with the expected term of
the stock option grants.
Expected dividend yield
We have never paid dividends on our common stock and have no plans to pay
dividends on our common stock. Therefore, we use an expected dividend yield of
zero.
Black-Scholes assumptions
The weighted-average assumptions used in our Black-Scholes option-pricing model,
including the Joint Venture, were as follows for stock option granted to our
employees, directors and nonemployees for the periods presented:
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                                           Three Months Ended
                                                March 31,
                                                           2021           2020

                                                             (unaudited)
Expected term (in years)                                6.01 - 6.04       6.06
Expected volatility                                    63.6% - 66.4%      73.3%
Risk-free interest rate                                 0.3% - 0.8%       1.6%
Expected dividend yield                                     -%             -%


For market-based restricted stock units, we derive the requisite service period
using the Monte Carlo simulation model. The estimated fair value of the
market-based restricted stock units was determined using a Monte Carlo
simulation model which requires the use of assumptions regarding a number of
variables that are complex, subjective and generally require significant
judgment to determine. Stock-based compensation expense will be recorded
regardless of achieving the market conditions or not. If the related market
condition is achieved earlier than its expected derived service period, the
stock-based compensation expense will be recognized as a cumulative catch-up
expense from the grant date to that point in time in achieving the share price
goal.
The assumptions used to calculate the fair value of our market-based restricted
stock units were as follows:
Fair Value of Common Stock
The fair value of our common stock is determined by the closing price, on the
date of grant, of its common stock, which is traded on the Nasdaq Global Select
Market.
Expected Volatility
Due to limited historical data for the trading of our common stock, expected
volatility is estimated based on the average volatility for comparable publicly
traded peer group companies and implied volatility of publicly traded options in
the same industry plus our expected volatility for the available periods. The
comparable companies are chosen based on their similar size, stage in the life
cycle or area of specialty.
Expected Term
The expected term represents the derived service period for the respective
tranches which has been estimated using the Monte Carlo simulation model.
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 market-based restricted stock units.
Risky Rate
The risky rate represents our cost of equity.
Expected Dividend Yield
We do not anticipate paying any dividends in the foreseeable future and,
therefore, uses an expected dividend yield of zero.
Discount for Lack of Marketability
The discount for lack of marketability represents the discount applied for post
vest term restrictions and has been derived using the Monte Carlo simulation
model.
The following assumptions were used to calculate the stock-based compensation
for market-based restricted stock units: a weighted-average expected term of
0.83 - 2.07 years; expected volatility of 65.5%; a risk-free interest rate of
0.53%; a zero dividend yield; a risky rate (cost of equity) of 16%; and a
discount for post-vesting restrictions of 10.4% - 14.5%.
We recognize stock-based compensation expense net of forfeitures as they occur.
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We will continue to use judgment in evaluating the assumptions related to our
stock-based compensation on a prospective basis. As we continue to accumulate
additional data related to our common stock, we may have refinements to our
estimates, which could materially impact our future stock-based compensation
expense.
Convertible Senior Notes
In accounting for the issuance of the convertible senior notes, we separate the
notes into liability and equity components. The carrying amount of the liability
component is calculated by measuring the fair value of a similar liability that
does not have an associated convertible feature, using a discounted cash flow
model with a risk adjusted yield. The carrying amount of the equity component
representing the conversion option is determined by deducting the fair value of
the liability component from the par value of the notes as a whole. This
difference represents a debt discount that is amortized to interest expense
using the effective interest method over the term of the notes. The equity
component is not remeasured as long as it continues to meet the conditions for
equity classification. In accounting for the transaction costs related to the
issuance of the notes, we allocated the total amount incurred to the liability
and equity components based on their relative fair values. Transaction costs
attributable to the liability component are netted with the liability component
and amortized to interest expense using the effective interest method over the
term of the notes. Transaction costs attributable to the equity component are
netted with the equity component of the notes in additional paid-in capital in
the consolidated balance sheets. Starting January 1, 2021, upon adoption of ASU
2020-06, Accounting for Convertible Instruments and Contracts in an Entity's Own
Equity, the carrying amount of the equity component of the cash conversion
feature along with the associated debt issuance costs were reclassified from
additional paid-in capital to long-term liabilities.
Recent accounting pronouncements
See Note 2, Summary of Significant Accounting Policies, to our unaudited
condensed consolidated financial statements included elsewhere in this Quarterly
Report on Form 10-Q for more information.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk in the ordinary course of our business. Market
risk represents the risk of loss that may impact our financial position due to
adverse changes in financial market prices and rates.
Interest rate risk
We are exposed to market risk for changes in interest rates related primarily to
our cash and cash equivalents, marketable securities and our indebtedness. As of
March 31, 2021, we had cash and cash equivalents of $869.4 million held
primarily in cash deposits and money market funds. Our marketable securities are
held in U.S. government debt securities. As of March 31, 2021, we had short-term
marketable securities of $1.1 billion. Our primary exposure to market risk is
interest income sensitivity, which is affected by changes in the general level
of the interest rates in the United States. As of March 31, 2021, a hypothetical
100 basis point increase in interest rates would have resulted in an
approximate $6.0 million decline of the fair value of our available-for-sale
securities and a hypothetical 100 basis point decrease in interest rates would
have resulted in an approximate $0.4 million increase of the fair value of our
available-for-sale securities. This estimate is based on a sensitivity model
that measures market value changes when changes in interest rates occur.
Foreign currency risk
The majority of our revenue is generated in the United States. Through March 31,
2021, we have generated an insignificant amount of revenues denominated in
foreign currencies. As we expand our presence in the international market, our
results of operations and cash flows are expected to increasingly be subject to
fluctuations due to changes in foreign currency exchange rates and may be
adversely affected in the future due to changes in foreign exchange rates. As of
March 31, 2021, the effect of a hypothetical 10% change in foreign currency
exchange rates would not be material to our financial condition or results of
operations. To date, we have not entered into any hedging arrangements with
respect to foreign currency risk. As our international operations grow, we will
continue to reassess our approach to manage our risk relating to fluctuations in
currency rates.
                                       53

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