Basis of Presentation and Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2017

The financial statements and accompanying notes were prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Reclassifications

Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations.

Going Concern

Going Concern and Liquidity

The Company implemented the criteria of Accounting Standards Update (“ASU”) No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, in the first quarter of 2016. In accordance with this guidance, management has assessed the Company’s ability to continue as a going concern within one year of the filing date of this Annual Report on Form 10‑K with the Securities and Exchange Commission (“SEC”). The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has had recurring operating losses and negative cash flows from operations since its inception and has an accumulated deficit of approximately $134.6 million. As of December 31, 2017, the Company had available cash and cash equivalents of approximately $10.0 million, and had current liabilities of approximately $13.3 million plus an additional $11.0 million in long-term liabilities. The Company’s liability balance is primarily attributable to its asset-secured growth capital term loan with Oxford Finance, LLC and Silicon Valley Bank (the “Growth Term Loan”), an obligation to NuvoGen Research, LLC (“NuvoGen”) and a subordinated convertible promissory note with QIAGEN North American Holdings, Inc. (the “QNAH Convertible Note”). Although the Company believed that the circumstances existing as of December 31, 2017 gave rise to substantial doubt about the Company’s ability to continue as a going concern, the Company successfully completed an underwritten public offering of 13,915,000 shares of its common stock at a price of $2.90 per share on January 23, 2018 (see Note 16). The aggregate net proceeds from the offering were approximately $37.7 million, after deducting underwriting discounts and commissions and offering expenses. After consideration of the net proceeds received in the offering, the Company believes that the substantial doubt that existed as of December 31, 2017 has been alleviated and there is no longer substantial doubt about the Company’s ability to continue as a going concern for at least the next 12 months from the issuance of the financial statements included in this Annual Report on Form 10-K.

Recently Adopted and New Accounting Pronouncements

Recently Adopted Accounting Pronouncements

In July 2015, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2015-11, Inventory: Simplifying the Measurement of Inventory. The standard requires inventory within the scope of the ASU to be measured using the lower of cost and net realizable value. The changes apply to all types of inventory, except those measured using last-in, first-out (“LIFO”) method or the retail inventory method, and are intended to more clearly articulate the requirements for the measurement and disclosure of inventory and to simplify the accounting for inventory by eliminating the notions of replacement cost and net realizable value less a normal profit margin. The standard was effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2016. The Company adopted this guidance effective January 1, 2017. The Company previously measured its inventory at the lower of cost or market with cost being determined by the first-in, first-out (“FIFO”) method. The adoption of the guidance did not have a material impact on the Company’s financial statements.

In April 2016, the FASB issued ASU No. 2016-09, Share-Based Payment: Simplifying the Accounting for Share-Based Payments. The standard addresses several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new standard was effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2016. The Company adopted this guidance effective January 1, 2017. Excess tax benefits recorded upon adoption of this standard are not material to the balance sheets. The elimination of the APIC pool affects the treasury stock method used to calculate weighted average shares outstanding; however, the impact of this change was not material. The Company elected to change its policy concerning potential forfeitures of employee share-based awards, and beginning January 1, 2017, the Company no longer estimates the number of awards expected to be forfeited but instead accounts for forfeitures as they occur. The Company implemented this portion of the guidance using a modified retrospective approach. The cumulative adjustment was not material to additional paid-in capital. Other provisions of ASU 2016‑09 had no impact on the Company’s financial statements.

New Accounting Pronouncements

The following are new FASB ASUs that had not been adopted by the Company as of December 31, 2017, and are grouped by their respective effective dates:

January 1, 2018

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.

In March 2016, the FASB issued ASU No. 2016-08, Revenue Recognition: Clarifying the new Revenue Standard’s Principal-Versus-Agent Guidance (“ASU 2016-08”). The standard amends the principal-versus-agent implementation guidance and illustrations in ASU 2014-09. ASU 2016-08 clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. As defined in ASU 2016-08, a specified good or service is “a distinct good or service (or a distinct bundle of goods or services) to be provided to the customer.” Therefore, for contracts involving more than one specified good or service, the Company may be the principal in one or more specified goods or services and the agent for others.

In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The amendments in this standard affect the guidance in ASU 2014-09 by clarifying two aspects: identifying performance obligations and the licensing implementation guidance.

In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients. The amendments in this standard affect the guidance in ASU 2014-09 by clarifying certain specific aspects of ASU 2014-09, including assessment of collectability, treatment of sales taxes and contract modifications, and providing certain technical corrections.

The new revenue standard and the standards that amend it are effective for public entities for fiscal years and interim periods within those fiscal years beginning after December 15, 2017, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company will adopt ASC 606 using the full retrospective approach, which will not have an effect on 2017 or 2016 revenue recognition and will have no cumulative effect on opening equity, as the timing and measurement of revenue recognition will be materially the same as under ASC 605. The Company will present additional quantitative and qualitative disclosures regarding identified revenue streams and performance obligations. We have identified and are implementing changes to our business processes and internal controls relating to implementation of the new standard. While the adoption of this guidance will not have a material impact on the Company’s financial statements, our disclosures will change to meet the requirements of this new guidance for the first quarter of 2018.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years with early adoption permitted, including adoption in an interim period. The Company will adopt ASU No. 2016-15 as of January 1, 2018. When considering the activity within the Company’s statements of cash flow as of the years ended December 31, 2017 and 2016, the Company does not believe the adoption of this standard will have a significant impact on its financial statements.

In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting. The new standard provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The new standard is effective on January 1, 2018; however, early adoption was permitted. The Company will adopt ASU No. 2017-09 as of January 1, 2018. The adoption of this update is not expected to impact the Company’s financial statements.

January 1, 2019

In February 2016, the FASB issued ASU No. 2016-02, Leases, (“ASU 2016-02”). Under this standard, which applies to both lessors and lessees, lessees will be required to recognize for all leases (except for short-term leases) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The effect of adoption of this standard on our financial statements depends on the leases existing at January 1, 2018. Based on the Company’s office and equipment leases at that date and considering the practical expedients, the Company expects that adoption of ASU 2016‑02 will not have a material effect on its statements of operations, will result in a gross-up on its balance sheets of less than $2.0 million relating to office and equipment leases and will have no effect on its statements of cash flows. The Company will continue to assess the new guidance and its potential applicability, to new agreements that it may enter into subsequent to January 1, 2018 through the date of adoption.

In July 2017, the FASB issued ASU 2017-11, Accounting for Certain Financial Instruments with Down Round Features. The new standard makes limited changes to previous guidance on classifying certain financial instruments as either liabilities or equity. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted, including adoption in an interim period. When considering the Company’s existing financial instruments, the Company does not believe the adoption of this standard will have an effect on its financial statements.

January 1, 2020

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses, which requires the measurement of expected credit losses for financial instruments carried at amortized cost held at the reporting date based on historical experience, current conditions and reasonable forecasts. The updated guidance also amends the current other-than-temporary impairment model for available-for-sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2019. Early adoption is permitted for fiscal years and interim periods within those fiscal years beginning after December 15, 2018. The Company does not believe the adoption of this standard will have a significant impact on its financial statements, given the high credit quality of the obligors to its available-for-sale debt securities and its limited history of bad debt expense relating to trade accounts receivable.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include revenue recognition, stock-based compensation expense, bonus accrual, income tax valuation allowances, recovery of long‑lived assets, inventory obsolescence and inventory valuation. Actual results could materially differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less to be cash and cash equivalents. Cash and cash equivalents consist of cash on deposit with financial institutions, money market instruments and high credit quality corporate debt securities purchased with a term of three months or less.

Accounts Receivable

Accounts receivable represent valid claims against debtors. Management reviews accounts receivable regularly to determine, using the specific identification method, if any receivable amounts will potentially be uncollectible and to estimate the amount of allowance for doubtful accounts necessary to reduce accounts receivable to its estimated net realizable value. There were no receivable amounts requiring an allowance for doubtful accounts as of December 31, 2017 or December 31, 2016.

Investments

The Company classifies its debt securities as available-for-sale, which are reported at estimated fair value with unrealized gains and losses included in accumulated other comprehensive loss, net of tax. Realized gains, realized losses and declines in value of securities judged to be other-than-temporary, are included in other income (expense) within the accompanying statements of operations. The cost of investments for purposes of computing realized and unrealized gains and losses is based on the specific identification method. Interest earned on all securities is included in other income (expense) within the accompanying statements of operations. Investments in securities with maturities of less than one year, or where management’s intent is to use the investments to fund current operations, or to make them available for current operations, are classified as short-term investments.

If the estimated fair value of a security is below its carrying value, the Company evaluates whether it is more likely than not that it will sell the security before its anticipated recovery in market value and whether evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. The Company also evaluates whether or not it intends to sell the investment. If the impairment is considered to be other-than-temporary, the security is written down to its estimated fair value. In addition, the Company considers whether credit losses exist for any securities. A credit loss exists if the present value of cash flows expected to be collected is less than the amortized cost basis of the security. Other-than-temporary declines in estimated fair value and credit losses are charged against other income (expense).

Fair Value of Financial Instruments

Fair value measurements are based on the premise that fair value is an exit price representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the following three-tier fair value hierarchy has been used in determining the inputs used in measuring fair value:

Level 1	–	Quoted prices in active markets for identical assets or liabilities on the reporting date.

Level 2	–	Pricing inputs are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3	–	Pricing inputs are generally unobservable and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require management’s judgment or estimation of assumptions that market participants would use in pricing the assets or liabilities. The fair values are therefore determined using factors that involve considerable judgment and interpretations, including but not limited to private and public comparables, third-party appraisals, discounted cash flow models, and fund manager estimates.

The carrying value of financial instruments classified as current assets and current liabilities approximate fair value due to their liquidity and short-term nature. Investments that are classified as available-for-sale are recorded at fair value, which was determined using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The QNAH Convertible Note is an obligation to a greater than 5% common stockholder of the Company (see Note 15). As of December 31, 2017, the estimated aggregate fair value of the QNAH Convertible Note is approximately $2.8 million. The fair value estimate is based on the note’s discounted cash flows and estimated option value of the conversion terms. The estimated fair value of the QNAH Convertible Note represents a Level 3 measurement. The NuvoGen obligation is an obligation relating to an asset purchase transaction with a then-common stockholder of the Company. Although the obligation is considered a financial instrument, the Company is unable to reasonably determine its fair value as the remaining payments due under the obligation will be made at the greater of a minimum quarterly payment or 6% of revenue, causing variability in the timing and amount of payments and the term of the remaining obligation.

Inventory, net

Inventory, consisting of raw materials, work in process and finished goods, is stated at the lower of cost (first-in, first-out) or net realizable value. Cost is determined using a standard cost system, whereby the standard costs are updated periodically to reflect current costs and net realizable value represents the lower of replacement cost or estimated net realizable value. The Company reserves or writes down its inventory for estimated obsolescence or inventory in excess of reasonably expected near term sales or unmarketable inventory, in an amount equal to the difference between the cost of inventory and the estimated market value, based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by the Company, additional inventory write-downs may be required. Inventory impairment charges establish a new cost basis for inventory and charges are not reversed subsequently to income, even if circumstances later suggest that increased carrying amounts are recoverable.

The reserve for shrinkage and excess inventory was 62,142 and $270,307 as of December 31, 2017 and 2016, respectively. Inventory of $208,112 and 167,100 was written off directly to cost of revenue in the accompanying statements of operations for the years ended December 31, 2017 and 2016, respectively.

Equipment that is under evaluation for purchase remains in inventory as the Company maintains title to the equipment throughout the evaluation period. The period of time customers use to evaluate the Company’s equipment generally ranges from 90 to 180 days, and in certain circumstances the evaluation period may need to be extended beyond that period. However, in no case will the evaluation period exceed one year. If the customer has not purchased the equipment or entered into a reagent rental agreement with the Company after evaluating the product for one year, the equipment is returned to the Company or the customer is allowed to continue use of the equipment, in which case the equipment is written off to selling, general and administrative expense in the accompanying statement of operations. HTG EdgeSeq instruments at customer locations under evaluation agreements are included in finished goods inventory. Finished goods inventory under evaluation as of December 31, 2017 was $53,365 compared to $185,557 as of December 31, 2016.

Property and Equipment, net

Property and equipment are stated at historical cost and depreciated over their useful lives, which range from three to five years, using the straight-line method. Equipment used in the field is amortized using the straight-line method over the lesser of the period of the related reagent rental or collaborative development services agreement where applicable or the estimated useful life. Leasehold improvements are amortized using the straight-line method over the lesser of the remaining lease term or the estimated useful life.

Certain leasehold improvements constructed by the landlord of the Company’s Tucson, AZ facilities as an incentive for the Company to extend its leases are included in leasehold improvements on the balance sheets as of December 31, 2017. The total cost of the improvements constructed by the landlord of $710,000 was capitalized when construction was completed in February 2016, and is being amortized over the remaining term of the lease agreement. The incentive of $710,000 has been recognized as deferred rent within other current liabilities and other liabilities on the balance sheets and is being accreted over the lease term as a reduction of rent expense (see Note 13).

Depreciation and leasehold improvement amortization expense was $1,241,873 for the year ended December 31, 2017, and $1,473,778 for the year ended December 31, 2016.

Costs incurred in the development and installation of software for internal use and in the development of the Company’s website are expensed or capitalized, depending on whether they are incurred in the preliminary project stage (expensed), application development stage (capitalized), or post-implementation stage (expensed). Amounts capitalized following project completion are amortized on a straight-line basis over the useful life of the developed asset, which is generally three years.

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flow, an impairment charge is recognized in the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. Although the Company has accumulated losses since inception, the Company believes the future cash flows will be sufficient to exceed the carrying value of the Company’s long-lived assets. There were no impairments of long-lived assets during the years ended December 31, 2017 and 2016.

Deferred Financing Costs and Debt Discounts

Certain costs incurred in connection with the Growth Term Loans and the QNAH Convertible Note have been deferred and are being amortized.

Debt issuance costs and debt discount relating to the Growth Term Loans are being presented as a direct reduction of term loan payable – current, net of discount and debt issuance costs as of December 31, 2017 and as a direct reduction of term loan payable – non-current, net of discount and debt issuance costs as of December 31, 2016 in the accompanying balance sheets. Debt issuance costs and debt discount are being amortized over the term of the Growth Term Loans using the effective interest method. The Company has recorded approximately $6,269 and $24,909 of Growth Term Loans deferred financing costs in the accompanying balance sheets as of December 31, 2017 and 2016, respectively. Deferred financing cost amortization expense relating to the Growth Term Loans for the years ended December 31, 2017 and 2016 was $18,640 and $27,468, respectively, and is included in interest expense in the accompanying statements of operations. The Company has recorded approximately $58,538 and $238,469 of discounts associated with Growth Term Loan A and Growth Term Loan B in the accompanying balance sheets as of December 31, 2017 and 2016, respectively. Amortization of the discounts associated with the Growth Term Loans totaled $179,931 and $249,868 for the years ended December 31, 2017 and 2016, and is included in interest expense in the accompanying statements of operations.

Debt issuance costs of $39,240 relating to the QNAH Convertible Note are being presented as a direct reduction of Convertible Note, related party – net of debt issuance costs as of December 31, 2017. There was no QNAH Convertible Note liability or related financing costs as of December 31, 2016. Deferred financing cost amortization relating to the QNAH Convertible Note for the years ended December 31, 2017 and 2016 was $1,269 and $0, respectively, and is included in interest expense in the accompanying statements of operations.

Deferred Offering Costs

Deferred offering costs represent legal and other direct costs related to stock offering transactions. Deferred offering costs of $2,953 included as current assets in the accompanying balance sheets as of December 31, 2017 represent legal costs incurred during the year ended December 31, 2017 by the Company in contemplation of the issuance of additional shares in a future financing transaction. There were deferred offering costs of $49,630 included in the accompanying balance sheets as of December 31, 2016.

Deferred Revenue

Deferred revenue represents cash receipts for products or services to be provided in future periods, including up-front fees received relating to custom RUO assay development and sample processing services and collaboration development services. When products are delivered or data is provided to customers for sample processing services rendered, deferred revenue is recognized as earned. Up-front fees received for custom RUO assay development and collaborative development services are recognized as development procedures are completed and outputs are produced on a proportional performance basis.

Revenue Recognition

The Company recognizes revenue from the sale of instruments, consumables, sample processing, custom RUO assay development and collaboration services when the following four basic criteria are met: (1) a contract has been entered into with a customer or persuasive evidence of an arrangement exists, (2) delivery has occurred or services rendered, (3) the fee is fixed or determinable, and (4) collectability is reasonably assured.

Contracts which combine one or more services, or services with sales of products or consumables are accounted for as multiple element arrangements under ASC 605-25, as described under product and product-related services revenue below. Anticipated losses, if any, on contracts are charged to earnings as soon as they are identified. Anticipated losses cover all costs allocable to contracts. Revenue arising from claims or change orders is recorded either as income or as an offset against a potential loss only when the amount of the claim can be estimated and its realization is probable.

Product and Product-related Services Revenue

The Company had product and product-related services revenue consisting of revenue from the sale of instruments and consumables and the use of the HTG EdgeSeq proprietary technology to process samples and develop custom RUO assays for the years ended December 31, 2017 and 2016 as follows:

	Years Ended December 31,
	2017		2016
Product revenue:
Instruments	$	385,143	$	522,813
Consumables		1,463,347		2,237,129
Total product revenue		1,848,490		2,759,942
Product-related services revenue:
Custom RUO assay development		419,515		235,818
Sample processing		4,529,250		2,136,970
Total product-related services revenue		4,948,765		2,372,788
Total product and product-related services revenue	$	6,797,255	$	5,132,730

Sale of instruments and consumables

Instrument product revenue is generally recognized upon installation and calibration of the instrument by field service engineers, unless the customer has specified any other acceptance criteria. The sale of instruments and related installation and calibration are considered to be one unit of accounting, as instruments are required to be professionally installed and calibrated before use. Installation generally occurs within one month of shipment.

Consumables are considered to be separate units of accounting as they are sold separately from instruments. Consumables revenue is recognized upon transfer of ownership. The Company’s standard terms and conditions provide that no right of return exists for instruments or consumables, unless replacement is necessary due to delivery of defective or damaged products. Shipping and handling fees charged to the Company’s customers for instruments and consumables shipped are included in the accompanying statements of operations as part of product and product-related service revenue. Shipping and handling costs for sold products shipped to the Company’s customers are included on the accompanying statements of operations as part of cost of revenue.

When a contract involves multiple elements, the items included in the arrangement, referred to as deliverables, are evaluated to determine whether they represent separate units of accounting in accordance with ASC 605-25, Revenue Recognition – Multiple-Element Arrangements (“ASC 605-25”). The Company performs this evaluation at the inception of an arrangement and as each item is delivered in the arrangement. Generally, the Company accounts for a deliverable (or a group of deliverables) separately if the delivered item has stand-alone value to the customer and delivery or performance of the undelivered item or service is probable and substantially in the Company’s control. When multiple elements can be separated into separate units of accounting, arrangement consideration is allocated at the inception of the arrangement, based on each unit’s relative selling price, and recognized based on the method most appropriate for that unit.

The Company provides instruments to certain customers under reagent rental agreements. Under these agreements, the Company installs instruments in the customer’s facility without a fee and the customer agrees to purchase consumable products at a stated price over the term of the agreement; in some instances, the agreements do not contain a minimum purchase requirement. Terms range from several months to multiple years and may automatically renew in several month or multiple year increments unless either party notifies the other in advance that the agreement will not renew. This represents a multiple element arrangement and because all consideration under the reagent rental agreement is contingent on the sale of consumables, no consideration has been allocated to the instrument and no revenue has been recognized upon installation of the instrument. The Company expects to recover the cost of the instrument under the agreement through the fees charged for consumables, to the extent sold, over the term of the agreement.

In reagent rental agreements, the Company retains title to the instrument and title is transferred to the customer at no additional charge at the conclusion of the initial arrangement. Because the pattern of revenue from the arrangement cannot be reasonably estimated, the cost of the instrument is amortized on a straight-line basis over the term of the arrangement, unless there is no minimum consumable product purchase in which case the instrument would be expensed as cost of revenue. Cost to maintain the instrument while title remains with the Company is charged to selling, general and administrative expense as incurred.

The Company offers customers the opportunity to purchase separately-priced extended warranty contracts to provide for service upon conclusion of the standard one-year warranty period. The revenue from these contracts is recorded as a component of deferred revenue in the balance sheets at the inception of the contract. Extended warranty product revenue is recognized over the contract service period as part of product and product-related services revenue on the accompanying statements of operations.

Service Revenue

Custom RUO Assay Development

The Company enters into custom RUO assay development agreements that may generate up-front fees and subsequent payments which might be earned upon completion of design process phases. The Company is able to estimate the total cost of services under these arrangements and recognizes revenue using a proportional performance revenue recognition model, under which revenue is recognized as performance occurs based on the delivery of the relative outputs under the respective agreement. Costs incurred to date compared to total expected costs are used to determine proportional performance, as this is considered to be representative of the delivery of outputs under the arrangements. Revenue recognized at any point in time is limited to cash received and amounts contractually due. Changes in estimates of total expected costs are accounted for prospectively as a change in estimate. From period to period, custom RUO assay development revenue can fluctuate substantially based on the completion of development-related phases.

Sample Processing Services

The Company also provides sample processing services and molecular profiling of retrospective cohorts for its customers through its VERI/O laboratory, whereby the customer provides samples to be processed using HTG EdgeSeq technology specified in the order. Customers are charged a per sample fee for sample processing services which is recognized as revenue upon delivery of a data file to the customer showing the results of testing, and completing delivery of the agreed upon service.

Collaborative Development Services

The Company follows ASC 605-25, Revenue Recognition – Multiple-Element Arrangements and ASC 808, Collaborative Arrangements to determine the appropriate recognition of revenue for its collaborative development services. Collaborative development services revenue includes services performed by the Company on biopharmaceutical company companion diagnostic development programs using its HTG EdgeSeq proprietary technology to develop, seek regulatory approval for and commercialize companion diagnostics for biopharmaceutical company drug candidates and corresponding therapeutics. These agreements often contain multiple elements, or deliverables, which may include access to the Company’s technology through grants of licenses to its intellectual property, research and development services and participation in joint development steering committees, amongst others. The payments the Company receives under these arrangements typically include one or more of the following: non-refundable up-front fees, monthly development service fees, milestone payments upon acceptance of contract deliverables or profit sharing payments for completed contract milestones. From period to period, collaborative development services revenue can fluctuate substantially based on the achievement of development-related milestones and the timing and number of development-related milestones in the project plan.

Product Warranty

The Company generally provides a one-year warranty on its HTG EdgeSeq systems covering the performance of system hardware and software in conformance with customer specifications under normal use and protecting against defects in materials and workmanship. The Company may, at its option, replace, repair or exchange products covered under valid warranty claims. A provision for estimated warranty costs is recognized at the time of sale, through cost of revenue, based upon recent historical experience and other relevant information as it becomes available. The Company continuously assesses the adequacy of its product warranty accrual by reviewing actual claims and adjusts the provision as needed.

Research and Development Expenses

Research and development expenses represent costs incurred internally for research and development activities and costs incurred externally to fund research activities. These costs include those generated through research and development efforts for the improvement and expansion of the Company’s proprietary technology and product offerings as well as those related to third-party collaborative development agreements, for which related revenue is included in collaborative development services revenue in the accompanying statements of operations.

Advertising

All costs associated with advertising and promotions are expensed as incurred. Advertising expense was $245 and $49,022 for the years ended December 31, 2017 and 2016, respectively, and is included as a component of selling, general and administrative expenses on the accompanying statements of operations.

Stock-Based Compensation

The Company incurs stock-based compensation expense relating to grants under its equity incentive plans of restricted stock units (“RSUs”) and stock options to employees, consultants and non-employee directors, and stock purchase rights granted under its employee stock purchase plan (“ESPP”).

The Company recognizes expense for stock-based awards to employees and non-employee directors based on the fair value of awards on the date of grant. The fair value of RSUs is based on the quoted market price of the Company’s common stock on the date of grant. The fair value of ESPP rights and stock options granted pursuant to the Company’s equity incentive plans is estimated on the date of grant using the Black-Scholes option pricing model. The determination of the fair value utilizing the Black-Scholes option pricing model is affected by the fair value of the Company’s stock price and several assumptions, including volatility, expected term, risk-free interest rate, and dividend yield. Generally, these assumptions are based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes.

The Company elected to change its policy surrounding forfeitures of equity awards with the adoption of the guidance in ASU No. 2016-09 on January 1, 2017. The Company no longer estimates the number of awards expected to be forfeited but instead accounts for such forfeitures as they occur.

For stock-based awards to consultants, the fair value of the stock-based award is used to measure the transaction, as the Company believes this to be a more reliable measure of fair value than the services received. The fair value of each award is remeasured at each measurement date until performance by the nonemployee is complete. Stock-based compensation to nonemployees is recognized as expense over the requisite service period, which is generally the vesting period for awards, on a straight-line basis.

Income Taxes

The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts and tax base of assets and liabilities using enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is established against net deferred tax assets for the uncertainty it presents of the Company’s ability to use the net deferred tax assets, in this case, primarily carryforwards of net operating tax losses and research and development tax credits. In assessing the realizability of net deferred tax assets the Company has assessed the likelihood that net deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not “more likely than not” or there is an insufficient history of operating profits, a valuation allowance is established. The Company records the valuation allowance in the period the Company determines that it is not more likely than not that net deferred tax assets will be realized. For the years ended December 31, 2017 and 2016, the Company has provided a full valuation allowance for all net deferred tax assets due to their current realization being considered remote in the near term. Uncertain tax positions taken or expected to be taken in a tax return are accounted for using the more likely than not threshold for financial statement recognition and measurement. The 2017 Tax Act, which was signed into law on December 22, 2017, significantly revises the Internal Revenue Code of 1986, as amended (the “IRC”) (see Note 14).

Comprehensive Loss

Comprehensive loss

Comprehensive loss includes certain changes in equity that are excluded from net loss. Specifically, unrealized gains and losses on short and long-term available-for-sale investments are included in comprehensive loss.

Concentration Risks

Financial instruments that potentially subject the Company to credit risk consist principally of cash and cash equivalents and accounts receivable. The Company maintains the majority of its cash balances in the form of cash deposits in bank checking and money market accounts in amounts in excess of federally insured limits. Management believes, based upon the quality of the financial institution, that the credit risk with regard to these deposits is not significant.

The Company sells its instruments, consumables, sample processing services, custom RUO panel design and collaborative development services primarily to biopharmaceutical companies, academic institutions and molecular labs. The Company routinely assesses the financial strength of its customers and credit losses have been minimal to date.

The top two customers accounted for 54% and 8% of the Company’s revenue for the year ended December 31, 2017, compared with 29% and 12% for the year ended December 31, 2016. The largest two customers accounted for approximately 66% and 11% of the Company’s net accounts receivable as of December 31, 2017. The largest of these amounts represents accounts receivable relating to work performed under two statements of work entered into under the Company’s Governing Agreement with QML. The largest two customers accounted for approximately 28% and 15% of the Company’s net accounts receivable at December 31, 2016.

Three vendors accounted for 23%, 17% and 15% of the Company’s accounts payable as of December 31, 2017 primarily related to the Company’s collaborative development services programs. Two vendors accounted for 11% and 8% of the Company’s accounts payable at December 31, 2016.

The Company currently relies on a single supplier to supply a subcomponent used in the HTG EdgeSeq processors. A loss of this supplier could significantly delay the delivery of products, which in turn would materially affect the Company’s ability to generate revenue.