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Item 2. Management’s Discussion and Analysis

2022-05-06 compared with 2021-11-05 · 145 added, 194 removed, 58 unchanged (85% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 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.

You should read the following discussion and analysis of our financial condition and results of operations together with the unaudited condensed consolidated financial statements and related notes that are included elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed with the U.S.

Securities and Exchange Commission, or the SEC, on February 28, 2022, or our Annual Report on Form 10-K.

This discussion contains forward-looking statements based upon current plans, expectations and beliefs that involve risks and uncertainties including the effect of the ongoing COVID-19 pandemic and our response thereto.

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.

We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements.

You should read the “Risk Factors” section of this Quarterly Report on Form 10-Q for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including, but not limited to, those discussed in the section entitled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, and you should not place undue reliance on our forward-looking statements.

We do not assume any obligation to update any forward-looking statements.

Business Overview

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.

In preparing this MD&A, we presume that readers have access to and have read the MD&A in our Annual Report on Form 10-K, pursuant to Instruction 2 to paragraph (b) of Item 303 of Regulation S-K.

Our Management’s Discussion and Analysis (MD&A) is organized in the following sections:

• Overview and Outlook

• Results of Operations

• Liquidity and Capital Resources

• Critical Accounting Policies and Estimates

• Recent Accounting Pronouncements

• Off Balance Sheet Arrangements

Overview and Outlook

We are a premier life science technology company that is designing, developing and manufacturing advanced sequencing solutions to help scientists and clinical researchers resolve genetically complex problems.

Our products and technology under development stem from two highly differentiated core technologies focused on accuracy, quality and completeness which include our existing HiFi long read sequencing and our emerging SBB short read sequencing technologies.

Our products address solutions across a broad set of research applications including human germline sequencing, plant and animal sciences, infectious disease and microbiology, oncology, and other emerging applications.

Our focus is on providing our customers with advanced sequencing technologies with higher throughput and improved workflows that we believe will enable dramatic advancements in routine healthcare.

Our customers include academic and governmental research institutions, commercial testing and service laboratories, genome centers, public health labs, hospitals and clinical research institutes, contract research organizations (CROs), pharmaceutical companies and agricultural companies.

As of March 31, 2022, our commercial team was comprised of over 188 employees, including 52 quota-carrying representatives, many with advanced degrees in biology and significant experience in the genomics industry.

Strategic Objectives

We outlined the following strategic objectives for 2021:

 Expand our commercial reach;

 Accelerate our product development pipeline;

 Drive market leadership in whole-genome clinical sequencing.

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

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.

We also intend to invest more heavily in marketing programs to increase the awareness of our products to a broader number of potential customers.

As a result of these commercial expansion activities, we expect our sales, general, and administrative expense to increase significantly in 2021 as compared to 2020.

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 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.

We believe that with the capabilities of our SMRT technology, we can be a market leader in whole-genome clinical sequencing.

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.

Our 2022 strategic objectives include:

 Execution - leveraging commercial investment to drive continued HiFi and Sequel II/IIe adoption;

 Progress our product pipeline - continuing the development of our future higher throughput HiFi sequencing platform and differentiated short-read technology;

 Delight our customers - deepening our customer relationships and expanding customer collaborations across existing and rapidly expanding new applications for our technology.

We will continue to leverage our commercial organization and make significant improvements in efficiency and usability of our Sequel II/IIe to seek to reach a broader customer base.

We believe the commercial investments we made in 2021 and expect to continue to make during the remainder of 2022 will further help drive growth in our business.

We employed 52 quota-carrying field sales personnel as of March 31, 2022, and we expect to continue to invest in our sales, general and administrative departments to support future growth.

To increase the adoption of HiFi sequencing, we have various development programs in progress to expand our product portfolio as well as increase the throughput and improve the usability of our existing sequencing technologies.

We continue to focus on programs to accelerate new platform launches in the near to mid-term as well as increase applications for our technologies.

To address the oncology markets with a highly differentiated alternative, we are also progressing our short read platform development with a goal of launching our SBB short read sequencing platform in the first half of 2023.

As a result, we expect our research and development expense to increase during 2022 as compared to 2021.

We continue to believe that with the capabilities of our HiFi chemistry and SMRT technology, we can be a market leader in whole-genome clinical sequencing.

Leading institutions have adopted our products to study rare and inherited disease.

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

We plan to continue to pursue customer collaborations where the technologies being developed or applications being considered extend beyond whole-genome clinical sequencing.

Collaborative arrangements add to the awareness of our products and service offerings and may drive new applications for use of our technology.

Financial Overview

The COVID-19 pandemic and efforts to control its spread have significantly curtailed the movement of people, goods, and services worldwide , including in the regions in which we sell our products and services and conduct our business operations.

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

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.

We have been negatively impacted by the COVID-19 pandemic and expect to continue to be impacted by COVID-19 for the foreseeable future.

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

In response to local stay-at-home orders and in alignment with CDC recommendations, we have limited our manufacturing and commercial operations based in Menlo Park, California.

We will, however, continue to provide consumables, instruments and support to scientists at government, academic, and commercial labs that remain open.

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 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.

The spread of COVID-19 has caused us to modify our business practices, including limiting certain of our commercial operations and limiting certain employees from working in the office.

Starting in April 2022, we invited employees located near our reopened offices to return to the office.

We have and will continue to provide consumables, instruments, and support to scientists at government, academic, and commercial labs that have remained open or as they reopen.

We have experienced and expect to 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.

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.

Such economic disruption could have a material adverse effect on our business, results of operations and liquidity.

The degree of impact of COVID-19 on our business will depend on several factors, such as the duration and the extent of the pandemic, as well as actions taken by governments, businesses and consumers in response to the pandemic, all of which continue to evolve and remain uncertain at this time.

The degree of impact of COVID-19 on our business will depend on several

factors, such as the duration and the extent of the pandemic, as well as actions taken by governments, businesses and consumers in response to the pandemic, all of which continue to evolve and remain uncertain at this time.

See the Risk Factors section for further discussion of the possible impact of the COVID-19 pandemic on our business.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with the rules and regulations of the SEC.

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

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.

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

Key highlights of the three months ended March 31, 2022 consolidated financial results include the following:

• Revenue increased $4.2 million, or 14%, to $33.2 million for the three months ended March 31, 2022, as compared to $29.0 million for the three months ended March 31, 2021, driven primarily by an increase in instrument and consumable revenue.

We expect revenue to grow during the remainder of 2022 compared to 2021.

However, our future revenues largely depend on the rate of sales of our sequencing instruments, which are a leading indicator of future sales of consumables.

We expect instrument placements to continue to grow as we expand our sales globally through our expanded sales force, through application of technology in new markets and through offering new features and solutions.

However, we also expect a potential slower ramp in the sales of consumables due to lower utilization resulting from project delays due to the COVID-19 pandemic and prolonged lockdowns in China.

• Gross profit as a percentage of revenue (gross margin) was 42.7% for the three months ended March 31, 2022, compared to 44.8% for the three months ended March 31, 2021.

Despite higher sales volumes, gross margin declined due to a lower average selling price (ASP) of instruments, resulting primarily from an increase in instruments sold as multi-unit orders with volume discounts, leading to lower ASP, and an increase in our average product costs during the quarter.

Our gross margin in future periods will depend on several factors, including strategic product pricing;

sales of higher-margin consumables;

supply chain constraints increasing costs of raw materials;

manufacturing capacity and production volumes impacting the cost of inventory;

freight costs;

and excess or obsolete inventories.

• Loss from operations increased $43.8 million or 130%, to a loss of $77.5 million for the three months ended March 31, 2022, as compared to a loss of $33.7 million for the three months ended March 31, 2021, driven primarily by an increase of $45.0 million in operating expenses, including a $32.4 million increase in research and development expenses primarily due to the Omniome acquisition and the establishment of an advanced research organization, $13.7 million increase in sales, general and administrative expenses, offset by a $1.1 million change in the fair value of contingent consideration.

Business Acquisitions in Part I, Item 1 of this Quarterly Report on Form 10-Q for further details .

• Cash, cash equivalents and short-term investments were $962.8 million at March 31, 2022, which represents a 7.8% decrease compared to the balance at December 31, 2021.

Results of Operations

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

Three Months Ended September 30,

(in thousands, except percentages)

Product revenue

Service and other revenue

Total revenue

Cost of revenue:

Cost of product revenue

Cost of service and other revenue

Amortization of intangible assets

Total cost of revenue

Operating expense:

Research and development

Sales, general and administrative

Merger-related expenses

Total operating expense

Operating loss

Interest 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

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

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.

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 acquisition of Omniome.

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 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,

Comparison of the Three Months Ended March 31, 2022 and 2021

Three Months Ended March 31,

(in thousands, except percentages)

10 unchanged sentences

Sales, general and administrative

Merger-related expenses

Change in fair value of contingent consideration

Total operating expense

Operating loss

Gain (loss) from Continuation Advances from Illumina

Loss from continuation advances from Illumina

Interest expense

Other income, net

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.

Other (expense) income, net

Revenue increased $4.2 million, or 14%, to $33.2 million for the three months ended March 31, 2022, as compared to $29.0 million for the three months ended March 31, 2021, driven primarily by an increase in instrument and consumable revenue.

Instrument revenue increased $0.6 million, or 4%, to $15.6 million for the three months ended March 31, 2022, as compared to $14.9 million for the three months ended March 31, 2021, primarily due to an increase in instruments sold offset by a lower average selling price of instruments attributed to volume-based discounts.

At March 31, 2022, our installed base was 424 Sequel II and Sequel IIe systems compared to the 244 systems in the three months ended March 31, 2021.

We expect the number of Sequel II/IIe placements to continue to grow during the remainder of 2022, 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.

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 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.

Consumables revenue increased $2.3 million, or 21%, to $12.7 million for the three months ended March 31, 2022, as compared to $10.4 million for the three months ended March 31, 2021.

The increase in consumable sales was primarily attributable to higher Sequel II/IIe consumables sales from growth of the installed base.

Service and other revenue increased $1.2 million, or 33%, to $4.9 million for the three months ended March 31, 2022, as compared to $3.7 million for the three months ended March 31, 2021, primarily due to product services contracts sold on the 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.

Cost of product revenue increased by $2.1 million, or 17%, to $14.8 million for the three months ended March 31, 2022, compared to $12.7 million for the three months ended March 31, 2021.

The increase in cost of product revenue was primarily due to the increase in instrument sales and higher average product costs.

Cost of service and other revenue increased by $0.7 million, or 21%, to $4.0 million for the three months ended March 31, 2022, compared to $3.3 million for the three months ended March 31, 2021, primarily due to higher service volumes from our growing installed base.

Gross profit increased $1.2 million, or 9%, to $14.2 million for the three months ended March 31, 2022, compared to the three months ended March 31, 2021.

Gross margin was 42.7% for the three months ended March 31, 2022, compared to gross margin of 44.8% for the three months ended March 31, 2021.

The decrease in gross margin percentage was primarily due to higher sales volumes offset by lower average selling price and increased product costs during the three months ended March 31, 2022, compared to the three months ended March 31, 2021.

The global shortage of semiconductors, which has been reported since early 2021, continues to be a challenge for us in our supply chain and resulted in cost increases that have and may continue to adversely impact margins.

During these periods of shortages or delays, the price of components may increase, or the components may not be available at all.

Additionally, in response to the rising COVID-19 infections, China has imposed lockdowns in certain parts of the country, which has had, and may continue to have, a negative impact on manufacturing and/or supply chains, as well as customer demand for our products and demand through certain distributors.

We may not be able to secure enough components at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed.

Accordingly, our revenue and gross margins could suffer until other sources can be developed.

Research and Development Expense

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.

Research and development expense increased by $32.4 million, or 158%, to $52.9 million for the three months ended March 31, 2022, compared to the three months ended March 31, 2021.

This change was primarily driven by an increase of $10.4 million in personnel expenses due to an increase in headcount, including the acquired workforce from the Omniome acquisition and an increase of $11.9 million of product development costs and other related costs.

Research and development expense included stock-based compensation expense of $9.0 million and $3.0 million during the three months ended March 31, 2022 and 2021, respectively.

We will continue to focus a significant portion of our resources on developing new products and solutions, including improving the efficiency and usability of existing products, developing new solutions, software, workflows and applications leveraging our core technologies.

We have collaborated and expect to continue to collaborate with strategic partners to develop sequencing solutions and expand the application of our technology.

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

We are currently renegotiating the terms of the Development Agreement.

While we expect to continue to develop next generation high throughput sequencing platforms and products, we do not anticipate that Invitae will continue to provide funding support for future development under the Development Agreement.

We expect to continue discussions with Invitae in connection with the Development Agreement to receive feedback and operational assistance and expertise which we will incorporate in the continued development of our high throughput sequencing platforms and products.

We expect research and development expenses to increase in 2022, when compared to 2021, due to continued product development, a full year of expenses associated with the acquisition of Omniome and our intent to continue to hire additional personnel in research and development.

Sales, General and Administrative Expense

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 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 Income (Loss) for the nine months ended September 30, 2021.

Sales, general and administrative expense increased by $13.7 million, or 52%, to $39.8 million for the three months ended March 31, 2022, compared to the three months ended March 31, 2021.

This change was primarily driven by an increase of $5.9 million in stock-based compensation expense and an increase of $2.9 million in salaries and related expense due to increased headcount, which included quota-carrying sales representatives.

Sales, general and administrative expense is planned to increase in 2022, when compared to 2021, as we incur a full year of expenses associated with the acquisition of Omniome and our prior year headcount growth.

Change in Fair Value of Contingent Consideration

Change in fair value of contingent consideration of $1.1 million during the three months ended March 31, 2022, represents the remeasurement impact of the contingent consideration of $200 million (composed of $100 million in cash and $100 million in shares of our common stock) that is due upon the achievement of a milestone, defined as the first commercial shipment to a customer of both an instrument and related consumables, utilizing SBB technology.

Loss from Continuation Advances from Illumina

As part of the Termination Agreement, Illumina paid us Continuation Advances totaling $52.0 million, which was 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.

Interest Expense

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.

Interest expense for the three months ended March 31, 2022, was $3.7 million compared to $1.8 million for the three months ended March 31, 2021.

The increase was primarily due to the full quarter interest incurred on the $900 million of 1.50% Convertible Senior Notes due February 15, 2028 that we issued on February 16, 2021.

Other (Expense) Income, Net

The increase in Other (expense) income, net was primarily driven by greater foreign exchange loss for the three months ended March 31, 2022.

Liquidity and Capital Resources

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.

Our primary sources of liquidity, other than our holdings of cash, cash equivalents, and investments, has primarily been through the issuance of debt or equity securities, together with cash flow from operating activities.

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 our strategic initiatives to grow our business.

As of March 31, 2022, we had cash, cash equivalents and investments of $962.8 million compared to $1.04 billion as of December 31, 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.

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 September 30, 2021.

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;

our ability to obtain new collaboration and customer arrangements;

our ability to obtain new collaboration and customer arrangements and maintain existing collaborations and arrangements;

the progress of our research and development programs;

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There can be no assurance that funds will be available on favorable terms, or at all.

Summary of Cash Flows

Three Months Ended March 31,

(in thousands)

Cash used in operating activities

Cash provided by investing activities

Cash provided by financing activities

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

Operating Activities

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 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.

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

We used $79.0 million of cash in operating activities for the three months ended March 31, 2022, compared to cash used in operating activities of $23.1 million for the three months ended March 31, 2021.

Cash used in operating activities for the three months ended March 31, 2022, of $79.0 million was due primarily to a $81.5 million net loss that included non-cash items such as stock-based compensation of $22.7 million, depreciation expense of $2.3 million, amortization of right-of-use assets of $1.7 million, a $1.1 million decrease in liability due to the change in estimated fair value of contingent consideration, and a net cash outflow due to $24.4 million in net changes to operating assets and liabilities.

The change in net operating assets and liabilities was primarily attributable to a decrease of $17.2 million in accrued expenses, $6.3 million increase in inventory, $3.6 million increase in accounts receivable, $2.5 million decrease in other liabilities, $1.9 million decrease in operating lease liabilities, $1.2 million increase in prepaid and other assets partially offset by an increase of $6.4 million in accounts payable and $1.9 million increase in deferred revenue.

Cash used in operating activities for the three months ended March 31, 2021, was due primarily to $87.4 million net loss, partially offset by a loss of $52.0 million from Continuation Advances repaid to Illumina that is considered a financing activity and non-cash items such as stock-based compensation of $10.2 million and depreciation of $1.6 million.

The change in net operating assets and liabilities was primarily attributable to decreases of $3.0 million in other liabilities and $2.7 million in accrued expenses and an increase of $2.6 million in inventory, partially offset by a decrease of $3.9 million in accounts receivable and an increase of $5.0 million in deferred revenue.

Investing Activities

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.

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

Cash provided by investing activities for the three months ended March 31, 2022, was due primarily to $122.1 million in maturities of investments offset by net purchases of investments of $76.4 million, and partially offset by purchases of property and equipment of $3.6 million.

Cash provided by investing activities for the three months ended March 31, 2021, was due primarily to net sales and maturities of investments of $8.6 million, partially offset by purchases of property and equipment of $0.4 million.

Financing Activities

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 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

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

Bank National Association, as trustee.

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 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 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 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.

The Indenture also includes customary covenants for convertible notes of this type.

Cash provided by financing activities was $5.2 million and $865.7 million for the three months ended March 31, 2022 and 2021, respectively.

Cash provided by financing activities during the three months ended March 31, 2022, resulted from proceeds of $5.6 million from the issuance of common stock through our equity compensation plans.

Cash provided by financing activities during the three months ended March 31, 2021, resulted from the net proceeds of $895.6 million from our February 2021 issuance of $900 million of 1.50% Convertible Senior Notes after deducting debt issuance costs and proceeds of $22.3 million from the issuance of common stock through our equity compensation plans, partially offset by $52.0 million of Continuation Advances repaid to Illumina.

Critical Accounting Policies and Estimates

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

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

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

There have been no changes to our significant accounting policies as disclosed in the Annual Report on Form 10-K for the year ended December 31, 2021, however, as a result of certain changes to the standard contractual terms and conditions with customers implemented during the quarter ended March 31, 2022, we concluded a change in the application of our accounting policy, in accordance with ASC 606, was appropriate.

Specifically, we modified the standard contractual terms with customers during the current quarter, to reflect transfer of title and risk of loss and right to invoice upon delivery.

We also updated the terms of the warranty provided with the instrument to remove the service component.

As a result, the warranty is no longer a separate performance obligation and, accordingly, we accrue for the cost of the assurance warranty when revenue of the instrument is recognized.

In addition, because of technical enhancements associated with our more recent instrument releases, including the Sequel IIe systems, installation services are now distinct from the instrument itself.

instrument revenue is now recognized upon transfer of control of the asset to the customer, which is generally upon delivery for sales made to our non-distributor customers.

Recent Accounting Pronouncements

Please see Note 1.

Organization and Significant Accounting Policies , subsection titled “Recent Accounting Pronouncements”, in Part II, Item 8 of the Annual Report on Form 10-K for information regarding applicable recent accounting pronouncements

Off-Balance Sheet Arrangements

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

As of March 31, 2022, 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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To the extent that such indemnification obligations apply to the lawsuits described in Note 8.

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 September 30, 2021.

Commitments and Contingencies in Part I, Item 1 of this Quarterly Report on 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 March 31, 2022.

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