Personalis, Inc. (PSNL) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes and other financial information included elsewhere in this Annual Report on Form 10-K. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. You should review the sections titled “Note Regarding Forward-Looking Statements” for a discussion of forward-looking statements and in Part I, Item 1A, “Risk Factors” for a discussion of factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and elsewhere in this Annual Report on Form 10-K.

Overview

We develop and market advanced cancer genomic tests and analytics. Our tests and analytics are used by pharmaceutical companies for translational research, biomarker discovery, the development of personalized cancer therapies, and we expect in the near future, for clinical trial enrollment. Our advanced tests are used by physicians to detect cancer recurrence, monitor cancer evolution, and uncover insights for therapy selection. We also provide sequencing and data analysis services to support population sequencing initiatives.

Today, our products are routinely used by many of the largest oncology-focused pharmaceutical companies for analysis of patient samples in their clinical trials and drug development programs. Our advanced genomic sequencing and analytics also support the development of personalized cancer vaccines and other next-generation cancer immunotherapies. For example, we are providing genomic testing to Moderna, Inc. ("Moderna") in its ongoing clinical trials evaluating a personalized cancer vaccine. In addition, we partner with diagnostics companies by providing our advanced tumor profiling and analysis capabilities as an input to their products. More recently, we launched new diagnostic offerings for the clinical setting and, in November 2023, entered into an agreement with Tempus AI, Inc. (formerly known as Tempus Labs, Inc., and referred to herein as "Tempus") to commercialize NeXT Personal Dx in the clinical diagnostics market. Finally, we have also pursued non-cancer related business opportunities, specifically within the population sequencing market, by providing whole genome sequencing ("WGS") services under contract with the U.S. Department of Veterans Affairs Million Veteran Program ("VA MVP").

As part of one of our new strategies for 2023 and beyond, we are working with a growing number of leading cancer centers and world-class academic research institutions to build and publish the clinical evidence-base to support our products and our key indications, as well as to obtain reimbursement coverage from Medicare and other payors. Because of the ultra-high analytical sensitivity of our technology, we are initially focusing on three indications: breast cancer, lung cancer, and immunotherapy (IO) monitoring. We have collaborations with Cancer Research UK, University College London, and the Francis Crick Institute (the TRACERx study); The Royal Marsden; the Vall d'Hebron Institute of Oncology (VHIO); Duke University; the Dana-Farber Cancer Institute; University Medical Center Hamburg-Eppendorf (also known as UKE); and Criterium and the Academic Breast Cancer Consortium that will focus on building the evidence-base for our technology and these indications. If the key opinion leaders ("KOLs") we are collaborating with have a positive experience using our products, we are optimistic this will support broader use of our products by other KOLs, as well as clinicians in the future.

Our work in oncology is underpinned by our experience and capacity for next-generation sequencing at scale. We have the capacity to sequence and analyze over 300 trillion bases of DNA per week in our facility. We believe that our capacity is already larger than most cancer genomics companies, and we continue to build automation and other infrastructure to scale further as demand increases. To date, we have sequenced more than 385,000 human samples, of which more than 175,000 were whole human genomes.

2023 Highlights

Total revenue increased 13%, or $8.4 million, during 2023 compared to 2022, primarily driven by higher revenue from enterprise sales and pharma tests. Revenue from enterprise sales was $31.7 million in 2023 compared to $26.6 million in 2022, an increase of 19%. Revenue from pharma tests was $31.9 million in 2023 compared to $29.6 million in 2022, an increase of 8%.

Key business accomplishments and financial updates in 2023 and early 2024 include:

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Received Medicare coverage for NeXT Dx.

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Amended Natera agreement to extend volume commitments through the end of 2024.

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Signed key partnership agreement with Tempus to commercialize NeXT Personal Dx in clinics or with oncologists.

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Established a partnership with Myriad to market ImmunoID NeXT.

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Completed the NeXT Personal Dx (LDT) early access launch.

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Presented compelling early-stage lung cancer clinical MRD data with TRACERx for NeXT Personal.

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Signed commercial agreement with Moderna to leverage NeXT platform in personalized mRNA cancer vaccine clinical trials.

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Reduced cash burn through headcount reduction of nearly 50%, resulting in an estimated $35 million in annual cost savings. Continued efforts to reduce expenses across the board.

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Factors Affecting Our Performance

We believe there are several important factors that we expect to impact our operating performance and results of operations, including:

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The continued development of the market for genomic-based tests. Our performance depends on the willingness of pharmaceutical companies, enterprise customers, and oncologists to continue to seek more comprehensive molecular information to develop more efficacious cancer therapies.

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Increasing adoption of our products and solutions by existing customers. Our performance depends on our ability to retain and broaden adoption with existing customers. Because our technology is novel, some customers begin using our products by initiating pilot studies involving a small number of samples to gain experience with our service. As a result, historically a significant portion of our revenue has come from existing customers. We believe that our ability to convert initial pilots into larger orders from existing customers has the potential to drive substantial long-term revenue. We expect there may be some variation in the number of samples they choose to test each quarter.

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Adoption of our products and solutions by new customers. While new customers initially may not account for significant revenue, we believe that they have the potential to grow substantially over the long term as they gain confidence in our service. Our ability to engage new customers is critical to our long-term success. Our publications, posters and presentations at scientific conferences lead to engagement at the scientific level with potential customers who often make the initial decision to gain experience with our products. Accessing these new customers through scientific engagement and marketing to gain initial buy-in is critical to our success and gives us the opportunity to demonstrate the utility of our products.

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Our revenue and cost are affected by the volume of samples we receive from customers from period to period. The timing and size of sample shipments received after orders have been placed is variable. Since sample shipments can be large, and are often received from a third party, the timing of arrival can be difficult to predict over the short term. Although our long-term performance is not affected, we see quarter-to-quarter volatility due to these factors. Samples arriving later than expected may not be processed in the quarter proposed and result in revenue the following quarter. Since many of our customers request defined turnaround times, we employ project managers to coordinate and manage the complex process from sample receipt to sequencing and delivery of results.

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Investment in product innovation to support growth. Investment in research and development, including the development of new products and capabilities is critical to establish and maintain our leading position. We have invested significantly in our NeXT platform, introducing new products and additional capabilities. We are also collaborating with KOLs to support the clinical utility of our products. We believe this work is critical to gaining customer adoption and expect our investments in these efforts to continue.

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Leverage our operational infrastructure. We have invested significantly in our sample processing capabilities and commercial infrastructure. With our current operating model and infrastructure, we can increase our production and commercialize new generations of our products. We expect to grow our revenue and spread our costs over a larger volume of services.

Components of Operating Results

Revenue

We derive our revenue from sales of advanced sequencing and analytics to the following four customer types:

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Pharma tests and services includes sales of testing services and data analytics for clinical trials and research to pharmaceutical companies in support of their drug development programs.

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Enterprise sales includes sales of tumor profiling and diagnostic tests directly to another business as an input to their products. Revenue from our partnership with Natera to provide advanced tumor analysis for use in Natera's MRD test currently makes up substantially all of the revenue in this category.

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Population sequencing includes sales of genomic sequencing services and data analytics to support large-scale genetic research programs. All of the revenue in this category is from our partnership with the VA MVP.

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Other includes sales of genomic tests and analytics to universities and non-profits. This category also includes sales of diagnostics tests ordered by healthcare providers for cancer patients, which was insignificant for periods presented.

Our ability to increase revenue will depend on our ability to further increase sales to these groups of customers, expand our customer base within each group, and expand our business in the clinical diagnostics market. To do this, we are developing a growing set of state-of-the-art services and products; advancing our operational infrastructure; building our regulatory credentials; focusing our marketing efforts on large pharmaceutical companies; building and publishing the clinical evidence-base to support our products and our key indications, as well as to obtain reimbursement coverage from Medicare and other payors; and seeking additional partnerships such

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as ours with Natera. We sell through a small direct sales force. In late 2023, we entered into an agreement with Tempus to commercialize NeXT Personal Dx in the clinical diagnostics market and will be leveraging Tempus' significantly larger sales force.

We have one reportable segment from the sale of sequencing and data analysis services. Most of our revenue to date has been derived from sales in the United States.

Costs and Expenses

Cost of Revenue

Cost of revenue consists of raw materials costs, personnel costs (salaries, bonuses, stock-based compensation, payroll taxes, and benefits), laboratory supplies and consumables, depreciation and maintenance on equipment, and allocated facilities and information technology (“IT”) costs. We expect variability in our gross margins over the medium-term due to fluctuations in customer mix and volume, investments in newer sequencing platforms and new capabilities such as automation of laboratory workflows, processing of diagnostic tests for the clinical market while we work to secure reimbursement, and costs related to our new Fremont facility. Over the long-term, we anticipate higher gross margins as growing revenue leads to economies of scale.

Research and Development Expenses

Research and development expenses consist of costs incurred for the research and development of our services and products and costs related to conducting studies and collaborations with partners to validate the clinical utility of our offerings. The expenses primarily consist of personnel costs (salaries, bonuses, stock-based compensation, payroll taxes, and benefits); laboratory supplies and consumables; costs of processing samples for research, product development, collaborations and studies; depreciation and maintenance on equipment; and allocated facilities and IT costs. We include in research and development expenses the costs to further develop software we use to operate our laboratory, analyze the data it generates, and automate our operations.

We expense our research and development costs in the period in which they are incurred. We expect research and development expenses to decrease as a result of our reductions in workforce initiated in 2023 and our closure of operations in China.

Selling, General and Administrative Expenses

Selling expenses consist of personnel costs (salaries, commissions, bonuses, stock-based compensation, payroll taxes, and benefits), customer support expenses, direct marketing expenses, and market research. Our general and administrative expenses include costs for our executive, accounting, finance, legal, and human resources functions. These expenses consist of personnel costs (salaries, bonuses, stock-based compensation, payroll taxes, and benefits), corporate insurance, audit and legal expenses, consulting costs, and allocated facilities and IT costs. We expense all selling, general and administrative costs as incurred.

Selling, general and administrative expenses have decreased significantly since the completion of our first quarter 2023 reduction in workforce. We expect expenses to remain around this lower level over the next couple of years.

Lease Impairment

We recognized an impairment loss for operating lease right-of-use assets as a result of the change in use of our Menlo Park facility during the third quarter of 2023.

Restructuring and Other Charges

Restructuring and other charges consists of charges in connection with our two reductions in workforce initiated in 2023 and charges in connection with the closure of our China operations.

Interest Income and Interest Expense

Interest income consists primarily of interest earned on our cash and cash equivalents and short-term investments. Interest expense is the recognition of imputed interest on noninterest bearing loans.

Other Income (Expense), Net

Other income (expense), net consists primarily of charges related to the issuance and remeasurement of warrants to Tempus during the year ended December 31, 2023. Otherwise, other income (expense), net consists primarily of foreign currency exchange gains and losses.

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Trend Financial Information

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto in Item 8 of Part II, “Financial Statements and Supplementary Data”. Historical results are not necessarily indicative of future results.

Results of Operations

This section generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 23, 2023, which is incorporated by reference herein.

Revenue

The following table shows revenue by customer type (in thousands):

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The following table shows customers that made up at least 10% of total revenue in each year presented:

Pharma tests and services

Revenue from pharma tests and services increased 8%, or $2.4 million, in 2023. Growth from new customers drove the revenue increase. Notably, three customers that were either new in 2023 or 2022, accounted for an increase of $3.8 million in revenue as these customers selected our advanced genomic tests for their clinical trials and research projects. Additionally, revenue from one of our customers developing personalized cancer therapies increased by $2.3 million. Those increases were partially offset by decreases in revenue from multiple customers due to non-recurring projects and variability in timing and spending levels on clinical trial projects in general.

Enterprise sales

Revenue from enterprise sales increased 19%, or $5.1 million, in 2023. This was due to an increase in the volume of samples we tested for Natera, partially offset by lower selling prices. The number of samples we processed for Natera increased by over 55% in 2023.

We amended our agreement with Natera during the fourth quarter of 2023 to extend minimum volume commitments through the end of 2024. Previously, Natera's volume commitments extended only through the first quarter of 2024. In addition, we plan to introduce a lower-cost version of our exome product offering for Natera in the first half of 2024 in order to support their price requirements, and we expect our total revenue from Natera in 2024 to decline, due to the lower prices.

Population sequencing

Population sequencing revenue is made up entirely of sales to the VA MVP. The increase in revenue was driven by an increase in samples we tested, which offset a nearly 50% reduction in selling prices in 2023 as compared to 2022.

Revenue recognized each period is also impacted by timing of our fulfillment of samples under each annual task order. Our annual task orders received in 2023, 2022, and 2021 were $7.5 million, $10.0 million, and $9.7 million, respectively. Our contract with the VA MVP does not include specific testing turnaround times. Therefore, we have the ability to modulate the volume of samples processed from the VA MVP up or down to complement sample volumes from other customers, which can vary from period to period. As of the end of 2023, our remaining unfulfilled task orders amounted to $7.4 million, which we expect to recognize as revenue within the next 12 months.

Costs and Expenses

Cost of revenue

The increase in cost of revenue of 7%, or $3.6 million, was primarily due to higher revenue levels (revenue increased 13% over the same period), partially offset by dedication of more laboratory resources to support sample processing required for clinical evidence generation, which is a non-revenue generating activity and thus reported as R&D expense. Specific components of the increase were a $4.9 million increase in direct material costs due to higher revenue levels, a $2.0 million increase in facilities and equipment costs (partly due to movement of our laboratory from our prior Menlo Park facility to the new Fremont facility), and a $2.0 million increase in laboratory supplies and consumables (enterprise customer orders require more supplies to process as compared to other customer categories); partially offset by a $5.3 million decrease in shared laboratory costs due to greater usage of our laboratory capacity for R&D activities.

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Research and development

Research and development expenses remained flat in 2023 as compared to 2022. Increases in costs associated with clinical evidence generation and collaborations, and increases in facility costs (as a result of the R&D function moving into our Fremont facility during 2023), were offset by cost savings from our reductions in workforce initiated in 2023.

Specific offsetting components of research and development expense include a $5.0 million increase in sample processing costs incurred in our laboratory for product development, collaborations, and clinical evidence generation, and a $2.2 million increase in facilities costs; offset by a $7.3 million decrease in personnel-related costs driven by our reductions in workforce.

Selling, general and administrative

The decrease in selling, general and administrative expenses of 22%, or $14.2 million was primarily due to cost savings from our reductions in workforce initiated in 2023.

Specific components of the decrease were a $11.7 million decrease in personnel-related costs driven by our reductions in workforce, a $5.1 million decrease in facilities costs as a result of the R&D function and additional lab teams moving into our Fremont facility and consequently receiving a share of such facility costs that were previously allocated to SG&A, and a $1.5 million decrease in professional services; partially offset by a $2.9 million increase in depreciation of office-related fixtures and furniture (driven by our Fremont headquarters), a $1.0 million increase in software and subscriptions costs, and a $0.2 million increase in marketing costs such as trade shows expenses.

Lease impairment

During the third quarter of 2023, we completed the move of our laboratory operations from our Menlo Park facility to our Fremont facility and began actively marketing the Menlo Park space for sublease. Accordingly, we evaluated the ongoing value of the operating lease right-of-use asset associated with the Menlo Park facility. Based on this evaluation, we determined that the right-of-use asset with a carrying amount of $6.7 million was no longer recoverable and was impaired and wrote it down to its estimated fair value of $1.1 million, which resulted in a noncash impairment loss of $5.6 million. Estimated fair value was based on expected future sublease cash flows (with the assistance of a third-party real estate broker), net of brokerage commissions and estimated tenant incentives, discounted at a market rate of return on similar assets. The estimation of fair value also included expected downtime prior to the commencement of a future sublease.

Restructuring and other charges

During 2023, we initiated two rounds of workforce reductions to reduce our cash burn and increase operating efficiencies. Combined, our headcount was reduced by almost 50% from 2022 levels. We also closed our China operations.

The $8.1 million in restructuring and other charges recognized in 2023 is comprised of $7.5 million in one-time employee termination benefits (including costs related to termination of our former China employees) and $0.6 million of other noncash charges (primarily asset disposals and impairments in connection with the closure of our China operations).

Interest Income, Interest Expense and Other Income (Expense), Net

Interest income and interest expense

The increase in interest income was due to increased yields on our investments. Interest expense is the recognition of imputed interest on noninterest bearing loans.

Other income (expense), net

In connection with our November 2023 agreement with Tempus, we issued two warrants to purchase, in the aggregate, up to 9,218,800 shares of our common stock. If Tempus acquires any shares of common stock directly from us other than by exercising the warrants, then the total number of shares issuable upon exercise of the warrants will be reduced by such shares. Because the number of shares issuable upon settlement are subject to adjustment, the warrants are classified as liability instruments and are subject to remeasurement at each balance sheet date, with changes in fair value recognized as other income (expense). Additionally, since the initial fair value of the warrants of $6.9 million exceeded the total proceeds received from Tempus of $6 million, a loss of $0.9 million was immediately recognized within other income (expense).

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Fair value of the warrants increased by $3.1 million as of December 31, 2023. The increase in fair value, plus the immediate loss of $0.9 million recognized upon issuance, resulted in a $4.0 million expense recognized in other income (expense), net during the year ended December 31, 2023.

During 2022 and 2021, other income (expense), net consisted mainly of foreign currency remeasurements.

Liquidity and Capital Resources

The following table presents selected financial information (in thousands):

From our inception through December 31, 2023, we have funded our operations primarily from $279.0 million in net proceeds from our follow-on equity offerings in August 2020 and January 2021, $144.0 million in net proceeds from our IPO in June 2019, $89.6 million from issuance of redeemable convertible preferred stock, $3.5 million in net proceeds from our ATM facility (see Note 2, Summary of Significant Accounting Policies), as well as cash from operations and debt financings. As of December 31, 2023, we had cash and cash equivalents of $57.0 million and short-term investments of $57.2 million.

We have incurred net losses since our inception. We anticipate that our current cash and cash equivalents and short-term investments, together with cash provided by operating activities, are sufficient to fund our near-term capital and operating needs for at least the next 12 months.

We have based these future funding requirements on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. If our available cash balances and anticipated cash flow from operations are insufficient to satisfy our liquidity requirements, including because of lower demand for our services or other risks described in this Annual Report on Form 10-K, we may seek to sell additional common or preferred equity or convertible debt securities, enter into an additional credit facility or another form of third-party funding or seek other debt financing. We filed a sales agreement prospectus in December 2023 pursuant to which we may offer and sell up to $50.0 million of shares of our common stock through our ATM facility. The sale of equity and convertible debt securities may result in dilution to our stockholders and, in the case of preferred equity securities or convertible debt, those securities could provide for rights, preferences or privileges senior to those of our common stock. The terms of debt securities issued or borrowings pursuant to a credit agreement could impose significant restrictions on our operations. Additional capital may not be available on reasonable terms, or at all.

Our short-term investments portfolio is primarily invested in highly rated securities, with the primary objective of minimizing the potential risk of principal loss. Our investment policy generally requires securities to be investment grade and limits the amount of credit exposure to any one issuer.

As of December 31, 2023, cash and cash equivalents held by foreign subsidiaries was $1.2 million, most of which was held by our China subsidiary. During the first half of 2023, we closed our China operations and, in February 2024, we completed the dissolution of the China entity and repatriated all cash that was held at the entity back to our headquarters.

Cash Flows

The $14.0 million decrease in cash used in operating activities during 2023 as compared to 2022 was primarily due to lower spend on operating expenses (particularly lower payroll expenses after our reductions in workforce initiated in 2023), higher customer deposits received (mostly in connection with our agreement with Moderna to support its ongoing clinical trials evaluating a personalized cancer vaccine), and efficient management of working capital; partially offset by lower landlord contributions received during 2023 versus 2022 in connection with our Fremont facility build-out.

The $39.4 million decrease in cash provided by investing activities during 2023 as compared to 2022 was due to significantly lower net proceeds from short-term investment maturities, partially offset by a $39.0 million reduction in capital expenditures.

The $9.7 million increase in cash provided by financing activities during 2023 as compared to 2022 was driven by $6 million in proceeds from issuance of warrants to Tempus and $3.5 million in net proceeds from sales of common stock under our ATM facility, both of which did not occur during 2022.

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Material Cash Requirements

Our material cash requirements in the short- and long-term consist primarily of variable costs of revenue, operating expenditures, capital expenditures, property leases, and other. We plan to fund our material cash requirements with our existing cash and cash equivalents and short-term investments, which amounted to $114.2 million as of December 31, 2023, as well as anticipated cash receipts from customers. To fund our material cash requirements in the short- and long-term, we may also seek to sell additional common or preferred equity or convertible debt securities, enter into an additional credit facility or another form of third-party funding or seek other debt financing.

Variable costs of revenue. From time to time in the ordinary course of business, we enter into agreements with vendors for the purchase of raw materials, laboratory supplies and consumables to be used in the sequencing of customer samples. However, we generally do not have binding and enforceable purchase orders beyond the short term, and the timing and magnitude of purchase orders beyond such period is difficult to accurately project. We currently expect spending in this area to increase in 2024 relative to 2023 to support expected higher levels of revenue.

Operating expenditures. Our primary use of cash relates to employee compensation, spend on professional services, spend related to research and development projects, and other costs related to our research and development, selling, general and administrative functions. We currently expect to decrease our spend in these areas as a result of our workforce reductions initiated in 2023. On a long-term basis, we manage future cash requirements relative to our long-term business plans.

Capital expenditures. Capital expenditures are expected to decrease from 2023 levels as we have completed significant laboratory capacity additions. Going forward, our capital expenditures are expected to consist primarily of laboratory equipment and computer equipment. We currently expect capital expenditures to be approximately $1 million in 2024 and between $4 million to $6 million in each of the years 2025 and 2026.

Property leases. Our noncancelable operating lease payments were $78.6 million as of December 31, 2023. The timing of these future payments, by year, can be found in Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements in Note 7, “Leases.”

Other. As of December 31, 2023, we have an outstanding noninterest bearing loan that was used to finance the purchase of equipment for our laboratory. We owe a total of $2.5 million, with half of that amount owed in 2024 and the other half in 2025. Additionally, we had an outstanding noninterest bearing loan that was used to finance the purchase of internal use software licenses and related ongoing support. We will make a payment of $0.4 million in September 2024 to pay off this loan. Further discussion of this loan can be found in Part II, Item 8 of this Form 10-K in the Notes to Consolidated Financial Statements in Note 6, “Loans.”

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with revenue recognition, leases, and common stock warrants have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.

Revenue Recognition

We generate our revenue from selling sequencing and data analysis services. We agree to provide services to our customers through a contract, which may be in the form of a combination of a signed agreement, statement of work and/or a purchase order.

We have evaluated the performance obligations contained in contracts with customers to determine whether any of the performance obligations are distinct, such that the customers can benefit from the obligations on their own, and whether the obligations can be separately identifiable from other obligations in the contract. For the significant majority of our contracts to date, the customer orders a specified quantity of a sequencing; therefore, the delivery of the ordered quantity per the purchase order is accounted for as one performance obligation. Our contracts include only one performance obligation—the delivery of the sequencing and data analysis services to the customer.

Fees for our sequencing and data analysis services are predominantly based on a fixed price per sample. The fixed prices identified in the arrangements only change if a pricing amendment is agreed with a customer. In limited cases we provide our customers a discount if samples received above a certain volume are purchased. In such cases, the discount applies prospectively. We have analyzed such discounts if they represent a material right provided to a customer. We have concluded that such discounts generally do not represent a material right provided to a customer since they are not deemed to be incremental to the pricing offered to the customer or are not enforceable options to acquire additional goods. As a result, these discounts do not constitute a material right and do not meet the definition of a separate performance obligation, except in limited instances. We do not offer retrospective discounts or rebates.

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Accordingly, all of the transaction price, net of any discounts, is allocated to one performance obligation. Therefore, upon delivery of the services, there are no remaining performance obligations.

Leases

Lease liabilities are recognized at the present value of the fixed lease payments, reduced by landlord incentives, using a discount rate based on our current borrowing rate at the lease commencement date (the incremental borrowing rate), unless the rate implicit in the lease is readily determinable.

In August 2021, we entered into a 13.5-year lease for our new corporate headquarters in Fremont, California. We estimated our incremental borrowing rate as the rate implicit in the lease was not readily determinable. To determine the incremental borrowing rate, we estimated our credit rating by comparing certain financial ratios and metrics of the Company to those of other issuers with publicly-available credit ratings from Standard & Poor’s (S&P). We then adjusted yields from publicly traded corporate bonds of companies of similar size and credit rating over a term approximating the term of our lease for the nature of the collateral. Our concluded incremental borrowing rate for this lease was 5.8%, which resulted in a lease liability and right-of-use asset of $44.7 million.

In September 2022, the lease commencement date for our new facility in Fremont, California was delayed from the original intended date due to delays in the completion of the work necessary for us to move into the facility, which resulted in a reassessment of the lease term and consequently a remeasurement of the lease liability and corresponding adjustment to the carrying amount of the right-of-use asset based on an updated incremental borrowing rate. We estimated our incremental borrowing rate by using the same method described above and concluded that the incremental borrowing rate for the remeasured lease was 10.5%. The lease reassessment resulted in a $12.9 million reduction to right-of-use assets in 2022. The increase in our estimated borrowing rate between August 2021 and September 2022 mostly reflects the higher interest rate environment in 2022 as compared to 2021.

During the third quarter of 2023, we completed the move of our laboratory operations from our Menlo Park facility to our Fremont facility and began actively marketing the Menlo Park space for sublease. Accordingly, we evaluated the ongoing value of the operating lease right-of-use asset associated with the Menlo Park facility. Based on this evaluation, we determined that the right-of-use asset with a carrying amount of $6.7 million was no longer recoverable and was impaired and wrote it down to its estimated fair value of $1.1 million, which resulted in a noncash impairment loss of $5.6 million. Estimated fair value was based on expected future sublease cash flows (with the assistance of a third-party real estate broker), net of brokerage commissions and estimated tenant incentives, discounted at a market rate of return on similar assets. The estimation of fair value also included expected downtime prior to the commencement of a future sublease.

Common Stock Warrants

In November 2023, we entered into an agreement with Tempus to commercialize NeXT Personal Dx in the clinical diagnostics market. In connection with this agreement, we issued to Tempus two warrants to purchase, in the aggregate, up to 9,218,800 shares of our common stock. If Tempus acquires any shares of common stock directly from us other than by exercising the warrants, then the total number of shares issuable upon exercise of the warrants will be reduced by such shares. Because the number of shares issuable upon settlement are subject to adjustment, the warrants are classified as liability instruments and are subject to remeasurement at each balance sheet date, with changes in fair value recognized as other income (expense).

The Black-Scholes option-pricing model was used to estimate fair value of the warrants issued to Tempus at the date of issuance, November 28, 2023, and at each subsequent balance sheet date. Estimating fair value using the Black-Scholes option-pricing model requires a number of assumptions. Changes in the assumptions can materially affect the fair value and ultimately how much other income (or expense) is recognized. The inputs generally require analysis to develop.

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Expected Term—The expected term assumption represents the contractual period of each of the two warrants.

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Expected Volatility—Expected volatility was based on the Company's actual historical volatility over the expected terms of the warrants.

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Expected Dividend Yield—The Black-Scholes option-pricing valuation model calls for a single expected dividend yield as an input. We currently have no history or expectation of paying cash dividends on our common stock.

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Risk-Free Interest Rate—The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon issues similar in duration to the expected term of the warrants.

Recent Accounting Pronouncements

See the sections titled “Summary of Significant Accounting Policies—Recent Accounting Pronouncements” in Note 2 to our consolidated financial statements for additional information.