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-developed tests (“LDTs”) 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. Oncocyte holds 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™ (see Note 7).

On January 31, 2020 (the “Merger Date”), Oncocyte completed its acquisition of Insight Genetics, Inc. (“Insight”) through a merger with a newly incorporated wholly-owned subsidiary of Oncocyte (the “Merger”) under the terms of an Agreement and Plan of Merger (the “Merger Agreement”). Prior to the 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. This new class of drugs modulate the immune response and show activity in multiple solid tumor types including non-small cell lung cancer (NSCLC), and triple negative breast cancer (TNBC). 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 has also performed assay development and clinical testing services for pharmaceutical and biotechnology companies. The Merger has been accounted for using the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, which requires, among other things, that the assets and liabilities assumed be recognized at their fair values as of the acquisition date. See Note 5 for a full discussion of the Merger.

Oncocyte is currently devoting substantially all of its efforts on developing and commercializing its cancer diagnostic tests DetermaRx™ and DetermaIO™.

Liquidity

Oncocyte has incurred operating losses and negative cash flows since inception and had an accumulated deficit of $110.6 million as of June 30, 2020. 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 for the six months ended June 30, 2020 were not sufficient to cover Oncocyte’s operating expenses for that period. Since inception, Oncocyte has financed its operations through the sale of common stock, warrants, warrant exercises, bank loans, and sales of Lineage Cell Therapeutics, Inc. (“Lineage”) common shares that it holds as marketable equity securities. Lineage also provided Oncocyte with accounting, billing, bookkeeping, payroll, treasury, payment of accounts payable, and other similar administrative services, and the use of Lineage office and laboratory facilities, under a Shared Facilities and Services Agreement (the “Shared Facilities Agreement”), which was terminated as to all services on September 30, 2019, and as to all use of facilities on December 31, 2019 (see Note 8). Lineage’s ownership interest in Oncocyte has decreased to below 10% and Lineage no longer exercises significant influence over the operations and management of Oncocyte.

On March 20, 2020, Oncocyte entered into an Equity Distribution Agreement with Piper Sandler & Co for an at-the-market sales agreement (“ATM Agreement”) with Piper Sandler & Co. as “Sales Agent”. Oncocyte may raise up to $25 million of additional equity capital through the sale of shares of Oncocyte common stock from time to time in at-the-market transactions under the ATM Agreement.

Oncocyte believes that its current cash, cash equivalents and marketable equity securities, and its access to additional capital through the ATM Agreement are sufficient to carry out current operations through at least twelve months from the issuance date of the condensed consolidated interim financial statements included in this Report.

Oncocyte will need to raise additional capital to finance its operations, including the development and commercialization of its cancer diagnostic tests, until such time as it is able to generate sufficient revenues from the commercialization of one or more of its cancer diagnostic tests to cover its operating expenses. Presently, Oncocyte is devoting substantially all of its efforts on initial commercialization efforts for DetermaRx™ and completing development and planning commercialization of its cancer diagnostic test 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. While Oncocyte plans to primarily market its diagnostic 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 diagnostic 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 cancer 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™ or any other future diagnostic tests that Oncocyte may develop or acquire. The availability of financing and Oncocyte’s ability to generate revenues from operating activities may be adversely impacted by the COVID-19 pandemic which could continue to cause deferrals of cancer surgeries that might otherwise have resulted in the utilization of DetermaRx, and which 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 favorable 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 balance sheet as of December 31, 2019 was derived from the audited consolidated financial statements at that date, but does not include all the information and footnotes required by GAAP. These 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, 2019.

Prior to January 1, 2020, to the extent Oncocyte did not have its own employees or human resources for its operations, Lineage or Lineage subsidiaries provided certain employees for administrative or operational services, as necessary, for the benefit of Oncocyte (see Note 8). Lineage allocated expenses such as salaries and payroll related expenses incurred and paid on behalf of Oncocyte based on the amount of time that particular employees devoted to Oncocyte affairs. Other expenses such as legal, accounting, human resources, marketing, travel, and entertainment expenses were allocated to Oncocyte to the extent that those expenses were incurred by or on behalf of Oncocyte. Lineage also allocated certain overhead expenses such as facilities rent, utilities, property taxes, insurance, and internet and telephone expenses based on a percentage determined by management. These allocations have been made based upon activity-based allocation drivers such as time spent, percentage of square feet of office or laboratory space used, and percentage of personnel devoted to Oncocyte’s operations or management. Management has evaluated the appropriateness of the percentage allocations on a periodic basis and believes that this basis for allocation is reasonable.

Principles of consolidation

On January 31, 2020, with the consummation of the Merger, Insight became Oncocyte’s wholly owned subsidiary and on that date Oncocyte began consolidating Insight’s operations and results with its own operations and results (see Note 5).

The accompanying 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 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.

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.

During the COVID-19 pandemic, Oncocyte may not be able to maintain its preferred level of physician or customer outreach and marketing of its diagnostic testing and pharma services, which could negatively impact potential new customers’ interest in those tests and services. Because of COVID-19, travel, visits, and in-person meetings related to Oncocyte’s business have been severely curtailed or canceled and Oncocyte has instead used on-line or virtual meetings to meet with potential customers and others.

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 diagnostic testing and pharma services and resulting revenues. Concerns over available hospital, staffing, equipment, and other resources, and the risk of exposure to the virus, has led to early stage lung cancer surgeries being delayed, and the continued deferral of lung cancer surgeries could result in delayed or reduced use of DetermaRx™ in the near term.

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.

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 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, assumptions related to the 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.

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. While Oncocyte considered known or expected impacts of COVID-19 in making its assessments and estimates, the future impacts of COVID-19 are not presently determinable and could cause actual results to differ materially from Oncocyte’s estimates and assessments. Oncocyte’s future analysis or forecast of COVID-19 impacts could lead to changes in Oncocyte’s future estimates and assessments which could result in material impacts to Oncocyte’s consolidated financial statements in future reporting periods.

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:

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 quoted on the NYSE American as of the acquisition date. 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.

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”) and CMS 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 5 and 6).

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 5 and 6. As of June 30, 2020, there has been no impairment of goodwill and intangible assets.

Obligations related to royalties

Certain of Oncocyte’s asset and business acquisitions involve the potential for future payment of consideration to third-parties and former selling shareholders that is contingent upon the royalty payments that would be due on future net revenues generated from diagnostic tests, subject to annual minimums to the licensors, as defined in the applicable agreements. The fair value of such liabilities is determined at the acquisition date 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 5 and 7).

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 share of earnings or losses from the investment. The equity method investment balance is shown in noncurrent assets on the condensed balance sheets.

Oncocyte reviews investments accounted for under the equity method for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment may not be fully recoverable. If a determination is made that an “other-than-temporary” impairment exists, Oncocyte writes down its investment to fair value. On September 30, 2019, Oncocyte acquired a 25% ownership interest in Razor accounted for under the equity method of accounting as further discussed in Note 7.

Impairment of long-lived assets

Oncocyte assesses the impairment of long-lived assets, which consist primarily of right-of-use assets for operating leases, machinery and equipment, whenever events or changes in circumstances indicate that such assets might be impaired and the carrying value may not be recoverable. 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 asset’s carrying value over its fair value is recorded.

As part of Oncocyte’s impairment assessment of its long-lived assets, Oncocyte determined that certain assets, mainly comprised of machinery and equipment and related prepaid service agreements used in the development of DetermaDx™ were impaired as of June 30, 2020 because Oncocyte determined to discontinue the development of that diagnostic test. Accordingly, Oncocyte recorded a noncash charge of $422,000 representing the net book value of those assets as of that date and included that charge in research and development expenses for the three and six months ended June 30, 2020 (see Note 4).

Revenue recognition

Prior to January 1, 2020, Oncocyte generated no revenues. Effective on January 1, 2020, Oncocyte adopted the revenue recognition standard ASC Topic 606, Revenue from Contracts with Customers (ASC) 606. 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.

Pharma services revenue

Revenues recognized during the three and six months ended June 30, 2020, were generated primarily from pharma services performed by Oncocyte’s Insight subsidiary. Insight provides a range of molecular diagnostic services to its pharmaceutical customers (referred to as “pharma services”) including testing for biomarker discovery, assay design and development, clinical trial support, and a broad spectrum of biomarker tests in its CLIA-certified laboratory. These pharma services are generally performed under individual scope of work (“SOW”) arrangements with specific deliverables defined by the customer. Pharma services are generally performed on a time and materials basis. Upon Insight’s completion of the service to the customer in accordance with the SOW, Insight has the right to bill the customer for the agreed upon price (either on a per test or per deliverable basis) and recognizes the pharma service revenue at that time. Insight identifies each sale of its pharma service offering as a single performance obligation.

Completion of the service and satisfaction of the performance obligation under a SOW 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 SOW. However, for certain SOWs under which work is performed pursuant to the customer’s highly customized specifications, Insight has the enforceable right to bill the customer for work completed, rather than upon completion of the SOW. For those SOWs, Insight recognizes revenue over a period of time 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 Insight satisfies the performance obligation under the SOW, 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 Onocyte’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.

Insight 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, and historical experience. If circumstances related to customers change, estimates of the recoverability of receivables would be further adjusted. Insight 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, 2020, Oncocyte has not recorded any losses or allowance for doubtful accounts on its account receivables from pharma services.

As of June 30, 2020, Oncocyte had accounts receivable and contract assets from pharma services customers of $79,000 and $27,000, respectively.

DetermaRx™ testing revenue

In the first quarter of 2020, Oncocyte commercially launched DetermaRx™ and commenced performing tests on clinical samples through orders received from physicians, hospitals and other healthcare providers. In determining whether all of 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 delivered or made available to the physician electronically and, as such, there are no shipping or handling fees incurred by Oncocyte or billed to customers. Oncocyte recognizes revenue on a cash basis rather than accrual basis when it cannot conclude that all the revenue recognition criteria have been met. Because there are no current reimbursement arrangements with government or third-party payers, the transaction price represents variable consideration. Application of the constraint for variable consideration is an area that requires significant judgment. Oncocyte currently is unable to conclude that significant reversal of revenue will not occur based on uncertainty of payment of any amount. Oncocyte expects to recognize revenue on a cash basis until it has a sufficient history to reliably estimate payment patterns or has contractual reimbursement arrangements, or both, in place. On April 30, 2020, Palmetto GBA, a Medicare Administrative Contractor for the Centers for Medicare & Medicaid Services (“CMS”), issued a final local coverage decision for DetermaRx™ which makes the test eligible for Medicare reimbursement for diagnostic services performed on or after June 14, 2020. Oncocyte has not yet been informed of CMS’ pricing decision for reimbursement. After a final Medicare coverage price has been established and while Medicare coverage is in effect, Oncocyte expects to recognize revenue when DetermaRx™ tests are performed for Medicare patients rather than on a cash basis.

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 pharma services and DetermaRx™ tests, and license fees due to third parties, and also include amortization of acquired 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 performing diagnostic tests and pharma services are recorded as the tests or services are performed regardless of whether revenue was recognized with respect to that test or pharma service. 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. As discussed above, Oncocyte generated no revenues or cost of revenues prior to January 1, 2020.

Research and development expenses

Research and development expenses are comprised of costs incurred to develop technology, and 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. For periods prior to January 1, 2020, indirect research and development expenses included overhead costs incurred and allocated by Lineage to Oncocyte under the Shared Facilities Agreement as expenses that benefited or supported Oncocyte’s research and development functions. The Shared Facilities Agreement was terminated as of December 31, 2019 (see Note 8).

General and administrative expenses

General and administrative expenses include both direct expenses incurred by Oncocyte and, prior to January 1, 2020, indirect overhead costs incurred by Lineage and allocated to Oncocyte under the Shared Facilities Agreement as expenses that benefited or supported Oncocyte’s general and administrative functions. Direct 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. Indirect general and administrative expenses allocated by Lineage to Oncocyte under the Shared Facilities Agreement, which was terminated as of December 31, 2019 (see Note 8), were primarily based on headcount or space occupied, as applicable, and include costs for financial reporting and compliance, rent and utilities, common area maintenance, telecommunications, property taxes, and insurance.

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. Prior to January 1, 2020, a portion of the expenses allocated by Lineage under the Shared Facilities Agreement were designated by Oncocyte as sales and marketing expenses to the extent Oncocyte determined that such expenses were fairly allocable to sales and marketing functions, including overhead.

Accounting for Lineage and AgeX shares of common stock

Oncocyte accounts for the Lineage and AgeX shares of common 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 and 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, 2020 and December 31, 2019, 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 $341,000 and $379,000, respectively.

Net loss per common share

All potentially dilutive common stock equivalents are antidilutive because Oncocyte reported a net loss for all periods presented. The following common stock equivalents were excluded from the computation of diluted net loss per common share of common stock for the periods presented because including them would have been antidilutive (in thousands):

Leases

On January 1, 2019, Oncocyte adopted Accounting Standards Update 2016-02, Leases (Topic 842, “ASC 842”) using the modified retrospective method. Oncocyte management 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 statements of operations. When determining whether a lease is a finance lease or an operating lease, ASC 842 does not specifically define criteria to determine “major part of remaining economic life of the underlying asset” and “substantially all of the fair value of the underlying asset.” For lease classification determination, Oncocyte continues to use (i) 75% or greater to determine whether the lease term is a major part of the remaining economic life of the underlying asset and (ii) 90% or greater to determine whether the present value of the sum of lease payments is substantially the fair value of the underlying asset. Oncocyte uses either the rate implicit in the lease or its incremental borrowing rate as the discount rate in lease accounting, as applicable. Operating leases require the recognition of right-of-use (“ROU”) assets and lease liabilities on the balance sheet.

The adoption of ASC 842 did not have a material impact to Oncocyte’s financial statements because Oncocyte did not have any significant operating leases at the time of adoption. During 2019, Oncocyte entered into various operating leases and an embedded operating lease in accordance with ASC 842 discussed in Note 13. Oncocyte’s accounting for financing leases (previously referred to as “capital leases”) remained substantially unchanged. Financing leases are included in machinery and equipment, and in financing lease liabilities, current and noncurrent, in Oncocyte’s condensed balance sheets (see Note 13).

Recently issued accounting pronouncements not yet adopted

The recently issued accounting pronouncements applicable to Oncocyte that are not yet effective are disclosed in Oncocyte’s Annual Report on Form 10-K for the year ended December 31, 2019.

3. Selected Balance Sheet Components

Restricted cash

ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents and restricted cash, and that restricted cash be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statements of cash flows. Prior to the adoption of ASU 2016-18, restricted cash was not included with cash and cash equivalents on the statements of cash flows.

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheet dates that comprise the total of the same such amounts shown in the condensed consolidated statements of cash flows for all periods presented in accordance with ASU 2016-18 (in thousands):

Prepaid expenses and other current assets

As of June 30, 2020 and December 31, 2019, prepaid expenses and other current assets were comprised of the following (in thousands):

Deposits and other noncurrent assets

As of June 30, 2020 and December 31, 2019, deposits and other noncurrent assets were comprised of the following (in thousands):

Accrued expenses and other current liabilities

As of June 30, 2020 and December 31, 2019, accrued expenses and other current liabilities were comprised of the following (in thousands):

4. Right-of-use assets, machinery and equipment, net

As of June 30, 2020 and December 31, 2019, rights-of-use assets, machinery and equipment, net were as follows (in thousands):

Depreciation expense amounted to $67,000 and $84,000 for the three months ended June 30, 2020 and 2019, and $127,000 and $194,000 for the six months ended June 30, 2020 and 2019, respectively. Accumulated depreciation and amortization as of June 30, 2020 reflects a noncash impairment charge of $333,000 representing the net book value of certain machinery and equipment primarily used in the discontinued DetermaDx™ development program (see Note 2); the noncash charge is included in research and development expenses in the consolidated statements of operations for the three and six months ended June 30, 2020.

5. Acquisition of Insight

On January 31, 2020, Oncocyte completed its acquisition of Insight pursuant to the Merger Agreement.

Merger Consideration at Closing

Under the terms of the 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 Merger Date but were placed in an escrow account and will 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 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 Merger Agreement.

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) a $1.5 million 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.

Revenue Share (Royalty Contingent Consideration)

As additional consideration for Insight’s shareholders, the 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.

Registration Rights

Pursuant to the Merger Agreement, Oncocyte agreed to file a registration statement with the SEC and to use reasonable efforts to register under the Securities Act the resale of the shares of common stock issued in connection with the Merger within six months following the closing.

Workforce

In connection with the closing of the 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 Merger were canceled on the Merger Date for no consideration. At the 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”.

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 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 Merger. As such, this was classified as Level 3 fair value hierarchy measurements and disclosures in accordance with ASC 820.

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 Merger Date, with the excess recorded as goodwill (in thousands):

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

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

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 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 12).

Customer relationships – Insight provided a range of molecular diagnostic services to its pharmaceutical customers referred to as “pharma services,” including testing for biomarker discovery, assay design and development, clinical trial support and a broad spectrum of biomarker tests in its CLIA-certified laboratory. 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 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 12).

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, Leases. 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 favorable or unfavorable terms of the lease when compared with market terms. Since the Nashville Lease was renewed by Insight in proximity to the Merger Date, the terms of the Nashville Lease were considered by Oncocyte to be market terms at the Merger Date. Accordingly, Oncocyte measured the net present value of the remaining contractual Nashville Lease payments as of the 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 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 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 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 Merger which Oncocyte valued and recorded as part of Contingent Consideration as of the 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 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 Merger Date contractual payment amounts, as applicable, and the corresponding fair value of each respective Contingent Consideration liability (in thousands):

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 12% 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 Merger Date will be 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 47%. 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 Merger Date will be 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, 2020, based on Oncocyte’s reassessment of the significant assumptions note above, there was no change to the fair value of the Contingent Consideration since the Merger Date.

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 6).

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

6. Goodwill and Intangible Assets, net

At June 30, 2020 and December 31, 2019, goodwill and intangible assets, net, consisted of the following (in thousands):

7. Equity Method Investment in 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 “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

Oncocyte has 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”). If the issuance of shares of Oncocyte common stock having a market value of $5 million would exceed the number of shares issuable without shareholder approval under applicable stock exchange rules, Oncocyte may deliver a number of shares of common stock that would not exceed 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 $5 million.

Oncocyte has 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™. Even if DetermaRx™ clinical trial milestones are not met within the time frame referenced in the Purchase Agreement and the Minority Purchase Agreements, Oncocyte will have the option, but not the obligation, to purchase the balance of the outstanding Razor common stock from Encore and the Minority Shareholders for the Additional Purchase Payment that would be applicable if the milestones were met. Oncocyte’s obligations to purchase the Razor shares from Encore and the Minority Shareholders are subject to the satisfaction of certain conditions customary for a transaction of this kind.

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 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”).

Oncocyte will be responsible for all expenses for the Clinical Trial that exceed the Clinical Trial Expense Reserve 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 be up to $12 million for Oncocyte’s portion.

The Development Agreement provides for certain payments by Oncocyte to Encore if certain product reimbursement, Clinical Trial, and financing milestones are attained. Oncocyte has paid Encore $1 million in cash as a milestone payment for the receipt of a preliminary positive coverage decision from the Centers for Medicare and Medicaid Services Molecular Diagnostic Services Program (“CSM/MolDx”) for DetermaRx™ (the “Preliminary Coverage Milestone Payment”). In June 2020, following Razor’s receipt of a positive final coverage decision from CMS/MolDx for reimbursement of patient costs of DetermaRx™, Oncocyte paid Encore $4 million (“CMS Final Milestone Payment”). Oncocyte accounted for those milestone payments as part of its equity method investment in Razor.

Upon completion of enrollment 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 our common stock having a market value of $3 million would require us to issue a number of shares that, when combined with any shares we 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.

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™.

Oncocyte will make royalty payments to Encore and the Minority Shareholders based on the net cash revenues actually collected from the commercialization of DetermaRx™, less certain related costs including certain payments by Oncocyte to third parties as royalties and revenue share payments owed by Razor to third parties with respect to revenues from the commercialization of DetermaRx™. The initial royalty rate payable to Encore and the Minority Shareholders will be a low double-digit percentage and will decline as certain cumulative net revenue benchmarks are reached, with a single digit royalty rate payable to them as the benchmarks are attained. Royalties will be payable to Encore and the Minority Shareholders on a quarterly basis.

Laboratory Agreement

Under the Laboratory Agreement, Oncocyte has assumed Razor’s Laboratory Agreement payment obligations of $450,000 per year (see Note 13). 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 after it completes the purchase of the shares of Razor common stock from Razor stockholders pursuant to the Purchase Agreement and Minority Purchase Agreements. 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.

Accounting for the Razor Investment

The Razor investment is accounted for under the equity method of accounting under ASC 323 because Oncocyte exercises significant influence over, but does not control, the Razor entity. Oncocyte does not control the Razor entity because, among other factors, Oncocyte is entitled to designate one person to serve on a three-member board of directors of Razor, with the other two members designated by Encore, and 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.

The Razor Preferred Stock is considered in-substance common stock for purposes of the ASC 323 equity method investment in Razor. The equity method investment in Razor is considered an asset, rather than a business, because, among other factors, Razor has no workforce, no commercial product, no revenues, no distribution system and no facilities. Substantially all of the fair value of Razor’s assets at the Initial Closing was concentrated in Razor’s intangible asset, DetermaRx™, thus satisfying the requirements of the screen test in accordance with Accounting Standards Update (“ASU”) 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business.

The aggregate Razor acquisition payments of $11.245 million incurred during September 2019, including $10 million paid for the Razor Preferred Stock, the $1 million Preliminary Coverage Milestone Payment, and $0.245 million in transaction expenses, and the $4 million CMS Final Milestone Payment made by Oncocyte during June 2020, will be amortized over a 10-year useful life of DetermaRx™ and will be reflected in Oncocyte’s pro rata earnings and losses of the equity method investment in Razor. Under ASC 323, the additional contingent consideration arrangements, including the Clinical Trial Milestone Payment and the Additional Purchase Payment discussed above, 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, 2020, none of those other contingent consideration payments were recorded as none of the applicable conditions were achieved as of that date.

Summarized standalone financial data for Razor

The unaudited results of operations for the three and six months ended June 30, 2020 of Razor is summarized below (in thousands):

8. Related Party Transactions

Shared Facilities Agreement

On October 8, 2009, Oncocyte and Lineage executed the Shared Facilities Agreement. Beginning on October 1, 2019, Oncocyte ceased using shared services and has relied its own administrative, finance and accounting personnel. Effective December 31, 2019, Oncocyte terminated the Shared Facilities Agreement. Under the terms of the Shared Facilities Agreement, Lineage permitted Oncocyte to use Lineage’s office and laboratory facility and equipment located in Alameda, California. Through September 30, 2019, Lineage provided accounting, billing, bookkeeping, payroll, treasury, payment of accounts payable, and other similar administrative services to Oncocyte and through December 31, 2019, Lineage permitted Oncocyte the use of Lineage’s office and laboratory facilities and equipment. In January 2020, Oncocyte moved into its new corporate headquarters in Irvine, California, and also operates clinical laboratories in Brisbane, California and Nashville, Tennessee (see Note 13).

Lineage charged Oncocyte a “Use Fee” for services received and usage of facilities, equipment, and supplies. For each billing period, Lineage prorated and allocated costs incurred, as applicable, to Oncocyte. Such costs included services of Lineage employees, equipment, insurance, lease, professional, software, supplies and utilities. Allocation of expenses between Lineage and Oncocyte depended on key cost drivers including actual documented use, square footage of facilities used, time spent, costs incurred by or for Oncocyte, or upon proportionate usage by Lineage and Oncocyte, as reasonably estimated by Lineage. Lineage charged Oncocyte a 5% markup on such allocated costs as permitted by the Shared Facilities Agreement.

In addition to the Use Fees, Oncocyte reimbursed Lineage for any out of pocket costs incurred by Lineage for the purchase of office supplies, laboratory supplies, and other goods and materials and services for the account or use of Oncocyte based on invoices documenting such costs.

The Shared Facilities Agreement was not considered a lease under the provisions of ASC 842 discussed in Note 2, because, among other factors, a significant part of the Shared Facilities Agreement was a contract for services, not a tangible asset, and was cancelable by either party without penalty.

In the aggregate, Lineage charged Use Fees to Oncocyte during the three and six months ended June 30, 2019 as follows (in thousands):

As of June 30, 2020 and December 31, 2019, amounts owed to Lineage under the Shared Facilities Agreement were insignificant.

Financing Transactions

On January 2, 2020, Oncocyte entered into Subscription Agreements with selected investors, including Broadwood Partners, L.P. (“Broadwood”) and certain funds and accounts managed by Pura Vida Investments LLC (“Pura Vida”), in a registered direct offering of 3,523,776 shares of common stock, no par value, at an offering price of $2.156 per share, for an aggregate purchase price of approximately $7.6 million.

During April 2020, Oncocyte sold 4,733,700 shares of common stock, no par value, at an offering price of $2.27 per share, for an aggregate purchase price of approximately $10.75 million, in a registered direct offering. Oncocyte paid no fees or commissions to broker-dealers or any underwriting or finder’s fees. Broadwood and certain funds and accounts managed by Pura Vida purchased shares in the offering.

Consulting Services

During the three and six months ended June 30, 2020, Oncocyte incurred consulting fees of $0.1 million and $0.4 million, respectively, to a firm in which Oncocyte’s current President and Chief Executive Officer, Ronald Andrews, formerly was a partner. Mr. Andrews resigned from the firm as an active partner effective June 30, 2019, the date prior to commencement of his employment by Oncocyte.

9. Loan Payable to Silicon Valley Bank

On February 21, 2017, Oncocyte entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (the “Bank”) pursuant to which Oncocyte borrowed $2.0 million. Payments of interest only on the principal balance were due monthly from the loan funding date, March 23, 2017, through October 31, 2017, and, beginning on November 1, 2017, monthly payments of principal of approximately $67,000 plus interest are due and payable.

The outstanding principal amount plus accrued interest was due and payable to the Bank at maturity on April 1, 2020, but was paid off through a loan refinancing completed in October 2019, including a payment of a $116,000 final payment fee due under the terms of the Loan Agreement. The Bank waived a 1.0% prepayment fee in connection with the refinancing of the loan.

Amended Loan Agreement

On October 17, 2019, Oncocyte entered into a First Amendment to Loan and Security Agreement (the “Amended Loan Agreement”) with the Bank pursuant to which Oncocyte obtained a new $3 million secured credit facility (“Tranche 1”), a portion of which was used to repay the remaining balance of approximately $400,000 on outstanding loans from the Bank, plus a final payment of $116,000, under the February 21, 2017 Loan Agreement. The credit line under the Amended Loan Agreement may be increased by an additional $2 million (“Tranche 2”) if Oncocyte obtains at least $20 million of additional equity capital, as was the case with the original Loan Agreement, and a positive final coverage determination is received from the Centers for Medicate and Medicaid Services for DetermaRx™ at a specified minimum price point per test (the “Tranche 2 Milestone”), and Oncocyte is not in default under the Amended Loan Agreement.

Payments of interest only on the principal balance were due monthly from the draw date through March 31, 2020, followed by 24 monthly payments of principal and interest, but the Bank has agreed to a deferral of principal payments, as discussed below. The outstanding principal balance of the loan will bear interest at a stated floating annual interest equal to the greater of (a) the prime rate or (b) 5% per annum. As of June 30, 2020, the latest published prime rate was 3.25% per annum.

On April 2, 2020, as part of the Bank’s COVID-19 pandemic relief program, Oncocyte and Silicon Valley Bank entered into a Loan Deferral Agreement (“Loan Deferral”) with respect to the Amended Loan Agreement. Under the Loan Deferral Agreement, the Bank agreed to (i) extend the scheduled maturity date of the Amended Loan Agreement from March 31, 2022 to September 30, 2022, and (ii) deferred the principal payments by an additional 6 months whereby payments of interest only on the Bank loan principal balance will be due monthly from May 1, 2020 through October 1, 2020, followed by 23 monthly payments of principal and interest beginning on November 1, 2020, all provided at no additional fees to Oncocyte. No other terms of the Amended Loan Agreement were changed or modified. The Loan Deferral was accounted for as a modification of debt in accordance with ASC 470-50, Debt – Modifications and Extinguishments, thus there was no gain or loss recognized on the transaction.

At maturity of the loan, Oncocyte will also pay the Bank an additional final payment fee of $200,000, which was recorded as a deferred financing charge in October 2019 and is being amortized to interest expense over the term of the loan using the effective interest method. As of June 30, 2020, the unamortized deferred financing cost was $113,000.

Oncocyte may prepay in full the outstanding principal balance at any time, subject to a prepayment fee equal to 3.0% of the outstanding principal balance if prepaid within one year after October 17, 2019, 2.0% of the outstanding principal balance if prepaid more than one year but less than two years after October 17, 2019, or 1.0% of the outstanding principal balance if prepaid two years or more after October 17, 2019. Any amounts borrowed and repaid may not be reborrowed.

The outstanding principal amount of the loan, with interest accrued, the final payment fee, and the prepayment fee may become due and payable prior to the applicable maturity date if an “Event of Default” as defined in the Amended Loan Agreement occurs. Oncocyte was in compliance with the Amended Loan Agreement as of the filing date of this Report.

Bank Warrants

In 2017, in connection with the Loan Agreement, Oncocyte issued common stock purchase warrants to the Bank (the “2017 Bank Warrants”) entitling the Bank to purchase shares of Oncocyte common stock in tranches related to the loan tranches under the Loan Agreement. In conjunction with the availability of the loan, the Bank was issued warrants to purchase 8,247 shares of Oncocyte common stock at an exercise price of $4.85 per share, through February 21, 2027. On March 23, 2017, the Bank was issued warrants to purchase an additional 7,321 shares at an exercise price of $5.46 per share, through March 23, 2027. The Bank may elect to exercise the 2017 Bank Warrants on a “cashless exercise” basis and receive a number of shares determined by multiplying the number of shares for which the applicable tranche is being exercised by (A) the excess of the fair market value of the common stock over the applicable exercise price, divided by (B) the fair market value of the common stock. The fair market value of the common stock will be the last closing or sale price on a national securities exchange, interdealer quotation system, or over-the-counter market.

On October 17, 2019, in conjunction with Tranche 1 becoming available under the Amended Loan Agreement, Oncocyte issued a common stock purchase warrant to the Bank (the “2019 Bank Warrant”) entitling the Bank to purchase 98,574 shares of Oncocyte common stock at the initial “Warrant Price” of $1.69 per share through October 17, 2029. The number of shares of common stock issuable upon the exercise of the 2019 Bank Warrant will increase on the date of each draw, if any, on Tranche 2. The number of additional shares of common stock issuable upon the exercise of the 2019 Bank Warrant will be equal to 0.02% of Oncocyte’s fully diluted equity outstanding for each $1 million draw under Tranche 2. The Warrant Price for Tranche 2 warrant shares will be determined upon each draw of Tranche 2 funds and will be closing price of Oncocyte common stock on the NYSE American or other applicable market on the date immediately before the applicable date on which Oncocyte borrows funds under Tranche 2. The Bank may elect to exercise the 2019 Bank Warrant on a “cashless exercise” basis and receive a number of shares determined by multiplying the number of shares for which the 2019 Bank Warrant is being exercised by (A) the excess of the fair market value of the common stock over the applicable Warrant Price, divided by (B) the fair market value of the common stock. The fair market value of the common stock will be last closing or sale price on a national securities exchange, interdealer quotation system, or over-the-counter market.

Paycheck Protection Program Loan

On April 23, 2020, Oncocyte entered into a U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) promissory note in the principal amount of $1,140,930 payable to Silicon Valley Bank evidencing a PPP loan from the Bank. The PPP loan will bear interest at a rate of 1% per annum. No payments will be due on the PPP loan during a six-month deferral period commencing on the date of the promissory note. Commencing one month after the expiration of the deferral period, and continuing on the same day of each month thereafter until the maturity date of the PPP loan, Oncocyte will be obligated to make monthly payments of principal and interest, each in such equal amount required to fully amortize the principal amount outstanding on the PPP loan by the maturity date. The maturity date is April 23, 2022.

The principal amount of the PPP loan is subject to forgiveness by the Bank through the SBA under the PPP upon Oncocyte’s request to the extent that PPP loan proceeds are used to pay expense permitted by the PPP, including payroll, rent, and utilities. The Bank may forgive interest accrued on any principal forgiven if the SBA pays the interest. There can be no assurance that any part of the PPP loan will be forgiven.

The PPP loan promissory note contains customary borrower default provisions and lender remedies, including the right of the Bank to require immediate repayment in full the outstanding principal balance of the PPP loan with accrued interest.

10. Shareholders’ Equity

Preferred Stock

Oncocyte is authorized to issue 5,000,000 shares of no par value preferred stock. As of June 30, 2020, no preferred shares were issued or outstanding.

Common Stock

Oncocyte has 150,000,000 shares of common stock, no par value, authorized. As of June 30, 2020 and December 31, 2019, respectively, Oncocyte had 67,217,906 and 57,031,654 shares of common stock issued and outstanding.

Common Stock Purchase Warrants

As of June 30, 2020, Oncocyte had an aggregate of 3,383,913 common stock purchase warrants issued and outstanding with exercise prices ranging from $1.69 to $5.50 per warrant. The warrants will expire on various dates through March 23, 2027. 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.

The following tables show changes in components of shareholders’ equity for the periods from January 1, 2019 to June 30, 2019, and from March 31, 2019 to June 30, 2019 (unaudited and in thousands).

11. 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 to employees and consultants, 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 (“Performance-Based Options”). 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, 2020, certain performance conditions required for vesting were met, and, accordingly, 215,000 and 265,000 shares vested, and $360,000 and $466,000 of stock-based compensation expense, respectively, was recorded with regard to the Performance-Based Options during these periods. During the three months ended June 30, 2019, none of the vesting conditions were met and, accordingly, no stock-based compensation expense was recorded during that period. During the six months ended June 30, 2019, certain performance conditions required for vesting were met, and, accordingly, 47,500 shares vested and $101,000 of stock-based compensation expense was recorded with regard to the Performance-Based Options. As of June 30, 2020, there were no Performance-Based Options outstanding.

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

As of June 30, 2020, 11,000,000 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.

In February 2020, Oncocyte granted stock options to purchase 2.1 million common shares with an exercise price of $2.63 per share to its employees, including to New Oncocyte Employees, under the 2018 Incentive Plan. These grants are subject to customary time-based vesting terms and conditions in accordance with the 2018 Incentive Plan.

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

Oncocyte recorded stock-based compensation expense in the following categories on the accompanying condensed statements of operations for the three and six months ended June 30, 2020 and 2019 (unaudited and in thousands):

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, 2020 and 2019 were as follows (unaudited):

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, 2020 and 2019 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.

12. 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 Merger discussed in Note 5 and in accordance with ASC 805, a change in the acquirer’s valuation allowance that stems from a business combination should be recognized as an element of the acquirer’s income tax expense or benefit in the period of the acquisition. Accordingly, for the six months ended June 30, 2020, Oncocyte recorded a $1.1 million partial release of its valuation allowance and a corresponding income tax benefit stemming from the DTLs generated by the IPR&D and customer relationships intangible assets acquired in the Merger.

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 release 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 carryforwards and other deferred tax assets.

Oncocyte did not record any provision or benefit for income taxes for the three months ended June 30, 2020, and for the three and six months ended June 30, 2019 as Oncocyte had a full valuation allowance for the periods presented.

Other tax matters

On March 27, 2020, the President of the United States signed into law the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. Oncocyte is currently assessing the impact of the CARES Act, but it does not expect there to be a material impact on its consolidated financial statements.

13. Commitments and Contingencies

Oncocyte has certain commitments other than discussed in Notes 5 and 7.

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 will construct a clinical diagnostic laboratory and a research laboratory at the Premises and then relocate its laboratories to the Premises later in 2020.

The Irvine Lease has an initial term of 89 calendar months, plus any fraction of the calendar month in which the “Commencement Date” occurs (the “Term”). The Commencement Date is expected to be on June 1, 2020, 150 days after the date on which Oncocyte took possession of the Premises. Oncocyte has an option to extend the term of the Lease 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%. If the Term or Extended Term commences or expires on a day other than the first day of a calendar month, the base monthly rent, and expenses and taxes payable by Oncocyte under the Lease as described below, will be prorated for the partial month. Oncocyte will not be obligated to pay base monthly rent during the period of its occupancy of the Premises prior to the Commencement Date and will be entitled to an abatement of 50% of the base monthly rent during the first ten calendar months of the Term. If the Lease is terminated based on the occurrence of an “event of default,” Oncocyte will be obligated to pay the abated rent to the lessor.

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 Landlord 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.

Oncocyte is entitled to an abatement of its obligations to pay Expenses and Taxes while constructing improvements to the Premises constituting “Tenant’s Work” under the Lease prior to the Commencement Date, except that (a) Oncocyte will be 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 is already built out as office space, and (b) the abatement will end prior to the Commencement Date if Oncocyte completes its “Tenant’s Work” for its laboratory space and opens the ground floor for use.

The lessor has agreed to provide Oncocyte with a “Tenant Improvement Allowance” in the amount of $1,340,000 to pay for the plan, design, permitting, and construction of the improvements constituting Tenant’s Work. The lessor shall be entitled to retain 1.5% of the Tenant Improvement Allowance as an administrative fee.

Oncocyte has provided the lessor with a security deposit in the amount of $150,000 and a letter of credit in the amount of $1,700,000. 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 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 sheet thresholds; provided, in each case, that Oncocyte is not in then default under the 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 (see Note 3).

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, 2020, for Oncocyte’s operating and financing leases (see Note 2).

Under the Laboratory Agreement discussed in Note 7, Oncocyte assumed all of Razor’s Laboratory Agreement payment obligations amounting to $450,000 per year. 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, 2020, the aggregate payments due to the landlord for early cancellation of the Brisbane Lease would be approximately $391,000 (aggregate payments from June 30, 2020 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.

The following table presents supplemental cash flow information related to operating and financing leases for the six months ended June 30, 2020 and 2019 (in thousands):

The following table presents supplemental balance sheet information related to operating and financing leases as of June 30, 2020 (in thousands, except lease term and discount rate):

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

Litigation – General

Oncocyte will be subject to various claims and contingencies in the ordinary course of its business, including those related to litigation, business transactions, employee-related matters, and other matters. When Oncocyte is aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. If it is probable that a loss will result and the amount of the loss can be reasonably estimated, Oncocyte will record a liability for the loss. If the loss is not probable or the amount of the loss cannot be reasonably estimated, Oncocyte discloses the claim if the likelihood of a potential loss is reasonably possible and the amount involved could be material.

Tax Filings

Oncocyte tax filings are subject to audit by taxing authorities in jurisdictions where it conducts business. These audits may result in assessments of additional taxes that are subsequently resolved with the authorities or potentially through the courts. Management believes Oncocyte has adequately provided for any ultimate amounts that are likely to result from these audits; however, final assessments, if any, could be significantly different than the amounts recorded in the financial statements.

Employment Contracts

Oncocyte has entered into employment contracts with certain executive officers. Under the provisions of the contracts, Oncocyte may be required to incur severance obligations for matters relating to changes in control, as defined, and certain terminations of executives.

Indemnification

In the normal course of business, Oncocyte may provide indemnification of varying scope under Oncocyte’s agreements with other companies or consultants, typically Oncocyte’s clinical research organizations, investigators, clinical sites, suppliers and others. Pursuant to these agreements, Oncocyte will generally agree to indemnify, hold harmless, and reimburse the indemnified parties for losses and expenses suffered or incurred by the indemnified parties arising from claims of third parties in connection with the use or testing of Oncocyte’s diagnostic tests. Indemnification provisions could also cover third party infringement claims with respect to patent rights, copyrights, or other intellectual property pertaining to Oncocyte’s diagnostic tests. The term of these indemnification agreements will generally continue in effect after the termination or expiration of the particular research, development, services, or license agreement to which they relate. The Purchase Agreement also contains provisions under which Oncocyte has agreed to indemnify Razor and Encore from losses and expenses resulting from breaches or inaccuracy of Oncocyte’s representations and warranties and breaches or nonfulfillment of Oncocyte’s covenants, agreements, and obligations under the Purchase Agreement. The potential future payments Oncocyte could be required to make under these indemnification agreements will generally not be subject to any specified maximum amounts. Historically, Oncocyte has not been subject to any claims or demands for indemnification. Oncocyte also maintains various liability insurance policies that limit Oncocyte’s financial exposure. As a result, Oncocyte management believes that the fair value of these indemnification agreements is minimal. Accordingly, Oncocyte has not recorded any liabilities for these agreements as of June 30, 2020 and December 31, 2019.