What changed in this filing

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Item 8. Financial Statements and Supplementary Data

2021-02-26 compared with 2020-02-28 · 431 added, 594 removed, 512 unchanged (67% of the section changed)

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Consolidated Balance Sheets

Consolidated Statements of Operations and Comprehensive Loss

Consolidated Statements of Stockholders’

Consolidated Statements of Operations and Comprehensive I ncome (Loss)

Consolidated Statements of Stockholders’ Equity

Consolidated Statements of Cash Flows

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the S tockholders and the Board of Directors of Pacific Biosciences of California, Inc.

To the Stockholders and the Board of Directors of Pacific Biosciences of California, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Pacific Biosciences of California, Inc.

(the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive loss, stockholders’

equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “consolidated financial statements”).

(the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive income (loss) , stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S.

generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 28, 2020 expressed an unqualified opinion thereon.

Adoption of ASU No.

As discussed in Note 3 to the consolidated financial statements, the Company changed its method for accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No.

2016-02, Leases (Topic 842), and the related amendments.

Basis for Opinion

These financial statements are the responsibility of the Company's management.

Our responsibility is to express an opinion on the Company’s financial statements based on our audits.

We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S.

These financial statements are the responsibility of the Company's management.

Our responsibility is to express an opinion on the Company’s financial statements based on our audits.

We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S.

federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

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Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.

The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.

As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.

Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.

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The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Revenue recognition –

Non-standard revenue contracts

Revenue recognition – Non-standard revenue contracts

Description of the Matter

As described in Note 3 to the consolidated financial statements, the Company's instrument is generally sold in a bundled arrangement and commonly includes the instrument, instrument accessories, installation, one-year period of service, training, and consumables.

The Company enters into non-standard sales arrangements for which significant discounts may be offered on the different components of the bundled arrangements and for which historical information for similar sales may not be available.

As part of the Company's identification of performance obligations and the resulting determination of the allocation of contract consideration, the Company considers if these discounts represent a material right when compared to the estimated standalone selling prices, and therefore a performance obligation to be included in the allocation of the contract value.

The Company also estimates the standalone selling price of each performance obligation to determine the allocation of consideration.

To estimate the selling price of each performance obligation, the Company uses historical sales data, as well as management judgment.

Auditing the Company's estimated standalone selling price, their determination of whether there are material rights that represent performance obligations and the resulting allocation of the contract value for non-standard sales arrangements is complex and required a higher level of judgment due to the level of estimation and subjectivity in establishing the standard selling price of each performance obligation.

How We Addressed the Matter in Our Audit

We obtained an understanding, evaluated the design and tested the operating effectiveness of controls addressing the identified audit risks.

For example, we tested controls over the process to determine the standard selling price of each performance obligation and whether material rights existed, and the allocation of the contract consideration among the identified performance obligations.

We tested the completeness of the identified performance obligations and tested the accuracy of the allocation of the total contract consideration among the identified performance obligations.

In order to do this, our audit procedures included, among others, evaluating the accuracy and completeness of the underlying data used in management's calculation of the standard selling price for each performance obligation by agreeing the data to historical transactions and contract pricing for backlog orders.

We tested the identification of performance obligations and the allocation of contract consideration using the standard selling price of each performance obligation for a sample of arrangements by reading the contracts with the customers and evaluating whether terms of the contracts (including future purchase options) resulted in material rights.

We also performed sensitivity analyses of significant assumptions to evaluate the changes in revenue recognized for the period under audit that would result from changes in the Company's estimated standard selling price for the performance obligations.

/s/ Ernst & Young LLP

We have served as the Company’s auditor since 2011.

Redwood City, California

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Prepaid expenses and other current assets

Short-term restricted cash

Total current assets

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Other long-term assets

Liabilities and Stockholders’

Liabilities and Stockholders’ Equity

Current liabilities

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Operating lease liabilities, non-current

Deferred rent, non-current

Notes payable, non-current

Financing derivative

Other liabilities, non-current

Total liabilities

Commitments and contingencies

Stockholders’

Stockholders’ equity

Preferred stock, $ 0.001 par value:

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Additional paid-in capital

Accumulated other comprehensive income (loss)

Accumulated other comprehensive income

Accumulated deficit

Total stockholders’

Total liabilities and stockholders’

( 1,036,869 )

( 1,066,240 )

Total stockholders’ equity

Total liabilities and stockholders’ equity

See accompanying notes to the consolidated financial statements.

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Consolidated Statements of Operations and Comprehensive Loss

Consolidated Statements of Operations and Comprehensive Income (Loss)

Years Ended December 31,

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Operating loss

Gain from Reverse Termination Fee from Illumina

Gain from Continuation Advances from Illumina

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Other income, net

Other comprehensive loss:

Net income (loss)

Other comprehensive income (loss):

Unrealized gain (loss) on investments

Comprehensive loss

Net loss per share:

Basic and diluted net loss per share

Shares used in computing basic and diluted net loss per share

Comprehensive income (loss)

Net income (loss) per share:

Weighted average shares outstanding used in calculating net income (loss) per share

See accompanying notes to the consolidated financial statements.

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Consolidated Statements of Stockholders ’

Consolidated Statements of Stockholders ’ Equity

Comprehensive

Stockholders'

(in thousands)

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Balance at December 31, 2017

Other comprehensive loss

Other comprehensive income (loss)

ASC606 adoption effect

Issuance of common stock in conjunction with equity plans

Issuance of common stock in conjunction with "at-the-market" offering, net of issuance costs

Issuance of common stock from Underwritten Public Equity Offering, net of issuance costs

Issuance of common stock from Underwritten Public Equity Offerings, net of issuance costs

Stock-based compensation expense

Balance at December 31, 2018

Other comprehensive loss

ASC606 adoption effect

Other comprehensive income (loss)

Issuance of common stock in conjunction with equity plans

Issuance of common stock from Underwritten Public Equity Offerings, net of issuance costs

Stock-based compensation expense

Balance at December 31, 2019

Other comprehensive loss

( 1,066,240 )

Other comprehensive income (loss)

ASC326 adoption effect

Issuance of common stock in conjunction with equity plans

Issuance of common stock from Underwritten Public Equity Offerings, net of issuance costs

Stock-based compensation expense

Balance at December 31, 2020

( 1,036,869 )

See accompanying notes to the consolidated financial statements.

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Cash flows from operating activities

Net income (loss)

Adjustments to reconcile net loss to net cash used in operating activities

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Loss on disposition of equipment

Loss on return of building under capital lease

Changes in assets and liabilities

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Other liabilities

Net cash used in operating activities

Net cash provided by (used in) operating activities

Cash flows from investing activities

Purchase of property and equipment

Proceeds from disposal of property and equipment

Purchase of investments

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Notes payable principal payoff

Proceeds from issuance of common stock from "at-the-market" offerings, net of issuance costs

Proceeds from issuance of common stock from underwritten public equity offerings, net of issuance costs

Net cash provided by financing activities

Net increase (decrease) in cash and cash equivalents and restricted cash

Net increase in cash and cash equivalents and restricted cash

Cash and cash equivalents and restricted cash at beginning of period

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Property and equipment transferred to inventory

Property and equipment paid for by landlord

Changes in deposits for property and equipment paid in prior period

Property and equipment returned to landlord

See accompanying notes to the consolidated financial statements.

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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;

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Our technology provides high accuracy, ultra-long reads, uniform coverage and the ability to simultaneously detect epigenetic changes.

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.

PacBio® sequencing systems, including associated consumables and software, provide a simple and fast end-to-end workflow for SMRT sequencing.

Our current products include the Sequel II and Sequel IIe instruments and SMRT Cell 8M, which when used 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 when used together are capable of sequencing up to approximately one million DNA molecules simultaneously.

In October 2020, we launched the Sequel IIe System, which has increased computational capacity, and is designed to enable customers to generate PacBio HiFi reads more efficiently.

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.

sequencing systems, including consumables and software, provide a simple and fast end-to-end workflow for SMRT sequencing.

The names “Pacific Biosciences,”

“PacBio,”

“SMRT,”

“SMRTbell,”

“Sequel”

and our logo are our trademarks.

The names “Pacific Biosciences,” “PacBio,” “SMRT,” “SMRTbell,” “Sequel” and our logo are our trademarks.

TERMINATION OF MERGER WITH ILLUMINA

On November 1, 2018, we entered into a Merger Agreement with Illumina and FC Ops Corp.

We, Illumina and Merger Subsidiary entered into the Amendment on September 25, 2019.

The Amendment, among other things, extended the End Time (as defined in the Merger Agreement) to December 31, 2019.

Additionally, Illumina had until December 18, 2019 to exercise its unilateral right to extend the End Time to March 31, 2020.

In addition, the Amendment provided that Illumina would make payments to us of $6.0 million on or before each of October 1, 2019, November 1, 2019 and December 2, 2019.

If Illumina elected to further extend the End Time to March 31, 2020, then, except under limited situations, Illumina would be required to make payments to us of $6.0 million on or before each of January 2, 2020, and March 2, 2020, and a payment of $22.0 million on or before February 3, 2020.

On December 17, 2019, the U.S.

Federal Trade Commission publicly announced that it had authorized legal action to block the Merger.

On December 18, 2019, we received written notice from Illumina pursuant to which Illumina exercised its right under Section 10.01(b)(i) of the Merger Agreement, to extend the End Time to March 31, 2020.

In accordance with the terms of the Merger Agreement , we received Continuation Advances totaling $18.0 million from Illumina during the fourth quarter of 2019, which are reflected in the “Gain from Continuation Advances from Illumina”

line in the consolidated statements of operations and comprehensive loss for the year ended December 31, 2019.

On January 2, 2020, we, Illumina and Merger Subsidiary entered into the Termination Agreement to terminate the Merger Agreement.

As part of our agreement to terminate the Merger Agreement, Illumina subsequently paid us the Reverse Termination Fee from which we expect to pay our financial advisor associated fees of approximately $10 million.

In addition, Illumina paid us the additional Continuation Advance s of $6 million in January 2020 and $22 million in February 2020 and is scheduled to make a final Continuation Advance to us of $6 million in March 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), then we will 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.

In addition, up to the full amount of the Continuation Advances paid to us are repayable without interest to Illumina if, within two years of March 31, 2020, we enter into 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 additional accounting considerations relating to the Continuation Advance s received.

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”).

Continuation Advances from Illumina

As part of the Termination Agreement, Illumina paid us cash payments (“Continuation Advances”), of $ 18.0 million during the fourth quarter of 2019 and $ 34.0 million during the first quarter of 2020.

We recorded the $ 34.0 million and $ 18.0 million as a part of other income in the consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2020 and 2019, respectively.

Please refer to “Note 4.

Financial Instruments” for the accounting treatment of the Continuation Advances.

Up to the full $ 52.0 million of 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 a single equity or debt financing (that may have multiple closings), with the amount repayable dependent on the amount raised by us.

Resulting from the issuance and sale of $ 900 million of 1.50 % Convertible Senior Notes due February 15, 2028 , $ 52.0 million of Continuation Advances were paid without interest to Illumina in February 2021.

Please see “Note 11.

Subsequent Events” for additional information.

Reverse Termination Fee from Illumina

As part of the Termination Agreement, Illumina paid us a $ 98.0 million termination fee (“Reverse Termination Fee”), from which we paid our financial advisor associated fees of $ 6.0 million in April 2020.

We recorded the $ 6.0 million of associated fees we paid to our financial advisor in the “Sales, general and administrative” expense line in the consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2020.

Pursuant to the Termination Agreement, in the event that, on or prior to September 30, 2020, we entered into a definitive agreement providing for, or consummated, a Change of Control Transaction, then we may have been 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 was not consummated by the two year anniversary of the execution of the definitive agreement for such Change of Control Transaction, then we would not have been 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 deferred the gain from the Reverse Termination Fee from Illumina until the date when the associated contingency lapsed.

On October 1, 2020, the contingency clauses lapsed and we recorded the $ 98.0 million as a part of other income in the consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2020.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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All intercompany transactions and balances have been eliminated.

Translation adjustments resulting from translating foreign subsidiaries’

results of operations and assets and liabilities into U.S.

Translation adjustments resulting from translating foreign subsidiaries’ results of operations and assets and liabilities into U.S.

dollars are immaterial for all periods presented.

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 December 31, 2020.

Use of Estimates

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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 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.

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 recognition and measurement of current and deferred income tax assets, along with the assessment of recoverability 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.

During 2017, we recorded a charge to cost of service and other revenue of $1.6 million relating to leased RS II instruments primarily due to a change in the estimated useful life of these instruments.

The charge of $1.6 million increased loss per share by $0.01 for the year ended December 31, 2017.

Reclassifications

Certain prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation with no effect on previously reported net loss, comprehensive loss, cash flows or stockholders’ equity.

Accounting Changes

In February 2016, the FASB issued ASU 2016-02 regarding ASC Topic 842 Leases and in July 2018, the FASB issued ASU 2018-11, Leases (Topic 842):

Targeted Improvements .

We refer to the new guidance as “ASC 842”.

On January 1, 2019, we adopted the ASC 842 using a modified retrospective approach , which requires the recognition of right-of-use assets and related operating and finance lease liabilities on the consolidated balance sheet.

As permitted by ASC 842, we elected the adoption date of January 1, 2019, which is the date of initial application.

As a result ,

the consolidated balance sheet prior to January 1, 2019 was not restated and continue s to be reported under ASC Topic 840, Leases , or “

ASC 840 ”

, which did not require the recognition of right-of-use assets and operating lease liabilities on the consolidated balance sheet and ;

t he expense recognition for operating leases under ASC 842 remained substantially consistent with ASC 840.

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:

quoted prices in active markets for identical assets or liabilities;

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;

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.

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 December 31, 2019 and 2018 , respectively (in thousands):

December 31, 2019

December 31, 2018

(in thousands)

Cash and cash equivalents:

Cash and money market funds

Commercial paper

Total cash and cash equivalents

Commercial paper

Corporate debt securities

US government & agency securities

Total investments

Long-term restricted cash:

Total assets measured at fair value

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 “Note 6.

Notes Payable’) was determined using Level 3 inputs, or significant unobservable inputs.

Refer to “Note 6.

Notes Payable”

for a detailed description and valuation approach.

Changes to the estimated fair value of the Financing Derivative are recorded in “Other income (expense), net”

in the consolidated statements of operations and comprehensive loss.

The following table provides the changes in the fair value of the Financing Derivative for the years ended December 31, 2019 and 2018 (in thousands), respectively:

Financing Derivative

Balance as of December 31, 2017

Gain on change in fair value of Financing Derivative

Balance as of December 31, 2018

Gain on change in fair value of Financing Derivative

Balance as of December 31, 2019

Estimated fair value of the C ontinuation A dvances liability

On November 1, 2018, we entered into a Merger Agreement with Illumina and FC Ops Corp.

We, Illumina and Merger Subsidiary entered into the Amendment on September 25, 2019.

In accordance with the terms of the Merger Agreement, we received Continuation Advance s totaling $18 .0 million from Illumina during the fourth quarter of 2019 .

We determined that the $18 .0 million of Continuation Advances received from Illumina in 2019 , which are subject to repayment under certain circumstances as discussed above, constitute a financial liability .

The fair value option was elected for the financial liability because management believes that among all measurement methods allowed by 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 received in 2019 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 December 31, 2019:

We enter into a Change of Control Transaction (as defined in the Termination Agreement) within two years following March 31, 2020;

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 f air value of the liability associated with the contingent repayment of the $18 .0 million of Continuation Advances received in the fourth quarter of 2019 was assessed to be zero as of December 31, 2019, with a resulting non-operating gain of $18 .0 million recorded as “Gain from Continuation Advances from Illumina”

in the consolidated statements of operations and comprehensive loss for the year ended December 31, 2019.

For the year ended December 31, 201 9 , 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.

Financial Assets and Liabilities Not Measured at Fair Value on a Recurring Basis

We determined the fair value of the Notes (as defined in “Note 6.

Notes Payable”) from the Facility Agreement we entered into during the first quarter of 2013 using Level 3 inputs, or significant unobservable inputs.

The value of the Notes 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 % and 9.6 % weighted average market yield at December 31, 201 9 and December 31, 201 8 , respectively.

Refer to “Note 6.

Notes Payable”

for additional details regarding the Notes.

The estimated fair value and carrying value of the Notes are as follows (in thousands):

December 31, 2019

December 31, 2018

Carrying Value

Long-term notes payable

Cash and Cash Equivalents

In June 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or 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/accumulated deficit to be recognized on the date of adoption with prior periods not restated.

The adoption of Topic 326 did not have a material impact on our financial statements and our bad debt expense was immaterial as of December 31, 2020.

Cash, Cash Equivalents and Investments

We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

We have designated all investments as available-for-sale and therefore, such investments are reported at fair value, with unrealized gains and losses recognized in accumulated other comprehensive income (loss) (“OCI”) in stockholders’

The cost of marketable securities is adjusted for the amortization of premiums and discounts to expected maturity.

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We include all of our available-for-sale securities in current assets.

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 with high credit ratings.

We have established guidelines regarding diversification of its investments and their maturities with the objectives of maintaining safety and liquidity, while maximizing yield.

Concentration and Credit Risks

Financial instruments that potentially subject us to credit risk consist principally of interest-bearing investments and trade receivables.

We maintain cash, cash equivalents and investments with various major financial institutions.

The counterparties to the agreements relating to our investment securities consist of various major corporations, financial institutions, municipalities and government agencies of high credit standing.

We perform periodic evaluations of the relative credit standing of these financial institutions.

In addition, we perform periodic evaluations of the relative credit quality of its investments.

All of our investments are subject to a periodic impairment review.

We recognize an impairment charge when a decline in the fair value of our investments below the cost basis is judged to be other-than-temporary.

Factors considered in determining whether a loss is temporary include the length of time and the extent to which an investment’s fair value has been less than its cost basis, the financial condition and near-term prospects of the investee, the extent of the loss related to credit of the issuer, the expected cash flows from the security, our intent to sell the security and whether or not we will be required to sell the security before the recovery of its amortized cost.

During the years ended December 31, 2019, 2018 and 2017, we did no t have any im pairment charges on our investments as it is more likely than not that we will recover their amortized cost basis upon sale or maturity.

Concentration and Other Risks

Our accounts receivable are derived from net revenue to customers and distributors located in the United States and other countries.

We perform credit evaluations of our customers’

financial condition and, generally, require no collateral from our customers.

We regularly review our accounts receivable including consideration of factors such as historical experience, credit quality, the age of the accounts receivable balances and current economic conditions that may affect a customer’s ability to pay.

For the years ended December 31, 2020, 2019 and 2018, we did no t have any impairment charges on our investments as it is more likely than not that we will recover their amortized cost basis upon sale or maturity.

Our trade receivables are derived from net revenue to customers and distributors located in the United States and other countries.

We perform credit evaluations of our customers’ financial condition and, generally, require no collateral from our customers.

The allowance for doubtful accounts is based on our assessment of the collectability of customer accounts.

We regularly review our trade receivable including consideration of factors such as historical experience, 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.

We have not experienced any significant credit losses to date.

F or the year s ended December 31, 2019, 2018 and 2017, one customer, Gene Company Limited, accounted for appr oximately 17 % , 26% and 31% of our total revenue, respectively.

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.

For the years ended December 31, 2020, 2019 and 2018, one customer, Gene Company Limited, accounted for approximately 14 %, 17 % and 26 % our total revenue, respectively.

As of December 31, 2020 and 2019, 43 % and 55 % of our accounts receivable were from domestic customers, respectively.

As of December 31, 2019 and 2018, one customer, Gene Company Limited, represented approximately 11 % and 14% of our net accounts receivable, respectively.

We currently purchase several key parts and components used in the manufacture of our p roducts from a limited number of suppliers.

As of December 31, 2020, two customers, Berry Genomics Co., Ltd and Gene Company Limited, represented approximately 15 % and 12 % of our net accounts receivable, respectively.

As of December 31, 2019, customer, Gene Company Limited, represented approximately 11 % of our net accounts receivable.

We currently purchase several key parts and components used in the manufacture of our products from a limited number of suppliers.

Generally, we have been able to obtain an adequate supply of such parts and components.

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Inventories are stated at the lower of average cost or net realizable value.

Cost is determined using the first-in, first-out (“FIFO”) method.

Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess or obsolete balances.

Cost includes depreciation, labor, material, and overhead costs, including product and process technology costs while determining net realizable value of inventories involves numerous judgements, including projecting future average selling prices, sales volumes, and costs to complete products in work in process inventories.

We enter into inventory purchases and commitments so that we can meet future shipment schedules based on forecasted demand for our products.

The business environment in which we operate is subject to rapid changes in technology and customer demand.

We perform a detailed assessment of inventory each period, which includes a review of, among other factors, demand requirements, product life cycle and development plans, component cost trends, product pricing, product expiration, and quality issues.

Based on our analysis, we record adjustments to inventory for potentially excess, obsolete, or impaired goods, when appropriate, in order to report inventory at net realizable value.

Inventory adjustments may be required if actual demand, component costs, supplier arrangements, or product life cycles differ from our estimates.

Any such adjustments would result in a charge to our results of operations .

Property and Equipment, Net

Property and equipment are stated at cost, net of accumulated depreciation and any impairment charges.

Depreciation is computed using the straight-line method over the estimated useful life of the asset, generally two to three years for computer equipment, three to five years for software, three to seven years for furniture and fixtures and three to five years for lab equipment.

Depreciation is computed using the straight-line method over the estimated useful life of the asset, generally two years to three years for computer equipment, three years to five years for software, three years to seven years for furniture and fixtures and three years to five years for lab equipment.

Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life of the related asset.

Major improvements are capitalized, while maintenance and repairs are expensed as incurred.

Long-term Restricted Cash

As required under the lease agreement for our corporate offices, 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 1305 O’Brien L ease, at May 1, 2019, the $4.5 million in restricted cash was reduced to $4.0 million.

As such, $4.0 million and $4.5 million was recorded in “Long-term restricted cash”

in the consolidated balance sheet as of December 31, 2019 and 2018, respectively.

Pursuant to the terms of the O’Brien Lease, the letter of credit balance of $4.0 million at December 31, 2019 will be reduce d again in May 2020 by $500,000 , resulting in a letter of credit balance of $3.5 million.

Impairment of Long-Lived Assets

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If indicators of impairment exist and the undiscounted projected cash flows associated with such assets are less than the carrying amount of the asset, an impairment loss is recorded to write the asset down to its estimated fair value.

To date, we have no t recorde d any im pairment charges.

To date, we have no t recorded any impairment charges.

Operating Leases

We lease administrative, manufacturing and laboratory facilities under operating leases.

Lease agreements may include rent holidays, rent escalation clauses and tenant improvement allowances.

We recognize scheduled rent increases on a straight-line basis over the lease term beginning with the date we take possession of the leased space.

Leasehold improvements are capitalized at cost and depreciated over the shorter of their expected useful life or the life of the lease.

On January 1, 2019, we adopted ASC 842, which requires the recognition of the right-of-use assets and related operating and finance lease liabilities on the consolidated balance sheet.

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 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.

Leases with terms of 12 months or less are expensed on a straight-line basis over the term and are not recorded in the consolidated balance sheets.

Short-term Restricted Cash

At December 31, 2020 the short-term restricted cash balance of $ 0.8 million was comprised of $ 0.5 million of a customer deposit and $ 0.3 million of the security deposit for the credit cards for employees.

Long-term Restricted Cash

Under the lease agreement for our corporate offices, 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, on May 1, 2019 the $ 4.5 million in restricted cash was reduced to $ 4.0 million and on May 1, 2020 the $ 4.0 million in restricted cash was reduced to $ 3.5 million.

Revenue Recognition

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Product revenue primarily consists of sales of our instruments and related consumables;

s ervice and other revenue primarily consist s of revenue earned from product maintenance agreements with some additional revenue from instrument lease agreements and grant revenue.

service and other revenue primarily consists of revenue earned from product maintenance agreements.

We account for a contract with a customer when there is a legally enforceable contract between us and the customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable.

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As a result, the system and installation are considered to be a single performance obligation recognized after installation is completed except for sales to qualified distributors, in which case the system is distinct and recognized when control has transferred to the distributor which typically occurs upon shipment.

The consideration for bundled arrangements is allocated between separate performance obligations based on their individual standalone selling price (“SSP”).

The SSP is determined based on observable prices at which we separately sell the products and services.

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We record deferred revenues when cash payments are received or due in advance of our performance for product maintenance agreements.

Deferred revenue is recognized over the related performance period, generally one to three years, on a straight-line basis as we are standing ready to provide services and a time-based measure of progress best reflects the satisfaction of the performance obligation.

As of December 31, 2019 , 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 such costs are incurred if the amortization period would have been a year or less.

Contract assets as of December 31, 2019 and December 31, 2018 were not material.

Instrument lease agreements - Instrument leases are generally classified as operating-type leases and revenue from these leases is recognized on a straight-line basis over the respective lease term, once the lessee takes (or has the right to take) control/possession of the property under the lease.

Effectively, this occurs once the installation is complete and control of the instrument is transferred to our customers.

Deferred revenue is recognized over the related performance period, generally one year to three years , on a straight-line basis as we are standing ready to provide services and a time-based measure of progress best reflects the satisfaction of the performance obligation.

Other practical expedients and exemptions - Customers generally are invoiced upon acceptance of the system, which is also the start of the one year service period.

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Research and development expense consists primarily of expenses for personnel engaged in the development of our SMRT Sequencing technology, the design and development of our future products and current product enhancements.

These expenses also

include prototype-related expenditures, development equipment and supplies, facilities costs and other related overhead.

These expenses also include prototype-related expenditures, development equipment and supplies, facilities costs and other related overhead.

We expense research and development costs during the period in which the costs are incurred.

However, we defer and capitalize non-refundable advance payments made for research and development activities until the related goods are received or the related services are rendered.

Operating Leases

We lease administrative, manufacturing and laboratory facilities under operating leases.

Lease agreements may include rent holidays, rent escalation clauses and tenant improvement allowances.

We recognize scheduled rent increases on a straight-line basis over the lease term beginning with the date we take possession of the leased space.

Leasehold improvements are capitalized at cost and depreciated over the shorter of their expected useful life or the life of the lease.

On January 1, 2019, we adopted ASC 842, which requires the recognition of the right-of-use assets and related operating and finance lease liabilities on the consolidated balance sheet.

Prior to that, we recorded tenant improvement allowances as deferred rent liabilities and amortize d the deferred rent over the term of the lease to rent expense on the statements of operations and comprehensive loss.

Leases with terms of 12 months or less are expensed on a straight-line basis over the term and are not recorded in the consolidated balance s heets.

Credit Losses

We adopted Topic 326 on January 1, 2020.

The adoption of Topic 326 did not have a material impact on our financial statements and our bad debt expense was immaterial as of December 31, 2020.

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 December 31, 2020.

We account for income taxes under the asset and liability method, which requires, among other things, that deferred income taxes be provided for temporary differences between the tax bases of our assets and liabilities and the amounts reported in the financial statements.

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Stock-based Compensation

Stock-based compensation expense for all stock-based compensation awards, including stock options, restricted stock units, and shares issued under the 2010 Employee Stock Purchase Plan (“ESPP”), is based on the grant date fair value.

The fair value for restricted stock units is based on grant date stock price , the fair value for stock option and ESPP shares is estimated using the Black-Scholes option pricing model with assumptions described in detail below:

Expected Term .

Starting January 1, 2018, we determined the expected term using historical option experience .

We determined expected term based on historical exercise patterns and an expectation of the time it will take for employees to exercise options still outstanding.

Prior to 2018, we did not believe that we were able to rely on our historical employee exercise behavior to provide accurate data for estimating our expected term for use in determining the fair value of these options due to limited trading history.

Therefore, for the period prior to 2018, the expected term of options is estimated based on the simplified method.

Expected Volatility .

Starting January 1, 2018, we estimate the volatility of our common stock at the date of grant based on the historical volatility of our common stock.

Prior to 2018, we did not have sufficient trading history to solely rely on the volatility of our own common stock for establishing expected volatility.

Therefore, we based our expected volatility on the historical stock volatilities of our common stock as well as several comparable publicly listed companies over a period equal to the expected term of the options.

Risk-Free Rate.

The risk-free interest rate is based on the U.S.

Treasury yield curve in effect at the time of grant for the expected term of the stock option.

We have never p aid any cash dividends on our common stock and we do not anticipate paying any cas h dividends in the foreseeable future.

Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model.

Expected Forfeiture Rate.

We estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior and other factors.

The impact from a forfeiture rate adjustment will be recognized in full in the period of adjustment, and if the actual number of future forfeitures differs from that which was estimated, we may be required to record adjustments to stock-based compensation expense in future periods.

We account for share-based payments using a fair-value based method for costs related to all share-based payments, including stock options, restricted stock units, and stock issued under our employee stock purchase plan (“ESPP”).

We estimate the fair value of share-based payment awards on the date of grant using an option-pricing model.

See Note 8 for further information regarding stock-based compensation.

Other Comprehensive Income (loss)

Other comprehensive income (loss) is comprised of unrealized gains (losses) on our investment securities.

Shipping and Handling

Costs related to shipping and handling are included in cost of revenues for all periods presented.

Recent Accounting Pronouncements

Recently Issued Accounting Standards

In August 2020, the FASB issued ASU No.

2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40):

Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.

This guidance simplifies the accounting for convertible instruments primarily by eliminating the existing cash conversion and beneficial conversion models within Subtopic 470-20, which will result in fewer embedded conversion options being accounted for separately from the debt host.

The guidance also amends and simplifies the calculation of earnings per share relating to convertible instruments.

This guidance is effective for annual periods beginning after December 15, 2021, including interim periods within that reporting period, excluding smaller reporting companies.

Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within that reporting period, using either a full or modified retrospective approach.

We are currently evaluating the impact of the provisions of this guidance on our consolidated financial statements.

In December 2019, the FASB issued ASU No.

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The standard will be effective for our annual reporting periods beginning after December 15, 2020, including interim reporting periods within those fiscal years.

We are evaluating the impact of adopting this new accounting guidance on our consolidated financial statements.

In August 2018, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU No.

2018-13, Fair Value Measurement (Topic 820):

Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement .

This ASU modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement.

The guidance is effective for annual and interim reporting periods beginning after December 15, 2019.

We plan to adopt ASU 2018-13 on January 1, 2020.

We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and determined it will not have a material impact.

In June 2016, the Financial Accounting Standards Board, or FASB, issued ASU 2016-13, Financial Instruments - Credit Losses:

Measurement of Credit Losses on Financial Instruments , or ASU 2016-13, which changes the impairment model for most financial assets.

The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses.

ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for annual and interim periods beginning after December 15, 2018.

We plan to adopt ASU 2016-13 on January 1, 2020.

We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and determined it will not have a material impact.

Recently Adopted Accounting Standards

Adoption of ASU 2018-07

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting , to simplify the accounting for nonemployee share-based payment transactions by expanding the scope of Accounting Standards Codification, or ASC, Topic 718, Compensation - Stock Compensation, to include share-based payment transactions for acquiring goods and services from nonemployees.

Under the new standard, most of the guidance on stock compensation payments to nonemployees would be aligned with the requirements for share-based payments granted to employees.

We adopted this standard beginning on January 1, 2019 and the adoption of this standard did not have a material impact on our consolidated financial statements for the year ended December 31 , 2019.

Adoption of ASU 2018-02

In February 2018, the FASB issued ASU 2018-02, Income Statement –

Reporting Comprehensive Income (Topic 220):

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income , that allows for an entity to elect to reclassify the income tax effects on items within accumulated other comprehensive income resulting from U.S.

tax reform to retained earnings.

We adopted this standard beginning on January 1, 2019 and the adoption of this standard did not have a material impact on our consolidated financial statements for the year ended December 31, 2019.

Adoption of ASC 842

On January 1, 2019, we adopted the FASB ASC, Topic 842, Leases , or ASC 842, which requires the recognition of the right-of-use assets and related operating and finance lease liabilities on the consolidated balance sheet.

As permitted by ASC 842, we elected the adoption date of January 1, 2019, which is the date of initial application.

As a result, the consolidated balance sheet prior to January 1, 2019 was not restated and continues to be reported under ASC Topic 840, Leases , or ASC 840, which did not require the recognition of right-of-use or operating lease liabilities on the consolidated balance sheet .

The expense recognition for operating leases under ASC 842 is substantially consistent with ASC 840.

As a result, there is no significant difference in our results of operations presented in our consolidated statements of operations and comprehensive loss for each period presented.

We adopted ASC 842 using a modified retrospective approach for leases existing at January 1, 2019.

The adoption of ASC 842 had a substantial impact on our balance sheet.

The most significant impact was the recognition of the operating lease right-of-use assets and the liability for operating leases.

Accordingly, adoption of this standard resulted in the recognition of operating lease right-of-use assets of $35.5 million and operating lease liabilities of $49.2 million comprised of $3.4 million of current operating lease liabilities and $45.8 million of non-current operating lease liabilities on the consolidated balance sheet as of January 1, 2019.

As permitted under ASC 842, we elected several practical expedients that permit us:

to not reassess whether a contract is or contains a lease;

to not reassess the lease classification;

to not reassess the initial direct costs as of the adoption date;

to not recognize right-of-use assets and lease liabilities for short-term leases that have a term of 12 months or less;

to not separate non-lease components for real estate leases.

The application of the practical expedients did not have a significant impact on the measurement of the operating lease liabilities.

Service and other revenue can include some revenue from instrument lease agreements.

Instrument leases are generally classified as operating-type leases and revenue from these leases is recognized on a straight-line basis over the respective lease term.

Lease income was not material in fiscal 2018 or for the year ended December 31 , 2019.

Disclosure s related to the amount and timing of cash flows arising from operating leases are included in “Leases”

section of Note 7 .

Commitments and Contingencies.

CASH AND CASH EQUIVALENTS AND INVESTMENTS

In June 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2016-13 Financial Instruments - Credit Losses (Topic 326):

The adoption of Topic 326 did not have a material impact on our financial statements and our bad debt expense was immaterial as of December 31, 2020.

FINANCIAL INSTRUMENTS