2.	Summary of Significant Accounting Policies

Summary of Accounting Policies

The significant accounting policies and estimates used in preparation of the unaudited condensed consolidated financial statements are described in the Company’s audited consolidated financial statements as of and for the year ended December 31, 2016, and the notes thereto, which are included in the Company’s Annual Report on Form 10-K. There have been no material changes to the significant accounting policies previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Reclassifications

Certain reclassifications have been made to the revenue captions of the Condensed Consolidated Statements of Operations and Comprehensive Loss to conform to the current classifications. These reclassifications had no net effect on the Company’s consolidated results.

Revenue Recognition

The Company derives revenue from the provision of molecular information services provided to its ordering physicians and biopharmaceutical customers, as well as from pharma research and development services provided to its biopharmaceutical customers. Molecular information services include molecular profiling and the delivery of other molecular information derived from the Company’s platform. Pharma research and development services include the development of new platforms and information solutions, including companion diagnostic development. The Company currently receives payments from commercial third-party payors, Medicare, certain hospitals and cancer centers with which it has direct-bill relationships, individual patients, and its biopharmaceutical customers.

The Company recognizes revenue in accordance with FASB ASC Topic 605, Revenue Recognition (“ASC 605”). Accordingly, the Company recognizes revenue when all of the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred; (iii) the fee is fixed or determinable; and (iv) collectability is reasonably assured. Criterion (i) is satisfied when the Company has an arrangement or contract in place. Criterion (ii) is satisfied when the Company delivers a report to the ordering physician or the biopharmaceutical customer. Determination of criteria (iii) and (iv) are based on management’s judgments regarding whether the fee is fixed or determinable, and whether the collectability of the fee is reasonably assured.

The Company recognizes revenue on a cash basis when it cannot conclude that criteria (iii) and (iv) have been met. The Company currently recognizes revenue on a cash basis from sales of its molecular information services to certain clinical customers, including payments received from commercial third-party payors, Medicare, and from patients who make co-payments, pay deductibles or from other amounts that the Company has been unable to collect from third-party payors. The Company uses judgment in its assessment of whether the fee is fixed or determinable and whether collectability is reasonably assured in determining when to recognize revenue in the future as it continues to gain payment experience with third-party payors and patients. Accordingly, the Company expects to recognize revenue on a cash basis for these clinical customers until it has sufficient history to reliably estimate payment patterns. The Company’s molecular information services are delivered electronically, and as such there are no shipping and handling fees incurred by the Company or billed to customers. The Company’s molecular information services are exempt from state sales taxation due to the nature of the services. As a result, the Company does not charge customers state sales tax.

The Company recognizes revenue from the sale of its molecular information services to clinical customers, including certain hospitals, cancer centers, other institutions and patients, at the time results of the test are reported to physicians, if criteria (i) through (iv) above are met.

Revenue from sales of the Company’s services to biopharmaceutical customers are based on a negotiated price per test or on the basis of an agreement to provide certain testing volume, data access, or pharma research and development services over a defined period. The Company recognizes revenue upon delivery of the test results, or over the period in which pharma research and development services are provided, as appropriate.

The Company performs pharma research and development services for its biopharmaceutical customers utilizing its molecular information platform. Contracts for pharma customers are primarily analyzed as multiple-element arrangements given the nature of the service deliverables. For pharma research and development services performed, the Company is compensated in various ways, including (1) through the reimbursement of costs incurred; (2) through non-refundable regulatory and other developmental milestone payments; and (3) through royalty and sales milestone payments. For some multiple-element arrangements, including the R&D Collaboration agreement with Roche, the Company will be reimbursed for either all or a portion of the research and development costs incurred. The Company performs pharma research and development services as part of its normal activities. The Company records these payments as Pharma research and development services revenue in the Consolidated Statements of Operations and Comprehensive Loss, using a proportional performance model over the period which the unit of accounting is delivered or based on the level of effort expended to date over the total expected effort, whichever is considered the most appropriate measure of performance. The research and development costs incurred by the Company under these arrangements are included as Research and development expenses in the Company’s Consolidated Statements of Operations and Comprehensive Loss given these costs are related to the development of new services to be owned and offered by the Company to its customers.

The Company analyzes multiple-element arrangements based on the guidance in FASB ASC Topic 605-25, Revenue Recognition-Multiple-Element Arrangements (“ASC 605-25”). Pursuant to the guidance in ASC 605-25, the Company evaluates multiple-element arrangements to determine (1) the deliverables included in the arrangement and (2) whether the individual deliverables represent separate units of accounting or whether they must be accounted for as a combined unit of accounting. This evaluation involves subjective determinations and requires management to make judgments about the individual deliverables and whether such deliverables are separable from the other aspects of the contractual relationship. Deliverables are considered separate units of accounting if: (i) the delivered items have value to the customer on a standalone basis and (ii) the arrangement includes a general right of return relative to the delivered items and delivery or performance of the undelivered items is considered probable and substantially in the control of the Company. In assessing whether an item has standalone value, the Company considers factors such as the research, development and commercialization capabilities of a third party and the availability of the associated expertise in the general marketplace. In addition, the Company considers whether the other party in the arrangement can use the other deliverables for their intended purpose without the receipt of the remaining elements, whether the value of the deliverable is dependent on the undelivered items, and whether there are other vendors that can provide the undelivered elements.

Arrangement consideration that is fixed or determinable is allocated among the separate units of accounting using the relative selling price method. Then, the applicable revenue recognition criteria in ASC 605-25 is applied to each of the separate units of accounting in determining the appropriate period and pattern of recognition. The Company determines the selling price of a unit of accounting following the hierarchy of evidence prescribed by ASC 605-25. Accordingly, the Company determines the estimated selling price for units of accounting within each arrangement using vendor-specific objective evidence (“VSOE”) of selling price, if available, third-party evidence (“TPE”) of selling price if VSOE is not available, or best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. The Company typically uses BESP to estimate the selling price, since it generally does not have VSOE or TPE of selling price for its units of accounting under multiple-element arrangements. Determining the BESP for a unit of accounting requires significant judgment. In developing the BESP for a unit of accounting, the Company considers applicable market conditions and estimated costs. The Company validates the BESP for units of accounting by evaluating whether changes in the key assumptions used to determine the BESP will have a significant effect on the allocation of arrangement consideration between multiple units of accounting. The Company recognizes arrangement consideration allocated to each unit of accounting when all of the revenue recognition criteria in ASC 605-25 are satisfied for that particular unit of accounting.

At the inception of an arrangement that includes milestone payments to the Company, the Company evaluates whether each milestone is substantive and at risk to both parties on the basis of the contingent nature of the milestone. This evaluation includes an assessment of whether: (i) the consideration is commensurate with either the Company’s performance to achieve the milestone or the enhancement of the value of the delivered items as a result of a specific outcome resulting from the Company’s performance to achieve the milestone, (ii) the consideration relates solely to past performance, and (iii) the consideration is reasonable relative to all of the deliverables and payment terms within the arrangement. The Company evaluates factors such as the scientific, clinical, regulatory, commercial, and other risks that must be overcome to achieve the respective milestone and the level of effort and investment required to achieve the respective milestone in making this assessment. There is considerable judgment involved in determining whether a milestone satisfies all of the criteria required to conclude that a milestone is substantive. Generally, once a substantive milestone has been achieved, the Company will recognize revenue related to that milestone using a proportional performance model over the period which the unit of accounting is delivered or based on the level of effort expended to date over the total expected effort, whichever is considered the most appropriate measure of performance. Revenue from commercial milestone payments are accounted for as royalties and recorded as revenue upon achievement of the milestone, assuming all other revenue recognition criteria are met.

The Company also recognizes royalty revenue in the period of sale of the related service(s), based on the underlying contract terms, provided that the reported sales are reliably measurable and the Company has no remaining performance obligations, assuming all other revenue recognition criteria are met. To date, royalty revenue recognized by the Company has been immaterial.

Cost of Revenue

Cost of molecular information services generally consists of specific reagents, specific consumable lab supplies, and shared costs that are allocated to the Company’s molecular information services – its FoundationOne, FoundationOne Heme, FoundationACT and FoundationFocus CDxBRCA tests – either on a direct or indirect basis, resulting in an overall cost for each specific test. The shared costs that are allocated to each test include personnel expenses (comprised of salaries, bonuses, employee benefits and stock-based compensation expenses), depreciation of laboratory equipment and amortization of leasehold improvements, shipping costs, third-party laboratory costs, and certain overhead expenses.

Costs associated with performing tests are recorded as tests are processed. These costs are recorded regardless of whether revenue is recognized with respect to those tests. Because the Company currently recognizes revenue on a cash basis from commercial third-party payors and patients who make co-payments, pay deductibles or pay other amounts that the Company has been unable to collect from their insurers, the costs of those tests are often recognized in advance of any associated revenues.

Cost of Related-party molecular information services from Roche is generally derived by taking the cost per test described above and applying it to each of the FoundationOne, FoundationOne Heme and FoundationACT tests processed for Roche. Costs of Related-party molecular information services from Roche are associated with performing molecular information services for Roche under both the (i) molecular information platform program within the Company’s R&D Collaboration Agreement with Roche, and (ii) the Company’s Ex-U.S. Commercialization Agreement with Roche. Revenues from tests performed by the Company under the molecular information platform and the Ex-U.S. Commercialization Agreement are recognized in the Related-party molecular information services from Roche caption within the Company’s Consolidated Statements of Operations and Comprehensive Loss.

Research and Development Expenses

Research and development expenses consist primarily of costs incurred for the development of new and enhanced services, immunotherapy testing, companion diagnostic development, significant service improvements, clinical trials to evaluate the clinical utility of the Company’s services, the development of our FoundationCORE knowledgebase, and various technology applications such as FoundationICE and Patient-Match. Costs to develop the Company’s technology capabilities are recorded as research and development unless they meet the criteria to be capitalized as internal-use software costs. The Company’s research and development activities include the following costs:

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personnel-related expenses such as salaries, bonuses, employee benefits, and stock-based compensation;

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fees for contractual and consulting services;

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costs to manage and synthesize our medical data and to expand FoundationCORE;

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clinical trials;

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laboratory supplies; and

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allocated overhead expenses.

Costs incurred for the performance of pharma research and development services requested by the Company’s biopharmaceutical customers, including non-molecular information services costs incurred under the R&D Collaboration Agreement with Roche, are included as Research and development expenses in the Consolidated Statements of Operations and Comprehensive Loss, given that these costs are related to the development of new services to be owned and offered by the Company to its customers. Revenues from these services are recognized in the Pharma research and development services and Related-party pharma research and development services from Roche captions within the Company’s Consolidated Statements of Operations and Comprehensive Loss.

Recent Accounting Pronouncements

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standard setting bodies and adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its financial position or results of operations upon adoption.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes the revenue recognition requirements in Accounting Standards Codification 605 (“ASC 605”) and most industry-specific guidance. The new standard requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this core principle, ASU 2014-09 includes provisions within a five-step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when, or as, an entity satisfies a performance obligation. The update also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB decided to delay the effective date of ASU 2014-09 through the issuance of an additional ASU, which revised the effective date for ASU 2014-09 to annual and interim periods beginning on or after December 15, 2017, with early adoption permitted, but not earlier than the original effective date of annual and interim periods beginning on or after December 15, 2016, for public entities. In May 2014, the FASB and International Accounting Standards Board formed The Joint Transition Resource Group for Revenue Recognition ("TRG"), consisting of financial statement preparers, auditors, and users, to seek feedback on potential issues related to the implementation of the new revenue standard. As a result of feedback from the TRG, the FASB issued additional guidance throughout 2016 to provide clarification, implementation guidance and practical expedients to address some of the challenges of implementation. The new ASUs have the same effective date and transition requirements as ASU 2014-09. We refer to these ASUs which comprise Accounting Standards Codification 606 (“ASC 606”) and Accounting Standards Codification 340-40 (“ASC 340-40”) collectively as the “new standard”.

The Company intends to adopt the new standard on January 1, 2018 utilizing the modified retrospective method, meaning the cumulative effect of applying the standard will be recognized to opening retained earnings at the date of initial application. The Company has a project team in place, including engagement of a third-party service provider, to analyze the impact of ASU 2014-09 and the related ASUs across all revenue streams. The Company has substantially completed a diagnostic review of current accounting policies and a sample of existing baseline contracts to identify potential differences that would result from applying the requirements under the new standard. In the second quarter of 2017, the Company began drafting its new accounting policies, including evaluation of any variations in key terms from the baseline contract reviews, and evaluating the new disclosure requirements, including any necessary changes to our business processes, systems, and controls to support the additional required disclosures.

The Company has identified two revenue streams for their contracts with customers: 1) molecular information services and 2) pharma research and development services. For the molecular information services revenue stream, the Company is in the process of evaluating the application of the new standard to arrangements with certain clinical customers and is not yet able to estimate the anticipated impact to our consolidated financial statements from the application of the new standard. Currently, for certain clinical customers, the Company will defer revenue recognition until cash receipt when the price pursuant to the underlying customer arrangement is not fixed and determinable and collectability is not reasonably assured. The Company is in the process of evaluating the accounting for these arrangements under the new standard. For the Company’s pharma research and development services revenue stream, the Company has not yet identified any significant implementation matters to be resolved, but the Company is in the process of evaluating their application of the new standard and cannot at this time estimate the anticipated impact to our consolidated financial statements from the application of the new standard. For both revenue streams, the Company expects that the disclosures in our notes to the consolidated financial statements related to revenue recognition will be significantly expanded under the new standard.

The Company believes it is following an appropriate timeline to allow for proper recognition, presentation, and disclosure upon adoption effective the beginning of fiscal year 2018. The Company will continue to monitor new customer contracts throughout the remainder of 2017. Additionally, the FASB has issued, and may issue in the future, interpretive guidance which may cause our evaluation to change.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, forfeiture rates, and classification on the statement of cash flows. ASU 2016-09 became effective for fiscal years beginning after December 15, 2016. The adoption of ASU 2016-09 resulted in an immaterial forfeiture rate adjustment, which was recorded in accumulated deficit upon adoption of the standard on January 1, 2017.

Effective as of January 1, 2017, the Company adopted a change in accounting policy in accordance with ASU 2016-09 to account for excess tax benefits and tax deficiencies as income tax expense or benefit, treated as discrete items in the reporting period in which they occur, and to recognize previously unrecognized deferred tax assets that arose directly from (or the use of which was postponed by) tax deductions related to equity compensation in excess of compensation recognized for financial reporting. The recognition of the federal and state excess tax benefit net operating losses increased the net operating loss deferred tax asset by $14.9 million. No prior periods were restated as a result of this change in accounting policy as the Company maintains a valuation allowance against its deferred tax assets, which also increased by $14.9 million after adoption.

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities, including for operating leases (See Note 12), on the balance sheet and disclosing key information about leasing arrangements. ASU 2016-02 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is still performing its assessment of ASU 2016-02, however expects that substantially all of its operating lease commitments will be subject to the new guidance.

In November 2016, the FASB issued ASU 2016-18, Restricted Cash (“ASU 2016-18”). ASU 2016-18 provides guidance on the classification of restricted cash and cash equivalents in the statement of cash flows. Although it does not provide a definition of restricted cash or restricted cash equivalents, it states that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The adoption of ASU 2016-18 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.

In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting (“ASU 2017-09”). ASU 2017-09 provides guidance about which terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-18 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The adoption of ASU 2017-09 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.