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Revenue Recognition

12 Months Ended

Dec. 31, 2019

3. Revenue Recognition

The Company recognizes revenues when, or as, performance obligations in the contracts are satisfied, in the amount reflecting the expected consideration to be received from the goods or services transferred to the customers.

Product Revenues

Product revenues are derived from contracts with insurance carriers, laboratory partners and patients in connection with sales of prenatal genetic tests. The majority of the Company’s revenues is derived from Panorama NIPT, HCS (as defined in Note 1), and to a lesser extent, other genetic tests. The Company enters into contracts with insurance carriers with primarily payment terms related to tests provided to the patients who have health insurance coverage. Insurance carriers are considered as third-party payers on behalf of the patients, and the patients are considered as the customers who receive genetic test services. Tests may be billed to insurance carriers, patients, or a combination of insurance carriers and patients. Further, the Company sells tests to a number of domestic and international laboratory partners and identifies the laboratory partners as customers provided that there is a test services agreement between the two parties.

A performance obligation represents a promise in a contract to transfer a distinct good or service to a customer, which represents a unit of accounting in accordance with ASC 606. A performance obligation is considered distinct from other obligations in a contract when it provides a benefit to the customer either on its own or together with other resources that are readily available to the customer and is separately identified in the contract. The Company considers a performance obligation satisfied once the Company has transferred control of a good or service to the customer, meaning the customer has the ability to use and obtain the benefit of the good or service. A portion of the consideration should be allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company evaluates its contracts with insurance carriers, laboratory partners and patients and identifies a single performance obligation in those contracts, which is the delivery of the test results.

The total consideration which the Company expects to collect in exchange for the Company’s products is an estimate and may be fixed or variable. Consideration includes reimbursement from both patients and insurance carriers, adjusted for variable consideration related to disallowed cases, discounts, refunds and doubtful accounts, and is estimated using the expected value approach. For insurance carriers with similar reimbursement characteristics, the Company uses a portfolio of relevant historical data to estimate variable consideration and total collections for the Company’s products. The Company constrains the estimated variable consideration when it assesses it is probable that a significant reversal in the amount of cumulative revenue recognized may occur in future periods. The consideration expected from laboratory partners usually includes a fixed amount, but it can be variable depending on the volume of tests performed, and the Company determines the variable consideration using the expected value approach. For insurance carriers, laboratory partners and patients, the Company allocates the total consideration to a single performance obligation, which is the delivery of the test results to the customers.

When assessing the total consideration for insurance carriers and patients, a certain percentage of revenues is further constrained for estimated refunds.

The Company generally bills an insurance carrier, a laboratory partner or a patient upon delivery of test results. The Company also bills patients directly for out-of-pocket costs involving co-pays and deductibles that they are responsible for. Tests billed to insurance carriers and directly to patients usually take an average of nine to twelve months to collect the payments, and for tests billed to laboratory distribution partners, the average collection cycle takes approximately two to three months. At times, the Company may or may not get reimbursed for the full amount billed. Further, the Company may not get reimbursed at all for tests performed if such tests are not covered under the insurance carrier’s reimbursement policies or the Company is not a qualified provider to the insurance carrier, or if the tests were not previously authorized.

Product revenue is recognized in an amount that equals to the total consideration (as described above) at a point in time when the test results are delivered. The Company reserves certain amounts in other accrued liabilities on the balance sheet in anticipation of requests for refunds of payments previously made by insurance carriers, which are accounted for as reductions in product revenues in the statement of operations and comprehensive loss. During the years ended December

31, 2019, 2018, and 2017 $2.4 million, $3.3 million, and 4.9 million respectively, were released from amounts previously held in reserves in other accrued liabilities and recognized as product revenue.

Licensing and Other Revenues

The Company recognizes licensing revenues from its cloud-based distribution service offering, Constellation, by granting licenses to its licensees to use certain of the Company’s proprietary intellectual properties and cloud-based software and IVD Kits. The Company also recognizes revenues from the Signatera (RUO) offering, the Qiagen LLC, BGI Genomics, and Foundation Medicine, Inc. agreements, and the Evercord offering for the collection and storage of newborn cord blood and cord tissue units. The Evercord business was sold on September 2019. See Note 13 – Disposal of Business for additional information.

Constellation

The laboratory partners with which the Company enters into a licensing arrangement represent the licensees and are identified as customers. The licensees do not have the right to possess the Company’s software, but rather receive the software as a service. These arrangements often include: (i) the delivery of the software as a service, (ii) the necessary support and training, and (iii) the reagent kits (“IVD kits”) to be consumed as tests are processed. The Company does not consider the software as a service, the support and training as being distinct in the context of such arrangements, and therefore they are combined as a single performance obligation. The software, support and training are delivered simultaneously to the licensees over the term of the arrangement.

The Company provides IVD kits that are customized for its licensees to process tests using its cloud-based software. IVD kits revenues are recognized based on their standalone selling price at a point in time upon delivery to the licensees and expiration of their right of return.

The Company bills the majority of licensees, who process the tests in their laboratories, a fixed price for each test processed. Licensing revenues are recognized as the performance obligations are satisfied (i.e., upon the delivery of each test) and reported in licensing and other revenues in the statements of operations and comprehensive loss.

Signatera

The Company enters into agreements with pharmaceutical companies to utilize the Company’s Signatera tests typically to study new cancer treatments or to validate the outcomes of clinical trials for which the pharmaceutical companies are identified as customers. Such arrangements generally involve performing whole exome sequencing (“WES”) services and the testing of patient samples to detect cancer mutations using its Signatera test. Each test is billable to customers and the personalized cancer profile also makes each test distinct within the context of the contract as customers can exercise control over the test results upon delivery. The company allocates the contract price to each test using the stand-alone selling price for each service and recognizes the test processing revenue as individual test results are delivered to customers.

Evercord

The Company recognized revenues from Evercord for the collection and storage of newborn cord blood and cord tissue units. The patient entered into an enrollment agreement with the Company. According to the agreement, there are two performance obligations: (i) the provision of a collection kit and the processing of newborn cord blood and cord tissue units, which are considered delivered at the beginning of the process (the “processing services”), and (ii) the storage of the cord blood and cord tissue units (the “storage services”), for either an annual fee or a prepayment covering an extended period or the lifetime of the newborn donor.

The Company offered its processing services together with storage services, and each of them is capable of being distinct, and is distinct in the context of the contract, and therefore, represents separate performance obligations. Evercord customers may have paid for both processing and storage services over a period of six, 12, or 18 months. The transaction price for the processing and storage services was calculated as the stated contract price, adjusted for discounts, refunds,

and significant financing components. The Company determined that the transaction price represents the standalone selling prices that are observable in the market for both the processing and storage services. The total consideration was allocated between the processing services and storage services based on their standalone selling prices.

Upon the completion of the processing services, the Company issued a certificate of preservation indicating that the cord blood and cord tissue units are ready for storage, and processing revenues were recognized at this particular point in time. Storage revenues were recognized over time, which is the applicable storage period. The Company believes the methodology of recognizing storage revenues over time meaningfully depicts the timing of storage services delivered to customers as it exerts the necessary efforts to deliver such services equally over time. Evercord revenues are reported in licensing and other revenues in the statements of operations and comprehensive loss through the period the Evercord business was sold in September 2019.

Qiagen

In March 2018, the Company entered into a License, Development and Distribution Agreement (“the Qiagen Agreement”) with Qiagen LLC under which the Company granted Qiagen a license to develop, manufacture, distribute and commercialize NGS-based genetic testing assays and sequencing systems utilizing such assays, which incorporate the Company’s proprietary technology. According to the terms of the agreement, the Company is initially entitled to receive an upfront license fee and prepaid royalties totaling $40.0 million, which was fully collected in 2018. All or a portion of the prepaid royalties are refundable in limited circumstances, including upon termination in certain circumstances. In addition, the Company is entitled to potential milestone payments from Qiagen upon the successful achievement of certain volume, regulatory and commercial milestones, and tiered royalties of $10.0 million, of which the Company has received $5.0 million as of December 31, 2019. The Qiagen Agreement has a term of 10 years and expires in March 2028, and it may be terminated earlier in certain circumstances. Upon termination of the Qiagen Agreement, the license granted to Qiagen will also terminate, except in certain limited circumstances. The Company provided to Qiagen standard indemnification protections, which is part of an assurance that the license meets the contract’s specifications and is not an obligation to provide goods or services. Qiagen has announced that it has discontinued the development of its Next Generation Sequencing Platform. The Company is in discussions with Qiagen regarding the resulting impact on the Qiagen Agreement.

The Company identified the following goods and services in the agreement that it concluded were distinct performance obligations:

Technology license. The Company granted the right to Qiagen to use its proprietary intellectual properties (“technology license”) to develop, manufacture, distribute and commercialize genetic testing assays and sequencing systems in certain countries. The technology license was transferred to Qiagen at the inception of this agreement when the license became effective and the technology transfer was completed.

Development services. The Company is responsible for providing certain support services to assist Qiagen in its design and development of the genetic testing assays.

Market development support. The Company is required to support Qiagen’s market development for the genetic testing assays.

Option to expand commercialization to another country. The Company has provided an option to Qiagen to expand the commercialization of its genetic testing assays to another country following all of the necessary regulatory approvals.

The initial transaction price was primarily comprised of the upfront non-refundable fee and a payment associated with the initial milestone under the agreement. The Company constrains the estimated variable consideration when it assesses it is probable that a significant reversal in the amount of cumulative revenue recognized may occur in future periods. The remaining milestone and prepaid royalty amounts were constrained and not included in the transaction price due to the uncertainties of research and development and the potential for prepaid royalty refund. The Company re-evaluates the transaction price, including the estimated variable consideration included in the transaction price and all constrained amounts, in each reporting period and as uncertain events are resolved or other changes in circumstances

occur. The allocation of the transaction price was performed based on standalone selling prices, which are based on estimated amounts that the Company would charge for a performance obligation if it were sold separately. Future variable consideration such as milestones and royalties are considered associated with the technology license performance obligation. The amounts included in the initial transaction price were allocated to the remaining value of the technology license, as well as development services, market development support and the option to expand commercialization using the relative standalone selling price approach. The amount initially allocated to the technology license was $5.5 million.

BGI Genomics

In February 2019, the Company entered into a License Agreement with BGI Genomics Co., Ltd. (“BGI Genomics” or “BGI”) to develop, manufacture, and commercialize NGS-based genetic testing assays for clinical and commercial use. The agreement has a term of ten years and expires in February 2029. According to the agreement, the Company is entitled to a total of $50 million, comprised of upfront technology license fees, prepaid royalties relating to future sales of licensed products and performance of assay interpretation services, and milestone payments. During the three months ended June 30, 2019, the Company received $35.6 million, net of withholding taxes, of these amounts. The Company recorded a receivable of $2.5 million upon achieving the first milestone as of June 30, 2019. Also, as required by the agreement with BGI Genomics, in June 2019 the Company prepaid $6.0 million to BGI Genomics for future sequencing services and $4.0 million for future sequencing equipment. These advance payments for equipment and services to be received in future periods aggregating $10 million were recorded in long-term advances.

Pursuant to the agreement, the Company licensed its intellectual property and will provide development services. Following completion of development services, the Company will provide assay interpretation services over the term of the agreement. The Company concluded that the license is not a distinct performance obligation as it is highly interrelated and interdependent with the related development services. Therefore, license and related development services, for each of NIPT and Oncology products, represents a single performance obligation.

The Company is responsible for granting a license to specified intellectual property and performing certain development activities to customize its genetic testing assays for oncology and NIPT for use with BGI Genomics’ sequencing instruments and proprietary technology platform. Revenue associated with these performance obligations is recognized over time using the input method, based on costs incurred to perform the development services, since the level of costs incurred over time best reflect the transfer of development services. Revenue associated with the assay interpretation services will be recognized upon delivery of these services. Funds received in advance are recorded as deferred revenue and will be recognized as the related services are delivered.

The initial transaction price was primarily comprised of license and milestone fees. The Company constrains the estimated variable consideration when it assesses it is probable that a significant reversal in the amount of cumulative revenue recognized may occur in future periods. Certain milestone and license fees were constrained and not included in the transaction price due to the uncertainties of research and development. The Company re-evaluates the transaction price, including the estimated variable consideration included in the transaction price and all constrained amounts, in each reporting period and as uncertain events are resolved or other changes in circumstances occur. The allocation of the transaction price was performed based on standalone selling prices, which are based on estimated amounts that the Company would charge for a performance obligation if it were sold separately.

In accordance with ASC 340-40, any incremental costs incurred to obtain a contract with a customer are required to be capitalized and amortized over the period in which the goods and services are transferred to the customer. The Company has elected to apply a practical expedient under ASC 340-40 to recognize the incremental costs of obtaining a contract as an expense when incurred provided that the amortization period of such costs, if capitalized, is one year or less. The incremental costs incurred in connection with the BGI arrangement is not material on an accumulated basis and therefore will not be capitalized on the balance sheet but will be expensed as incurred.

Foundation Medicine, Inc.

In August 2019, the Company entered into a License and Collaboration Agreement with Foundation Medicine, Inc. (“Foundation Medicine” or “FMI”) to develop and commercialize personalized circulating tumor DNA monitoring assays, for use by biopharmaceutical and clinical customers who order Foundation Medicine’s FoundationOne CDx. The agreement has an initial term of five years, expiring in August 2024, with automatic renewals thereafter for successive one-year terms. Natera and Foundation Medicine will share the revenues generated from both biopharmaceutical and clinical customers. The agreement provides for approximately $13.3 million in upfront licensing fees and prepaid revenues payable to Natera, and up to approximately $32.0 million in minimum annual payments and payments tied to Natera’s achievement of certain developmental, regulatory, and commercial milestones. During the year ended December 31, 2019, the Company received $16.3 million of these amounts, of which $3.0 million was for achieving development performance milestones, and $13.3 million was for licensing fees and prepaid revenue.

Pursuant to the agreement, the Company will provide development services in conjunction with granting the use of the Company’s intellectual property. Following completion of development services, the Company will provide assay testing services over the term of the agreement. The Company concluded that the license is not a distinct performance obligation as it is highly interrelated and interdependent with the related development services. Therefore, license and related development services represents a single performance obligation.

The Company is responsible for providing the technology license and certain development services that are required to customize its proprietary Signatera test to work with FMI’s FoundationOne CDX. The intellectual property has been licensed to Foundation Medicine for the customized test. In addition, the Company is responsible for delivering clinical study plans in order to demonstrate efficacy of the customized test. Revenues associated with each of the performance obligations are recognized over time using the input method, based on costs incurred to perform the development services, since the level of costs incurred over time best reflect the transfer of development services. Revenue associated with the assay testing services will be recognized upon delivery of these services. Funds received in advance are recorded as deferred revenue and will be recognized as the related services are delivered.

The initial transaction price was primarily comprised of license and milestone fees. The Company constrains the estimated variable consideration when it assesses it is probable that a significant reversal in the amount of cumulative revenue recognized may occur in future periods. Certain milestone fees were constrained and not included in the transaction price due to the uncertainties of research and development. The Company re-evaluates the transaction price, including the estimated variable consideration included in the transaction price and all constrained amounts, in each reporting period and as uncertain events are resolved or other changes in circumstances occur. The allocation of the transaction price was performed based on standalone selling prices, which are based on estimated amounts that the Company would charge for a performance obligation if it were sold separately.

Disaggregation of Revenues

Our disaggregated revenues were as follows (in thousands):


	Year Ended December 31,
	2019		2018		2017
(Amounts in thousands)
Product revenues
Sale of genetic tests	$	269,881	$	240,366	$	203,777
Licensing and other
Upfront license and Constellation and paternity		5,089		10,344		4,229
License and development services		16,379		294		—
Other		10,979		6,650		1,619
Licensing and other revenues		32,447		17,288		5,848
Total revenues	$	302,328	$	257,654	$	209,625

The Company measures its performance results primarily based on revenues recognized from the three categories described below. The following table shows disaggregation of revenues by payer types:


	Year Ended December 31,
	2019		2018		2017
(Amounts in thousands)
Insurance carriers	$	210,919	$	193,895	$	163,861
Laboratory partners		59,876		44,062		36,001
Patients		31,533		19,697		9,763
Total revenues	$	302,328	$	257,654	$	209,625

The following table presents total revenues by geographic area based on the location of the Company’s payers:


	Year ended December 31,
	2019		2018		2017
(Amounts in thousands)
United States	$	260,846	$	225,931	$	185,533
Americas, excluding U.S.		3,218		3,472		3,028
Europe, Middle East, India, Africa		15,434		20,866		13,998
Asia Pacific and Other		22,830		7,385		7,066
Total	$	302,328	$	257,654	$	209,625

The Company recognizes revenue from billings to insurance carriers and patients based on estimates of the amount that will ultimately be realized (“expected consideration”). The expected consideration estimated for genetic test services is based on many factors such as length of payer relationship, historical collection trends, changes in contract provisions and insurance reimbursement policies. Cash collections for certain tests delivered may differ from the expected consideration originally estimated. During the year ended December 31, 2019, the Company’s collections did not differ significantly from original estimates of expected consideration. Thus, the Company did not recognize a cumulative catch-up of revenue for the year ended December 31, 2019. However, for the year ended December 31, 2018, the original estimates of expected consideration differed significantly from actual collections, and the updates of the Company’s estimate resulted in a $10.2 million cumulative catch-up of revenue. These changes in estimates decreased the Company’s loss from operations by $10.2 million and decreased basic and diluted net loss per share by approximately $0.18 for the year ended December 31, 2018.

Contract Balances

The following table summarizes the Company’s beginning and ending balances of accounts receivable and deferred revenues:


	Balance at		Balance at
	December 31,		December 31,
	2019		2018
(Amounts in thousands)
Assets:
Accounts receivable	$	53,351	$	62,223
Liabilities:
Deferred revenue, current portion	$	56,016	$	4,131
Deferred revenue, long-term portion		23,808		40,058
Total deferred revenues	$	79,824	$	44,189

The following table shows the changes in the balance of deferred revenues during the period:


	Deferred
	Revenues
	(in thousands)
Balance at December 31, 2018	$	44,189
Increase in deferred revenues		65,026
Revenue recognized during the period that was included in deferred revenues at the beginning of the period		(970)
Revenue recognized from performance obligations satisfied within the same period		(23,209)
Transferred in the sale of business		(5,212)
Balance at December 31, 2019	$	79,824

During the year ended December 31, 2019, revenue recognized that was included in the deferred revenue balance at the beginning of the period totaled $1.0 million, of which $0.5 million was related to genetic testing services and the provision of IVD kits and $0.3 million pertained to undelivered Evercord storage services, and approximately $0.2 million was related to the Qiagen Agreement.

As of December 31, 2019, total deferred revenues were $79.8 million were comprised of the current and long-term portions of $56.0 million and $23.8 million, respectively. The current portion was primarily comprised of unsatisfied performance obligations from our strategic partnership agreements of $55.3 million. The increase of $51.9 million in current deferred revenues from $4.1 million in December 31, 2018 was primarily attributable to two new strategic partnership agreements executed in the current year resulting in an additional $16.7 million of current deferred revenues and the reclassification of long-term deferred revenues to current deferred revenues of $36.2 million due to the discontinuance of Qiagen’s GeneReader NGS sequencing platform and the Company’s expectation to resolve contractual obligations within the next 12 months. The long-term portion included $23.8 million of unsatisfied performance obligations expected to be provided through the end of fiscal year 2021, resulting from two new strategic partnership agreements executed in the current year of $23.8 million.