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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2022

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ___________ to __________

 

Commission file number 1-37648

 

Oncocyte Corporation

(Exact name of registrant as specified in its charter)

 

California   27-1041563
(State or other jurisdiction
of incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

15 Cushing

Irvine, California 92618

(Address of principal executive offices) (Zip Code)

 

(949) 409-7600

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Exchange Act:

 

Title of each class   Trading Symbol   Name of each exchange on which registered
Common Stock, no par value   OCX   The Nasdaq Stock Market LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐ Accelerated filer ☐
Non-accelerated filer Smaller reporting company
  Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No

 

The number of shares of common stock outstanding as of August 3, 2022 was 118,608,821.

 

 

 

 
 

 

PART 1—FINANCIAL INFORMATION

 

This Report on Form 10-Q (“Report”) contains forward-looking statements that involve risks and uncertainties. We make such forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. All statements other than statements of historical facts contained in this Report are forward-looking statements. In some cases, you can identify forward-looking statements by words such as “anticipate,” “believe,” “contemplate,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will,” “would,” or the negative of these words or other comparable terminology.

 

Any forward-looking statements in this Report reflect our current views with respect to future events or to our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Factors that may cause actual results to differ materially from current expectations include, among other things, those discussed in this Report under Item 1 of the Notes to Condensed Consolidated Interim Financial Statements, under Risk Factors in this Report and those Risk Factors in Part I, Item 1A of our most recent Annual Report on Form 10-K as filed with the Securities and Exchange Commission. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by law, we assume no obligation to update or revise these forward-looking statements for any reason, even if new information becomes available in the future.

 

The forward-looking statements in this Report also include, among other things, statements about:

 

  the timing and potential achievement of future milestones;
  the timing and our ability to obtain and maintain coverage and reimbursements from the Centers for Medicare and Medicaid Services and other third-party payers;
  our plans to pursue research and development of diagnostic test;
  the potential commercialization of our diagnostic tests currently in development;
  the timing and success of future clinical trials and the period during which the results of the clinical trials will become available;
  the potential receipt of revenue from future sales of our diagnostic tests or diagnostic tests in development;
  our assumptions regarding obtaining reimbursement and reimbursement rates;
  our estimates regarding future orders of tests and our ability to perform a projected number of tests;
  our estimates and assumptions around patient populations, market size and price points for reimbursement for our diagnostic tests;
  our estimates regarding future revenues and operating expenses, and future capital requirements;
  our intellectual property position;
  the uncertainties associated with the coronavirus (COVID-19) ongoing pandemic, including its possible effects on our operations and the demand for our diagnostic tests and Pharma Services;
  our ability to efficiently and flexibly manage our business amid uncertainties related to COVID-19;
  the impact of government laws and regulations; and
  our competitive position.

 

Unless the context otherwise requires, all references to “Oncocyte,” the “Company,” “we,” “us,” “our,” or similar words refer to Oncocyte Corporation, together with our consolidated subsidiaries.

 

The description or discussion, in this Form 10-Q, of any contract or agreement is a summary only and is qualified in all respects by reference to the full text of the applicable contract or agreement.

 

DetermaRx™, DetermaIO™, DetermaTx™, DetermaMx™, DetermaCNI™, DetermaDx™ and VitaGraftTM are trademarks of Oncocyte Corporation, and TheraSure™ is a trademark of Chronix Biomedical, Inc., regardless of whether the “TM” symbol accompanies the use of or reference to the applicable trademark in this Report.

 

2
 

 

Item 1. Financial Statements

 

ONCOCYTE CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

                 
    June 30, 2022     December 31, 2021  
             
ASSETS                
CURRENT ASSETS                
Cash and cash equivalents   $ 44,836     $ 35,605  
Accounts receivable     1,802       1,437  
Marketable equity securities     579       904  
Prepaid expenses and other current assets     2,151       1,197  
Total current assets     49,368       39,143  
                 
NONCURRENT ASSETS                
Right-of-use and financing lease assets, net     2,489       2,779  
Machinery and equipment, net, and construction in progress     9,087       5,748  
Goodwill     18,684       18,684  
Intangible assets, net     89,341       91,245  
Restricted cash     1,700       1,700  
Other noncurrent assets     382       264  
TOTAL ASSETS   $ 171,051     $ 159,563  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY                
CURRENT LIABILITIES                
Accounts payable   $ 2,465     $ 2,447  
Accrued compensation     2,789       3,376  
Accrued expenses and other current liabilities     4,564       2,425  
Accrued severance from acquisition     2,314       2,352  
Accrued liabilities from acquisition     609       1,388  
Loans payable, net of deferred financing costs     574       1,313  
Right-of-use and financing lease liabilities, current     839       819  
Total current liabilities     14,154       14,120  
                 
NONCURRENT LIABILITIES                
Right-of-use and financing lease liabilities, noncurrent     3,134       3,545  
Contingent consideration liabilities     65,666       76,681  
                 
TOTAL LIABILITIES     82,954       94,346  
                 
Commitments and contingencies     -          
                 
Series A Redeemable Convertible Preferred Stock, no par value; stated value $1,000 per share; 12 shares authorized, 6 shares issued and outstanding at June 30, 2022; aggregate liquidation preference of $5,911 as of June 30, 2022     4,854       -  
                 
SHAREHOLDERS’ EQUITY                
Preferred stock, no par value, 5,000 shares authorized; no shares issued and outstanding     -       -  
Common stock, no par value, 230,000 shares authorized; 118,609 and 92,232 shares
 issued and outstanding at June 30, 2022 and December 31, 2021, respectively
    289,649       252,954  
Accumulated other comprehensive loss     31       37  
Accumulated deficit     (206,437 )     (187,774 )
Total shareholders’ equity     83,243       65,217  
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY   $ 171,051     $ 159,563  

 

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.

 

3
 

 

ONCOCYTE CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

    2022     2021     2022     2021  
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2022     2021     2022     2021  
                         
Net revenue   $ 2,067     $ 2,030     $ 3,491     $ 3,154  
                                 
Cost of revenues     1,405       1,350       2,426       2,088  
Cost of revenues – amortization of acquired intangibles     976       1,074       1,912       1,381  
Gross profit     (314 )     (394 )     (847 )     (315 )
                                 
Operating expenses:                                
Research and development     5,574       2,537       10,702       5,898  
Sales and marketing     3,522       2,673       6,759       4,927  
General and administrative     5,511       7,934       11,164       12,698  
Change in fair value of contingent consideration     (6,359 )     30       (11,015 )     1,090  
Total operating expenses     8,248       13,174       17,610       24,613  
                                 
Loss from operations     (8,562 )     (13,568 )     (18,457 )     (24,928 )
                                 
OTHER INCOME (EXPENSES), NET                                
Interest expense, net     (21 )     (49 )     (51 )     (117 )
Unrealized gain (loss) on marketable equity securities     5       173       (325 )     386  
Pro rata loss from equity method investment in Razor     -       -       -       (270 )
Gain on extinguishment of debt (PPP loan)     -       1,141       -       1,141  
Other income, net     278       16       242       18  
Total other expenses, net     262       1,281       (134 )     1,158  
                                 
LOSS BEFORE INCOME TAXES     (8,300 )     (12,287 )     (18,591 )     (23,770 )
                                 
Income tax benefit     -       1,794       -       9,358  
                                 
NET LOSS   $ (8,300 )   $ (10,493 )   $ (18,591 )   $ (14,412 )
                                 
Net loss per share: basic and diluted   $ (0.07 )   $ (0.12 )   $ (0.18 )   $ (0.17 )
                                 
Weighted average shares outstanding: basic and diluted     113,042       89,758       102,700       85,961  

 

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.

 

4
 

 

ONCOCYTE CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

 

    2022     2021     2022     2021  
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2022     2021     2022     2021  
                         
NET LOSS   $ (8,300 )   $ (10,493 )   $ (18,591 )   $ (14,412 )
Foreign currency translation adjustments     (7 )     -       (6 )     -  
COMPREHENSIVE LOSS   $ (8,307 )   $ (10,493 )   $ (18,597 )   $ (14,412 )

 

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.

 

5
 

 

ONCOCYTE CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

 

    Shares     Amount     Shares     Amount       Income     Deficit     Equity  
    Three Months Ended June 30, 2022  
    Series A Redeemable Convertible Preferred Stock     Common Stock     Accumulated Other
Comprehensive
    Accumulated     Total
Stockholders’
 
    Shares     Amount     Shares     Amount       Income     Deficit     Equity  
Balance at March 31, 2022     -     $ -       92,247     $ 254,994     $ 38     $ (198,065 )   $ 56,967  
Net Loss     -       -       -       -       -       (8,300 )     (8,300 )
Foreign currency translation adjustment     -       -       -       -       (7 )     -       (7 )
Stock-based compensation     -       -       -       2,232       -       -       2,232  
Issuance of common shares, including at-the-market transactions, net of financing costs and underwriting discounts     -       -       26,266       32,423       -       -       32,423  
Shares issued upon vesting of RSU, net of shares retired to pay employees’ taxes     -       -       96       -       -       -       -  
Issuance of Series A redeemable convertible preferred stock, net of financing costs     11,765       4,782       -       -       -       -       -  
Accretion of Series A convertible preferred stock to redemption value     -       72       -       -       -       (72 )     (72 )
Balance at June 30, 2022     11,765     $ 4,854       118,609     $ 289,649     $ 31     $ (206,437 )   $              83,243  

 

    Three Months Ended June 30, 2021  
    Series A Redeemable Convertible Preferred Stock     Common Stock     Accumulated Other
Comprehensive
    Accumulated     Total
Stockholders’
 
    Shares     Amount     Shares     Amount     Income     Deficit     Equity  
Balance at March 31, 2021     -     $ -       88,914     $ 234,224     $ -     $ (127,596 )   $ 106,628  
Net Loss     -       -       -       -       -       (10,493 )     (10,493 )
Stock-based compensation     -       -       -       1,997       -       -       1,997  
Stock options exercised     -       -       617       1,251       -       -       1,251  
Warrants exercised     -       -       7       21       -       -       21  
Shares issued upon vesting of RSU, net of shares retired to pay employees’ taxes     -       -       130       (37 )     -       -       (37 )
Issuance of common stock to Chronix Biomedical acquisition     -       -       648       3,299       -       -       3,299  
Balance at June 30, 2021     -     $ -       90,316     $ 240,755     $ -     $ (138,089 )   $ 102,666  

 

    Six Months Ended June 30, 2022  
    Series A Redeemable Convertible Preferred Stock     Common Stock     Accumulated Other
Comprehensive
    Accumulated     Total
Stockholders’
 
    Shares     Amount     Shares     Amount       Income     Deficit     Equity  
Balance at December 31, 2021     -     $ -       92,232     $ 252,954     $ 37     $ (187,774 )   $ 65,217  
Net Loss     -       -       -       -       -       (18,591 )     (18,591 )
Foreign currency translation adjustment     -       -       -       -       (6 )     -       (6 )
Stock-based compensation     -       -       -       4,242       -       -       4,242  
Issuance of common shares, including at-the-market transactions, net of financing costs and underwriting discounts     -       -       26,281       32,453       -       -       32,453  
Shares issued upon vesting of RSU, net of shares retired to pay employees’ taxes     -       -       96       -       -       -       -  
Issuance of Series A redeemable convertible preferred stock, net of financing costs     11,765       4,782       -       -       -       -       -  
Accretion of Series A convertible preferred stock to redemption value     -       72       -       -       -       (72 )     (72 )
Balance at June 30, 2022     11,765     $ 4,854       118,609     $ 289,649     $ 31     $ (206,437 )   $ 83,243  

 

    Six Months Ended June 30, 2021  
    Series A Redeemable Convertible Preferred Stock     Common Stock     Accumulated Other
Comprehensive
    Accumulated     Total
Stockholders’
 
    Shares     Amount     Shares     Amount       Income     Deficit     Equity  
Balance at December 31, 2020     -     $ -       69,117     $ 157,160     $ -     $ (123,677 )   $ 33,483  
Net Loss     -       -       -       -       -       (14,412 )     (14,412 )
Stock-based compensation     -       -       -       3,287       -       -       3,287  
Issuance of common shares, including at-the-market transactions, net of financing costs and underwriting discounts     -       -       18,427       68,868       -       -       68,868  
Stock options exercised     -       -       757       1,599       -       -       1,599  
Warrants exercised     -       -       255       823       -       -       823  
Shares issued upon vesting of RSU, net of shares retired to pay employees’ taxes     -       -       130       (37 )     -       -       (37 )
Issuance of common stock to Razor Genomics     -       -       982       5,756       -       -       5,756  
Issuance of common stock to Chronix Biomedical     -       -       648       3,299       -       -       3,299  
Balance at June 30, 2021     -       -       90,316       240,755     $ -       (138,089 )     102,666  

 

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.

 

6
 

 

ONCOCYTE CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

    2022     2021  
    Six Months Ended  
    June 30,  
    2022     2021  
             
CASH FLOWS FROM OPERATING ACTIVITIES:                
Net loss   $ (18,591 )   $ (14,412 )
Adjustments to reconcile net loss to net cash used in operating activities:                
Depreciation expense     671       327  
Amortization of intangible assets     1,904       1,381  
Pro rata loss from equity method investment in Razor     -       270  
Stock-based compensation     4,242       3,286  
Unrealized (gain) loss on marketable equity securities     325       (386 )
Amortization of debt issuance costs     11       33  
Change in fair value of contingent consideration     (11,015 )     1,090  
Change in fair value of Series A redeemable convertible preferred stock second tranche obligation     (305 )     33  
Deferred income tax benefit     -       (9,358 )
Gain on extinguishment of debt (PPP loan)     -       (1,141 )
Accrued severance from Chronix Biomedical acquisition     -       2,452  
                 
Changes in operating assets and liabilities:                
Accounts receivable     (365 )     (817 )
Lease liabilities     (94 )     218  
Prepaid expenses and other assets     (773 )     (103 )
Accounts payable and accrued liabilities     239       (766 )
Accrued severance and liabilities from Chronix Biomedical acquisition     (817 )     -  
Net cash used in operating activities     (24,568 )     (17,893 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:                
Acquisition of Insight Genetics, net of cash acquired     -       (607 )
Acquisition of Razor Genomics asset, net of cash acquired     -       (6,648 )
Acquisition of Chronix Biomedical, net of cash acquired     -       (4,459 )
Construction in progress and purchases of furniture and equipment     (2,679 )     (1,452 )
Net cash used in investing activities     (2,679 )     (13,166 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:                
Proceeds from exercise of stock options     -       1,600  
Proceeds from sale of common shares     32,812       65,262  
Financing costs to issue common shares     (389 )     (2,676 )
Proceeds from sale of redeemable convertible Series A preferred shares     4,875       -  
Financing costs to issue redeemable convertible Series A preferred shares     (93 )     -  
Proceeds from sale of common shares under at-the-market transactions     31       6,483  
Financing costs for at-the-market sales     (1 )     (203 )
Proceeds from exercise of warrants     -       823  
Common shares received and retired for employee taxes paid     -       (37 )
Repayment of loan payable     (750 )     (750 )
Repayment of financing lease obligations     (7 )     (84 )
Net cash provided by financing activities     36,478       70,418  
                 
NET INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH     9,231       39,359  
                 
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING     37,305       8,843  
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, ENDING   $ 46,536     $ 48,202  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION                
Cash paid for interest   $ 21     $ 70  
                 
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING AND INVESTING ACTIVITIES                
Common stock issued for acquisition of Razor Genomics asset   $ -     $ 5,756  
Deferred tax liability generated from the acquisition of Razor Genomics asset     -       7,564  
Common stock issued for acquisition of Chronix Biomedical     -       3,299  
Deferred tax liability generated from the acquisition of Chronix     -       1,794  
Initial fair value of contingent consideration at acquisition date     -       42,295  
Assumed liability from Chronix Acquisition     -       9,294  
Construction in progress, machinery and equipment purchases included in accounts payable, accrued liabilities and landlord liability     1,331       9  
See Note 10 for additional disclosures around leases                

 

The accompanying notes are an integral part of these unaudited condensed consolidated interim financial statements.

 

7
 

 

ONCOCYTE CORPORATION

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS

(UNAUDITED)

 

1. Organization, Description of the Business and Liquidity

 

Oncocyte Corporation (“Oncocyte”), incorporated in 2009 in the state of California, is a molecular diagnostics company focused on developing and commercializing proprietary laboratory tests to serve unmet medical needs across the cancer care continuum. Oncocyte’s mission is to provide actionable information to physicians and patients at critical decision points to optimize diagnosis and treatment decisions, improve patient outcomes, and reduce overall cost of care. Oncocyte has prioritized lung cancer as its first indication. Lung cancer remains the leading cause of cancer death in the United States, despite the availability of molecular testing and novel therapies to treat patients.

 

Oncocyte’s first product for commercial release is a proprietary treatment stratification test called DetermaRx™ that identifies which patients with early-stage non-small cell lung cancer may benefit from chemotherapy, resulting in a significantly higher, five-year survival rate. Beginning in September 2019 through February 23, 2021, Oncocyte held a 25% equity interest in Razor Genomics, Inc. (“Razor”), a privately held company, that has developed and licensed to Oncocyte the lung cancer treatment stratification laboratory test that Oncocyte is commercializing as DetermaRx™. On February 24, 2021, Oncocyte completed the purchase of all the remaining issued and outstanding shares of common stock of Razor and paid the selling shareholders in total $10 million in cash and issued them Oncocyte common stock having a market value of $5.7 million on that date. As a result of the purchase of the Razor common stock, Oncocyte became the sole shareholder of Razor. The acquisition of the remaining equity interests was accounted for as an asset acquisition in accordance with Accounting Standards Codification (“ASC”) Topic 805-50, Business Combinations. See Note 3 for a full discussion of the Razor asset acquisition.

 

Oncocyte completed its acquisition of Insight Genetics, Inc. (“Insight”) on January 31, 2020 (the “Insight Merger Date”) through a merger with a newly incorporated wholly owned subsidiary of Oncocyte (the “Insight Merger”) under the terms of an Agreement and Plan of Merger (the “Insight Merger Agreement”). Prior to the Insight Merger, Insight was a privately held company specializing in the discovery and development of the multi-gene molecular, laboratory-developed diagnostic tests that Oncocyte has branded as DetermaIO™. DetermaIO™ is a proprietary gene expression assay with promising data supporting its potential to help identify patients likely to respond to checkpoint inhibitor drugs. Insight has a CLIA-certified diagnostic laboratory with the capacity to support clinical trials or assay design on certain commercially available analytic platforms that may be used to develop additional diagnostic tests. Insight also performs Pharma Services in its CLIA-certified laboratory for pharmaceutical and biotechnology companies, including testing for biomarker discovery, assay design and development, clinical trial support, and a broad spectrum of biomarker tests (“Pharma Services”). The Insight Merger was accounted for using the acquisition method of accounting in accordance with ASC 805, which requires, among other things, that the assets and liabilities assumed be recognized at their fair values as of the acquisition date. See Note 3 for a full discussion of the Insight Merger.

 

On April 15, 2021 (the “Chronix Merger Date”), Oncocyte completed its acquisition of Chronix Biomedical, Inc. (“Chronix”) pursuant to an Agreement and Plan of Merger dated February 2, 2021, amended February 23, 2021, and amended and restated as of April 15, 2021 (as amended and restated, the “Chronix Merger Agreement”), by and among Oncocyte, CNI Monitor Sub, Inc., a Delaware corporation and wholly-owned subsidiary of Oncocyte (“Merger Sub”), Chronix, the stockholders party to the Chronix Merger Agreement and a party named as equity holder representative. Pursuant to the Chronix Merger Agreement, Merger Sub merged with and into Chronix, with Chronix surviving as a wholly owned subsidiary of Oncocyte (the “Chronix Merger”). Prior to the Chronix Merger, Chronix was a privately held molecular diagnostics company, developing blood tests for use in cancer treatment and organ transplantation. Through the Chronix Merger, Oncocyte has added to its laboratory test development pipeline the DetermaCNITM (formerly TheraSureTM-CNI Monitor), a patented, blood-based test for immunotherapy monitoring, and VitaGraft™ (formerly TheraSureTM Transplant Monitor), a blood-based solid organ transplantation monitoring test. See Note 3 for additional information about the Chronix Merger.

 

8
 

 

Other tests in the development pipeline include DetermaTx™, a test intended to complement DetermaIO™ by assessing the mutational status of a tumor to help identify the appropriate targeted therapy. Oncocyte also plans to initiate the development of DetermaMx™ as a blood-based test to monitor cancer patients for recurrence of their disease.

 

Liquidity

 

Oncocyte has incurred operating losses and negative cash flows since inception and had an accumulated deficit of $206.4 million as of June 30, 2022. Oncocyte expects to continue to incur operating losses and negative cash flows for the foreseeable future. Oncocyte did not generate revenues from its operations prior to the first quarter of 2020, and revenues since that period through the date of this Report were not sufficient to cover Oncocyte’s operating expenses. Oncocyte finances its operations primarily through the sale of shares of its common stock.

 

As of June 30, 2022, Oncocyte had $44.8 million of cash and cash equivalents and held shares of Lineage Cell Therapeutics, Inc. (“Lineage”) and AgeX Therapeutics, Inc. (“AgeX”) common stock as marketable equity securities with a combined fair market value of $0.6 million. Oncocyte believes that its current cash, cash equivalents and marketable equity securities are sufficient to carry out current operations through at least twelve months from the issuance date of the unaudited condensed consolidated interim financial statements included in this Report.

 

On June 11, 2021, Oncocyte entered into an at-the-market sales agreement with BTIG, LLC as sales agent and/or principal (the “Agent” or “BTIG”) pursuant to which Oncocyte may sell up to an aggregate of $50,000,000 of shares of Oncocyte common stock from time to time through the Agent (the “ATM Offering”).

 

Between July 1, 2021 and June 30, 2022, Oncocyte sold 1,123,337 shares of common stock at an average offering price of $5.58 per share, for gross proceeds of approximately $6.27 million through the ATM Offering. Oncocyte will need to raise additional capital to finance its operations, including the development and commercialization of its cancer diagnostic and other tests, until such time as it is able to generate sufficient revenues from the commercialization of one or more of its laboratory tests and other tests, and performing Pharma Services to cover its operating expenses.

 

On April 13, 2022, Oncocyte entered into a securities purchase agreement (the “Securities Purchase Agreement”) with institutional accredited investors (the “Investors”), including Broadwood Capital, L.P. (“Broadwood”), Oncocyte’s largest shareholder, in a registered direct offering of 11,765 shares of our Series A Convertible Preferred Stock (the “Series A Preferred Stock”), which are convertible into a total of 7,689,542 shares of our common stock, at a conversion price of $1.53 (the “Series A Preferred Stock Offering”). The purchase price of each share of Series A Preferred Stock was $850, which included an original issue discount to the stated value of $1,000 per share. The closing of the Series A Preferred Stock Offering will occur in two equal tranches of $5,000,000 each for aggregate gross proceeds from both closings of $10,000,000. The first closing occurred on June 1, 2022, and Oncocyte received net proceeds of approximately $4.9 million from the Series A Preferred Stock issued from the first tranche. See Note 14 for additional information about the Series A Preferred Stock Offering.

 

Further, on April 13, 2022, Oncocyte entered into an underwriting agreement (the “Underwriting Agreement”) with BTIG, LLC, as representative of the underwriters named therein (the “Underwriters”), pursuant to which Oncocyte agreed to issue and sell to the Underwriters an aggregate of 26,266,417 shares of common stock, and 26,266,417 warrants to purchase up to 13,133,208.5 shares of common stock (“April 2022 Warrants”) (the “Underwritten Offering,” and collectively with the Series A Preferred Stock Offering, the “April 2022 Offerings”). The Underwritten Offering closed on April 19, 2022. Pursuant to the Underwritten Offering, Broadwood acquired from us (i) 5,220,654 shares of common stock, and (ii) 6,003,752 April 2022 Warrants to purchase up to 3,001,876 shares of common stock at an exercise price of $1.53 per share. Pura Vida acquired from us (i) 4,984,093 shares of common stock, and (ii) 5,731,707 April 2022 Warrants to purchase up to 2,865,853 shares of common stock. On April 19, 2022, Oncocyte received net proceeds of approximately $32.8 million from the Underwritten Offering of 26,266,417 shares of common stock and 26,266,417 April 2022 Warrants to purchase up to 13,133,208.5 shares of common stock. See Note 14 for additional information about the Underwritten Offering.

 

Presently, Oncocyte is devoting substantially all of its efforts on initial commercialization efforts for DetermaRx™, completing clinical development and planning commercialization of DetermaIO™, although DetermaIO™ is currently available for biopharma diagnostic development and research use only as a companion test in immunotherapy drug development to select patients for clinical trials; continuing development and planning commercialization of DetermaTxTM and the clinical launch of VitaGraftTM. While Oncocyte plans to primarily market its laboratory tests in the United States through its own sales force, it is also beginning to make marketing arrangements with distributors in other countries. In order to reduce capital needs and to expedite the commercialization of any new laboratory tests that may become available for clinical use, Oncocyte may also pursue marketing arrangements with other diagnostic companies through which Oncocyte might receive licensing fees and royalty on sales, or through which it might form a joint venture to market its tests and share in net revenues, in the United States or abroad.

 

In addition to general economic and capital market trends and conditions, Oncocyte’s ability to raise sufficient additional capital to finance its operations from time to time will depend on a number of factors specific to Oncocyte’s operations such as operating revenues and expenses, progress in development of, or in obtaining reimbursement coverage from Medicare for DetermaIO™ and other future laboratory tests that Oncocyte may develop or acquire.

 

9
 

 

The availability of financing and Oncocyte’s ability to generate revenues from operating activities may be adversely impacted by the ongoing COVID-19 pandemic which could continue to cause deferrals of cancer surgeries that might otherwise have resulted in the utilization of DetermaRx™ and deferrals of drug development clinical trials that might have utilized Oncocyte’s Pharma Services. The COVID-19 pandemic also could continue to depress national and international economies and disrupt capital markets, supply chains, and aspects of Oncocyte’s operations. The extent to which the ongoing COVID-19 pandemic will ultimately impact Oncocyte’s business, results of operations, financial condition, or cash flows is highly uncertain and difficult to predict because it will depend on many factors that are outside Oncocyte’s control.

 

The unavailability or inadequacy of financing or revenues to meet future capital needs could force Oncocyte to modify, curtail, delay, or suspend some or all aspects of planned operations. Sales of additional equity securities could result in the dilution of the interests of its shareholders. Oncocyte cannot assure that adequate financing will be available on favourable terms, if at all.

 

2. Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of presentation

 

The unaudited condensed consolidated interim financial statements presented herein, and discussed below, have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. In accordance with those rules and regulations, certain information and footnote disclosures normally included in comprehensive consolidated financial statements have been condensed or omitted. The condensed consolidated balance sheets as of December 31, 2021 was derived from the audited consolidated financial statements at that date. These unaudited condensed consolidated interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in Oncocyte’s Annual Report on Form 10-K for the year ended December 31, 2021.

 

Principles of consolidation

 

On January 31, 2020, with the consummation of the Insight Merger, Insight became a wholly owned subsidiary of Oncocyte, and on that date Oncocyte began consolidating Insight’s operations and results with Oncocyte’s operations and results (see Note 3). On February 24, 2021, with the acquisition of the remaining equity interests in Razor, Razor became a wholly owned subsidiary of Oncocyte, and on that date Oncocyte began consolidating Razor’s results with Oncocyte’s operations and results (see Note 3). On April 15, 2021, with the acquisition of Chronix, Chronix became a wholly owned subsidiary of Oncocyte, and on that date Oncocyte began consolidating Chronix’s operations and results with Oncocyte’s operations and results (see Note 3).

 

The accompanying unaudited condensed consolidated interim financial statements, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of Oncocyte’s financial condition and results of operations. The unaudited condensed consolidated results of operations are not necessarily indicative of the results to be expected for any other interim period or for the entire year. All material intercompany accounts and transactions have been eliminated in consolidation.

 

Use of estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and contingent assets and liabilities, at the date of the unaudited condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates estimates which are subject to significant judgment, including, but not limited to, valuation methods used, assumptions requiring the use of judgment to prepare financial projections, timing of potential commercialization of acquired in-process intangible assets, applicable discount rates, probabilities of the likelihood of multiple outcomes of certain events related to contingent consideration, comparable companies or transactions, determination of fair value of the assets acquired and liabilities assumed including those relating to contingent consideration, the valuation of Series A redeemable convertible preferred stock second tranche obligation, revenue recognition, assumptions related to going concern assessments, allocation of direct and indirect expenses, useful lives associated with long-lived intangible assets, key assumptions in operating and financing leases including incremental borrowing rates, loss contingencies, valuation allowances related to deferred income taxes, and assumptions used to value debt and stock-based awards and other equity instruments. Actual results may differ materially from those estimates.

 

10
 

 

Similarly, Oncocyte assessed certain accounting matters that generally require consideration of forecasted financial information. The accounting matters assessed included, but were not limited to, Oncocyte’s equity investments, the carrying value of goodwill, acquired in-process intangible assets and other long-lived assets. Those assessments as well as other estimates referenced above were made in the context of information reasonably available to Oncocyte.

 

Business combinations and fair value measurements

 

Oncocyte accounts for business combinations in accordance with ASC 805, which requires the purchase consideration transferred to be measured at fair value on the acquisition date in accordance with ASC 820, Fair Value Measurement. ASC 820 establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and expands on required disclosures about fair value measurement. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. ASC 820 describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

 

Level 1 – Quoted prices in active markets for identical assets and liabilities.

 

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted market prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

When a part of the purchase consideration consists of shares of Oncocyte common stock, Oncocyte calculates the purchase price attributable to those shares, a Level 1 security, by determining the fair value of those shares as of the acquisition date based on prices quoted on the principal national securities exchange on which the shares traded. Oncocyte recognizes estimated fair values of the tangible assets and identifiable intangible assets acquired, including in-process research and development, and liabilities assumed, including any contingent consideration, as of the acquisition date. Goodwill is recognized as any amount of the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed in excess of the consideration transferred. ASC 805 precludes the recognition of an assembled workforce as an asset, effectively subsuming any assembled workforce value into goodwill.

 

In determining fair value, Oncocyte utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, and also considers counterparty credit risk in its assessment of fair value. For the periods presented, Oncocyte has no financial assets or liabilities recorded at fair value on a recurring basis, except for cash and cash equivalents consisting of money market funds and marketable equity securities of Lineage and AgeX common stock held by Oncocyte described below. These assets are measured at fair value using the period-end quoted market prices as a Level 1 input. Oncocyte also has certain contingent consideration liabilities which are carried at fair value based on Level 3 inputs (see Note 3).

 

The carrying amounts of cash equivalents, prepaid expenses and other current assets, accounts payable, accrued expenses and other current liabilities approximate fair values because of the short-term nature of these items.

 

The carrying amount of the loan payable to Silicon Valley Bank approximates fair value because the loan bears interest at a floating market rate (see Note 12).

 

11
 

 

Cash, cash equivalents, and restricted cash

 

The Company’s reconciliation of cash and cash equivalents, and restricted cash reported within the unaudited condensed consolidated balance sheets that sum to the total of the same amounts shown in the unaudited condensed consolidated statements of cash flows were as follows (in thousands):

 

    June 30,     December 31,  
    2022     2021  
Cash and cash equivalents   $ 44,836     $ 35,605  
Restricted cash     1,700       1,700  
Cash, cash equivalents and restricted cash shown in the condensed statements of cash flows   $ 46,536     $ 37,305  

 

 

Goodwill and intangible assets

 

In accordance with ASC 350, Intangibles – Goodwill and Other, in-process research and development (“IPR&D”) projects acquired in a business combination that are not complete as of the acquisition date are capitalized and accounted for as indefinite-lived intangible assets until completion or abandonment of the related research and development efforts. Upon successful completion of the project, the capitalized amount is amortized over its estimated useful life. If a project is abandoned, all remaining capitalized amounts are written off immediately. Oncocyte considers various factors and risks for potential impairment of IPR&D assets, including the current legal and regulatory environment and the competitive landscape. Adverse clinical trial results, significant delays or inability to obtain local determination coverage (“LCD”) from the Centers for Medicare and Medicaid Services (“CMS”) for Medicare reimbursement for a diagnostic test, the inability to bring a diagnostic test to market and the introduction or advancement of competitors’ diagnostic tests could result in partial or full impairment of the related intangible assets. Consequently, the eventual realized value of the IPR&D project may vary from its fair value at the date of acquisition, and IPR&D impairment charges may occur in future periods. During the period between completion or abandonment, the IPR&D assets will not be amortized but will be tested for impairment on an annual basis and between annual tests if Oncocyte becomes aware of any events occurring or changes in circumstances that would indicate a reduction in the fair value of the IPR&D projects below their respective carrying amounts (see Notes 3 and 4).

 

Goodwill represents the excess of the purchase price over the fair value of net identifiable assets and liabilities. Goodwill, similar to IPR&D, is not amortized but is tested for impairment at least annually, or if circumstances indicate its value may no longer be recoverable. Qualitative factors considered in this assessment include industry and market conditions, overall financial performance, and other relevant events and factors affecting Oncocyte’s business. Based on the qualitative assessment, if it is determined that the fair value of goodwill is more likely than not to be less than its carrying amount, the fair value of a reporting unit will be calculated and compared with its carrying amount and an impairment charge will be recognized for the amount that the carrying value exceeds the fair value. Oncocyte continues to operate in one segment and considered to be the sole reporting unit and, therefore, goodwill is tested for impairment at the enterprise level.

 

Oncocyte does not have intangible assets with indefinite useful lives other than goodwill and the acquired IPR&D discussed in Notes 3 and 4. As of June 30, 2022, there has been no impairment of goodwill and intangible assets.

 

Long-lived intangible assets

 

Long-lived intangible assets, consisting primarily of acquired customer relationships, are stated at acquired cost, less accumulated amortization. Amortization expense is computed using the straight-line method over the estimated useful life of 5 years (see Notes 3 and 4).

 

Contingent consideration liabilities

 

Certain of Oncocyte’s asset and business acquisitions involve the potential for future payment of consideration to third-parties and former selling shareholders in amounts determined as a percentage of future net revenues generated, or upon attainment of revenue milestones, from Pharma Services or laboratory tests, as applicable, or annual minimum royalties to certain licensors, as provided in the applicable agreements. The fair value of such liabilities is determined using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows and the risk-adjusted discount rate used to present value the cash flows (see Notes 3 and 4). These obligations are referred to as contingent consideration.

 

ASC 805 requires that contingent consideration be estimated and recorded at fair value as of the acquisition date as part of the total consideration transferred. Contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests to the selling shareholders in the future if certain future events occur or conditions are met, such as the attainment of product development milestones. Contingent consideration also includes additional future payments to selling shareholders based on achievement of components of earnings, such as “earn-out” provisions or percentage of future revenues, including royalties paid to the selling shareholders based on a percentage of certain revenues generated.

 

The fair value of contingent consideration after the acquisition date is reassessed by Oncocyte as changes in circumstances and conditions occur, with the subsequent change in fair value recorded in the condensed consolidated statements of operations. Changes in key assumptions can materially affect the estimated fair value of contingent consideration liabilities and, accordingly, the resulting gain or loss that Oncocyte records in its unaudited condensed consolidated interim financial statements. See Notes 3 and 4 for a full discussion of these liabilities.

 

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Investments in capital stock of privately held companies

 

Oncocyte evaluates whether investments held in common stock of other companies require consolidation of the company under, first, the variable interest entity (“VIE”) model, and then under the voting interest model in accordance with accounting guidance for consolidations under Accounting Standards Codification (“ASC”) 810-10. If consolidation of the entity is not required under either the VIE model or the voting interest model, Oncocyte determines whether the equity method of accounting should be applied in accordance with ASC 323, Investments – Equity Method and Joint Ventures. The equity method applies to investments in common stock or in-substance common stock if Oncocyte exercises significant influence over, but does not control, the entity, where significant influence is typically represented by ownership of 20% or more, but less than majority ownership, of the voting interests of a company.

 

Oncocyte initially records equity method investments at fair value on the date of the acquisition with subsequent adjustments to the investment balance based on Oncocyte’s pro rata share of earnings or losses from the investment.

 

Since February 24, 2021, the date of Oncocyte’s acquisition of the remaining interests in Razor, the Razor entity’s financial statements have been consolidated with Oncocyte (see Notes 3 and 4).

 

Impairment of long-lived assets

 

Oncocyte assesses the impairment of long-lived assets whenever events or changes in circumstances indicate that such assets might be impaired and the carrying value may not be recoverable. Oncocyte’s long-lived assets consist primarily of intangible assets, right-of-use assets for operating leases, customer relationships, and machinery and equipment. If events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable and the expected undiscounted future cash flows attributable to the asset are less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying value of the asset over its fair value, is recorded. As of June 30, 2022, there has been no impairment of long-lived assets.

 

Revenue recognition

 

Pursuant to ASC 606, revenues are recognized when control of services performed is transferred to customers, in an amount that reflects the consideration Oncocyte expects to be entitled to in exchange for those services. ASC 606 provides for a five-step model that includes:

 

(i) identifying the contract with a customer,

(ii) identifying the performance obligations in the contract,

(iii) determining the transaction price,

(iv) allocating the transaction price to the performance obligations, and

(v) recognizing revenue when, or as, an entity satisfies a performance obligation.

 

Oncocyte determines transaction prices based on the amount of consideration we expect to receive for transferring the promised goods or services in the contract. Consideration may be fixed, variable, or a combination of both. The Company considers any constraints on the variable consideration and includes in the transaction price variable consideration to the extent it is deemed probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

 

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DetermaRx™ testing revenue

 

Oncocyte generates revenue from performing DetermaRx™ tests on clinical samples through orders received from physicians, hospitals, and other healthcare providers. In determining whether all the revenue recognition criteria (i) through (v) above are met with respect to DetermaRx™ tests, each test result is considered a single performance obligation and is generally considered complete when the test result is delivered or made available to the prescribing physician electronically, and, as such, there are no shipping or handling fees incurred by Oncocyte or billed to customers. Although Oncocyte bills a list price for all tests ordered and completed for all payer types, Oncocyte considers constraints on the variable consideration when recognizing revenue for DetermaRx™. Because DetermaRx™ is a novel test and there are no current reimbursement arrangements with third-party payers other than Medicare, the transaction price represents variable consideration. Application of the constraint for variable consideration is an area that requires significant judgment. For all payers other than Medicare, Oncocyte must consider the novelty of the test, the uncertainty of receiving payment, or being subject to claims for a refund, from payers with whom it does not have a sufficient payment collection history or contractual reimbursement agreements. Accordingly, for those payers, Oncocyte expects to continue to recognize revenue upon payment until it has a sufficient history to reliably estimate payment patterns or has contractual reimbursement arrangements, or both, in place.

 

During the three months ended March 31, 2021, after accumulating additional history of cash receipts and other factors considered by management for Medicare Advantage covered tests, including the recently published Medicare rate which management believes entitles Oncocyte to get reimbursed for Medicare Advantage covered tests at the Medicare rate, Oncocyte commenced recognizing Medicare Advantage covered tests on an accrual basis when the test result is delivered or made available to the prescribing physician electronically, upon considering no further constraints on the variable consideration, at the Medicare rate.

 

As of June 30, 2022, Oncocyte had accounts receivable of $1.7 million from Medicare and Medicare Advantage covered DetermaRx™ tests (see Note 7). As of December 31, 2021, Oncocyte had accounts receivable of $1.1 million from Medicare covered DetermaRx™ tests.

 

Pharma services revenue

 

Revenues recognized include Pharma Services performed by Oncocyte’s Insight and Chronix subsidiaries for its pharmaceutical customers, including testing for biomarker discovery, assay design and development, clinical trial support, and a broad spectrum of biomarker tests. These Pharma Services are generally performed under individual scope of work (“SOW”) arrangements or license agreements (together with SOW the “Pharma Services Agreements”) with specific deliverables defined by the customer. Pharma Services are performed on a (i) time and materials basis or (ii) per test completed basis. Upon completion of the service to the customer in accordance with a Pharma Services Agreement, Oncocyte has the right to bill the customer for the agreed upon price (either on a per test or per deliverable basis) and recognizes Pharma Service revenue at that time. Insight identifies each sale of its Pharma Service offering as a single performance obligation. Chronix identifies the processing of test samples as a separate performance obligation (considered a series) within license agreements with customers.

 

Completion of the service and satisfaction of the performance obligation is typically evidenced by access to the report or test made available to the customer or any other form or applicable manner of delivery defined in the Pharma Services Agreements. However, for certain SOWs under which work is performed pursuant to the customer’s highly customized specifications, Oncocyte has the enforceable right to bill the customer for work completed, rather than upon completion of the SOW. For those SOWs, Oncocyte recognizes revenue over a period during which the work is performed using a formula that accounts for expended efforts, generally measured in labor hours, as a percentage of total estimated efforts for the completion of the SOW. As performance obligations are satisfied under the Pharma Services Agreements, any amounts earned as revenue and billed to the customer are included in accounts receivable. Any revenues earned but not yet billed to the customer as of the date of Oncocyte’s consolidated financial statements are recorded as contract assets and are included in prepaids and other current assets as of the financial statement date. Amounts recorded in contract assets are reclassified to accounts receivable in Oncocyte’s consolidated financial statements when the customer is invoiced according to the billing schedule in the contract.

 

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Oncocyte establishes an allowance for doubtful accounts based on the evaluation of the collectability of its Pharma Services accounts receivables after considering a variety of factors, including the length of time receivables are past due, significant events that may impair the customer’s ability to pay, such as a bankruptcy filing or deterioration in the customer’s operating results or financial position, reasonable and supportable forecast that affect the collectability of the reported amount, and historical experience. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. Oncocyte continuously monitors collections and payments from customers and maintains a provision for estimated credit losses and uncollectible accounts, if any, based upon its historical experience and any specific customer collection issues that have been identified. Amounts determined to be uncollectible are written off against the allowance for doubtful accounts. As of June 30, 2022, Oncocyte has not recorded any losses or allowance for doubtful accounts on its account receivables from Pharma Services.

 

As of June 30, 2022, Oncocyte had accounts receivable from Pharma Services customers of $0.1 million, as compared to $0.4 million as of December 31, 2021 (see Note 7).

 

Licensing revenue

 

Revenues recognized includes licensing revenue derived from agreements with customers for exclusive rights to market Oncocyte’s proprietary testing technology. Under the agreements, Oncocyte grants exclusive rights to certain trademarks and technology of Oncocyte for the purpose of marketing Oncocyte’s tests within a defined geographic territory. A license agreement may specify milestone deliverables or performance obligations, for which Oncocyte recognizes revenue when its licensee confirms the completion of Oncocyte’s performance obligation. A licensing agreement may also include ongoing sales support from Oncocyte and typically includes non-refundable licensing fees and per-test Pharma Services revenues discussed above, for which Oncocyte treats the licensing of the technology, trademarks, and ongoing support as a single performance obligation satisfied by the passage of time over the term of the agreement.

 

Cost of revenues

 

Cost of revenues generally consists of cost of materials, direct labor including benefits, bonus and stock-based compensation, equipment and infrastructure expenses, clinical sample related costs associated with performing DetermaRx™ tests and Pharma Services, providing deliverables according to our licensing agreements, license fees due to third parties, and amortization of acquired intangible assets such as the Razor asset and customer relationship intangible assets. Infrastructure expenses include depreciation of laboratory equipment, allocated rent costs, leasehold improvements, and allocated information technology costs for operations at Oncocyte’s CLIA laboratories in California and Tennessee. Costs associated with generating the revenues are recorded as the tests or services are performed regardless of whether revenue was recognized. Royalties or revenue share payments for licensed technology calculated as a percentage of revenues generated using the associated technology are recorded as expenses at the time the related revenues are recognized.

 

Research and development expenses

 

Research and development expenses are comprised of costs incurred to develop technology, which include salaries and benefits (including stock-based compensation), laboratory expenses (including reagents and supplies used in research and development laboratory work), infrastructure expenses (including allocated facility occupancy costs), and contract services and other outside costs. Indirect research and development expenses are allocated primarily based on headcount, as applicable, and include rent and utilities, common area maintenance, telecommunications, property taxes, and insurance. Research and development costs are expensed as incurred.

 

Sales and marketing expenses

 

Sales and marketing expenses consist primarily of personnel costs and related benefits, including stock-based compensation, trade show expenses, branding and positioning expenses, and consulting fees. Sales and marketing expenses also include indirect expenses for applicable overhead allocated based on headcount, and include allocated costs for rent and utilities, common area maintenance, telecommunications, property taxes, and insurance.

 

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General and administrative expenses

 

General and administrative expenses consist primarily of compensation and related benefits (including stock-based compensation) for executive and corporate personnel, professional and consulting fees, rent and utilities, common area maintenance, telecommunications, property taxes, and insurance.

 

Net loss per common share

 

Basic loss per share is computed by dividing the net loss applicable to common stockholders after deducting cumulative unpaid dividends and accretion of the preferred stock, by the weighted average number of shares of common stock outstanding during the year. Diluted loss per share is computed by dividing the net loss applicable to common stockholders after deducting cumulative unpaid dividends and accretion of the preferred stock, by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued, using the treasury stock method or the if-converted method, or the two-class method for participating securities, whichever is more dilutive. Potential common shares are excluded from the computation if their effect is antidilutive.

 

All common stock equivalents are antidilutive because Oncocyte reported a net loss for all periods presented. The following table presents the calculation of basic and diluted loss per share of common stock (in thousands):

 

    2022     2021     2022     2021  
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2022     2021     2022     2021  
Numerator:                                
Net loss attributable to Oncocyte Corporation   $ (8,300 )   $ (10,493 )   $ (18,591 )   $ (14,412 )
Dividend on Series A redeemable convertible preferred stock     (29 )     -       (29 )     -  
Accretion of Series A redeemable convertible preferred stock     (43 )     -       (43 )     -  
Net loss at attributable to common stockholders - Basic and Diluted   $ (8,372 )   $ (10,493 )   $ (18,663 )   $ (14,412 )
                                 
Denominator:                                
Weighted average shares used in computing net loss per share attributable to common stockholders - Basic and Diluted     113,042       89,758       102,700       85,961  
                                 
Basic and diluted net loss per common share   $ (0.07 )   $ (0.12 )   $ (0.18 )   $ (0.17 )
                                 
Anti-dilutive potential common shares excluded from the computation of diluted net loss per common share:                                
Stock options     14,611       3,941       13,132       2,856  
Warrants     16,892       3,129       16,892       3,129  
Series A redeemable convertible preferred stock     6       -       6       -  
Total     31,509       7,070       30,030       5,985  

 

Leases

 

Oncocyte accounts for leases in accordance with ASC 842, Leases. Oncocyte determines if an arrangement is a lease at inception. Leases are classified as either financing or operating, with classification affecting the pattern of expense recognition in the condensed consolidated statements of operations. Under the available practical expedients for the adoption of ASC 842, Oncocyte accounts for the lease and non-lease components as a single lease component. Oncocyte recognizes right-of-use (“ROU”) assets and lease liabilities for leases with terms greater than twelve months in the condensed consolidated balance sheet. ROU assets represent the right to use an underlying asset during the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most leases do not provide an implicit rate, Oncocyte uses an incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Oncocyte uses the implicit rate when it is readily determinable. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Lease terms may include options to extend or terminate the lease when it is reasonably certain that Oncocyte will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Operating leases are included as right-of-use assets in machinery and equipment, and ROU lease liabilities, current and long-term, in the condensed consolidated balance sheets. Financing leases are included in machinery and equipment, and in financing lease liabilities, current and long-term, in the condensed consolidated balance sheets. Oncocyte discloses the amortization of our ROU assets and operating lease payments as a net amount, “Amortization of right-of-use assets and liabilities”, on the condensed consolidated statements of cash flows. Based on the available practical expedients under the standard, Oncocyte elected not to capitalize leases that have terms of twelve months or less.

 

During 2020 and 2021, Oncocyte entered into various operating leases and an embedded operating lease in accordance with ASC 842 discussed in Note 10. Oncocyte’s accounting for financing leases remained substantially unchanged.

 

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Accounting for Lineage and AgeX shares of common stock

 

Oncocyte accounts for the shares of Lineage and AgeX common stock it holds as marketable equity securities in accordance with ASC 320-10-25, Investments – Debt and Equity Securities, as amended by Accounting Standards Update (“ASU”) 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, as the shares have a readily determinable fair value quoted on the NYSE American and are held principally to meet future working capital purposes, as necessary. The securities are measured at fair value, with related gains and losses in the value of such securities recorded in the condensed consolidated statements of operations in other income (expense), and are reported as current assets on the condensed consolidated balance sheets based on the closing trading price of the security as of the date being presented.

 

As of June 30, 2022 and December 31, 2021, Oncocyte held 353,264 and 35,326 shares of common stock of Lineage and AgeX, respectively, as marketable equity securities with a combined fair market value of $0.6 million and $0.9 million, respectively.

 

Deferred revenue

 

In June 2018 and subsequently amended in June 2019, Chronix and a medical diagnostic service company in Germany (“the German customer”) entered into a licensing and testing service agreement (“the German agreement”) for intellectual property related to DetermaCNITM and VitaGraft™. Under the terms of the agreement, Chronix received from the German customer an upfront payment of €3.7 million, less applicable VAT obligations, which Chronix recognized ratably over the contract term of 3.5 years. The German agreement contains a stipulation that requires Chronix to refund to the German customer a portion of the upfront fee on a pro rata basis if the German agreement is terminated prior to December 31, 2021. The deferred revenue of $738,000 recorded at the acquisition date represents the refund Oncocyte would pay to the German customer should it terminate the agreement prior to the agreed upon term. As of December 31, 2021, Oncocyte has fully amortized the deferred revenue and recorded revenue ratably over the remaining period as the German customer’s refund rights expire.

 

Recently issued accounting pronouncements not yet adopted

 

The following accounting standards, which are not yet effective, are presently being evaluated by Oncocyte to determine the impact that it might have on its consolidated financial statements.

 

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In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and subsequent amendments to the initial guidance under ASU 2018-19, ASU 2019-04, ASU 2019-05 and ASU 2019-10, which amends the current approach to estimate credit losses on certain financial assets, including trade and other receivables. Generally, this amendment requires entities to establish a valuation allowance for the expected lifetime losses of these certain financial assets. Upon the initial recognition of such assets, which will be based on, among other things, historical information, current conditions, and reasonable supportable forecasts. Subsequent changes in the valuation allowance are recorded in current earnings and reversal of previous losses are permitted. Currently, U.S. GAAP requires entities to write down credit losses only when losses are probable and loss reversals are not permitted. The update will be effective for Oncocyte in the first quarter of 2023. Early adoption is permitted. Oncocyte is currently evaluating the impact the adoption of this standard will have on its consolidated financial statements and related disclosures.

 

In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, to provide specific guidance to eliminate diversity in practice on how to recognize and measure acquired contract assets and contract liabilities from revenue contracts from customers in a business combination consistent with revenue contracts with customers not acquired in an acquisition. The amendments in this update provide that the acquirer should consider the terms of the acquired contracts, such as timing of payment, identify each performance obligation in the contracts, and allocate the total transaction price to each identified performance obligation on a relative standalone selling price basis as of contract inception (that is, the date the acquiree entered into the contracts) or contract modification to determine what should be recorded at the acquisition date. These amendments are effective for the Company beginning with fiscal year 2023. The impact of the adoption of the amendments in this update will depend on the magnitude of any customer contracts assumed in a business combination in 2023 and beyond.

 

COVID-19 impact and related risks

 

The ongoing global outbreak of COVID-19, and the various attempts throughout the world to contain it, have created significant volatility, uncertainty and disruption. In response to government directives and guidelines, health care advisories and employee and other concerns, Oncocyte has altered certain aspects of its operations. A number of Oncocyte’s employees have had to work remotely from home and those on site have had to follow Oncocyte’s social distance guidelines, which could impact their productivity. COVID-19 could also disrupt Oncocyte’s operations due to absenteeism by infected or ill members of management or other employees, or absenteeism by members of management and other employees who cannot effectively work remotely but who elect not to come to work due to the illness affecting others in Oncocyte’s office or laboratory facilities, or due to quarantines.

 

In addition to operational adjustments, the consequences of the COVID-19 pandemic have led to uncertainties related to Oncocyte’s business growth and ability to forecast the demand for its laboratory tests and Pharma Services and resulting revenues. Concerns over available hospital, staffing, equipment, and other resources, and the risk of exposure to the virus, have led to delays in early-stage lung cancer surgeries and clinical trials of drugs under development by pharma companies, and the continued deferral of lung cancer surgeries and drug development clinical trials due to resurgence in COVID-19 cases could continue to result in delayed or reduced use of DetermaRx™ and Oncocyte’s Pharma Services.

 

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It is possible that impacts of COVID-19 on Oncocyte’s operations or revenues or its access to capital could prevent Oncocyte from complying, or could result in a material noncompliance, with one or more obligations or covenants under material agreements to which Oncocyte is a party, with the result that Oncocyte would be in material breach of the applicable obligation, covenant, or agreement. Any such material breach could cause Oncocyte to incur material financial liabilities or an acceleration of the date for paying a financial obligation to the other party to the applicable agreement, or could cause Oncocyte to lose material contractual rights, such as rights to use leased equipment or laboratory or office space, or rights to use licensed patents or other intellectual property, the use of which is material to Oncocyte’s business. Similarly, it is possible that impacts of COVID-19 on the business, operations, or financial condition of any third party with whom Oncocyte has a contractual relationship could cause the third party to be unable to perform its contractual obligations to Oncocyte, resulting in Oncocyte’s loss of the benefits of a contract that could be material to Oncocyte’s business.

 

The full extent to which the COVID-19 pandemic and the various responses to it might impact Oncocytes’ business, operations and financial results will depend on numerous evolving factors that are not subject to accurate prediction and that are beyond Oncocyte’s control.

 

3. Business Combinations

 

Acquisition of Insight Genetics, Inc.

 

On January 31, 2020 (the “Insight Merger Date”), Oncocyte completed its acquisition of Insight pursuant to the Insight Merger Agreement.

 

Merger Consideration at Closing

 

Under the terms of the Insight Merger Agreement, Oncocyte agreed to pay $7 million in cash and $5 million of Oncocyte common stock (the “Initial Merger Consideration”), subject to a holdback for indemnity claims not to exceed ten percent of the total Merger Consideration. The parties agreed to holdback $0.6 million in cash (“Cash Holdback”) and approximately 0.2 million shares of Oncocyte common stock (“Stock Holdback”) through December 31, 2020, in the event that Oncocyte has indemnity claims. The Stock Holdback shares are considered to be issued and outstanding shares of Oncocyte common stock as of the Insight Merger Date but were placed in an escrow account and was to be released from escrow after the holdback period, less any shares that may be returned to Oncocyte on account of any indemnity claims. Accordingly, on the Insight Merger Date, Oncocyte delivered approximately $11.4 million in Merger Consideration, consisting of $6.4 million in cash, which was net of the $0.6 million cash holdback, and 1.9 million shares of Oncocyte common stock, which includes the stock holdback shares placed in escrow. The shares of Oncocyte common stock delivered were valued at $5 million, based on the average closing price of Oncocyte common stock on the NYSE American during the five trading days immediately preceding the date of the Insight Merger Agreement.

 

In March 2021, in accordance with the Insight Merger Agreement, the Cash Holdback was paid and the Stock Holdback was released from escrow to the selling shareholders.

 

Milestone Payments (Milestone Contingent Consideration)

 

In addition to the Initial Merger Consideration, Oncocyte may also pay contingent consideration of up to $6.0 million in any combination of cash or shares of Oncocyte common stock if certain milestones are achieved (the “Milestone Contingent Consideration”), which consist of (i) $1.5 million for clinical trial completion and data publication milestone, (ii) $3.0 million for an affirmative final local coverage determination from CMS for a specified lung cancer test, and (iii) up to $1.5 million for achieving certain CMS reimbursement milestones. As of June 30, 2022, no milestones have been met and no payments have been made.

 

Revenue Share (Royalty Contingent Consideration)

 

As additional consideration for Insight’s shareholders, the Insight Merger Agreement provides for Oncocyte to pay a revenue share of not more than ten percent of net collected revenues for current Insight pharma service offerings over a period of ten years, and a tiered revenue share percentage of net collected revenues through the end of the technology lifecycle if certain new cancer tests are developed and commercialized using Insight technology (“Royalty Contingent Consideration”). As of June 30, 2022, the royalty contingent consideration has not been met and no payments have been made.

 

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Registration Rights

 

Pursuant to the Insight Merger Agreement, Oncocyte filed a registration statement with the SEC to register the resale of the shares of common stock under the Securities Act of 1933, as amended (the “Securities Act”) issued in connection with the Insight Merger, which the SEC declared effective in August 2020.

 

Workforce

 

In connection with the closing of the Insight Merger, Oncocyte did not assume sponsorship of the Insight Equity Incentive Plan. Accordingly, the Insight Equity Incentive Plan and all related stock options to purchase shares of Insight common stock outstanding immediately prior to the Insight Merger were cancelled on the Insight Merger Date for no consideration. At the Insight Merger Date, all of Insight’s employees ceased employment with Insight, and Oncocyte offered employment to certain of those former Insight employees, principally in laboratory roles and certain administrative roles (“New Oncocyte Employees”), and granted new equity awards to the New Oncocyte Employees under the Oncocyte 2018 Equity Incentive Plan. All Oncocyte stock option awards granted to the New Oncocyte Employees have vesting terms and conditions consistent with stock options granted to most other Oncocyte employees.

 

Aggregate Merger Consideration and Purchase Price Allocation

 

The calculation of the aggregate merger consideration, consisting of the Initial Merger Consideration, Milestone Contingent Consideration and Royalty Contingent Consideration (the “Aggregate Merger Consideration”) transferred on January 31, 2020, at fair value, is shown in the following table (in thousands, except for share and per share amounts). The Milestone Contingent Consideration and the Royalty Contingent Consideration are collectively referred to as “Contingent Consideration”.

 

Cash consideration   $ 7,000 (1)
         
         
Stock consideration        
         
Shares of Oncocyte common stock issued on the Merger Date     1,915,692 (2)
         
Closing price per share of Oncocyte common stock on the Merger Date   $ 2.61  
         
Market value of Oncocyte common stock issued   $ 5,000  
         
Contingent Consideration   $ 11,130 (3)
         
Total fair value of consideration transferred on the Merger Date   $ 23,130  

 

(1) The cash consideration paid on the Insight Merger Date was $6.4 million, which was net of a $0.6 million cash holdback discussed above, recorded as a holdback liability since Oncocyte retained the cash. In accordance with ASC 805, amounts held back for general representations and warranties of the sellers are included as part of the total consideration transferred.
   
(2) The 229,885 Stock Holdback shares were placed in an escrow account and considered to be issued and outstanding Oncocyte common stock. In accordance with ASC 805, amounts held back for general representations and warranties of the sellers, including escrowed shares of common stock, are included as part of the total consideration transferred.
   
(3) In accordance with ASC 805, Contingent Consideration, at fair value, is part of the total considered transferred on the Insight Merger Date, as further discussed below.

 

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Aggregate Merger Consideration allocation

 

Oncocyte allocated the Aggregate Merger Consideration transferred to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of the Insight Merger Date. The fair values of the identifiable intangible assets acquired and the liabilities assumed was determined based on inputs that were unobservable and significant to the overall fair value measurement, which is also based on estimates and assumptions made by management at the time of the Insight Merger. As such, this was classified as Level 3 fair value hierarchy measurements and disclosures in accordance with ASC 820, Fair Value Measurement.

 

The following table sets forth the allocation of the Aggregate Merger Consideration transferred to Insight’s tangible and identifiable intangible assets acquired and liabilities assumed on the Insight Merger Date, with the excess recorded as goodwill (in thousands):

 

    January 31,  
    2020  
Assets acquired:        
Cash and cash equivalents   $ 36  
Accounts receivable and other current assets     42  
Right-of-use assets, machinery and equipment     585  
Long-lived intangible assets - customer relationships     440  
Acquired in-process research and development     14,650  
         
Total identifiable assets acquired (a)     15,753  
         
Liabilities assumed:        
Accounts payable     61  
Right-of-use liabilities - operating lease     495  
Long-term deferred income tax liability     1,254  
         
Total identifiable liabilities assumed (b)     1,810  
         
Net assets acquired, excluding goodwill (a) - (b) = (c)     13,943  
         
Total cash, contingent consideration, and stock consideration transferred (d)     23,130  
         
Goodwill (d) - (c)     9,187  

 

The valuation of identifiable intangible assets and applicable estimated useful lives are as follows (in thousands, except for useful life):

 

    Estimated
Assets
    Useful Life  
    Fair Value     (Years)  
In process research and development (“IPR&D”)   $ 14,650       n/a  
Customer relationships     440       5  
    $ 15,090          

 

The following is a discussion of the valuation methods and significant assumptions used to determine the fair value of Insight’s material assets and liabilities in connection with the Insight Merger:

 

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Acquired In-Process Research and Development and Deferred Income Tax Liability – The fair value of identifiable IPR&D intangible assets consists of $14.7 million allocated to DetermaIO™.

 

Oncocyte determined the estimated aggregate fair value of DetermaIO™ using the Multi-Period Excess Earnings Method (“MPEEM”) under the income approach. MPEEM calculates the economic benefits by determining the income attributable to an intangible asset after the returns are subtracted for contributory assets such as working capital, assembled workforce, and fixed assets. The resulting after-tax net earnings are discounted at a rate commensurate with the risk inherent in the economic benefit projections of the assets.

 

To calculate fair value of DetermaIO™ under MPEEM, Oncocyte used probability-weighted, projected cash flows discounted at a rate considered appropriate given the significant inherent risks associated with similar assets. Cash flows were calculated based on projections of revenues and expenses related to the asset and were assumed to extend through a multi-year projection period. Revenues from commercialization of DetermaIO™ were based on the estimated market potential for the indications for use which may include tests for the treatment of certain lung cancers and tests for the treatment of certain breast cancers. The expected cash flows from DetermaIO™ were then discounted to present value using a weighted-average cost of capital for companies with profiles substantially similar to that of Oncocyte and the risk inherent in the economic benefit projections of similar assets, which Oncocyte believes represents the rate that market participants would use to value those assets. The discount rate used to value DetermaIO™ was approximately 35%. The projected cash flows were based on significant assumptions, including the time and resources needed to complete development of the asset, timing and reimbursement rates from CMS, regulatory approvals, if any, to commercialize the asset, estimates of the number of tests that might be performed, revenue and operating profit expected to be generated by the asset, the expected economic life of the asset, market penetration and competition, and risks associated with achieving commercialization, including delay or failure to obtain CMS and any required regulatory approval, failure of clinical trials, and intellectual property litigation.

 

Because the IPR&D (prior to completion or abandonment of the research and development) is considered an indefinite-lived asset for accounting purposes but is not recognized for tax purposes, the fair value of the IPR&D on the acquisition date generated a deferred income tax liability (“DTL”) in accordance with ASC 740, Income Taxes. This DTL is computed using the fair value of the IPR&D assets on the acquisition date multiplied by Oncocyte’s federal and state effective income tax rates. While this DTL would reverse on impairment or sale or commencement of amortization of the related intangible assets, ASC 740 allows Oncocyte to treat acquired available deferred tax assets (“DTAs”), such as Insight’s net operating loss carryforwards (“NOLs”) (subject to the annual limitation under Section 382 of the Internal Revenue Code) as available DTAs to offset against the DTLs, as the DTLs are expected to reverse within the NOL carryforward period. Any excess DTAs over those DTLs would be assessed for a valuation allowance in accordance with ASC 740. This accounting treatment is acceptable if, at the time of the acquisition, Oncocyte can both reasonably estimate a timeline to commercialization and the economic useful life of the IPR&D assets upon commercialization, which will be amortized during the carryforward period of the offsetting DTAs. On the Insight Merger Date, Oncocyte estimated and recorded a net DTL of $1.3 million after offsetting the acquired available NOLs with the IPR&D generated DTLs (see Note 8).

 

Customer relationships – Insight provided a range of Pharma Services to its pharmaceutical customers. None of the Pharma Services are related to DetermaIO™. The Pharma Service customer relationships are considered separate long-lived intangible assets under ASC 805 and were valued primarily using the MPEEM discussed above, and will be amortized over their useful life, estimated to be 5 years based on the net income that can be expected from these relationships in future years and based on observed historical trends. The resulting cash flows were discounted to the valuation date based on a rate of return that recognizes a lower level of risk associated with these assets as compared to DetermaIO™ discussed above. As of the Insight Merger Date, there were no uncompleted performance obligations by Insight under any of its Pharma Services contracts, therefore no deferred revenues were assumed.

 

Customer relationships generate similar DTLs to IPR&D as Oncocyte records this asset for accounting purposes but not for tax purposes. Accordingly, Oncocyte has offset all the acquired DTLs associated with the customer relationships with available acquired NOLs and included in the amount recorded discussed above (see Note 8).

 

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Right-of-use assets and liabilities, machinery and equipment – Insight is a lessee under an operating lease with a third-party lessor for its facilities, including its laboratory, in Nashville, Tennessee (the “Nashville Lease”). In April 2019, the Nashville lease was renewed by Insight for a five-year term and is classified as an operating lease under ASC 842. In accordance with ASC 805, when a company acquired in a business combination is a lessee, the acquirer initially measures the lease liability and the right-of-use asset for an acquired operating lease as if the lease is new at the acquisition date. In other words, the lease liability is measured at the present value of the remaining lease payments as of the acquisition date and the right-of-use asset is generally measured at an amount equal to the lease liability, adjusted for favourable or unfavourable terms of the lease when compared with market terms. Since the Nashville Lease was renewed by Insight in proximity to the Insight Merger Date, the terms of the Nashville Lease were considered by Oncocyte to be market terms at the Insight Merger Date. Accordingly, Oncocyte measured the net present value of the remaining contractual Nashville Lease payments as of the Insight Merger Date using an incremental borrowing rate consistent with Oncocyte’s other operating leases and recorded a right-of-use liability and a corresponding right-of-use asset of $0.5 million. In addition, $0.1 million was allocated to certain laboratory machinery and equipment approximating the fair value of those assets as of the Insight Merger Date.

 

Contingent consideration liabilities – ASC 805 requires that contingent consideration be estimated and recorded at fair value as of the acquisition date as part of the total consideration transferred. Contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests to the selling shareholders in the future if certain future events occur or conditions are met, such as the attainment of product development milestones. Contingent consideration also includes additional future payments to selling shareholders based on achievement of components of earnings, such as “earn-out” provisions or percentage of future revenues, including royalties paid to the selling shareholders based on a percentage of revenues generated from DetermaIO™ and Insight Pharma Services over their respective useful life. Accordingly, Oncocyte determined there are two types of contingent consideration in connection with the Insight Merger, the Milestone Contingent Consideration and the Royalty Contingent Consideration discussed below, which are collectively referred to as the “Contingent Consideration”.

 

There are three milestones comprising the Milestone Contingent Consideration, collectively referred to as the Milestones, in connection with the Insight Merger which Oncocyte valued and recorded as part of Contingent Consideration as of the Insight Merger Date (see table below), which consist of (i) a payment for clinical trial completion and related data publication (“Milestone 1”), (ii) a payment for an affirmative final local coverage determination from CMS for a specified lung cancer test (“Milestone 2”), and (iii) a payment for achieving specified CMS reimbursement milestones (“Milestone 3”). If achieved, any respective Milestone will be paid at the contractual value shown below, with the payment made either in cash or in shares of Oncocyte common stock as determined by Oncocyte. There can be no assurance that any of the Milestones will be achieved.

 

There are two separate components of the Royalty Contingent Consideration, collectively referred to as the Royalty Payments, in connection with the Insight Merger which Oncocyte valued and recorded as part of Contingent Consideration as of the Insight Merger Date (see table below); Royalty Payments consist of (i) revenue share payments based on a percentage of future sales generated from DetermaIO™ (“Royalty 1”), and (ii) revenue share payments based on percentage of future sales generated from current Insight Pharma Service offerings, as defined in the Insight Merger Agreement (“Royalty 2”). There can be no assurance that any revenues on which the Royalty Payments are based will be generated from DetermaIO™ or Pharma Service offerings.

 

The following table shows the Insight Merger Date contractual payment amounts, as applicable, and the corresponding fair value of each respective Contingent Consideration liability (in thousands):

 

          Fair  
    Contractual     Value on the  
    Value     Merger Date  
Milestone 1   $ 1,500     $ 1,340  
Milestone 2     3,000       1,830  
Milestone 3 (a)     1,500       770  
Royalty 1 (b)     See(b)       5,980  
Royalty 2 (b)     See(b)       1,210  
Total   $ 6,000     $ 11,130  

 

(a) Indicates the maximum payable if the Milestone is achieved.
   
(b) As defined, Royalty Payments are based on a percentage of future revenues of DetermaIO™ and Pharma Services over their respective useful life, accordingly there is no fixed contractual value for the Royalty Contingent Consideration.

 

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The fair value of the Milestone Contingent Consideration was determined using a scenario analysis valuation method which incorporates Oncocyte’s assumptions with respect to the likelihood of achievement of the Milestones, credit risk, timing of the Milestone Contingent Consideration payments and a risk-adjusted discount rate to estimate the present value of the expected payments. The discount rate was estimated at approximately 15% after adjustment for the probability of achievement of the Milestones. No Milestone Contingent Consideration is payable with respect to a particular Milestone unless and until the Milestone is achieved. Since the Milestone Contingent Consideration payments are based on nonfinancial, binary events, management believes the use of the scenario analysis method is appropriate. The fair value of each Milestone after the Insight Merger Date is reassessed by Oncocyte as changes in circumstances and conditions occur, with the subsequent change in fair value recorded in Oncocyte’s condensed consolidated statements of operations.

 

The fair value of the Royalty Contingent Consideration was determined using a single scenario analysis method to value the Royalty Payments. The single scenario method incorporates Oncocyte’s assumptions with respect to specified future revenues generated from DetermaIO™ and current Insight Pharma Services over their respective useful lives, credit risk, and a risk-adjusted discount rate to estimate the present value of the expected royalty payments. The credit and risk-adjusted discount rate was estimated at approximately 45%. Since the Royalty Contingent Consideration payments are based on future revenues and linear payouts, management believes the use of the single scenario method is appropriate.

 

The fair value of the Contingent Consideration after the Insight Merger Date is reassessed by Oncocyte as changes in circumstances and conditions occur, with the subsequent change in fair value recorded in Oncocyte’s condensed consolidated statements of operations. As of June 30, 2022, based on Oncocyte’s reassessment of the significant assumptions noted above, there was an increase of approximately $1.4 million to the fair value of the Contingent Consideration primarily attributable to revised estimates of the timing of the possible future payouts and, accordingly, this increase was recorded as change in fair value of contingent consideration in the unaudited condensed consolidated statements of operations for the six months ended June 30, 2022.

 

The following tables reflect the activity for Oncocyte’s Contingent Consideration for the six months ended June 30, 2022 and June 30, 2021, measured at fair value using Level 3 inputs (in thousands):

 

    Fair Value  
Balance at December 31, 2020   $ 7,120  
Change in estimated fair value     1,090  
Balance at June 30, 2021   $ 8,210  

 

    Fair Value  
Balance at December 31, 2021   $ 7,060  
Change in estimated fair value     1,400  
Balance at June 30, 2022   $ 8,460  

 

Contingent consideration is not deductible for tax purposes, even if paid; therefore, no deferred tax assets related to the Contingent Consideration were recorded.

 

Goodwill – Goodwill is calculated as the difference between the acquisition date fair value of the consideration transferred and the values assigned to the assets acquired and liabilities assumed, including Contingent Consideration. Goodwill also includes the $1.3 million of net deferred tax liabilities recorded principally related to DetermaIO™ and customer relationships discussed above. Goodwill is not amortized but is tested for impairment at least annually, or more frequently if circumstances indicate potential impairment (see Notes 2 and 4). The slight increase to Goodwill as of March 31, 2021 from December 31, 2020 was related to the true up of the final working capital adjustment paid to the selling shareholders in March 2021.

 

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Goodwill and identifiable intangible assets are not amortizable or deductible for tax purposes since these assets are not recognized for tax purposes.

 

Asset acquisition of Razor Genomics, Inc.

 

On September 30, 2019, Oncocyte completed the purchase of 1,329,870 shares of Razor Series A Convertible Preferred Stock, par value $0.0001 per share (the “Razor Preferred Stock”), representing 25% of the outstanding equity of Razor on a fully diluted basis, for $10 million in cash (the “Initial Closing”), pursuant to a Subscription and Stock Purchase Agreement (the “Purchase Agreement”) dated September 4, 2019, among Oncocyte, Encore Clinical, Inc. (“Encore”), and Razor. Pursuant to the Purchase Agreement, Oncocyte entered into Minority Holder Stock Purchase Agreements of like tenor (the “Minority Purchase Agreements”) with the shareholders of Razor other than Encore (the “Minority Shareholders”) for the future purchase of the shares of Razor common stock they own. Oncocyte has also entered into certain other agreements with Razor and Encore, including a Sublicense and Distribution Agreement (the “Sublicense Agreement”), a Development Agreement (the “Development Agreement”), and an amendment to a Laboratory Services Agreement (the “Laboratory Agreement”) pursuant to which Oncocyte became a party to that agreement.

 

Purchase Option

 

The Purchase Agreement and Minority Shareholder Agreements granted Oncocyte the option to acquire the balance of the outstanding shares of Razor common stock from Encore under the Purchase Agreement and from the Minority Shareholders under the Minority Purchase Agreements (the “Option”) for an additional $10 million in cash and Oncocyte common stock valued at $5 million in total (the “Additional Purchase Payment”). Oncocyte agreed to exercise the Option if, within a specified time frame, certain milestones are met related to the contracting of clinical trial sites for a clinical trial of DetermaRx™.

 

On January 29, 2021, the principal shareholder of Razor informed Oncocyte that the milestone requiring Oncocyte to purchase the outstanding shares of Razor common stock had been attained under the Purchase Agreement and Minority Shareholder Purchase Agreements. On February 24, 2021, Oncocyte exercised the Option and completed the purchase of all the issued and outstanding shares of common stock of Razor and paid the selling shareholders in total $10 million in cash and issued a total of 982,318 shares of Oncocyte common stock having a market value of $5.7 million on that date. As a result of Oncocyte exercising the Option and purchasing the Razor common stock, Oncocyte is now the sole shareholder of Razor.

 

Development Agreement

 

Under the Development Agreement, Razor reserved as a “Clinical Trial Expense Reserve” $4 million of the proceeds it received at the Initial Closing from the sale of the Razor Preferred Stock to Oncocyte, to fund Razor’s share of costs incurred in connection with a clinical trial of DetermaRx™ for purposes of promoting commercialization (“Clinical Trial”).

 

On February 24, 2021, upon the completion of the outstanding shares of Razor common stock and consolidation of Razor’s accounts, Oncocyte obtained control of approximately $3.4 million in cash from Razor, which was the remaining balance in the Clinical Trial Expense Reserve account that Razor was using to pay for the Clinical Trial expenses. Beginning on February 24, 2021, this balance was transferred to Oncocyte’s control as part of the acquisition date assets and liabilities recorded from the Razor entity shown below. Oncocyte will be responsible for all expenses for the Clinical Trial up to the total budget amount approved by representatives of Oncocyte and Encore on a Steering Committee, which is expected to cover multiple years and is estimated to cost up to $16 million.

 

Upon completion of enrolment of the full number of patients for the Clinical Trial, Oncocyte will issue to Encore and the Minority Shareholders shares of Oncocyte common stock with an aggregate market value at the date of issue equal to $3 million (“Clinical Trial Milestone Payment”). If the issuance of shares of common stock having a market value of $3 million would require Oncocyte to issue a number of shares that, when combined with any shares issued under the Purchase Agreement and the Minority Shareholder Purchase Agreements, would exceed the number of shares that may be issued without shareholder approval under applicable stock exchange rules, Oncocyte may deliver the number of shares permissible under stock exchange rules and an amount of cash necessary to bring the combined value of cash and shares to $3 million.

 

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If, within a specified time frame, Encore is substantially responsible for obtaining funding to Oncocyte or Razor for the Clinical Trial from any third-party pharmaceutical company, a portion of such additional funding amount will be paid to Encore, subject to a $3 million cap on the payment to Encore if the funding is provided by a designated pharmaceutical company.

 

Sublicense Agreement

 

Under the Sublicense Agreement, Razor granted to Oncocyte an exclusive worldwide sublicense under certain patent rights applicable to DetermaRx™ in the field of use covered by the applicable license held by Razor for purposes of commercialization and development of DetermaRx™.

 

Pursuant to the Razor Sublicense Agreement, Oncocyte will pay all royalties and all revenue sharing and earnout payments owed by Razor to certain third parties with respect to DetermaRx™ revenues, including the licensor of the patent rights sublicensed to Oncocyte, but those payments will be deducted from gross revenues to determine net revenues for the purpose of paying royalties to the former Razor shareholders. Total royalty and earnout payments to the former Razor shareholders, the licensor, and other third parties will be a low double-digit percentage, and in addition certain milestone payments may become due if cumulative net revenue benchmarks are reached. Royalties and earnout payments will be payable on a quarterly basis. This payment obligation will continue after Oncocyte’s purchase of the Razor common stock from Encore and the Minority Shareholders.

 

Laboratory Agreement

 

Under the Laboratory Agreement, Oncocyte has assumed Razor’s Laboratory Agreement payment obligations of $450,000 per year (see Note 10). The Laboratory Agreement gives Oncocyte the right to use Razor’s CLIA laboratory in Brisbane, California. Oncocyte pays Encore a quarterly fee for services related to operating and maintaining the CLIA laboratory, including certain staffing. The Laboratory Agreement will expire on September 29, 2021, but Oncocyte may extend the term for additional one-year periods, or Oncocyte may terminate the agreement at its option. Oncocyte also has the right to terminate the Laboratory Agreement if there is an event or occurrence that adversely affects, in any material respect, DetermaRx™ or its prospects or its ability to be commercialized, and it remains continuing and uncured. The agreement was not extended after the expiration date.

 

Accounting for the Razor Investment

 

Beginning on the Initial Closing and through February 23, 2021, Oncocyte has accounted for the Razor investment under the equity method of accounting under ASC 323 because prior to the Additional Purchase Payment discussed above Oncocyte exercised significant influence over, but did not control, the Razor entity. Oncocyte did not control Razor because, among other factors, Oncocyte was entitled to designate one person to serve on a three-member board of directors of Razor, with the other two members designated by Encore. Also, any deadlocked decisions by a Steering Committee of Oncocyte and Encore representatives that makes decisions with respect to the Clinical Trial, other than with respect to the Clinical Trial budget, will be resolved by a member designated by Encore.

 

Prior to February 24, 2021, the aggregate Razor acquisition payments of $11.245 million incurred during September 2019 and a $4 million CMS milestone payment made by Oncocyte during June 2020 under the Development Agreement, were amortized over a 10-year useful life of DetermaRx™ and were reflected in Oncocyte’s pro rata earnings and losses of the equity method investment in Razor in the condensed consolidated statements of operations. Beginning on February 24, 2021, Razor’s results are included with Oncocyte’s consolidated results, primarily consisting of outside research and development expenses incurred by Razor for the Clinical Trial.

 

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The Initial Closing equity method investment in Razor and the Additional Purchase Payment for the remaining interests in Razor are both considered an asset acquisition, rather than a business combination, because, among other factors, Razor had no workforce, no commercial product (Razor had granted all commercial rights to Oncocyte), no revenues, no distribution system and no facilities. Substantially all of the fair value of Razor’s assets at the Initial Closing and on February 24, 2021 was concentrated in Razor’s intangible asset, the DetermaRx™ patent and related know-how, thus satisfying the requirements of the practical screen test to be considered an asset acquisition in accordance with ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. Accordingly, no goodwill may be recognized in an asset acquisition in accordance with ASC 805-50.

 

As Razor became a wholly owned subsidiary of Oncocyte on February 24, 2021, the DTA associated with the previous equity method investment was reversed. There is no tax effect of this reversal as the DTA had been fully offset by a valuation allowance (see Note 8). However, upon payment of the Additional Purchase Payment, Oncocyte recorded an additional step-up to fair value for the Razor intangible asset under ASC 805-50 for financial reporting purposes but this “step-up” is not recognized for income tax purposes. As a result, the fair value adjustment of the Razor intangible asset on the acquisition date generated a DTL in accordance with ASC 740. This DTL is computed using the fair value of the intangible assets on the acquisition date multiplied by Oncocyte’s federal and state effective income tax rates, using the simultaneous equations method for asset acquisitions under the guidance provided in ASC 740-10-25-51, which requires that the DTL be recognized as part of the investment of the acquired asset instead of any immediate income tax expense or benefit arising from the recognition of the DTL. Furthermore, ASC 740 allows Oncocyte to treat acquired available deferred tax assets, such as Razor’s NOLs (subject to the annual limitation under Section 382 of the Internal Revenue Code) as available DTAs to offset against the DTLs, as the DTLs are expected to reverse within the NOL carryforward period. Any excess DTAs over those DTLs would be assessed for a valuation allowance in accordance with ASC 740.

 

On February 24, 2021, Oncocyte estimated and recorded a net DTL of $7.1 million after offsetting the acquired available NOLs with the intangible asset shown in the table below. See Note 8 for a discussion related to the partial release of Oncocyte’s valuation allowance pertaining to the DTL generated above in accordance with ASC 740.

 

On February 24, 2021, upon Oncocyte’s acquisition of the outstanding common stock of Razor, the Razor intangible asset balance recorded on the acquisition date and included in Intangible Assets was as follows (in thousands):

 

    As of
February 24,
 
    2021  
Razor intangible asset recorded on the acquisition date:        
Equity method investment carrying value   $ 13,147  
Cash paid as Additional Purchase Payment for the Razor asset     10,000  
Oncocyte common stock issued (982,318 shares issued at market value) as Additional Purchase Payment     5,756  
Less: cash balance received from Razor for Clinical Trial expenses     (3,352 )
Deferred tax liability generated from the Razor asset     7,077  
Other     169  
         
Total Razor investment asset balance as of February 24, 2021 (a)   $ 32,797  

 

(a) This balance will be amortized over the remaining useful life of the Razor asset, approximating 8.5 years, as of the February 24, 2021 acquisition date, with the amortization expense included in “Cost of revenues – amortization of acquired intangibles” on the condensed consolidated statements of operations.

 

Under ASC 805-50, for asset acquisitions, the remaining Clinical Trial Milestone Payment will be recorded only if the consideration is both probable (milestone has been achieved) and estimable in accordance with ASC 450, Contingencies, and as of June 30, 2022, no contingent consideration payment was recorded as the Clinical Trial Milestone Payment was not deemed probable of achievement as of that date.

 

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Summarized standalone financial data for Razor from January 1, 2021 through February 23, 2021

 

The unaudited standalone results of operations for Razor prior to being consolidated with Oncocyte is summarized below (in thousands):

 

    For the period from  
    January 1, 2021
through
 
    February 23, 2021  
Condensed Statement of Operations (1)   (unaudited)  
Research and development expense   $ 125  
General and administrative expense     -  
Loss from operations     (125 )
Net loss   $ (125 )

 

(1) The unaudited condensed standalone statement of operations of Razor is provided for informational purposes only. Razor’s results for the period from January 1, 2021 through February 23, 2021 are not included in Oncocyte’s consolidated results of operations because Razor was not consolidated with Oncocyte’s financial statements but had been accounted for under the equity method of accounting since the September 30, 2019 Initial Closing date, however, Oncocyte’s results included its pro rata losses from Razor. Beginning on February 24, 2021, Razor’s results are included with Oncocyte’s consolidated results, primarily consisting of outside research and development expenses incurred by Razor for the Clinical Trial discussed above.

 

Acquisition of Chronix Biomedical, Inc.

 

On April 15, 2021, the Chronix Merger Date, Oncocyte completed its acquisition of Chronix pursuant the Chronix Merger Agreement.

 

Merger Consideration at Closing

 

Pursuant to the Chronix Merger Agreement, Oncocyte agreed to deliver closing consideration consisting of approximately (i) 648,000 shares of Oncocyte common stock (the “Closing Shares”), which represents approximately $1.43 million of Closing Shares issued to Chronix stockholders and approximately $1.87 million of Closing Shares issued to payoff assumed liabilities, based on the $5.09 closing price per share of Oncocyte common stock on the NYSE American on February 1, 2021; (ii) $4.0 million in cash; and (iii) $550,000 net settlement of acquirer/acquiree pre-combination activity (collectively, the “Chronix Closing Consideration”).

 

Contingent Consideration

 

As additional consideration for holders of certain classes and series of Chronix capital stock, the Chronix Merger Agreement also provides for Oncocyte to pay “Chronix Contingent Consideration” consisting of (i) “Chronix Milestone Payments” of up to $14 million in any combination of cash or Oncocyte common stock if certain milestones specified in the Chronix Merger Agreement are achieved, (ii) “Royalty Payments” of up to 15% of net collections for sales of specified tests and products during the five-to-ten year earnout periods, and (iii) “Transplant Sale Payments” of up to 75% of net collections from the sale or license to a third party of Chronix’s patents for use in transplantation medicine during a seven-year earnout period.

 

The Chronix Closing Consideration and Chronix Contingent Consideration include amounts payable to certain directors, officers and employees of Chronix, including officers and employees who are expected to continue to provide services to Chronix following the Chronix Merger.

 

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Liabilities

 

Pursuant to the Chronix Merger Agreement, to the extent that Oncocyte or any of its subsidiaries, including Chronix, pays, performs or discharges an amount of liabilities of Chronix in excess of $8.25 million (the “Excess Liabilities”), Oncocyte may offset the Excess Liabilities against any Chronix Contingent Consideration payments that subsequently become due and payable pursuant to the Chronix Merger Agreement. Chronix had Excess Liabilities approximating $4.6 million as of the Chronix Merger Date. Prior to Chronix equity holders receiving any Chronix Contingent Consideration payments, all or a partial amount of any funds that would otherwise be payable as Chronix Contingent Consideration payments may be used to pay Excess Liabilities.

 

Deferred Revenue - In June 2018 and subsequently amended in June 2019, Chronix and a medical diagnostic service company in Germany (“the German customer”) entered into a licensing and testing service agreement (“the German agreement”) for intellectual property related to DetermaCNITM and VitaGraftTM. Under the terms of the agreement, Chronix received from the German customer an upfront payment of €3.7 million, less applicable VAT obligations, which Chronix recognized ratably over the contract term of 3.5 years. The German agreement contains a stipulation that requires Chronix to refund to the German customer a portion of the upfront fee on a pro rata basis if the German agreement is terminated prior to December 31, 2021. The deferred revenue of $738,000 recorded at the acquisition date represents the refund Oncocyte would pay to the German customer should it terminate the agreement prior to the agreed upon term. Oncocyte will amortize the deferred revenue and record revenue ratably over the remaining period as the German customer’s refund rights expire. As of June 30, 2022, Oncocyte has fully amortized the deferred revenue and recorded revenue ratably over the remaining period as the German customer’s refund rights expire.

 

Registration Rights

 

Pursuant to the Chronix Merger Agreement, Oncocyte filed a registration statement with the SEC to register the resale of the shares of common stock under the Securities Act issued in connection with the Chronix Merger, which the SEC declared effective in July 2021.

 

Workforce

 

At the Chronix Merger Date, all of Chronix’s employees ceased employment with Chronix, and Oncocyte offered employment to certain of those former Chronix employees, principally in laboratory roles and certain administrative roles in Germany, and granted new equity awards to them under the Oncocyte 2018 Equity Incentive Plan. All these Oncocyte stock option awards granted have vesting terms and conditions consistent with stock options granted to most other Oncocyte employees.

 

Aggregate Chronix Merger Consideration and Purchase Price Allocation

 

Measurement period adjustments reflect new information obtained about facts and circumstances that existed as of the acquisition date. Final determination of the fair values may result in further adjustments to the values presented. To the extent that significant changes occur in the future, Oncocyte will disclose such changes in the reporting period in which they occur.

 

The calculation of the aggregate merger consideration, consisting of the Closing Consideration and Chronix Contingent Consideration (the “Aggregate Chronix Merger Consideration”), at fair value, is shown in the following table (in thousands, except for share and per share amounts). In accordance with ASC 805, the Chronix Contingent Consideration, at fair value, is part of the total considered transferred on the Chronix Merger Date, as further discussed below.

 

Cash consideration   $ 3,960  
         
Settlement of acquirer/acquiree activity pre-combination, net   $ 550  
         
Stock consideration        
Shares of Oncocyte common stock issued on the Merger Date     647,911  
Closing price per share of Oncocyte common stock on the Merger Date   $ 5.09  
Market value of Oncocyte common stock issued   $ 3,298  
         
Contingent Consideration   $ 42,295  
         
Total fair value of consideration transferred on the Merger Date   $ 50,103  

 

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Pursuant to ASC 805, Business Combinations (“ASC 805”), Oncocyte accounted for the Chronix acquisition as a business combination using the acquisition method of accounting. Identifiable assets and liabilities of Chronix, including identifiable intangible assets, were recorded based on their fair values as of the date of the closing of the acquisition. The excess of the purchase price over the fair value of the net assets acquired was recorded as goodwill.

 

Upon further review of the assets acquired and liabilities assumed, it was determined that the amount previously reported as assumed liabilities were not properly reflected. The following has been updated to reflect the assets acquired and liabilities as of the date of acquisition. The following table sets forth the allocation of the Aggregate Chronix Merger Consideration transferred to Chronix’s tangible and identifiable intangible assets acquired and liabilities assumed (in thousands):

 

    April 15, 2021  
Assets acquired:        
Cash and cash equivalents   $ 50  
Accounts receivable and other current assets     25  
Long-term assets     12  
Acquired in-process research and development     46,800  
         
Total identifiable assets acquired (a)     46,887  
         
Liabilities assumed:        
Deferred revenue     738  
Assumed liability     3,352  
Long-term deferred income tax liability     2,184  
         
Total identifiable liabilities assumed (b)     6,274  
         
Net assets acquired, excluding goodwill (a) - (b) = (c)     40,613  
         
Total cash, contingent consideration, and stock consideration transferred (d)     50,103  
         
Goodwill (d) - (c)   $ 9,490  

 

All tangible assets and liabilities were valued at their respective carrying amounts as management believes that these amounts approximated their acquisition date fair values.

 

The following is a discussion of the valuation methods and significant assumptions used to determine the fair value of Chronix’s material assets and liabilities in connection with the Chronix Merger:

 

Acquired In-Process Research and Development and Deferred Income Tax Liability – The fair value of identifiable IPR&D intangible assets consists of $46.8 million allocated to DetermaCNITM and VitaGraftTM. Oncocyte determined the estimated aggregate fair value of the test assets for DetermaCNITM and VitaGraftTM (the “Test Assets”) using the MPEEM under the income approach. MPEEM calculates the economic benefits by determining the income attributable to an intangible asset after the returns are subtracted for contributory assets such as working capital, assembled workforce, and fixed assets. The resulting after-tax net earnings are discounted at a rate commensurate with the risk inherent in the economic benefit projections of the assets.

 

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To calculate fair value of the Test Assets under MPEEM, Oncocyte used probability-weighted, projected cash flows discounted at a rate considered appropriate given the significant inherent risks associated with similar assets. Cash flows were calculated based on projections of revenues and expenses related to the asset and were assumed to extend through a multi-year projection period. The discount rate used to value Test Assets was approximately 12%. The projected cash flows were based on significant assumptions, including the time and resources needed to complete development of the asset, timing and reimbursement rates from CMS, regulatory approvals, if any, to commercialize the asset, estimates of the number of tests that might be performed, revenue and operating profit expected to be generated by the asset, the expected economic life of the asset, market penetration and competition, and risks associated with achieving commercialization, including delay or failure to obtain CMS and any required regulatory approval, failure of clinical trials, and intellectual property litigation.

 

Because the IPR&D is considered an indefinite-lived asset for accounting purposes but is not recognized for tax purposes, the fair value of the IPR&D on the acquisition date generated a DTL in accordance with ASC 740, Income Taxes. This DTL is computed using the fair value of the IPR&D assets on the acquisition date multiplied by Oncocyte’s federal and state effective income tax rates. ASC 740 allows Oncocyte to treat acquired available DTAs, such as Chronix’s NOLs (subject to the annual limitation under Section 382 of the Internal Revenue Code) as available DTAs to offset against the DTLs, as the DTLs are expected to reverse within the NOL carryforward period. Any excess DTAs over those DTLs would be assessed for a valuation allowance in accordance with ASC 740. This accounting treatment is acceptable if, at the time of the acquisition, Oncocyte can both reasonably estimate a timeline to commercialization and the economic useful life of the IPR&D assets upon commercialization, which will be amortized during the carryforward period of the offsetting DTAs. Oncocyte estimated and recorded a net DTL of $2.2 million after offsetting the acquired available NOLs with the IPR&D generated DTLs (see Note 8).

 

Contingent consideration liabilities – ASC 805 requires that contingent consideration be estimated and recorded at fair value as of the acquisition date as part of the total consideration transferred. Contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests to the selling shareholders in the future if certain future events occur or conditions are met, such as the attainment of product development milestones. Contingent consideration also includes additional future payments to selling shareholders based on achievement of components of earnings, such as “earn-out” provisions or percentage of future revenues, including royalties paid to the former Chronix shareholders based on a percentage of revenues generated from DetermaCNITM and VitaGraftTM tests over the useful life of the assets. Accordingly, Oncocyte determined there are three types of contingent consideration in connection with the Chronix Merger: the Milestone Payments, the Royalty Payments, and Transplant Sale Payments, discussed below, which comprise the “Chronix Contingent Consideration”.

 

The fair value of the Milestone Payments was determined using a scenario analysis valuation method which incorporates Oncocyte’s assumptions with respect to the likelihood of achievement of the milestones defined in the Chronix Merger Agreement, credit risk, timing of the Milestone Payments and a risk-adjusted discount rate to estimate the present value of the expected payments. The discount rate was estimated at approximately 15% after adjustment for the probability of achievement of the milestones.

 

The fair value of the Royalty Payments was determined using a single scenario analysis method. The single scenario method incorporates Oncocyte’s assumptions with respect to specified future revenues generated from DetermaCNITM, over its estimated useful life, taking into account credit risk and a risk-adjusted discount rate to estimate the present value of the expected Royalty Payments. The credit and risk-adjusted discount rate was estimated at approximately 15%.

 

The fair value of the Transplant Sale Payments was determined using a single scenario analysis method. The single scenario method incorporates Oncocyte’s assumptions with respect to specified future licensing revenues generated from VitaGraftTM, over its estimated useful life, taking into account credit risk and a risk-adjusted discount rate to estimate the present value of the expected Transplant Sale Payments. The credit and risk-adjusted discount rate was estimated at approximately 15%.

 

The fair value of the Chronix Contingent Consideration after the Chronix Merger Date is reassessed by Oncocyte as changes in circumstances and conditions occur, with the subsequent change in fair value recorded in Oncocyte’s condensed consolidated statements of operations. As of June 30, 2022, based on Oncocyte’s reassessment of the significant assumptions noted above, there was a decrease of approximately $12.4 million to the fair value of the Contingent Consideration primarily attributable to revised estimates of the timing of the possible future payouts and, accordingly, this decrease was recorded as a change in fair value of contingent consideration in the unaudited condensed consolidated statements of operations as of June 30, 2022.

 

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The following tables reflect the activity for Oncocyte’s Contingent Consideration for the six months ended June 30, 2022 and June 30, 2021, measured at fair value using Level 3 inputs (in thousands):

    Fair Value  
Balance at April 15, 2021   $ 42,295  
Change in estimated fair value     -  
Balance at June 30, 2021   $ 42,295  

 

    Fair Value  
Balance at December 31, 2021   $ 69,621  
Change in estimated fair value     (12,415 )
Balance at June 30, 2022   $ 57,206  

 

Goodwill - Goodwill is calculated as the difference between the acquisition date fair value of the Aggregate Chronix Merger Consideration transferred and the values assigned to the assets acquired and liabilities assumed. Goodwill also includes the $2.2 million of net deferred tax liabilities recorded principally related to the VitaGraftTM discussed above. Oncocyte recognized approximately $9.5 million of goodwill related to the Chronix acquisition.

 

None of the goodwill recognized is expected to be deductible for income tax purposes. Goodwill is not amortized but is tested for impairment at least annually, or more frequently if circumstances indicate potential impairment (see Notes 2 and 4).

 

Goodwill and identifiable intangible assets are not amortizable or deductible for tax purposes since these assets are not recognized for tax purposes.

 

4. Goodwill and Intangible Assets, net

 

At June 30, 2022 and December 31, 2021, goodwill and intangible assets, net, consisted of the following (in thousands):

 

 

    June 30, 2022     December 31, 2021  
Goodwill - Insight Merger(1)   $ 9,194     $ 9,194  
Goodwill - Chronix Merger(1)     9,490       9,490  
Total Goodwill     18,684       18,684  
                 
Intangible assets:                
Acquired IPR&D - DetermaIOTM (2)   $ 14,650     $ 14,650  
Acquired IPR&D - DetermaCNI™ and VitaGraft™ (3)     46,800       46,800  
                 
Intangible assets subject to amortization:                
Acquired intangible assets - customer relationship     440       440  
Acquired intangible assets - Razor (see Note 3)     32,797       32,797  
Total intangible assets     94,687       94,687  
Accumulated amortization - customer relationship(4)     (213 )     (169 )
Accumulated amortization - Razor(4)     (5,133 )     (3,273 )
Intangible assets, net   $ 89,341     $ 91,245  

 

(1) Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in the Insight Merger and the Chronix Merger (see Note 3).
(2) See Note 3 for information on the Insight Merger.
(3) See Note 3 for information on the Chronix Merger.
(4) Amortization of intangible assets is included in “Cost of revenues – amortization of acquired intangibles” on the condensed consolidated statements of operations in the current year because the intangible assets pertain directly to the revenues generated from the acquired intangibles.

 

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Future amortization expense of intangible assets subject to amortization is expected to be the following (in thousands):

 

    Amortization  
Year ending December 31,        
2022     1,952  
2023     3,904  
2024     3,904  
2025     3,823  
2026     3,816  
Thereafter     10,492  
Total   $ 27,891  

 

5. Shareholders’ Equity

 

Series A Redeemable Convertible Preferred Stock

 

On April 13, 2022, the Company entered into a securities purchase agreement (“Purchase Agreement”) with institutional accredited investors, including Broadwood Capital, L.P., the Company’s largest shareholder, (the “Investors”) in a registered direct offering of 11,765 shares of our Series A Convertible Preferred Stock (the “Preferred Stock”), which shares of Preferred Stock are convertible into a total of 7,689,542 shares of our common stock, at a conversion price of $1.53. The purchase price of each share of Preferred Stock was $850, which included an original issue discount to the stated value of $1,000 per share. The rights, preferences and privileges of the Preferred Stock are set forth in our Certificate of Determination of Preferences, Rights and Limitations of Series A Convertible Preferred Stock (the “Certificate of Determination”), which we will file with the Secretary of State of the State of California. The closing of the offering of Preferred Stock will occur in two equal tranches of $5,000,000 each for aggregate gross proceeds from both closings of $10,000,000. The first closing will occur on the later of (i) the second (2nd) trading day following the execution of the Purchase Agreement and (ii) the second (2nd) trading day following the date that the Secretary of State accepts the Certificate of Determination. The second closing will occur on the earlier of (a) the second (2nd) trading day following the date that we receive notice from an Investor to accelerate the second closing and (b) a date selected by us on or after October 8, 2022 and on or prior to March 8, 2023. The Company intends to use the proceeds of the offering for general corporate purposes and working capital.

 

The Preferred Stock is convertible into shares of the Company’s common stock at any time at the holder’s option. The conversion price will be subject to customary anti-dilution adjustments for matters such as stock splits, stock dividends and other distributions on our common stock, and recapitalizations. The holder will be prohibited from converting shares of Preferred Stock into shares of common stock if, as a result of such conversion, the holder, together with its affiliates, would own more than 4.99% of the shares of our common stock then issued and outstanding (provided a holder may elect, at the first closing, to increase such beneficial ownership limitation solely as to itself up to 19.99% of the number of shares of our common stock outstanding immediately after giving effect to the conversion). The Company may force the conversion of up to one-third of the shares of Preferred Stock originally issued, subject to customary equity conditions, if the daily volume weighted average price of our common stock for 20 out of 30 trading days exceeds 140% of the conversion price and on 20 out of the same 30 trading days the daily trading volume equals or exceeds 400,000 shares of our common stock. The Company may only effect one forced conversion during any 30-trading day period.

 

In the event of the Company’s liquidation, dissolution, or winding up, holders of Preferred Stock will receive a payment equal to the stated value of the Preferred Stock plus accrued but unpaid dividends and any other amounts that may have become payable on the Preferred Stock due to any failure or delay that may have occurred in issuing shares of common stock upon conversion of a portion of the Preferred Stock, before any distribution or payment to the holders of common stock or any of our other junior equity.

 

Shares of Preferred Stock will generally have no voting rights, except as required by law and except that the consent of holders of a majority of the outstanding Preferred Stock will be required to amend any provision of our certificate of incorporation that would have a materially adverse effect on the rights of the holders of the Preferred Stock. Additionally, as long as any shares of Preferred Stock remain outstanding, unless the holders of at least 51% of the then outstanding shares of Preferred Stock shall have otherwise given prior written consent, we, on a consolidated basis with our subsidiaries, are not permitted to (1) have less than $8 million of unrestricted, unencumbered cash on hand (“Cash Minimum Requirement”); (2) other than certain permitted indebtedness, incur indebtedness to the extent that our aggregate indebtedness exceeds $15 million; (3) enter into any agreement (including any indenture, credit agreement or other debt instrument) that by its terms prohibits, prevents, or otherwise limits our ability to pay dividends on, or redeem, the Preferred Stock in accordance with the terms of the Certificate of Determination; or (4) authorize or issue any class or series of preferred stock or other capital stock of the Company that ranks senior or pari passu with the Preferred Stock.

 

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Shares of Preferred Stock will be entitled to receive cumulative dividends at a rate per share (as a percentage of stated value) of 6% per annum, payable quarterly in cash or, at our option, by accreting such dividends to the stated value.

 

The Company is required to redeem, for cash, the shares of Preferred Stock on the earlier to occur of (1) April 8, 2024, (2) the commencement of certain a voluntary or involuntary bankruptcy, receivership, or similar proceedings against the Company or its assets, (3) a Change of Control Transaction (as defined herein) and (4) at the election and upon notice of 51% in interest of the holders, if the Company fails to meet the Cash Minimum Requirement. A “Change of Control Transaction” means the occurrence of any of (a) an acquisition by an individual or legal entity or “group” (as described in Rule 13d-5(b)(1) promulgated under the Exchange Act) of effective control (whether through legal or beneficial ownership of capital stock of the Company, by contract or otherwise) of in excess of 50% of the voting securities of the Company (other than by means of conversion of Preferred Stock), (b) the Company merges into or consolidates with any other person, or any person merges into or consolidates with the Company and, after giving effect to such transaction, the stockholders of the Company immediately prior to such transaction own less than 50% of the aggregate voting power of the Company or the successor entity of such transaction, or (c) the Company sells or transfers all or substantially all of its assets to another person. Additionally, the Company has the right to redeem the Preferred Stock for cash upon 30 days prior notice to the holders; provided if the Company undertakes a capital raise in connection with such redemption, the Investors will have the right to participate in such financing.

 

As of June 30, 2022, Oncocyte had 11,765 preferred shares, no-par value, authorized, and 5,882.4 shares issued and outstanding. The future right or obligation associated with the Second Closing Tranche Preferred Stock is recorded at fair value from the $5 million proceeds received. The Company will remeasure the right or obligation associated with the Second Closing Tranche Preferred Stock to its fair value and record the change in fair value through earnings as an element of other income/expense. As of June 30, 2022, the Company determined the fair value to be $0.3 million and recorded the change in fair value through earnings as an element of other income/expense on the unaudited condensed consolidated statements of operations and within other current assets on the unaudited condensed consolidated balance sheets.

 

Common Stock

 

As of June 30, 2022 and December 31, 2021, Oncocyte has 230,000,000 shares of common stock, no-par value, authorized. As of June 30, 2022 and December 31, 2021, Oncocyte had 118,608,821 and 92,231,917 shares of common stock issued and outstanding, respectively.

 

Common Stock Purchase Warrants

 

As of June 30, 2022, Oncocyte had an aggregate of 16,892,266 common stock purchase warrants issued and outstanding with exercise prices ranging from $1.53 to $5.50 per warrant. The warrants will expire on various dates through October 17, 2029. Certain warrants have “cashless exercise” provisions meaning that the value of a portion of warrant shares may be used to pay the exercise price rather than payment in cash, which may be exercised under any circumstances in the case of the 2017 Bank Warrants and 2019 Bank Warrants or, in the case of certain other warrants, only if a registration statement for the warrants and underlying shares of common stock is not effective under the Securities Act or a prospectus in the registration statement is not available for the issuance of shares upon the exercise of the warrants.

 

Oncocyte has considered the guidance in ASC 815-40, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, which states that contracts that require or may require the issuer to settle the contract for cash are liabilities recorded at fair value, irrespective of the likelihood of the transaction occurring that triggers the net cash settlement feature. This liability classification guidance also applies to financial instruments that may require cash or other form of settlement for transactions outside of the company’s control and, in which the form of consideration to the warrant holder may not be the same as to all other shareholders in connection with the transaction. However, if a transaction is not within the company’s control but the holder of the financial instrument can solely receive the same type or form of consideration as is being offered to all the shareholders in the transaction, then equity classification of the financial instrument is not precluded, if all other applicable equity classification criteria are met. Based on the above guidance and, among other factors, the fact that the warrants cannot be cash settled under any circumstance but require share settlement, all of the outstanding warrants meet the equity classification criteria and have been classified as equity.

 

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6. Stock-Based Compensation

 

Oncocyte had a 2010 Stock Option Plan (the “2010 Plan”) under which 5,200,000 shares of common stock were authorized for the grant of stock options or the sale of restricted stock. On August 27, 2018, Oncocyte shareholders approved a new Equity Incentive Plan (the “2018 Incentive Plan”) to replace the 2010 Plan. In adopting the 2018 Incentive Plan, Oncocyte terminated the 2010 Plan and will not grant any additional stock options or sell any stock under restricted stock purchase agreements under the 2010 Plan; however, stock options issued under the 2010 Plan will continue in effect in accordance with their terms and the terms of the 2010 Plan until the exercise or expiration of the individual options.

 

In 2018, under the 2010 Plan, Oncocyte granted certain stock options with exercise prices ranging from $2.30 per share to $3.15 per share, that will vest in increments upon the attainment of specified performance conditions related to the development of DetermaDx™ and obtaining Medicare reimbursement coverage for that test (“2018 Performance-Based Options”). The Medicare reimbursement conditions will not be met as Oncocyte has determined not to pursue commercialization of DetermaDx™. Approximately 125,000 stock options granted in May 2018 contain a hybrid vesting condition which vest on the earlier to occur of three years of service from the grant date or achieving a defined Performance-Based Option milestone with respect to DetermaDx™ local decision coverage. These stock options are considered to be service-based awards for financial accounting purposes with the fair value of the options being recognized in stock-based compensation expense over an effective three-year service period. During the three and six months ended June 30, 2022, and 2021, no stock-based compensation expense was recorded with regard to the Performance-Based Options due to the discontinuation of the development of DetermaDx™. As of June 30, 2022, there were no 2018 Performance-Based Options outstanding.

 

During the six months ended June 30, 2022, the Company awarded executive share-based payment awards under the 2018 Plan to certain executive officers and employees with time-based, market-based and performance-based vesting conditions (“2022 equity awards”).

 

The fair value of the 2022 equity awards with performance-based vesting condition was estimated using the Black-Scholes option-pricing model assuming that performance goals will be achieved. If such performance conditions are not met, no compensation cost is recognized and any recognized compensation cost is reversed. The grant-date fair value of the stock options with time-based and performance-based vesting condition granted during the six months ended June 30, 2022 was $0.96 per option. The probability of 2022 equity awards performance-based vesting conditions will be evaluated each reporting period and the Company will true-up the amount of cumulative cost recognized for the 2022 performance-based awards at each reporting period based on the most up-to-date probability estimates. The Company will recognize the compensation expense for 2022 performance-based awards expected to vest on a straight-line basis over the respective service period for each separately vesting tranche.

 

The fair value of the 2022 equity awards with market-based vesting condition was estimated using the Monte Carlo simulation model. Assumptions and estimates utilized in the model include the risk-free interest rate, dividend yield, expected stock volatility and the estimated period to achievement of the performance and market conditions, which are subject to the achievement of the market-based goals established by the Company and the continued employment of the participant. These awards vest only to the extent that the market-based conditions are satisfied as specified in the vesting conditions. Unlike the performance-based awards, the grant date fair value and associated compensation cost of the market-based awards reflect the probability of the market condition being achieved, and the Company will recognize this compensation cost regardless of the actual achievement of the market condition. Assumptions utilized in connection with the Monte Carlo valuation technique included: estimated risk-free interest rate of 2.0 percent; term of 2.8 years; expected volatility of 100 percent; and expected dividend yield of 0 percent. The risk-free interest rate was determined based on the yields available on U.S. Treasury zero-coupon issues. The expected stock price volatility was determined using historical volatility. The expected dividend yield was based on expectations regarding dividend payments. The total grant date fair value of the market-based awards was $117,625.

 

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In May 2022, the Company approved amendments to vesting conditions of 1,237,500 performance-based and 250,000 market-based awards of certain executive officers and employees. The performance-based awards were modified such that the stock awards will be eligible to vest as follows: (i) 50% will vest on December 31, 2023 if the Company achieves LCD reimbursement for VitaGraftTM (formerly TheraSureTM Transplant Monitor) for one organ no later than December 31, 2022 and (ii) 50% will vest on December 31, 2023 if DetermaIO™ or DetermaCNI™ (formerly TheraSureTM - CNI Monitor) submission for LCD is completed no later than December 31, 2022. Additional performance-based RSU awards were modified to be eligible to vest upon the achievement by the Company of average market capitalization minimum, target, and maximum goals of (i) $300 million; (ii) $400 million; and (iii) $500 million, respectively, during the period beginning on January 1, 2022 and ending on December 31, 2024. The market-based RSU awards were modified such that the awards will be eligible to vest upon the achievement of product commercial launch minimum, target, and maximum goals as follows: (i) 1 laboratory test product in the US; (ii) 2 laboratory test products in US, and (iii) 3 laboratory test products in the US, respectively.

 

In accordance with ASC 718, the Company calculated the fair value of the market-based awards on the date of modification, noting an increase in the fair value of approximately $58,500 on the date of modification, with the incremental increase in fair value representing additional unrecognized stock-based compensation expense. The following assumptions were used in calculating the fair value of the market-based options on the date of modification:

 

Risk-free interest rates     2.72 %
Expected term (in years)     2.6  
Volatility     95.0 %
Grant date fair value of awards granted during the period   $ 1.13  

 

A summary of Oncocyte’s 2010 Plan activity and related information follows (in thousands except weighted average exercise price):

 

    Shares     Number     Weighted  
    Available     of Options     Average  
Options   for Grant     Outstanding     Exercise Price  
                   
Balance at December 31, 2021     -       923     $ 3.65  
Options exercised     -       -     $ -  
Options forfeited, canceled and expired     -       -     $ -  
Balance at June 30, 2022     -       923     $ 3.65  
Exercisable at June 30, 2022             923     $ 3.65  

 

As of June 30, 2022, 21,000,000 shares of common stock were reserved under the 2018 Incentive Plan for the grant of stock options or the sale of restricted stock or for the settlement of hypothetical units issued with reference to common stock (“RSUs”). Oncocyte may also grant stock appreciation rights under the 2018 Incentive Plan.

 

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A summary of Oncocyte’s 2018 Incentive Plan activity and related information follows (in thousands except weighted average exercise price):

 

                Weighted  
    Shares Available     Number of Options     Number of RSUs     Average Exercise  
    for Grant     Outstanding     Outstanding     Price  
                         
Balance at December 31, 2021     9,006       10,679       121     $ 3.63  
RSUs vested     96       -       (96 )   $ -  
RSUs granted     (56 )     -       56     $ -  
Performance RSUs granted     (500 )     -       500     $ -  
Options granted     (3,432 )     3,432       -     $ 1.20  
Options exercised     -       -       -     $ -  
Options forfeited/cancelled     704       (704 )     -     $ 2.51  
Balance at June 30, 2022     5,818       13,407       581     $ 3.02  
Options exercisable at June 30, 2022             5,033             $ 3.23  

 

Oncocyte recorded stock-based compensation expense in the following categories on the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2022 and 2021 (unaudited and in thousands):

 

    2022     2021     2022     2021  
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2022     2021     2022     2021  
Cost of revenues   $ 76     $ 74     $ 145     $ 96  
Research and development     470       379       896       636  
Sales and marketing     403       308       738       541  
General and administrative     1,283       1,235       2,463       2,013  
Total stock-based compensation expense   $ 2,232     $ 1,996     $ 4,242     $ 3,286  

 

The assumptions that were used to calculate the grant date fair value of Oncocyte’s employee and non-employee stock option grants for the six months ended June 30, 2022 and 2021 were as follows:

 Schedule of Assumptions Used to Calculate Fair Value of Stock Options

    Six Months Ended  
    June 30,  
    2022     2021  
Expected life (in years)     6.01       6.00  
Risk-free interest rates     2.24 %     0.88 %
Volatility     106.98 %     100.67 %
Dividend yield     0 %     0 %

 

The determination of stock-based compensation is inherently uncertain and subjective and involves the application of valuation models and assumptions requiring the use of judgment. If Oncocyte had made different assumptions, its stock-based compensation expense and net loss for the three and six months ended June 30, 2022 and 2021 may have been significantly different.

 

Oncocyte does not recognize deferred income taxes for incentive stock option compensation expense and records a tax deduction only when a disqualified disposition has occurred.

 

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7. Disaggregation of Revenues and Concentration Risk

 

The following table presents the percentage of consolidated revenues generated by unaffiliated customers that individually represent greater than ten percent of consolidated revenues:

 

    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2022     2021     2022     2021  
Medicare for DetermaRx™     22 %     21 %     26 %     23 %
Medicare Advantage for DetermaRx™     15 %     12 %     23 %     17 %
Pharma services - Company A     10 %     *       12 %     *  
Licensing - Company B     48 %     49 %     30 %     32 %
Licensing - Company C     *       11 %     *       *  

 

* Less than 10%

 

The following table presents the percentage of consolidated revenues by products or services classes:

 

                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2022     2021     2022     2021  
DetermaRx™     40 %     32 %     53 %     40 %
Pharma Services     11 %     8 %     18 %     22 %
Licensing     49 %     60 %     29 %     38 %
Concentration risk, percentage     100 %     100 %     100 %     100 %

 

The following table presents the percentage of consolidated revenues attributable to geographical locations:

 

                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2022     2021     2022     2021  
United States     50 %     32 %     65 %     43 %
Outside of the United States – Pharma Services     2 %     8 %     5 %     19 %
Outside of the United States – Licensing     48 %     60 %     30 %     38 %
Concentration risk, percentage     100 %     100 %     100 %     100 %

 

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The following table presents accounts receivable, as a percentage of total consolidated accounts receivables, from third-party payers and other customers that provided in excess of 10% of Oncocyte’s total accounts receivable.

 

                 
    June 30, 2022     December 31, 2021  
Medicare for DetermaRx™     15 %     9 %
Medicare Advantage for DetermaRx™     80 %     65 %

 

As of December 31, 2021, our accounts receivable were $1.4 million. During the six months ending June 30, 2022, our accounts receivable increased by $3.5 million for revenues recognized, offset by cash collected of approximately $3.1 million (see Notes 2 and 3).

 

8. Income Taxes

 

The provision for income taxes for interim periods is determined using an estimated annual effective tax rate in accordance with ASC 740-270, Income Taxes, Interim Reporting. The effective tax rate may be subject to fluctuations during the year as new information is obtained, which may affect the assumptions used to estimate the annual effective tax rate, including factors such as valuation allowances against deferred tax assets, the recognition or de-recognition of tax benefits related to uncertain tax positions, if any, and changes in or the interpretation of tax laws in jurisdictions where Oncocyte conducts business.

 

In connection with the Razor acquisition discussed in Note 3, a change in the acquirer’s valuation allowance that stems from the purchase of assets should be recognized as an element of the acquirer’s income tax benefit in the period of the acquisition. Accordingly, for the three months ended March 31, 2021, Oncocyte recorded a $7.6 million partial release of its valuation allowance and a corresponding income tax benefit stemming from the estimated DTLs generated by the Razor intangible asset we acquired.

 

Oncocyte did not record any provision or benefit for income taxes for the six months ended June 30, 2022, as Oncocyte had a full valuation allowance for the periods presented.

 

A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Other than the partial releases discussed above, Oncocyte established a full valuation allowance for all periods presented due to the uncertainty of realizing future tax benefits from its net operating loss carry-forwards and other deferred tax assets.

 

In December 2017, the Tax Cuts and Jobs Act, or Tax Act, was signed into law. The Tax Act, among other things, contains significant changes to corporate taxation, including changes to the expensing of research and development expenses for tax years beginning after December 31, 2021. The changes will not have a material impact to the Company’s provision as the Company still expects to be in a taxable loss position.

 

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9. Right-of-use assets, machinery and equipment, net, and construction in progress

 

As of June 30, 2022 and December 31, 2021, right-of-use assets, machinery and equipment, net, and construction in progress were as follows (in thousands):

 

                 
    June 30, 2022
(unaudited)
    December 31, 2021  
             
Right-of-use assets (1)     3,499       3,499  
Machinery and equipment     8,841       6,501  
Accumulated depreciation and amortization     (3,621 )     (2,715 )
Right-of-use assets, machinery and equipment, net     8,719       7,285  
Construction in progress     2,857       1,242  
Right-of-use assets, machinery and equipment, net, and construction in progress     11,576       8,527  

 

Depreciation expense amounted to $384,000 and $206,000 for the three months ended June 30 2022 and 2021, and $671,000 and $327,000 for the six months ended June 30, 2022 and 2021, respectively.

 

10. Commitments and Contingencies

 

Oncocyte has certain commitments other than discussed in Note 3.

 

Office Lease Agreement

 

On December 23, 2019, Oncocyte entered into an Office Lease Agreement (the “Irvine Lease”) of a building containing approximately 26,800 square feet of rentable space located at 15 Cushing in Irvine, California (the “Premises”) that will serve as Oncocyte’s new principal executive and administrative offices and laboratory facility. Oncocyte completed the relocation of its offices to the Premises in January 2020 and subsequently constructed a laboratory at the Irvine facility to perform cancer diagnostic tests.

 

The Irvine Lease has an initial term of 89 calendar months (the “Term”), which commenced on June 1, 2020 (the “Commencement Date”). Oncocyte has an option to extend the Term for a period of five years (the “Extended Term”).

 

Oncocyte will pay base monthly rent in the amount of $61,640 during the first 12 months of the Term. Base monthly rent will increase annually, over the base monthly rent then in effect, by 3.5%. Oncocyte was entitled to an abatement of 50% of the base monthly rent during the first ten calendar months of the Term. If the Irvine Lease is terminated based on the occurrence of an “event of default,” Oncocyte will be obligated to pay the abated rent to the lessor.

 

If Oncocyte exercises its option to extend the Term, the initial base monthly rent during the Extended Term will be the greater of the base monthly rent in effect during the last year of the Term or the prevailing market rate. The prevailing market rate will be determined based on annual rental rates per square foot for comparable space in the area where the Premises are located. If Oncocyte does not agree with the prevailing market rate proposed by the lessor, the rate may be determined through an appraisal process. The base monthly rent during the Extended Term shall be subject to the same annual rent adjustment as applicable for base monthly rent during the Term.

 

In addition to base monthly rent, Oncocyte will pay in monthly installments (a) all costs and expenses, other than certain excluded expenses, incurred by the lessor in each calendar year in connection with operating, maintaining, repairing (including replacements if repairs are not feasible or would not be effective) and managing the Premises and the building in which the Premises are located (“Expenses”), and (b) all real estate taxes and assessments on the Premises and the building in which the Premises are located, all personal property taxes for property that is owned by lessor and used in connection with the operation, maintenance and repair of the Premises, and costs and fees incurred in connection with seeking reductions in such tax liabilities (“Taxes”). Subject to certain exceptions, Expenses shall not be increased by more than 4% annually on a cumulative, compounded basis.

 

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Oncocyte was entitled to an abatement of its obligations to pay Expenses and Taxes while constructing improvements to the Premises constituting “Tenant’s Work” under the Irvine Lease prior to the Commencement Date, except that Oncocyte was obligated to pay 43.7% of Expenses and Taxes during the period prior to the Commencement Date for its use of the second floor of the Premises, which was already built out as office space.

 

The lessor provided Oncocyte with a “Tenant Improvement Allowance” in the amount of $1.3 million to pay for the plan, design, permitting, and construction of the improvements constituting Tenant’s Work. The lessor retained 1.5% of the Tenant Improvement Allowance as an administrative fee as provided in the Irvine Lease. As of June 30, 2022, the lessor had provided $1.3 million of the total Tenant Improvement Allowance.

 

Oncocyte has provided the lessor with a security deposit in the amount of $150,000 and a letter of credit in the amount of $1.7 million. The lessor may apply the security deposit, in whole or in part, for the payment of rent and any other amount that Oncocyte is or becomes obligated to pay under the Irvine Lease but fails to pay when due and beyond any cure period. The lessor may draw on the letter of credit from time to time to pay any amount that is unpaid and due, or if the original issuing bank notifies the lessor that the letter of credit will not be renewed or extended for the period required under the Irvine Lease and Oncocyte fails to timely provide a replacement letter of credit, or an event of default under the Irvine Lease occurs and continues beyond the applicable cure period, or if certain insolvency or bankruptcy or insolvency with respect to Oncocyte occur. Oncocyte is required to restore any portion of the security deposit that is applied by the lessor to payments due under the Irvine Lease, and Oncocyte is required to restore the amount available under the letter of credit to the required amount if any portion of the letter of credit is drawn by the lessor. Commencing on the 34th month of the Term, (a) the amount of the letter of credit that Oncocyte is required to maintain shall be reduced on a monthly basis, in equal installments, to amortize the required amount to zero at the end of the Term, and (b) Oncocyte will have the right to cancel the letter of credit at any time if it meets certain market capitalization and balance sheets thresholds; provided, in each case, that Oncocyte is not in then default under the Irvine Lease beyond any applicable notice and cure period and the lessor has not determined that an event exists that would lead to an event of default.

 

To obtain the letter of credit, Oncocyte has provided the issuing bank with a restricted cash deposit that the bank will hold to cover its obligation to pay any draws on the letter of credit by the lessor. The restricted cash may not be used for any other purpose.

 

On August 27, 2021, Oncocyte entered into a lease agreement to add an additional suite to its Nashville office space, containing approximately 1,928 square feet of rentable space located at 2 International Plaza, Suite 103, Nashville TN. The term of the lease commences on October 1, 2021 and extends through April 9, 2024 and will serve as additional office space for Insight Genetics’s operations.

 

Application of leasing standard, ASC 842

 

The Irvine Lease is an operating lease under ASC 842 included in the tables below. The tables below provide the amounts recorded in connection with the application of ASC 842 as of, and during, the six months ended June 30, 2022, for Oncocyte’s operating and financing leases (see Note 2).

 

Under the Laboratory Agreement discussed in Note 3, Oncocyte assumed all of Razor’s Laboratory Agreement payment obligations. Although Oncocyte is not a party to any lease agreement with Razor or Encore, under the terms of the Laboratory Agreement, Oncocyte received the landlord’s consent for the use of the laboratory at Razor’s Brisbane, California location (the “Brisbane Facility”) under the terms of a sublease to which Encore is the sublessee. The sublease expires on March 31, 2023 (the “Brisbane Lease”). The laboratory fee payments to Encore include both laboratory services and the use of the Brisbane Facility. Under the provisions of the Laboratory Agreement, if Oncocyte terminates the Laboratory Agreement prior to the expiration of the Brisbane Lease, Oncocyte shall assume the costs related to the subletting or early termination of the Brisbane Lease. If the Laboratory Agreement were to be terminated on June 30, 2022, the aggregate payments due to the landlord for early cancellation of the Brisbane Lease would be approximately $117,000 (aggregate payments from July 1, 2022 through March 31, 2023). Oncocyte determined that the Laboratory Agreement contains an embedded operating lease for the Brisbane Facility, and Oncocyte allocated the aggregate payments to this lease component for purposes of calculating the net present value of the right-of-use asset and liability as of the inception of the Laboratory Agreement in accordance with ASC 842, as shown in the table below.

 

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Financing lease

 

As of June 30, 2022, Oncocyte has one financing lease remaining through December 2023 for certain laboratory equipment with aggregate remaining payments of $186,000 shown in the table below. Oncocyte’s lease obligations are collateralized by the equipment financed under the lease schedule.

 

Operating and Financing leases

 

The following table presents supplemental cash flow information related to operating and financing leases for the six months ended June 30, 2022 and 2021 (in thousands):

 

                 
    Six Months Ended  
    June 30,  
    2022     2021  
Cash paid for amounts included in the measurement of financing lease liabilities:            
Operating cash flows from operating leases     564       499  
Operating cash flows from financing leases     51       19  
Financing cash flows from financing leases     7       84  

 

The following table presents supplemental balance sheets information related to operating and financing leases as of June 30, 2022 and June 30, 2021 (in thousands, except lease term and discount rate):

 

                 
    June 30, 2022     June 30, 2021  
Operating lease                
Right-of-use assets, net   $ 2,343     $ 2,683  
                 
Right-of-use lease liabilities, current   $ 728     $ 252  
Right-of-use lease liabilities, noncurrent     3,075       4,092  
Total operating lease liabilities   $ 3,803     $ 4,344  
                 
Financing lease                
Machinery and equipment   $ 537     $ 537  
Accumulated depreciation     (391 )     (270 )
Machinery and equipment, net   $ 146     $ 267  
Current liabilities   $ 110     $ 118  
Noncurrent liabilities     60       170  
Total financing lease liabilities   $ 170     $ 288  
                 
Weighted average remaining lease term                
Operating lease     4.9 years       5.8 years  
Financing lease     1.5 years       2.4 years  
                 
Weighted average discount rate                
Operating lease     11.20 %     11.18 %
Financing lease     11.55 %     11.43 %

 

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Future minimum lease commitments are as follows (in thousands):

 

    Operating     Financing  
    Leases     Leases  
Year Ending December 31,                
2022     579       62  
2023     1,048       124  
2024     903       -  
2025     869       -  
2026     899       -  
Thereafter     695       -  
Total minimum lease payments   $ 4,992     $ 186  
Less amounts representing interest     (1,190 )     (16 )
Present value of net minimum lease payments   $ 3,803