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Item 2. Management’s Discussion and Analysis

2021-11-05 compared with 2021-08-06 · 140 added, 181 removed, 112 unchanged (74% of the section changed)

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You should read the following discussion and analysis of our financial condition and results of operations together with our condensed consolidated financial statements and the related notes included in this Quarterly Report on Form 10-Q and those in our Annual Report on Form 10-K for the year ended December 31, 2020.

Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including statements related to our expectations regarding the potential impacts of the COVID-19 pandemic on our business, financial condition, and results of operations, expectations regarding sales of products in future periods that reflect increased commercial presence and customer demand, expectations regarding the impact of the Circulomics acquisition and Omniome transaction, and information with respect to our products, plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties, including statements regarding our expected financial results in future periods.

Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including statements related to our expectations regarding the potential impacts of the COVID-19 pandemic on our business, financial condition, and results of operations, expectations regarding sales of products in future periods that reflect increased commercial presence and customer demand, expectations regarding the impact of our recently completed Circulomics and Omniome acquisitions, and information with respect to our products, plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties, including statements regarding our expected financial results in future periods.

The words “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “projects,” “seeks,” “should,” “target,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.

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Business 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 and Sequel IIe instruments 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.

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 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.

Senior Management

Our President and Chief Executive Officer Christian O.

Henry was appointed effective September 14, 2020, succeeding Dr.

Michael Hunkapiller who announced his retirement, which was effective at the end of 2020.

Our Chief Financial Officer Susan G.

Kim was appointed effective September 28, 2020, succeeding Susan K.

Barnes who retired on August 7, 2020.

Our Chairman of the Board Dr.

Milligan was appointed effective September 14, 2020.

On December 31, 2020, the Board of Directors appointed Mark Van Oene to the role of Chief Operating Officer and designated him as the Company’s principal operating officer, and appointed Peter Fromen to the role of Chief Commercial Officer, effective in each case upon his commencement of employment with the Company on January 8, 2021.

Our Vice President and Chief Accounting Officer, Michele Farmer, was appointed effective May 17, 2021.

We design, develop and manufacture sequencing systems to help scientists and clinical researchers resolve genetically complex problems.

Our products address several applications based on our novel Single Molecule, Real-Time (SMRT®) sequencing technology, including human germline sequencing, plant and animal sciences, infectious disease and microbiology, oncology, and other emerging applications.

Across these applications, customers use our technology in a wide range of sequencing methods, including whole genome sequencing and de novo genome assembly, long-range phasing, targeted sequencing, full-length RNA and single-cell sequencing, methylation and epigenetic characterization, and others.

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

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

In addition to our SMRT sequencing technology, we are developing a highly accurate short-read sequencing platform based on the novel Sequencing by Binding (SBB®) technology.

Upon launch, we expect SBB to address adjacent applications and complement our existing long-read sequencing technology.

Strategic Objectives

For 2021, we have outlined three strategic objectives:

We outlined the following strategic objectives for 2021:

 Expand our commercial reach;

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Expanding our commercial reach includes hiring senior level team members with extensive commercial experience.

By the end of 2021, we expect to more than double our number of quota-carrying field sales personnel from the 22 that we employed at the end of 2020.

We employed 44 quota-carrying field sales personnel as of September 30, 2021 and we expect to more than double our number of quota-carrying field sales personnel by the end of 2021 as compared to the 22 representatives that we employed at the end of 2020.

In addition, we plan to expand our commercial support activities and invest in more sales tools.

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Accelerating our product development pipeline includes significantly expanding our research and development team in an effort to accelerate the development of multiple new products.

In association with the collaboration we entered into with Invitae Corporation (“Invitae”) in January 2021, as described below, we plan to develop a new platform with production-scale high-throughput capability, which will be in addition to other new products we already have in development.

In order to develop these multiple products in parallel, we are significantly increasing our Research and Development headcount.

In addition, we expect to increase our spending on outside development costs.

In association with the collaboration we entered into in January 2021 with Invitae Corporation (“Invitae”), a leader in medical genetic testing, we plan to develop a new platform with production-scale high-throughput capability to complement the other new products we already have in development.

In addition, with our acquisition of Omniome, Inc.

(“Omniome”), we expect to continue to invest in the development of a short-read sequencing platform.

As a result, we expect our research and development expense to increase significantly in 2021 as compared to 2020.

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Leading institutions such as Children’s Mercy Kansas City, Invitae, the HudsonAlpha Institute for Biotechnology and Stanford University have adopted our products to study rare and inherited disease.

We believe the market opportunity for clinical sequencing is very large, and could drive significant revenue growth for the company.

To accelerate this growth, we entered into the collaboration with Invitae, who is a market leader in medical genetic testing, and has the desire to sequence hundreds of thousands of genomes annually with our technology.

We will continue to pursue additional partnerships to further drive the adoption of whole-genome clinical sequencing.

Acquisition of Omniome, Inc.

On July 19, 2021, we entered into an Agreement and Plan of Merger and Plan of Reorganization (the “Omniome Merger Agreement”) with Omniome, Inc.

(“Omniome”), Apollo Acquisition Corp, a wholly owned subsidiary of ours (“Omniome Merger Sub I”), Apollo Acquisition Sub, LLC, a wholly owned subsidiary of ours (“Omniome Merger Sub II” and together with Omniome Merger Sub I, the “Omniome Merger Subs”), and Shareholder Representative Services, LLC, as securityholder representative.

Omniome is a San Diego-based company developing a highly differentiated, proprietary short-read DNA sequencing platform capable of delivering high accuracy.

Pursuant to the Omniome Merger Agreement, we agreed to acquire all of the outstanding equity interests of Omniome, with Omniome becoming a wholly owned subsidiary of ours (the “Omniome Merger”).

Omniome’s stockholders approved the Omniome Merger.

No approval of our stockholders is required to consummate the Omniome Merger.

Subject to the terms and conditions of the Omniome Merger Agreement, at the effective time of the Omniome Merger, holders of Omniome’s outstanding equity interests will be entitled to receive approximately $600 million (composed of approximately 9.4 million shares of our common stock and $300 million in cash).

Subject to the terms of the Omniome Merger Agreement and the achievement of a specified milestone, holders of Omniome’s outstanding equity interests will also be entitled to receive $200 million (composed of $100 million in cash and the rest in shares of our common stock).

All amounts are subject to adjustment as specified in the Omniome Merger Agreement.

As part of the Merger, we will assume certain of Omniome’s unvested stock options.

Pursuant to the Omniome Merger Agreement, we will be required to register the equity portion of the merger consideration for resale with the SEC following the closing of the Merger.

The closing of the Omniome Merger is subject to the satisfaction of customary conditions, including, among others:

(1) the accuracy of representations and warranties of, and performance of covenants by, the other party (in each case, subject to certain qualifications, if applicable), (2) the absence of a continuing material adverse effect, (3) the absence of any law or order restraining, enjoining or otherwise prohibiting the Omniome Merger;

and (4) the expiration or termination of the waiting period under the United States Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.

The Company, Omniome, and the Omniome Merger Subs have made customary representations, warranties, and covenants in the Omniome Merger Agreement, including, among other things, covenants with respect to the conduct of

Omniome’s business during the period between the execution of the Omniome Merger Agreement and consummation of the Omniome Merger.

The Omniome Merger Agreement contains customary termination rights for both the Company and Omniome including, but not limited to, (1) in the event that the Omniome Merger has not been consummated on or prior to December 16, 2021, (2) the parties’ mutual written agreement to terminate the Omniome Merger Agreement, or (3) a material breach by one party, which breach cannot be cured within 20 calendar days, entitling the non-breaching party to not consummate its closing conditions under the Omniome Merger Agreement.

Invitae Collaboration

On January 12, 2021 we entered into a multi-year Development and Commercialization Agreement (the “Development Agreement”) with Invitae Corporation (“Invitae”).

Pursuant to the Development Agreement, Invitae is providing certain funding to us to develop products relating to production-scale high-throughput sequencing (“Program Products”).

Subject to completion of the Omniome Merger, we intend to expand the Development Agreement to include the sequencing technology developed by Omniome.

If and when Program Products become commercially available for sale, Invitae may purchase the Program Products.

In addition to selling the Program Products to Invitae, we will have the right to broadly commercialize Program Products for sale to other customers.

The funding Invitae will provide to us will equal certain development costs we incur in connection with the Program Products (“Program Development Costs”).

Under the Development Agreement, we will be responsible for conducting a program to develop the Program Products, and subsequently for manufacturing the Program Products.

We will make general decisions regarding the development program jointly with Invitae but we are responsible for all research and development activities.

The entire development program is expected to last approximately sixty months, but may be shorter or longer.

As the primary benefit of its contribution, Invitae will be entitled to preferred pricing on the Program Products if and when they are available for commercial sale.

Each Program Product will have a preferential pricing period, which will not exceed four years from the date of the first delivery of that Program Product (“Preferential Pricing Period”).

During the Preferential Pricing Period for each Program Product, Invitae may purchase the Program Product at a substantially reduced margin until it has recouped a multiple of its contribution as defined in the Development Agreement.

For a specified period after the end of the Preferential Pricing Period, Invitae has the right to purchase the Program Product at a higher price, determined by a formula, than the price during the Preferential Pricing Period (“Extended Pricing Period”).

The Extended Pricing Periods will terminate early if Invitae does not meet certain volume minimums.

We and Invitae may terminate the Development Agreement if the other party remains in material breach of the Development Agreement following a cure period to remedy the material breach.

In addition, the Development Agreement includes certain other circumstances for termination by each party, including circumstances where Invitae may terminate for delays, IP concerns, our change in control, or without cause.

In certain termination circumstances, (i) we will be obligated to refund all or a portion of the development costs advanced by Invitae and/or (ii) we will owe Invitae a share of the revenue that may be generated from the sale of the Program Products to third parties if and when they are commercialized, until such time as Invitae has recouped the amounts reimbursed to us, and in certain circumstances, a mutually agreed return.

We expect to incur significant development costs over the duration of the Development Agreement.

There can be no assurances that the development program will be successful or that the Program Products will become ready for commercial sale.

We determined that the primary benefit from the arrangement to Invitae is the ability to procure the Program Products during the Preferential Pricing Period at substantial discounts.

As we expect the Program Products to be available for Invitae to purchase in the future, we concluded the arrangement is within the scope of ASC Topic 606, Revenue from Contracts with Customers.

In addition, Invitae is not expected to substantially benefit from the intellectual property developed under the arrangement, or benefit from other goods or services during the development period.

It is also not a collaboration in the scope of ASC Topic 808 Collaborative Arrangements, as we are responsible for performing the research and development activities.

Accordingly, the amounts received by the Company from Invitae during the development period represent significant discounts toward future supplies of the Program Products during the Preferential Pricing Period, and will be accounted as material rights in accordance with ASC Topic 606 .

Proportionate amounts of t hese material rights will be recognized in revenue when Invitae places purchase orders for Program Products and the associated goods or services are delivered to Invitae.

To the extent the discounts are not expected to be used, they will be recognized consistent with the guidance in Topic 606 relating to breakage, in proportion to the expected purchases by Invitae.

Any remaining unused discounts will be recognized when they expire.

All amounts received from Invitae will be initially deferred and accumulated in non-current deferred revenue.

As of June 30, 2021, we have $8.7 million of non-current deferred revenue on the Condensed Consolidated Balance Sheet related to payments received from Invitae.

Costs incurred to develop the Program Products are considered research and development and are expensed as incurred.

There are no origination or fulfilment costs related to the arrangement with Invitae that are eligible to be capitalized.

We expect to incur significant development costs over the duration of the Development Agreement including $20-25 million expected to be incurred during fiscal 2021.

There can be no assurances that the development program will be successful or that the Program Products will become ready for commercial sale.

We believe the market opportunity for clinical sequencing is significant, and could drive substantial revenue growth for the company.

In addition to our collaboration with Invitae, who has the desire to sequence hundreds of thousands of genomes annually with our technology, we continue to pursue additional partnerships to further drive the adoption of whole-genome clinical sequencing.

Recent Business Developments

On January 12, 2021, we entered into a multi-year Development and Commercialization Agreement (the “Development Agreement”) with Invitae to develop a production-scale high-throughput sequencing platform that leverages the power of our highly accurate HiFi sequencing to expand Invitae’s whole genome testing capabilities.

On February 16, 2021, we issued convertible senior notes to SB Northstar LP, a subsidiary of SoftBank Group Corp., pursuant to an investment agreement with SB Northstar LP, for $900 million at 1.50% interest rate, due February 15, 2028.

On July 22, 2021, we acquired Circulomics Inc (“Circulomics”), a leader in high molecular weight DNA extraction to enable a path toward an end-to-end automated workflow.

On September 20, 2021, we completed our acquisition of Omniome, a San Diego-based company developing a highly differentiated, proprietary short-read DNA sequencing platform capable of delivering high accuracy results, for total consideration transferred of $714.8 million.

This amount consisted of approximately $315.7 million in cash, 8,911,580 shares of our common stock with a fair value of $249.4 million and contingent consideration with a fair value of $168.6 million.

Out of the total payment, approximately $18.9 million, comprised of $7.4 million of cash, 226,811 shares of PacBio common stock with a fair value of $6.3 million and $5.2 million of contingent consideration, was accounted for as a one-time post acquisition stock-based compensation expense.

On September 20, 2021, in connection with the acquisition of Omniome, we issued and sold 11,214,953 shares of common stock in a private placement transaction at a price of $26.75 per share, for aggregate proceeds of approximately $294.8 million, net of issuance costs of approximately $5.2 million.

COVID-19 Update

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A significant number of our customer sites that shut down due to COVID-19 have now re-opened.

A significant number of customers delayed purchases or had difficulties obtaining funding for capital expenditures due to the negative impact of the pandemic on their businesses.

However, a significant number of customers delayed purchases or had difficulties obtaining funding for capital expenditures due to the negative impact of the pandemic on their businesses.

Due to the uncertain scope and duration of the pandemic, we cannot reasonably estimate the future impact to our operations and financial results.

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To aid in containing the spread of COVID-19, we have implemented remote-work options and are limiting employee travel as much as possible.

We are monitoring this rapidly evolving situation, including regarding the Delta variant of COVID-19.

Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact to our business as a result of its global economic impact, including any recession that has occurred or may occur in the future.

We are monitoring this rapidly evolving situation, including all developments surrounding the Delta variant of COVID-19.

Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact to our business as a result of the global economic impact of the pandemic, including any recession that has occurred or may occur in the future.

Specifically, difficult macroeconomic conditions, decreases in discretionary capital spending, increased and prolonged unemployment or a decline in consumer confidence as a result of the COVID-19 pandemic could have a continuing adverse effect on the demand for some of our products.

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The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.

On an ongoing basis, we evaluate our critical accounting policies and estimates.

We evaluate our critical accounting policies and estimates on an ongoing basis.

We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Actual results may differ from these estimates under different assumptions or conditions.

Except for the adoption of ASU 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, as discussed in Note 4.

Summary of Significant Accounting Policies and Note 7 .

Convertible Senior Notes , there have been no material changes to our significant accounting policies as discussed in our Annual Report on Form 10-K for the year ended December 31, 2020 .

All changes to critical accounting policies and estimates are discussed in Note 5, “Significant Accounting Policies” of the unaudited condensed consolidated financial statements.

Results of Operations

Comparison of the three months ended June 30, 2021 and 2020

Three Months Ended June 30,

Comparison of the three months ended September 30, 2021 and 2020

Three Months Ended September 30,

(in thousands, except percentages)

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Cost of service and other revenue

Amortization of intangible assets

Total cost of revenue

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Sales, general and administrative

Merger-related expenses

Total operating expense

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Interest expense

Other income, net

Total revenue for the three months ended June 30, 2021 was $30.6 million compared to $17.1 million for the same period during 2020.

Product revenue of $26.5 million for the three months ended June 30, 2021 consisted of approximately $14.3 million from instrument revenue and $12.2 million from consumables revenue, compared to total product revenue of $13.8 million for the same period during 2020, consisting of approximately $8.9 million from instrument revenue and $4.9 million of consumables revenue.

The increase in instrument sales was primarily attributable to a higher number of instrument shipments and installations, as we placed 38 Sequel II/IIe systems during the three months ended June 30, 2021 compared to 23 for the same period of 2020.

We expect the number of Sequel II/IIe placements to continue to grow during the second half of 2021 relative to the first half, reflecting our increased commercial presence and customer demand.

The increase in consumable sales was primarily attributable to higher Sequel II/IIe consumables sales as the installed base of Sequel II/IIe systems has grown, as well as lower utilization of the installed base of instruments due to the impact of the COVID-19 pandemic during the three months ended June 30, 2020.

Service and other revenue of $4.1 million and $3.3 million for the three months ended June 30, 2021 and 2020, respectively, was primarily derived from product maintenance agreements sold on our installed instruments.

Service revenue has grown as our installed base of Sequel II/IIe systems has grown.

Gross profit for the three months ended June 30, 2021 was $13.8 million, resulting in a gross margin of 44.9%, compared to gross profit of $6.6 million for the same period during 2020, resulting in a gross margin of 38.7%.

The improved gross margin percentage was primarily due to higher volumes and increased factory utilization during the three months ended June 30, 2021, compared to the same period of 2020.

Cost of product revenue was $13.2 million for the three months ended June 30, 2021, compared to $8.2 million for the same period during 2020.

The increase of $5.0 million in cost of product revenue was primarily due to increased product shipments as described above.

Cost of service and other revenue for the three months ended June 30, 2021 increased to $3.6 million, compared to $2.2 million for the same period during 2020, due primarily to higher service volumes and increased stock-based compensation expense.

Other income (expense), net

Loss before benefit from income taxes

Benefit from income taxes

Net income (loss)

Revenue increased $15.8 million, or 83%, to $34.9 million for the three months ended September 30, 2021 as compared to $19.1 million for the three months ended September 30, 2020, driven primarily by an increase in instrument and consumable revenue.

Instrument revenue increased $8.2 million, or 106%, to $15.9 million for the three months ended September 30, 2021, as compared to the three months ended September 30, 2020, primarily due to an increase in the instruments sold.

During the three months ended September 30, 2021, we placed 44 Sequel II and Sequel IIe systems compared to the 20 systems placed in the three months ended September 30, 2020.

Consumables revenue increased $6.6 million, or 82%, to $14.6 million for the three months ended September 30, 2021, as compared to the three months ended September 30, 2020.

The increase in our consumables revenue is primarily attributable to the growth in the instrument installed base.

Instrument and consumables revenues were adversely impacted by customer site closures and lower utilization of the installed base of instruments due to the impact of the COVID-19 pandemic during the three months ended September 30, 2020.

Service and other revenue increased $1.1 million, or 32%, to $4.4 million for the three months ended September 30, 2021, primarily due to higher product maintenance agreements sold on the growing installed base.

Cost of revenue, gross profit and gross margin

Cost of product revenue increased by $6.3 million, or 68%, to $15.5 million for the three months ended September 30, 2021, compared to $9.2 million for the three months ended September 30, 2020.

The increase in cost of product revenue was primarily due to higher sales.

Cost of service and other revenue increased by $1.1 million, or 39%, to $3.9 million compared to $2.8 million for the three months ended September 30, 2020, primarily due to higher service volumes from our growing installed base and increased stock-based compensation expense.

Gross profit increased $8.3 million, or 117%, to $15.4 million for the three months ended September 30, 2021, compared to the three months ended September 30, 2020.

Gross margin was 44.0% for the three months ended September 30, 2021 compared to gross margin of 37.0% for the same period during 2020.

The improved gross margin percentage was primarily due to higher volumes and increased factory utilization during the three months ended September 30, 2021, compared to the same period of 2020, which was adversely impacted by the impact of the COVID-19 pandemic.

Research and Development Expense

During the three months ended June 30, 2021, research and development expense increased by $7.3 million, or 48%, compared to the same period during 2020.

The increase in research and development expense was primarily driven by an increase of $4.0 million in compensation expenses due primarily to planned personnel additions during 2021, and an increase of $2.4 million in product development costs.

Research and development expense included stock-based compensation expense of $4.3 million and $1.4 million during the three months ended June 30, 2021 and 2020, respectively.

We expect research and development expenses to increase significantly in 2021, as we intend to hire a significant number of additional personnel in research and development.

We estimate costs associated with the Invitae collaboration to total between $20 million and $25 million for 2021.

Stock-based compensation included in research and development expense is expected to increase significantly in 2021.

Research and development costs will also significantly increase following the closing of the Omniome Merger.

Research and development expense increased by $11.0 million, or 67%, to $27.5 million for the three months ended September 30, 2021, compared to the three months ended September 30, 2020.

The increase was primarily driven by an increase of $7.5 million in personnel expenses, including $3.1 million in stock-based compensation expense due to increase in headcount, and an increase of $2.2 million in product development costs compared to the same period of 2020.

Research and development expense included stock-based compensation expense of $5.2 million and $2.1 million during the three months ended September 30, 2021, and 2020, respectively.

We expect research and development expenses to increase significantly in 2021, due to the acquisition of Omniome and our intent to continue to hire a significant number of additional personnel in research and development.

We estimate costs associated with the Invitae collaboration to total approximately $20 million for 2021.

Sales, General and Administrative Expense

During the three months ended June 30, 2021, sales, general and administrative expense increased by $13.9 million, or 92%, compared to the same period during 2020.

The increase in sales, general and administrative expense was primarily attributable to a $12.1 million increase in compensation expense and a $0.9 million increase in legal and other professional expenses during the three months ended June 30, 2021 compared to the same period of 2020.

The increase in compensation expense is primarily attributable to executive hiring related to senior management transitions during the second half of 2020 and early 2021, as well as planned personnel additions as we execute on our plan to more than double quota-carrying sales representatives during 2021.

During the three months ended June 30, 2021, we added 11 quota-carrying sales representatives, bringing the total to 39.

Sa les, general and administrative expense included stock-based compensation expense of $9.6 million and $1.3 million during the three months ended June 30, 2021 and 2020, respectively.

Sales, general and administrative expense is planned to increase significantly in 2021, as we expect to more than double our quota-carrying sales representatives, increase headcount as part of our business expansion and incur incremental costs in connection with the planned acquisition of Omniome.

Sales, general and administrative expense increased by $16.8 million, or 114%, to $31.6 million for the three months ended September 30, 2021, compared to the three months ended September 30, 2020.

The increase in sales, general and administrative expense was primarily attributable to a $14.8 million increase in compensation expense, including $7.7 million in stock-based compensation expense, and a $0.7 million increase in legal and other professional expenses during the three months ended September 30, 2021 compared to the three months ended September 30, 2020.

The increase in compensation expense is primarily due to increase in headcount, as well as planned personnel additions as we execute on our plan to more than double our quota-carrying sales representatives during 2021.

Sa les, general and administrative expense included stock-based compensation expense of $9.9 million and $2.2 million during the three months ended September 30, 2021 and 2020, respectively.

Stock-based compensation included in sales, general, and administrative expense is expected to increase significantly in 2021.

Merger-related expenses

Merger-related expenses of $30.7 million during the three months ended September 30, 2021 consist of $11.8 million of transaction costs arising from the acquisitions of Omniome and Circulomics and $18.9 million of stock-based compensation expense resulting from the acceleration of certain equity awards in connection with the Omniome merger.

We recognized $18.9 million of stock-based compensation expense for the acceleration that was not attributable to pre-combination services, consisting of $6.3 million that was settled in shares of our common stock, $7.4 million that was settled in cash and $5.2 million related to contingent consideration.

Interest Expense

Interest expense for the three months ended June 30, 2021 was $3.6 million compared to none in the same period in 2020, due to interest incurred on the $900 million of 1.50% Convertible Senior Notes that were issued on February 16, 2021.

Comparison of the six months ended June 30, 2021 and 2020

Six Months Ended June 30,

Interest expense for the three months ended September 30, 2021 was $3.7 million compared to none in the same period in 2020, primarily due to $3.5 million of interest incurred on the $900 million of 1.50% Convertible Senior Notes due February 15, 2028 that we issued on February 16, 2021.

Benefit from Income Taxes

A deferred income tax benefit of $94.8 million for the three and nine months ended September 30, 2021, is related to the release of the valuation allowance for deferred tax assets due to the recognition of deferred tax liabilities in connection with the Omniome and Circulomics acquisitions.

We maintain a full valuation allowance on the net deferred tax assets of our U.S.

entities as we have concluded that it is more likely than not that we will not realize our deferred tax assets.

Accordingly, this benefit from income taxes is reflected on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended September 30, 2021.

Comparison of the nine months ended September 30, 2021 and 2020

Nine Months Ended September 30,

(in thousands, except percentages)

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Cost of service and other revenue

Amortization of intangible assets

Total cost of revenue

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Sales, general and administrative

Merger-related expenses

Total operating expense

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Other income, net

Total revenue for the six months ended June 30, 2021 was $59.6 million, compared to $32.7 million for the same period during 2020.

Product revenue of $51.8 million for the six months ended June 30, 2021 consisted of approximately $29.2 million from instrument revenue and $22.6 million from consumables revenue, compared to total product revenue of $26.0 million for the same period during 2020, consisting of approximately $13.0 million from instrument revenue and $13.0 million of consumables revenue.

The increase in instrument sales was primarily attributable to a higher number of instrument shipments and installations, as we placed 79 Sequel II/IIe systems during the six months ended June 30, 2021 compared to 34 for the same period of 2020.

We expect the number of Sequel II/IIe placements to continue to grow during the second half of 2021 relative to the first half, reflecting our increased commercial presence and customer demand.

Service and other revenue of $7.8 million and $6.6 million for the six months ended June 30, 2021 and 2020, respectively, was primarily derived from instrument maintenance agreements.

Gross profit for the six-month period ended June 30, 2021 was $26.7 million, resulting in a gross margin of 44.8%, compared to gross profit of $14.1 million, resulting in a gross margin of 43.2% for the same period during 2020.

The improved gross margin percentage was primarily due to higher volumes and increased factory utilization during the six months ended June 30, 2021, compared to the same period of 2020.

Cost of product revenue was $25.9 million for the six months ended June 30, 2021, compared to cost of product revenue of $13.6 million for the same period during 2020.

The increase of $12.2 million in cost of product revenue was primarily due to increased product shipments as described above.

Cost of service and other revenue for the six-month period ended June 30, 2021 increased to $7.0 million, compared to $4.9 million for the same period during 2020, due primarily to higher service volumes and increased stock-based compensation expense.

Loss before benefit from income taxes

Benefit from income taxes

Revenue increased $42.7 million, or 83%, to $94.5 million for the nine months ended September 30, 2021, as compared to $51.8 million for the nine months ended 2020, driven primarily by an increase in instrument and consumable revenue.

Instrument revenue increased $24.5 million, or 118%, to $45.1 million for the nine months ended September 30, 2021 as compared to the nine months ended September 30, 2020, due primarily to an increase in the instruments sold.

During the nine months ended September 30, 2021 we placed 123 Sequel II/IIe systems compared to 54 for the nine months ended September 30, 2020.

We expect the number of Sequel II/IIe placements to continue to grow during the remainder of 2021, reflecting our increased commercial presence and customer demand.

Consumables revenue increased $16.1 million, or 76%, to $37.2 million for the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020.

Service and other revenue increased $2.2 million, or 22%, to $12.2 million for the nine months ended September 30, 2021, due primarily to a higher number of product maintenance agreements sold on our growing installed base.

Cost of revenue, gross profit, and gross margin

Cost of product revenue increased $18.6 million, or 81%, to $41.4 million for the nine months ended September 30, 2021, compared to $22.9 million for the nine months ended September 30, 2021.

The increase in cost of product revenue was primarily due to higher sales.

Cost of service and other revenue increased $3.1 million, or 40%, to $10.8 million for the nine-months ended September 30, 2021, compared to $7.7 million for the nine months ended September 30, 2020, due primarily to higher service volumes due to the growing installed base and increased stock-based compensation expense.

Gross profit increased $20.9 million, or 99%, to $42.1 million for the nine-month period ended September 30, 2021 compared to the nine months ended September 30, 2020.

Gross margin was 44.5%, for the nine months ended September 30, 2021, compared to gross margin of 40.9% for the nine months ended September 30, 2020.

The improved gross margin percentage was primarily due to higher sales volumes and increased factory utilization during the nine months ended September 30, 2021, compared to the same period of 2020, which was adversely impacted by the impact of the COVID-19 pandemic.

Research and Development Expense

During the six months ended June 30, 2021, research and development expense increased by $12.6 million, or 41%, compared to the same period during 2020.

The increase in research and development expense was primarily driven by an increase of $7.3 million in compensation expenses due primarily to planned personnel additions during 2021, and an increase of $4.0 million in product development costs.

Research and development expense included stock-based compensation expense of $7.4 million and $3.2 million during the six months ended June 30, 2021 and 2020, respectively.

We expect research and development expenses to increase significantly in 2021, as we intend to hire a significant number of additional personnel in research and development.

We estimate costs associated with the Invitae collaboration to total between $20 million and $25 million for 2021.

Stock-based compensation included in research and development expense is expected to increase significantly in 2021.

Research and development costs will also significantly increase following the closing of the Omniome Merger.

Research and development expense increased by $23.6 million, or 50%, to $70.3 million for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020.

The increase in research and development expense was primarily driven by an increase of $14.8 million in personnel expenses, including $7.2 million in stock-based compensation expense, and an increase of $6.1 million in product development costs compared to the same period of 2020.

Research and development expense included stock-based compensation expense of $12.5 million and $5.3 million during the nine months ended September 30, 2021 and 2020, respectively.

We expect research and development expenses to continue to grow in 2021, due to the acquisition of Omniome and our intent to hire a significant number of additional personnel in research and development.

We estimate costs associated with the Invitae collaboration to total approximately $20 million for 2021.

Sales, General and Administrative Expense

During the six months ended June 30, 2021, sales, general and administrative expense increased by $15.1 million, or 38%, compared to the same period during 2020.

The increase in sales, general and administrative expense was primarily attributable to an increase of $23.6 million in compensation expense, partially offset by a $6.0 million financial advisory fee during the six months ended June 30, 2020 related to the terminated merger with Illumina and $3.1 million in lower legal and other professional expenses during the six months ended June 30, 2021 compared to the same period of 2020.

During the six months ended June 30, 2021, we added 17 quota-carrying sales representatives, bringing the total to 39.

Sales, general and administrative expense included stock-based compensation expense of $15.7 million and $3.1 million during the six-month periods ended June 30, 2021 and 2020, respectively.

Stock-based compensation included in sales, general, and administrative expense is expected to increase significantly in 2021.

Sales, general and administrative expense increased by $32.0 million, or 58%, to $86.8 million for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020.

The increase in sales, general and administrative expense was primarily attributable to an increase of $38.4 million in compensation expense, including $20.3 million in stock-based compensation expense, partially offset by a $6.0 million financial advisory fee during the nine months ended September 30, 2020 related to the terminated merger with Illumina.

The increase in compensation expense is primarily attributable to executive hiring related to senior management transitions during the second half of 2020 and first half of 2021, as well as planned personnel additions as we execute on our plan to more than double our quota-carrying sales representatives during 2021.

During the nine months ended September 30, 2021, we added 22 quota-carrying sales representatives, bringing our total to 44.

Sales, general and administrative expense included stock-based compensation expense of $25.6 million and $5.2 million during the nine-month periods ended September 30, 2021 and 2020, respectively.

Merger-related expenses

Merger-related expenses of $30.7 million during the nine months ended September 30, 2021 consist of $11.8 million of transaction costs arising from the acquisitions of Omniome and Circulomics and $18.9 million of stock-based compensation expense resulting from the acquisition of Omniome.

Gain (loss) from Continuation Advances from Illumina

As part of the Termination Agreement, Illumina paid us 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 as part of other income in the condensed consolidated statements of operations and comprehensive loss for the six months ended June 30, 2020.

We recorded the $34.0 million as part of other income in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the nine months ended September 30, 2020.

Up to the full $52.0 million of Continuation Advances paid to us were repayable without interest to Illumina if, within two years of March 31, 2020, we entered into, or consummated a Change of Control Transaction or raised 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 and recorded as other expense in the condensed consolidated statements of operations and comprehensive loss for the six months ended June 30, 2021.

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 and recorded as other expense in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the nine months ended September 30, 2021.

Interest Expense

Interest expense for the six m onths ended June 30, 2021 increased by $5.1 million compared to the same period in 2020, primarily due to interest incurred on the $900 million of 1.50% Convertible Senior Notes that were issued February 16, 2021.

Interest expense for the nine m onths ended September 30, 2021, increased by $8.8 million compared to the same period in 2020, primarily due to $8.8 million of interest incurred on the $900 million of 1.50% Convertible Senior Notes that were issued February 16, 2021.

Benefit from Income Taxes

We maintain a full valuation allowance on the net deferred tax assets of our U.S.

entities as we have concluded that it is more likely than not that we will not realize our deferred tax assets.

Accordingly, this benefit from income taxes is reflected on our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the nine months ended September 30, 2021.

Liquidity and Capital Resources

Cash, cash equivalents and investments at June 30, 2021 totaled $1.14 billion, compared to $318.8 million at December 31, 2020.

The increase was attributable to the net proceeds from our issuance of $900 million of 1.50% Convertible Senior Notes on February 16, 2021, partially offset by the repayment of $52 million of Continuation Advances to Illumina in the first quarter of 2021.

We have historically incurred, and expect to continue to incur, operating losses and generate negative cash flows from operations on an annual basis due to the investments we intend to make as described above, and as a result, we may require additional capital resources to execute on our strategic initiatives to grow our business.

For example, on July 19, 2021, we entered into a purchase agreement for approximately $300 million of shares of our common stock, conditioned upon, among other customary closing conditions, the closing of the Omniome Merger.

We believe that our existing cash, cash equivalents and investments will be sufficient to fund our projected operating requirements for at least the next 12 months from the date of filing of this Quarterly Report on Form 10-Q for the quarter ended June 30, 2021.

As of September 30, 2021, we had $1.08 billion in cash, cash equivalents and investments, compared to $318.8 million at December 31, 2020.

The increase was attributable to the net proceeds from our issuance of $900 million of 1.50% Convertible Senior Notes on February 16, 2021 and $300 million of common stock in a private placement.

This increase was partially offset by the payment of $319.8 million, net of cash acquired, in the acquisitions of Omniome and Circulomics in the third quarter of 2021 and repayment of $52 million of Continuation Advances to Illumina in the first quarter of 2021.

We have historically incurred, and expect to continue to incur, operating losses and generate negative cash flows from operations on an annual basis due to the investments we intend to make as described in “—Results of Operations” above, and as a result, we may require additional capital resources to execute on our strategic initiatives to grow our business.

Factors that may affect our capital needs include, but are not limited to, the pace of adoption of our products, which affects the sales of our products and services;

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future acquisitions;

manufacturing costs, service costs, the impact of product quality, litigation costs, including the costs involved in preparing, filing, prosecuting, defending and enforcing intellectual property rights;

manufacturing costs;

service costs;

the impact of product quality;

litigation costs, including the costs involved in preparing, filing, prosecuting, defending and enforcing intellectual property rights;

costs of developing new and enhanced products;

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Our primary uses of cash in operating activities are for the development of ongoing product enhancements and future products, manufacturing, and support functions related to our sales, general and administrative activities.

We had $38.8 million of cash used in operating activities for the six months ended June 30, 2021, compared to cash provided by operating activities of $51.6 million for the same period in 2020.

Cash used in operating activities for the six months ended June 30, 2021 was due primarily to a $128.4 million net loss, partially offset by a loss of $52.0 million from Continuation Advances repaid to Illumina that is considered a financing activity, non-cash items such as stock-based compensation of $26.0 million and depreciation of $3.2 million and a net change in operating assets and liabilities of $4.9 million.

The change in net operating assets and liabilities was primarily attributable to increases of $9.4 million in deferred revenue and $5.6 million in accrued expenses, partially offset by increases of $5.0 million in inventory and $3.1 million in accounts receivable and a decrease of $2.1 million in operating lease liabilities.

Cash provided by operating activities for the six months ended June 30, 2020 was due to the $98.0 million Reverse Termination Fee received from Illumina, non-cash items such as stock-based compensation of $7.3 million and depreciation of $3.2 million, partially offset by a net loss of $21.8 million and a gain from Continuation Advances from Illumina of $34.0 million, which is considered to be a financing activity.

The change in net operating assets and liabilities was primarily attributed to a decrease of $3.9 million in accounts receivable, an increase of other liabilities of 2.0 million primarily relating to employee contributions for the Employee Stock Purchase Plan, partially offset by an increase of $3.8 million in inventory.

We used $79.5 million of cash in operating activities for the nine months ended September 30, 2021, compared to cash provided by operating activities of $33.8 million for the same period in 2020.

Cash used in operating activities for the nine months ended September 30, 2021 was due primarily to a $111.9 million net loss, which includes a $94.8 million deferred income tax benefit, that was partially offset by a loss of $52.0 million from Continuation Advances repaid to Illumina that is considered a financing activity, non-cash items such as stock-based compensation of $54.4 million and depreciation of $4.9 million and a net cash inflow from changes in operating assets and liabilities of $9.8 million.

The change in net operating assets and liabilities was primarily attributable to increases of $17.9 million in deferred revenue and $10.3 million in accrued expenses, partially offset by an increase of $5.5 million in inventory, an increase of $6.9 million in accounts receivable, a decrease of $3.2 million in operating lease liabilities and a decrease of $3.0 million in other liabilities.

Cash provided by operating activities for the nine months ended September 30, 2020 was due to the $98.0 million Reverse Termination Fee received from Illumina, non-cash items such as stock-based compensation of $12.3 million and depreciation of $4.8 million, partially offset by a net loss of $45.5 million and a gain from Continuation Advances from Illumina of $34.0 million, which is considered to be a financing activity.

Investing Activities

Our investing activities consist primarily of capital expenditures and investment purchases, sales and maturities.

We used $452.6 million of cash for investing activities for the six months ended June 30, 2021, compared to $57.2 million for the same period in 2020.

Cash used in investing activities for the six months ended June 30, 2021 was due primarily to net purchases of investments of $450.7 million and purchases of property and equipment of $2.0 million.

Cash used in investing activities for the six months ended June 30, 2020 was due primarily to net purchases of investments of $56.8 million and purchases of property and equipment of $0.4 million.

Our investing activities consist primarily of business acquisitions, capital expenditures and investment purchases, sales and maturities.

We used $744.3 million of cash for investing activities for the nine months ended September 30, 2021, compared to $120.8 million for the same period in 2020.

Cash used in investing activities for the nine months ended September 30, 2021 was due primarily to net purchases of investments of $421.4 million, cash paid, net of cash acquired, of $319.8 million for the acquisitions of Omniome and Circulomics and purchases of property and equipment of $3.1 million.

Cash used in investing activities for the nine months ended September 30, 2020 was due primarily to net purchases of investments of $119.9 million and purchases of property and equipment of $1.0 million.

Financing Activities

Cash provided by financing activities was $868.6 million and $18.8 million for the six months ended June 30, 2021 and 2020, respectively.

Cash provided by financing activities during the six months ended June 30, 2021 resulted from the net proceeds of $895.5 million from our February 2021 issuance of $900 million of 1.50% Convertible Senior Notes after deducting debt issuance costs and proceeds of $25.3 million from the issuance of common stock through our equity compensation plans, partially offset by $52.0 million of Continuation Advances repaid to Illumina.

Cash provided by financing activities during the six months ended June 30, 2020 was due to $34.0 million of Continuation Advances received from Illumina and proceeds of $0.8 million from the issuance of common stock through our equity compensation plans, partially offset by $16.0 million we repaid for the remaining outstanding principal upon the maturity of a credit facility agreement.

Cash provided by financing activities was $1.17 billion and $126.0 million for the nine months ended September 30, 2021 and 2020, respectively.

Cash provided by financing activities during the nine months ended September 30, 2021 resulted from the net proceeds of $895.5 million from our February 2021 issuance of $900 million of 1.50% Convertible Senior Notes after deducting debt issuance costs, net proceeds of $294.8 million from our September 2021 private placement of common stock after deducting issuance costs and proceeds of $30.1 million from the issuance of common stock through our equity compensation plans, partially offset by $52.0 million of Continuation Advances repaid to Illumina.

Cash provided by financing activities during the nine months ended September 30, 2020 consisted of net proceeds of $93.8 million from our August 2020 underwritten public equity offering after deducting underwriter commissions and paid offering expenses, $34.0 million of Continuation Advances received from Illumina and proceeds of $14.2 million from the issuance of common stock through our equity compensation plans, partially offset by $16.0 million we repaid for the remaining outstanding principal upon the maturity of a credit facility agreement.

Private Placement of Common Stock

On July 19, 2021, we entered into a purchase agreement with certain qualified institutional buyers and institutional accredited investors, pursuant to which we agreed to sell an aggregate of 11,214,953 shares of common stock, at a price of $26.75 per share, for aggregate gross proceeds of approximately $300 million.

The closing is conditioned upon, among other customary closing conditions, the closing of the Omniome Merger.

The transaction closed on September 20, 2021.

We registered the private placement shares for resale with the SEC following the closing of the merger.

Issuance and Sale of 1.50% Convertible Senior Notes due February 15, 2028

On February 9, 2021, we entered into an investment agreement with SB Northstar LP (the “Purchaser”), a subsidiary of SoftBank Group Corp., relating to the issuance and sale to the Purchaser of $900 million in aggregate principal amount of the Company’s 1.50% Convertible Senior Notes due February 15, 2028 (the “Notes”).

The Notes were issued on February 16, 2021.

The Notes are governed by an indenture (the “Indenture”) between the Company and U.S.

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The Notes bear interest at a rate of 1.50% per annum.

Interest on the Notes is payable semi-annually in arrears on February 15 and August 15 commencing on August 15, 2021.

Interest on the Notes is payable semi-annually in arrears on February 15 and August 15 and commenced on August 15, 2021.

The Notes will mature on February 15, 2028, subject to earlier conversion, redemption or repurchase.

The Notes are convertible at the option of the holder at any time until the second scheduled trading day prior to the maturity date, including in connection with a redemption by the Company.

The Notes are convertible into shares of the Company’s common stock based on an initial conversion rate of 22.9885 shares of common stock per $1,000 principal amount of the Notes (which is equal to an initial conversion price of $43.50 per share), in each case subject to customary anti-dilution and other adjustments as a result of certain extraordinary transactions.

The Notes are convertible into shares of our common stock based on an initial conversion rate of 22.9885 shares of common stock per $1,000 principal amount of the Notes (which is equal to an initial conversion price of $43.50 per share), in each case subject to customary anti-dilution and other adjustments as a result of certain extraordinary transactions.

Upon conversion of the Notes, we may elect to settle such conversion obligation in shares, cash or a combination of shares and cash.

On or after February 20, 2026 and prior to the 31 st scheduled trading day immediately preceding the maturity date of the Notes, the Notes will be redeemable by the Company in the event that the closing sale price of the Company’s common stock has been at least 150% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which the Company provides the redemption notice at a redemption price of 100% of the principal amount of such Notes, plus accrued and unpaid interest to, but excluding, the redemption date.

With certain exceptions, upon a change of control of the Company or the failure of the Company’s common stock to be listed on certain stock exchanges, the holders of the Notes may require that the Company repurchase all or part of the principal amount of the Notes at a purchase price of par plus unpaid interest to, but excluding, the maturity date.

On or after February 20, 2026 and prior to the 31 st scheduled trading day immediately preceding the maturity date of the Notes, the Notes will be redeemable by the Company in the event that the closing sale price of our common stock has been at least 150% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which we provide the redemption notice at a redemption price of 100% of the principal amount of such Notes, plus accrued and unpaid interest up to, but excluding, the redemption date.

With certain exceptions, upon a change of control of the Company or the failure of our common stock to be listed on certain stock exchanges, the holders of the Notes may require that we repurchase all or part of the principal amount of the Notes at a purchase price of par plus unpaid interest up to, but excluding, the maturity date.

The Indenture includes customary “events of default,” which may result in the acceleration of the maturity of the Notes under the Indenture.

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Off-Balance Sheet Arrangements

As of June 30, 2021, we did not have any off-balance sheet arrangements.

As of September 30, 2021, we did not have any off-balance sheet arrangements.

In the ordinary course of business, we enter into standard indemnification arrangements.

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Commitments and Contingencies in Part I, Item 1 of this Form 10-Q, any associated expenses incurred are included within the related accrued litigation expense amounts.

No additional liability associated with such indemnification agreements has been recorded as of June 30, 2021.

Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in market risk from the information provided in our Annual Report on Form 10-K for the year ended December 31, 2020.

No additional liability associated with such indemnification agreements has been recorded as of September 30, 2021.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis