PACIFIC BIOSCIENCES OF CALIFORNIA, INC. 10-Q

Item 1. Financial Statements PACIFIC BIOSCIENCES OF CALIFORNIA, INC. Condensed Consolidated Balance Sheets (Unaudited) June 30, December 31, (in thousands, except per share amounts) 2020 2019 Assets Current assets Cash and cash equivalents $ 43,342 $ 29,627 Investments 76,621 19,472 Accounts receivable 11,346 15,266 Inventory 16,768 13,312 Prepaid expenses and other current assets 2,862 3,369 Total current assets 150,939 81,046 Property and equipment, net 27,733 30,070 Operating lease right-of-use assets, net 31,435 32,827 Long-term restricted cash 3,500 4,000 Other long-term assets 41 42 Total assets $ 213,648 $ 147,985 Liabilities and Stockholders’ Equity Current liabilities Accounts payable $ 7,436 $ 8,368 Accrued expenses 12,203 13,242 Deferred revenue, current 6,932 7,610 Operating lease liabilities, current 4,103 3,837 Notes payable, current — 15,871 Deferred gain from Reverse Termination Fee 98,000 — Other liabilities, current 2,188 225 Total current liabilities 130,862 49,153 Deferred revenue, non-current 1,531 1,951 Operating lease liabilities, non-current 39,863 41,964 Total liabilities 172,256 93,068 Commitments and contingencies Stockholders’ equity Preferred stock, $ 0.001 par value: Authorized 50,000 shares; No shares issued or outstanding — — Common stock, $ 0.001 par value: Authorized 1,000,000 shares; issued and outstanding 154,318 shares and 153,119 shares at June 30, 2020 and December 31, 2019, respectively 154 153 Additional paid-in capital 1,129,091 1,120,999 Accumulated other comprehensive income 243 5 Accumulated deficit ( 1,088,096 ) ( 1,066,240 ) Total stockholders’ equity 41,392 54,917 Total liabilities and stockholders’ equity $ 213,648 $ 147,985 See accompanying notes to the condensed consolidated financial statements. 4 Table of Contents PACIFIC BIOSCIENCES OF CALIFORNIA, INC. Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited) Three Months Ended June 30, Six Months Ended June 30, (in thousands, except per share amounts) 2020 2019 2020 2019 Revenue: Product revenue $ 13,756 $ 21,250 $ 26,049 $ 34,707 Service and other revenue 3,321 3,371 6,626 6,339 Total revenue 17,077 24,621 32,675 41,046 Cost of revenue: Cost of product revenue 8,225 11,980 13,646 20,598 Cost of service and other revenue 2,239 3,028 4,928 5,718 Total cost of revenue 10,464 15,008 18,574 26,316 Gross profit 6,613 9,613 14,101 14,730 Operating expense: Research and development 15,010 14,910 30,260 30,395 Sales, general and administrative 15,127 19,083 40,074 38,849 Total operating expense 30,137 33,993 70,334 69,244 Operating loss ( 23,524 ) ( 24,380 ) ( 56,233 ) ( 54,514 ) Gain from Continuation Advances — — 34,000 Interest expense — ( 644 ) ( 267 ) ( 1,269 ) Other income, net 438 428 676 863 Net loss ( 23,086 ) ( 24,596 ) ( 21,824 ) ( 54,920 ) Other comprehensive income (loss): Unrealized income on investments 213 11 238 53 Comprehensive loss $ ( 22,873 ) $ ( 24,585 ) $ ( 21,586 ) $ ( 54,867 ) Net loss per share: Basic and diluted net loss per share $ ( 0.15 ) $ ( 0.16 ) $ ( 0.14 ) $ ( 0.36 ) Shares used in computing basic and diluted net loss per share 154,172 152,776 153,229 152,029 See accompanying notes to the condensed consolidated financial statements. ‎ 5 Table of Contents PACIFIC BIOSCIENCES OF CALIFORNIA, INC. Condensed Consolidated Statements of Stockholders ’ Equity (Unaudited) Accumulated Additional Other Total Paid-in Comprehensive Accumulated Stockholders' (in thousands) Common Stock Capital Income (Loss) Deficit Equity For the three months ended June 30, 2020 Balance at March 31, 2020 153,953 $ 154 $ 1,125,229 $ 30 $ ( 1,065,010 ) $ 60,403 Net loss — — — — ( 23,086 ) ( 23,086 ) Other comprehensive income — — — 213 — 213 Issuance of common stock in conjunction with equity plans 365 — 628 — — 628 Stock-based compensation expense — — 3,234 — — 3,234 Balance at June 30, 2020 154,318 $ 154 $ 1,129,091 $ 243 $ ( 1,088,096 ) $ 41,392 For the three months ended June 30, 2019 Balance at March 31, 2019 152,672 $ 153 $ 1,107,121 $ 6 $ ( 1,012,430 ) $ 94,850 Net loss — — — — ( 24,596 ) ( 24,596 ) Other comprehensive income — — — 11 — 11 Issuance of common stock in conjunction with equity plans 287 — 1,400 — — 1,400 Stock-based compensation expense — — 4,089 — — 4,089 Balance at June 30, 2019 152,959 $ 153 $ 1,112,610 $ 17 $ ( 1,037,026 ) $ 75,754 For the six months ended June 30, 2020 Balance at December 31, 2019 153,119 $ 153 $ 1,120,999 $ 5 $ ( 1,066,240 ) $ 54,917 Net loss — — — — ( 21,824 ) ( 21,824 ) Other comprehensive income — — — 238 — 238 Adoption effect of Topic 326 ( 32 ) ( 32 ) Issuance of common stock in conjunction with equity plans 1,199 1 826 — — 827 Stock-based compensation expense — — 7,266 — — 7,266 Balance at June 30, 2020 154,318 $ 154 $ 1,129,091 $ 243 $ ( 1,088,096 ) $ 41,392 For the six months ended June 30, 2019 Balance at December 31, 2018 150,244 $ 150 $ 1,096,053 $ ( 36 ) $ ( 982,106 ) $ 114,061 Net loss — — — — ( 54,920 ) ( 54,920 ) Other comprehensive income — — — 53 — 53 Issuance of common stock in conjunction with equity plans 2,715 3 8,087 — — 8,090 Stock-based compensation expense — — 8,470 — — 8,470 Balance at June 30, 2019 152,959 $ 153 $ 1,112,610 $ 17 $ ( 1,037,026 ) $ 75,754 See accompanying notes to the condensed consolidated financial statements 6 Table of Contents PACIFIC BIOSCIENCES OF CALIFORNIA, INC. Condensed Consolidated Statements of Cash Flows (Unaudited) Six Months Ended June 30, (in thousands) 2020 2019 Cash flows from operating activities Net loss $ ( 21,824 ) $ ( 54,920 ) Adjustments to reconcile net loss to net cash used in operating activities Gain from Continuation Advances ( 34,000 ) — Depreciation 3,246 3,586 Amortization of operating lease right-of-use assets 1,392 1,289 Amortization of debt discount and financing costs 129 574 Gain on derivative — ( 16 ) Stock-based compensation 7,266 8,470 Amortization (accretion) from investment premium (discount) ( 177 ) ( 677 ) Changes in assets and liabilities Accounts receivable 3,888 ( 3,528 ) Inventory ( 3,822 ) ( 40 ) Prepaid expenses and other assets 524 388 Accounts payable ( 1,039 ) 685 Accrued expenses ( 1,039 ) 3,198 Deferred revenue ( 1,098 ) 734 Operating lease liabilities ( 1,835 ) ( 1,677 ) Other liabilities 1,963 ( 938 ) Deferred gain from Reverse Termination Fee 98,000 — Net cash provided by (used in) operating activities 51,574 ( 42,872 ) Cash flows from investing activities Purchase of property and equipment ( 436 ) ( 1,866 ) Purchase of investments ( 119,200 ) ( 36,748 ) Maturities of investments 62,450 84,410 Net cash provided by (used in) investing activities ( 57,186 ) 45,796 Cash flows from financing activities Continuation Advances 34,000 — Notes payable principal payoff ( 16,000 ) — Proceeds from issuance of common stock from equity plans 827 8,090 Net cash provided by financing activities 18,827 8,090 Net increase in cash and cash equivalents and restricted cash 13,215 11,014 Cash and cash equivalents and restricted cash at beginning of period 33,627 23,344 Cash and cash equivalents and restricted cash at end of period $ 46,842 $ 34,358 Cash and cash equivalents at end of period 43,342 30,358 Restricted cash at end of period 3,500 4,000 Cash and cash equivalents and restricted cash at end of period $ 46,842 $ 34,358 Supplemental disclosure of cash flow information Inventory transferred to property and equipment 366 1,427 See accompanying notes to the condensed consolidated financial statements. 7 Table of Contents PACIFIC BIOSCIENCES OF CALIFORNIA, INC. Notes to Condensed Consolidated Financial Statements (Unaudited) NOTE 1. OVERVIEW We design, develop and manufacture sequencing systems to help scientists resolve genetically complex problems. Based on our novel Single Molecule, Real-Time (SMRT®) sequencing technology, our products enable: de novo genome assembly to finish genomes in order to more fully identify, annotate and decipher genomic structures; full-length transcript analysis to improve annotations in reference genomes, characterize alternatively spliced isoforms in important gene families, and find novel genes; targeted sequencing to more comprehensively characterize genetic variations; and real-time kinetic information for epigenome characterization. Our technology provides high accuracy, ultra-long reads, uniform coverage and the ability to simultaneously detect epigenetic changes. PacBio® sequencing systems, including consumables and software, provide a simple and fast end-to-end workflow for SMRT sequencing. Our current products include the Sequel II instrument and SMRT Cell 8M, which together are capable of sequencing up to approximately eight million DNA molecules simultaneously, and the previous generation Sequel instrument and Sequel SMRT Cell 1M, which together are capable of sequencing up to approximately one million DNA molecules simultaneously. Our customers and our scientific collaborators have published numerous peer-reviewed articles in journals including Nature, Science, Cell, PNAS and The New England Journal of Medicine highlighting the power and applications of SMRT sequencing in projects such as finishing genomes, structural variation discovery, isoform transcriptome characterization, rare mutation discovery and the identification of chemical modifications of DNA related to virulence and pathogenicity. Our research and development efforts are focused on developing new products and further improving our existing products including continuing chemistry and sample preparation improvements to increase throughput and expand our supported applications. By providing access to genetic information that was previously inaccessible, we enable scientists to confidently increase their understanding of biological systems. The names “Pacific Biosciences,” “PacBio,” “SMRT,” “SMRTbell,” “Sequel” and our logo are our trademarks. NOTE 2 TERMINATION OF MERGER WITH ILLUMINA On November 1, 2018, we entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) with Illumina, Inc. (“Illumina”) and FC Ops Corp., a wholly owned subsidiary of Illumina (“Merger Subsidiary”). On January 2, 2020, we, Illumina and Merger Subsidiary, entered into an agreement to terminate the Merger Agreement (the “Termination Agreement”). As part of the Termination Agreement, Illumina paid us a $ 98.0 million termination fee (the “Reverse Termination Fee”), from which we paid our financial advisor associated fees of $ 6.0 million in April 2020, which is less than the amount we initially expected. In addition, Illumina paid us cash payments (“Continuation Advances”) of $ 34.0 million during the first quarter of 2020. However, pursuant to the Termination Agreement, in the event that, on or prior to September 30, 2020, we enter into a definitive agreement providing for, or consummate, a Change of Control Transaction (as defined in the Termination Agreement) (“Change of Control Transaction”), then we may be required to repay the Reverse Termination Fee (without interest) to Illumina in connection with the consummation of such Change of Control Transaction. If such Change of Control Transaction is not consummated by the two-year anniversary of the execution of the definitive agreement for such Change of Control Transaction, then we will not be required to repay the Reverse Termination Fee. Please refer to “Note 5. Balance Sheet Components” for the accounting treatment of the Reverse Termination Fee. In addition, up to the $ 52.0 million of the Continuation Advances paid to us are repayable without interest to Illumina if, within two years of March 31, 2020, we enter into, or consummate a Change of Control Transaction or raise at least $ 100 million in equity in a single transaction or debt financing (that may have multiple closings), with the amount repayable dependent on the amount raised by us. Please refer to “Note 3. Summary of Significant Accounting Policies” for the accounting treatment of the Continuation Advances. 8 Table of Contents NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Consolidation In the opinion of management, our accompanying unaudited condensed consolidated financial statements (“Financial Statements”) have been prepared on a consistent basis with our December 31, 2019 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein. The Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and, as permitted by such rules and regulations, omit certain information and footnote disclosures necessary to present the statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). These Financial Statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2019. The results of operations for the three and six months ended June 30, 2020 are not necessarily indicative of the results to be expected for the entire year or any future periods. The condensed consolidated financial statements include the accounts of Pacific Biosciences and our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated. COVID-19 We are subject to risks and uncertainties as a result of the novel coronavirus pandemic (COVID-19). The extent of the impact of the COVID-19 pandemic on our business is highly uncertain as responses to the pandemic can change quickly and information is rapidly evolving. We considered the impact of COVID-19 on the assumptions and estimates used to determine the results reported and asset valuations as of June 30, 2020. Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes to the financial statements. Our estimates include, but are not limited to, the valuation of inventory, the determination of stand-alone selling prices for revenue recognition, the valuation of a financing derivative and long-term notes, the probability of repaying the Continuation Advances and Reverse Termination Fee to Illumina, the valuation and recognition of share-based compensation, the expected renewal period for service contracts to derive the amortization period for capitalized commissions, the useful lives assigned to long-lived assets, the computation of provisions for income taxes and the determination of the internal borrowing rate used in calculating the operating lease right-of-use assets and operating lease liabilities. Actual results could differ materially from these estimates. Fair Value of Financial Instruments The carrying amount of our accounts receivable, prepaid expenses, other current assets, accounts payable, accrued expenses and other liabilities, current, approximate fair value due to their short maturities. The fair value hierarchy established under U.S. GAAP requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are as follows:  Level 1: quoted prices in active markets for identical assets or liabilities;  Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and  Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. We consider an active market as one in which transactions for the asset or liability occurs with sufficient frequency and volume to provide pricing information on an ongoing basis. Conversely, we view an inactive market as one in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate, our non-performance risk, or that of our counterparty, is considered in determining the fair values of liabilities and assets, respectively. We classify our cash deposits and money market funds within Level 1 of the fair value hierarchy because they are valued using bank balances or quoted market prices. We classify our investments as Level 2 instruments based on market pricing and other observable inputs. We did not classify any of our investments within Level 3 of the fair value hierarchy. 9 Table of Contents Assets and liabilities measured at fair value are classified in their entirety based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the entire fair value measurement requires management to make judgments and consider factors specific to the asset or liability. Assets and Liabilities Measured at Fair Value on a Recurring Basis The following table sets forth the fair value of our financial assets and liabilities that were measured on a recurring basis as of June 30, 2020 and December 31, 2019 respectively: June 30, 2020 December 31, 2019 (in thousands) Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Assets Cash and cash equivalents: Cash and money market funds $ 33,294 $ — $ — $ 33,294 $ 18,644 $ — $ — $ 18,644 Commercial paper — 10,048 — 10,048 — 10,983 — 10,983 Total cash and cash equivalents 33,294 10,048 — 43,342 18,644 10,983 — 29,627 Investments: Commercial paper — 51,929 — 51,929 — 16,971 — 16,971 Corporate debt securities — 14,662 — 14,662 — 2,501 — 2,501 US government & agency securities — 10,030 — 10,030 — — — — Total investments — 76,621 — 76,621 — 19,472 — 19,472 Long-term restricted cash: Cash 3,500 — — 3,500 4,000 — — 4,000 Total assets measured at fair value $ 36,794 $ 86,669 $ — $ 123,463 $ 22,644 $ 30,455 $ — $ 53,099 Liabilities Financing Derivative $ — $ — $ — $ — $ — $ — $ — $ — Continuation Advances — — — — — — — — Total liabilities measured at fair value $ — $ — $ — $ — $ — $ — $ — $ — Estimated fair value of the financing derivative liability The estimated fair value of the Financing Derivative liability (as defined in the “Notes payable, current” section in “Note 5. Balance Sheet Components”) was determined using Level 3 inputs, or significant unobservable inputs. Changes to the estimated fair value of the Financing Derivative are recorded in “Other income, net” in the consolidated statements of operations and comprehensive loss. The estimated fair value of the Financing Derivative was determined by comparing the difference between the fair value of the Notes from the debt facility that we entered into during the first quarter of 2013 (the “Notes”) with and without the Financing Derivative by calculating the respective present values from future cash flows using a 6.5 % discount rate at December 31, 2019. The estimated fair value of the Financing Derivative as of December 31, 2019 was $ 0 . In February 2020, upon maturity of the Notes, the Financing Derivative was extinguished. Refer to the “Notes payable, current” section in “Note 5. Balance Sheet Components” for a detailed description and valuation approach. Estimated fair value of the Continuation Advances liability In accordance with the terms of the Merger Agreement, we received Continuation Advances of $ 18.0 million and $ 34.0 million from Illumina during the fourth quarter of 2019 and the first quarter of 2020, respectively. We determined that the Continuation Advances, which are subject to repayment under certain circumstances as discussed below, constitute a financial liability. 10 Table of Contents The fair value option was elected for the financial liability because management believes that among all measurement methods allowed by Accounting Standards Codification, or ASC, 825, Financial Instruments , the fair value option would most fairly represent the value of such a financial liability. Management applied the income approach to estimate the fair value of this financial liability. The estimated fair value of the liability related to the Continuation Advances was determined using Level 3 inputs, or significant unobservable inputs. Management estimated that there would be no future cash outflows associated with this financial instrument because the probabilities of either of the following events occurring and requiring repayment to Illumina were evaluated as being remote as of June 30 2020:  we enter into a Change of Control Transaction within two years following March 31, 2020; or  we raise $ 100 million or more in a single equity or debt financing (that may have multiple closings) within two years following March 31, 2020. As a result, the estimated fair value of the liability associated with the contingent repayment of the Continuation Advances received in the first quarter of 2020 was assessed to be zero as of both March 31, 2020 and June 30, 2020, with a resulting non-operating gain of $ 34.0 million recorded as “Gain from Continuation Advances from Illumina” for the quarter ended March 31, 2020. We recorded a similar gain of $ 18.0 million in 2019 for the Continuation Advances received during the fourth quarter of 2019. For the quarter ended June 30, 2020, there were no transfers between Level 1, Level 2, or Level 3 assets or liabilities reported at fair value on a recurring basis and our valuation techniques did not change compared to the prior year. Net Loss per Share The following outstanding common stock options, restricted stock units (“RSUs”), with time-based vesting and RSUs with performance-based vesting, were excluded from the computation of diluted net loss per share for the periods presented because including them would have had an anti-dilutive effect. See Note 7. Stockholders’ Equity for detailed information on RSUs with time-based vesting and RSUs with performance-based vesting. Six Months Ended June 30, (in thousands) 2020 2019 Options to purchase common stock 20,485 23,414 RSUs with time-based vesting 5,109 1,121 RSUs with performance-based vesting 138 138 Concentration and Other Risks For the three and six months ended June 30, 2020, Gene Company Limited accounted for approximately 15 % and 11 %, respectively, of our total revenue during the period with no other customer exceeding 10% during those periods. For the three and six months ended June 30, 2019, Gene Company Limited accounted for approximately 23 % and 20 % of our total revenue, respectively, with no other customer exceeding 10% during those periods. Gene Company Limited is our primary distributor in China. Recent Accounting Pronouncements Recently Issued Accounting Standards In December 2019, the Financial Accounting Standards Board, or FASB issued Accounting Standards Update, or ASU No. 2019-12, Income Taxes (Topic 740)—Simplifying the Accounting for Income Taxes . ASU 2019-12 is intended to simplify accounting for income taxes. It removes certain exceptions to the general principles in Topic 740 and amends existing guidance to improve consistent application. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years, which is fiscal 2021 for us, with early adoption permitted. We do not expect adoption of the new guidance to have a material impact on our financial statements. Recently Adopted Accounting Standards Adoption of Topic 326 11 Table of Contents In June 2016, FASB issued ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“Topic 326”), which replaces existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost. We adopted Topic 326 on January 1, 2020, using a modified retrospective transition method, which requires a cumulative-effect adjustment to the opening balance of retained earnings to be recognized on the date of adoption with prior periods not restated. The cumulative-effect adjustment recorded on January 1, 2020, is shown below (in thousands): Balance Sheets Balance at December 31, 2019 Adjustments Due to Topic 326 Balance at January 1, 2020 Assets Accounts receivable $ 15,266 $ ( 32 ) $ 15,234 Liabilities and Stockholders' Equity Accumulated deficit ( 1,066,240 ) ( 32 ) ( 1,066,272 ) The adoption of Topic 326 did not have a material impact on our financial statements and our bad debt expense was immaterial as of June 30 2020. Please see the description of our “Credit Losses” accounting policy in the “Significant Accounting Policies” section below. Significant Accounting Policies With the exception of the change for the accounting of credit losses as a result of the adoption of Topic 326, there have been no new or material changes to the significant accounting policies discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, that are of significance, or potential significance, to us. Credit Losses Trade accounts receivable. The allowance for doubtful accounts is based on our assessment of the collectability of customer accounts. We regularly review the allowance by considering factors such as the age of the accounts receivable balances, customer creditworthiness, customer industry, and current and forecasted economic conditions that may affect a customer’s ability to pay. Available-for-sale debt securities. Our investment portfolio at any point in time contains investments in cash deposits, money market funds, commercial paper, corporate debt securities and US government and agency securities. We regularly review the securities in an unrealized loss position and evaluate the current expected credit loss by considering factors such as significance of loss, historical experience, market data, issuer-specific factors, and current economic conditions and concluded that an allowance for credit losses was not required as of June 30 2020. Although we have historically not experienced significant credit losses, our exposure to credit losses may increase if our customers are adversely affected by changes in economic pressures or uncertainty associated with local or global economic recessions, disruption associated with the current COVID-19 pandemic, or other customer-specific factors. NOTE 4. CASH, CASH EQUIVALENTS AND INVESTMENTS The following tables summarize our cash, cash equivalents and investments as of June 30, 2020 and December 31, 2019 (in thousands): 12 Table of Contents As of June 30, 2020 Gross Gross Amortized unrealized unrealized Fair Cost gains losses Value Cash and cash equivalents: Cash and money market funds $ 33,294 $ — $ — $ 33,294 Commercial paper 10,048 — — 10,048 Total cash and cash equivalents 43,342 — — 43,342 Investments: Commercial paper 51,892 37 — 51,929 Corporate debt securities 14,483 179 — 14,662 US government & agency securities 10,003 27 — 10,030 Total investments 76,378 243 — 76,621 Total cash, cash equivalents and investments $ 119,720 $ 243 $ — $ 119,963 Long-term restricted cash: Cash $ 3,500 $ — $ — $ 3,500 As of December 31, 2019 Gross Gross Amortized unrealized unrealized Fair Cost gains losses Value Cash and cash equivalents: Cash and money market funds $ 18,644 $ — $ — $ 18,644 Commercial paper 10,983 — — 10,983 Total cash and cash equivalents 29,627 — — 29,627 Investments: Commercial paper 16,971 1 ( 1 ) 16,971 Corporate debt securities 2,496 5 — 2,501 Total investments 19,467 6 ( 1 ) 19,472 Total cash, cash equivalents and investments $ 49,094 $ 6 $ ( 1 ) $ 49,099 Long-term restricted cash: Cash $ 4,000 $ — $ — $ 4,000 The following table summarizes the contractual maturities of our cash equivalents and available-for-sale investments, excluding money market funds, as of June 30, 2020 (in thousands): Fair Value Due in one year or less $ 81,034 Due after one year through 5 years 5,635 Total investments $ 86,669 Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without call or prepayment penalties. NOTE 5. BALANCE SHEET COMPONENTS Inventory As of June 30, 2020 and December 31, 2019, our inventory consisted of the following components: 13 Table of Contents June 30, December 31, (in thousands) 2020 2019 Purchased materials $ 5,289 $ 3,966 Work in process 5,795 4,594 Finished goods 5,684 4,752 Inventory $ 16,768 $ 13,312 Long-term restricted cash For our facility located at 1305 O’Brien Drive, Menlo Park, California (the “O’Brien Lease”), we were required to establish a letter of credit for the benefit of the landlord and to submit $ 4.5 million as a deposit for the letter of credit in October 2015. Subsequently, pursuant to the terms of the O’Brien Lease, on May 1, 2019, the amount of the letter of credit was reduced from $ 4.5 million to $ 4.0 million. As such, $ 4.0 million was recorded in “Long-term restricted cash” in the condensed consolidated balance sheet as of December 31, 2019. Pursuant to the terms of the O’Brien Lease, the letter of credit balance of $ 4.0 million was reduced again in May 2020 by $ 500,000 . As such, $ 3.5 million was recorded in “Long-term restricted cash” in the condensed consolidated balance sheet as of June 30, 2020. Deferred gain from Reverse Termination Fee As part of the Termination Agreement, Illumina paid us a Reverse Termination Fee of $ 98.0 million, from which we owed our financial advisor associated fees of $ 6.0 million. Pursuant to the Termination Agreement, in the event that, on or prior to September 30, 2020, we enter into a definitive agreement providing for, or consummate, a Change of Control Transaction, then we may need to repay the Reverse Termination Fee (without interest) to Illumina in connection with the consummation of such Change of Control Transaction. If such Change of Control Transaction is not consummated by the two year anniversary of the execution of the definitive agreement for such Change of Control Transaction, then we will not be required to repay the Reverse Termination Fee. As indicated in ASC 450, Contingencies , a gain contingency usually is not recognized in the financial statements until the period in which all contingencies are resolved and the gain is realizable. As such we have deferred the gain from the Reverse Termination Fee from Illumina until the date when the associated contingency is resolved and accordingly, we recorded the $ 98.0 million as “Deferred Gain from Reverse Termination Fee” in the condensed consolidated balance sheet as of June 30, 2020. We recorded the $ 6.0 million of associated fees owed to our financial advisor in the “Sales, general and administrative” expense line in the condensed consolidated statements of operations and comprehensive income for the six months ended June 30, 2020. Notes payable, current As of December 31, 2019, a balance of $ 16.0 million aggregate principal amount of debt remained outstanding under the debt agreement with Deerfield entered into in February 2013 (the “Facility Agreement”) and was presented as “Notes payable, current” on the condensed consolidated balance sheet as of December 31, 2019. In February 2020, upon the maturity of the Facility Agreement, we repaid the remaining outstanding principal of $ 16.0 million and interest. Financing Derivative A number of features embedded in the Notes required accounting for them as a derivative, including the indemnification of certain withholding taxes and the acceleration of debt upon (i) a qualified financing, (ii) an event of default, (iii) a Major Transaction (as such term is defined in the Facility Agreement), and (iv) the exercise of the warrant via offset to the debt principal. These features represent a single derivative (the “Financing Derivative”) that was bifurcated from the debt instrument and accounted for as a liability at fair value, with changes in fair value between reporting periods recorded in other income (expense), net. The estimated fair value of the Financing Derivative was determined by comparing the difference between the fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using a 6.5 % discount rate at December 31, 2019. The estimated fair value of the Financing Derivative as of December 31, 2019 was $ 0 . In February 2020, after we repaid the remaining outstanding principal of $ 16.0 million and interest to Deerfield, the Financing Derivative balance was reduced to $ 0 . 14 Table of Contents Deferred revenue As of June 30, 2020, we had a total of $ 8.4 million of deferred revenue from our service contracts, $ 6.9 million of which was recorded as “Deferred revenue, current” to be recognized over the next year and the remaining $ 1.5 million was recorded as “Deferred revenue, non-current” to be recognized in the next 3 years. Revenue recorded in the three months ended June 30, 2020 includes $ 2.1 million of previously deferred revenue that was included in “Deferred revenue, current” as of December 31, 2019. Contract assets as of June 30, 2020 and December 31, 2019 were not material. As of June 30, 2020, we had a total of $ 0.6 million of deferred commissions included in “Prepaid expenses and other current assets” which is recognized as the related revenue is recognized. Additionally, as a practical expedient, we expense costs to obtain a contract as incurred if the amortization period would have been a year or less. NOTE 6. COMMITMENTS AND CONTINGENCIES Leases As of June 30, 2020, we leased approximately 180,000 square feet in 1305 O’Brien Drive, Menlo Park, California, where we house our headquarters, research and development, service and support functions. We also leased a sales office facility in Singapore and engineering support facilities in Allen, Texas. On July 22, 2015, we entered into a lease agreement with respect to our facility located at 1305 O’Brien Drive, Menlo Park, California. The term of the O’Brien Lease is one hundred thirty-two ( 132 ) months. In December 2016, we entered into an amendment to the O’Brien Lease which defined the commencement date of the lease to be October 25, 2016, notwithstanding that such substantial completion did not occur until the first quarter of 2017. Base monthly rent was abated for the first six (6) months of the lease term and thereafter was $ 540,000 per month during the first year of the lease term, with specified annual increases thereafter until reaching $ 711,000 per month during the last twelve (12) months of the lease term. If the rent is not received within five days of the due date, there will be an additional sum equal to 5 % of the amount overdue as a late charge. Any amount not paid within 10 days after receipt of landlord’s written notice will bear interest from the date due until paid, at the lesser rate of (1) the prime rate of interest as published in the Wall Street Journal, plus 2 % or (2) the maximum rate allowed by law, in addition to the late payment charge. We were required to establish a letter of credit for the benefits of the landlord and to submit $ 4.5 million as a deposit for the letter of credit in October 2015. Subsequently pursuant to the terms of the O’Brien Lease, at May 1, 2019 the $ 4.5 million in restricted cash was reduced to $ 4.0 million and at May 1, 2020 the $ 4.0 million in restricted cash was reduced to $ 3.5 million. All of our leases are operating leases. Operating lease assets and liabilities are reflected within “Operating lease right-of-use assets, net”, “Operating lease liabilities, current” and “Operating lease liabilities, non-current” on the condensed consolidated balance sheets. These assets and liabilities are recognized at the commencement date based on the present value of remaining minimum lease payments over the lease term using our estimated secured incremental borrowing rates at the effective date of January 1, 2019. Lease payments included in the measurement of the lease liability comprise the base rent per the term of the Lease. Lease expense for these leases is recognized on a straight-line basis over the lease term, with variable lease payments, such as common area maintenance fees, recognized in the period those payments are incurred. We often have options to renew lease terms for buildings. For the O’Brien Lease, the renewal option is 5 years and the rent will be based on fair market value at the time of renewal and was not included in the lease term. In addition, certain lease arrangements may be terminated prior to their original expiration date at our discretion. We evaluate renewal and termination options at the lease commencement date to determine if we are reasonably certain to exercise the option on the basis of economic factors. The weighted average remaining lease term for our operating leases as of June 30, 2020 was 7.3 years. The discount rate implicit within our leases is generally not determinable and therefore we determine the discount rate based on our incremental borrowing rate. The incremental borrowing rate for our leases is determined based on lease term and currency in which lease payments are made, adjusted for impacts of collateral. The weighted average discount rate used to measure our operating lease liabilities as of June 30, 2020 was 7.9 %. The following table presents information as to the amount and timing of cash flows arising from our operating leases as of June 30, 2020: 15 Table of Contents Maturity of Lease Liabilities Amount Years ending December 31, (in thousands) Remaining of 2020 $ 3,597 2021 7,328 2022 7,502 2023 7,704 2024 7,920 Thereafter 23,598 Total undiscounted operating lease payments 57,649 Less: imputed interest ( 13,683 ) Present value of operating lease liabilities 43,966 Balance Sheet Classification Operating lease liabilities, current 4,103 Operating lease liabilities, non-current 39,863 Total operating lease liabilities 43,966 Cash Flows Cash paid for amounts included in the present value of operating lease liabilities was $ 1.8 million and $ 3.6 million, respectively, for the three and six months ended June 30, 2020 and included in operating cash flow. Operating Lease Costs Operating lease costs were $ 1.6 million and $ 3.1 million for the three and six months ended June 30, 2020, respectively. Operating lease costs were $ 1.6 million and $ 3.1 million for the three and six months ended June 30, 2019, respectively. For both 2020 and 2019 the operating lease costs primarily related to our operating leases, but also included immaterial amounts for variable leases. Contingencies We may become involved in legal proceedings, claims and assessments from time to time in the ordinary course of business. We accrue liabilities for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. Legal U.S. District Court Proceedings On March 15, 2017, we filed a complaint in the U.S. District Court for the District of Delaware against ONT Inc. for patent infringement (C.A. No. 17-cv-275 (“275 Action”)). The complaint is based on our U.S. Patent No. 9,546,400 (the “’400 Patent”), entitled “Nanopore sequencing using n-mers” which covers novel methods for nanopore sequencing of nucleic acid molecules using the signals from multiple monomeric units. This patent was granted on January 17, 2017. We are seeking remedies including injunctive relief, damages and costs. On August 23, 2018, we filed an amended complaint, adding ONT Ltd. as a defendant in the 275 Action. On August 15, 2019, the judge granted our motion to amend the complaint in the 275 Action to add allegations of willful infringement by ONT Inc. and ONT Ltd. On September 25, 2017, we filed a second complaint in the U.S. District Court for the District of Delaware against ONT Inc. for patent infringement (C.A. No. 17-cv-1353 (“1353 Action”)). The complaint is based on our U.S. Patent No. 9,678,056 (the “’056 Patent”) entitled “Control of Enzyme Translation in Nanopore Sequencing”, granted June 13, 2017, and U.S. Patent No. 9,738,929 (the “’929 Patent”) entitled “Nucleic Acid Sequence Analysis”, granted August 22, 2017. We are seeking remedies including injunctive relief, damages and costs. On March 28, 2018, we added a claim for infringement of our U.S. Patent No. 9,772,323 (the “’323 Patent”), entitled “Nanopore sequencing using n-mers.” On August 23, 2018 we filed an amended complaint, adding ONT Ltd. as a defendant in the 1353 Action. On August 15, 2019, the judge granted our motion to amend the complaint in the 1353 Action to add allegations of willful infringement by ONT Inc. and ONT Ltd. 16 Table of Contents A trial for the U.S. District Court matters was held from March 9 through March 18, 2020. The jury determined that ONT Inc. and ONT Ltd. infringed the ‘056 Patent, the ‘400 Patent, and the ‘323 Patent, but the jury declined to find these patents valid based on enablement and, in the case of claim one of the ’056 Patent, written description and indefiniteness. The jury declined to find valid or infringed U.S. Patent No. 9,738,929. We plan to appeal the decision to the U.S. Court of Appeals for the Federal Circuit. Unrelated to the preceding matters, on September 26, 2019, Personal Genomics of Taiwan, Inc. (“PGI”) filed a complaint in the U.S. District Court for the District of Delaware against us for patent infringement (C.A. No. 19-cv-1810). The complaint is based on PGI’s U.S. Patent No. 7,767,441 (the “441 Patent”). We plan to vigorously defend in this matter. On November 20, 2019, we filed our answer to the complaint, denying infringement and seeking a declaratory judgement of invalidity of the ‘441 Patent. A trial for this matter is scheduled to begin on March 14, 2022. On June 22, 2020, we filed a petition requesting institution of an inter-partes review (IPR) to the Patent Trial and Appeals Board (the “Board”) at the United States Patent Office requesting the Board to find a set of claims in the ‘441 invalid. On June 27, 2020, we filed a second petition requesting institution of an IPR requesting the Board to find another set of claims in the ‘441 invalid. The two petitions requesting IPRs assert that all of the claims relevant to the PGI complaint are invalid. On May 19, 2020, PGI filed a complaint in the Wuhan People’s Court alleging infringement of one or more claims of China patent No. CN101743321B, which is related to the ‘441 Patent. We have not received service. We plan to vigorously defend in this matter. Other Proceedings From time to time, we may also be involved in a variety of other claims, lawsuits, investigations and proceedings relating to securities laws, product liability, patent infringement, contract disputes, employment and other matters that arise in the normal course of our business. In addition, third parties may, from time to time, assert claims against us in the form of letters and other communications. We record a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We currently do not believe that the ultimate outcome of any of the matters described above is probable or reasonably estimable, or that these matters will have a material adverse effect on our business; however, the results of litigation and claims are inherently unpredictable. Regardless of the outcome, litigation can have an adverse impact on us because of litigation and settlement costs, diversion of management resources and other factors. Indemnification Pursuant to Delaware law and agreements entered into with each of our directors and officers, we may have obligations, under certain circumstances, to hold harmless and indemnify each of our directors and officers against losses suffered or incurred by the indemnified party in connection with their service to us, and judgements, fines, settlements and expenses related to claims arising against such directors and officers to the fullest extent permitted under Delaware law, our bylaws and certificate of incorporation. We also enter and have entered into indemnification agreements with our directors and officers that may require us to indemnify them against liabilities that arise by reason of their status or service as directors or officers, except as prohibited by applicable law. In addition, we may have obligations to hold harmless and indemnify third parties involved with our fundraising efforts and their respective affiliates, directors, officers, employees, agents or other representatives against any and all losses, claims, damages and liabilities related to claims arising against such parties pursuant to the terms of agreements entered into between such third parties and us in connection with such fundraising efforts. To the extent that any such indemnification obligations apply to the lawsuits described above, any associated expenses incurred are included within the related accrued litigation expense amounts. No additional liability associated with such indemnification obligations has been recorded at June 30, 2020. NOTE 7. STOCKHOLDERS’ EQUITY Equity Plans As of June 30, 2020, in total, we had three active equity compensation plans: the 2010 Equity Incentive Plan (“ 2010 Plan”) , the 2010 Outside Director Equity Incentive Plan (“ 2010 Director Plan”) and the 2010 Employee Stock Purchase Plan (“ESPP”). Pursuant to the terms of the then-in-process Merger Agreement, the ESPP was terminated after the completion of the purchase period ended March 1, 2019. After the merger with Illumina was terminated in January 2020, we began offerings under the ESPP again starting with the offering period beginning on March 1, 2020. Our 2010 Equity Incentive Plan (“ 2010 Plan”) and 2010 Outside Director Equity Incentive Plan (“ 2010 Director Plan”) expired on July 29, 2020. 17 Table of Contents On August 4, 2020, stockholders at the 2020 Annual Meeting approved a new 2020 Equity Incentive Plan and the 2010 Equity Incentive Plan and 2010 Outside Director Equity Incentive Plan were terminated. A description of the 2020 Equity Incentive Plan can be found in the Company’s Proxy Statement for the 2020 Annual Meeting of Stockholders, dated June 24, 2020. Stock Options The following table summarizes stock option activity for all our stock option plans for the six months ended June 30, 2020 (in thousands, except per share amounts): Stock Options Outstanding Weighted Number average of shares Exercise price exercise price Balances, December 31, 2019 22,697 $ 1.16 – 16.00 $ 5.57 Options granted 35 2.45 2.45 Options exercised ( 341 ) 1.16 – 4.25 2.43 Options canceled ( 1,906 ) 2.54 – 15.77 7.39 Balances, June 30, 2020 20,485 $ 1.16 – 16.00 $ 5.45 For the three and six months ended June 30, 2020, we recognized stock-based compensation expense of $ 1.1 million and $ 2.9 million, respectively, related to options. Restricted Stock Units, or “RSUs” Time-based RSUs The following table summarizes the time-based RSUs activity for the six months ended June 30, 2020 (in thousands, except per share amounts): Weighted average Number grant date of shares fair value RSUs outstanding at December 31, 2019 1,086 $ 6.12 RSUs granted 5,280 4.34 RSUs released ( 858 ) 6.78 RSUs forfeited ( 399 ) 4.47 Unvested RSUs outstanding at June 30, 2020 5,109 $ 4.30 For the three and six months ended June 30, 2020, we recognized stock-based compensation expense of $ 1.6 million and $ 3.8 million, respectively, related to time-based RSUs. Performance-based RSUs The following table summarizes the performance-based RSUs activity for the six months ended June 30, 2020 (in thousands, except per share amounts): 18 Table of Contents Weighted average Number grant date of shares fair value PSUs outstanding at December 31, 2019 138 $ 2.63 PSUs granted — — PSUs released — — PSUs forfeited — — Unvested PSUs outstanding at June 30, 2020 138 $ 2.63 For the three and six months ended June 30, 2020, we recognized stock-based compensation expense of $ 0 related to the performance-based RSUs. In January 2020, an additional 7.7 million shares and 1.5 million shares, respectively, were reserved under the 2010 Plan and the 2010 Director Plan. As of June 30, 2020, we had an aggregate of 27.2 million shares of common stock reserved and available for future issuance under the 2010 Plan and 2010 Director Plan. ESPP shares Shares issued under our ESPP were none and 1,306,329 during the six months ended June 30, 2020 and 2019, respectively. In January 2020, an additional 3.1 million shares were reserved under the ESPP. As of June 30, 2020, 6,713,447 shares of our common stock remain available for issuance under our ESPP. For the three and six months ended June 30, 2020, we recognized stock-based compensation expense of $ 408,000 and $ 537,000 , respectively, related to the ESPP shares. Stock-Based Compensation The following table summarizes the stock-based compensation expense for the three and six months ended June 30, 2020 and 2019, respectively (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Cost of revenue $ 452 $ 444 $ 979 $ 956 Research and development 1,433 1,918 3,192 3,930 Sales, general and administrative 1,349 1,727 3,095 3,584 Total stock-based compensation expense $ 3,234 $ 4,089 $ 7,266 $ 8,470 W e estimated the fair value of employee stock options on the grant date using the Black-Scholes option pricing model. The estimated fair value of employee stock options is amortized on a straight-line basis over the requisite service period of the awards. We did no t grant any stock options for the three months ended June 30, 2020. We did no t grant any stock options for the year ended December 31, 2019 due to the then-in-process merger with Illumina. Three Months Ended June 30, Six Months Ended June 30, Stock Option 2020 2019 2020 2019 Expected term in years — — 5.1 — Expected volatility — — 57 % — Risk-free interest rate — — 1.2 % — Dividend yield — — — — 19 Table of Contents We estimate the value of employee stock purchase rights on the grant date using the Black-Scholes option pricing model. Pursuant to the terms of the then-in-process merger with Illumina, the ESPP was terminated after the completion of the purchase period ended March 1, 2019 and there were no offerings after March 1, 2019. As such there were no new Black-Scholes calculations performed to calculate the fair value of new purchase rights granted for the year ended December 31, 2019. After the merger with Illumina was terminated in January 2020, we began offerings under the ESPP again starting with the offering period on March 1, 2020. Three Months Ended June 30, Six Months Ended June 30, ESPP 2020 2019 2020 2019 Expected term in years 0.5 - 2.0 — 0.5 - 2.0 — Expected volatility 0.6 — 0.6 — Risk-free interest rate 0.8 % - 1.0 % — 0.8 % - 1.0 % — Dividend yield — — — — NOTE 8. REVENUE A summary of our revenue by geographic location for the three and six months ended June 30, 2020 and 2019 is as follows (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 North America $ 8,457 $ 14,222 $ 16,218 $ 23,209 Europe (including the Middle East and Africa) 4,191 3,414 7,586 6,478 Asia Pacific 4,429 6,985 8,871 11,359 Total $ 17,077 $ 24,621 $ 32,675 $ 41,046 A summary of our revenue by category for the three and six months ended June 30, 2020 and 2019 is as follows (in thousands): Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2020 2019 2020 2019 Instrument revenue $ 8,934 $ 12,664 $ 12,958 $ 18,287 Consumable revenue 4,822 8,586 13,091 16,420 Product revenue 13,756 21,250 26,049 34,707 Service and other revenue 3,321 3,371 6,626 6,339 Total revenue $ 17,077 $ 24,621 $ 32,675 $ 41,046 20 Table of Contents