Item 2. Management’s Discussion and Analysis
Item 2. 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 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. 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. 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
About PacBio
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.
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Strategic Objectives
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; and
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. 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. 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.
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
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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.
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; product mix; 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. See Note 2. 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.
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Results of Operations
Comparison of the Three Months Ended March 31, 2022 and 2021
Three Months Ended March 31,
2022
2021
$ Change
% Change
Revenue:
(in thousands, except percentages)
Product revenue
$
28,244
$
25,303
$
2,941
12%
Service and other revenue
4,929
3,694
1,235
33%
Total revenue
33,173
28,997
4,176
14%
Cost of revenue:
Cost of product revenue
14,820
12,697
2,123
17%
Cost of service and other revenue
4,015
3,323
692
21%
Amortization of intangible assets
183
—
183
100%
Total cost of revenue
19,018
16,020
2,998
19%
Gross profit
14,155
12,977
1,178
9%
Operating expense:
Research and development
52,937
20,548
32,389
158%
Sales, general and administrative
39,804
26,139
13,665
52%
Change in fair value of contingent consideration
(1,063)
—
(1,063)
(100%)
Total operating expense
91,678
46,687
44,991
96%
Operating loss
(77,523)
(33,710)
(43,813)
(130%)
Loss from continuation advances from Illumina
—
(52,000)
52,000
100%
Interest expense
(3,697)
(1,789)
(1,908)
(107%)
Other (expense) income, net
(279)
64
(343)
(536%)
Net loss
$
(81,499)
$
(87,435)
$
5,936
7%
Revenue
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 $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.
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Cost of Revenue, Gross Profit and Gross Margin
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 $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.
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Sales, General and Administrative Expense
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.
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 three months ended March 31, 2021.
Interest Expense
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.
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Liquidity and Capital Resources
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 March 31, 2022.
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 and maintain existing collaborations and arrangements; the progress of our research and development programs; initiation or expansion of research programs and collaborations; the purchase of patent licenses; 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; costs of developing new and enhanced products; acquisitions of complementary businesses, technologies or assets; and other factors. 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)
2022
2021
Cash used in operating activities
$
(79,029)
$
(23,104)
Cash provided by investing activities
42,053
8,170
Cash provided by financing activities
5,215
865,721
Net (decrease) increase in cash, cash equivalents and restricted cash
$
(31,761)
$
850,787
Operating Activities
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.
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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 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 $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 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.
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. Therefore,
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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 March 31, 2022, we did not have any off-balance sheet arrangements.
In the ordinary course of business, we enter into standard indemnification arrangements. Pursuant to these arrangements, we indemnify, hold harmless, and agree to reimburse the indemnified parties for losses suffered or incurred by the indemnified party in connection with any trade secret, copyright, patent or other intellectual property infringement claim by any third party with respect to its technology, or from claims relating to our performance or non-performance under a contract, any defective products supplied by us, or any acts or omissions, or willful misconduct, committed by us or any of our employees, agents or representatives. The term of these indemnification agreements is generally perpetual after the execution of the agreement. The maximum potential amount of future payments we could be required to make under these agreements is not determinable because it involves claims that may be made against us in future periods but have not yet been made. To date, we have not incurred costs to defend lawsuits or settle claims related to these indemnification agreements.
We also enter and have entered into indemnification agreements with our directors and officers that may require us to indemnify them against liabilities that arise by reason of their status or service as directors or officers, except as prohibited by applicable law. In addition, we may have obligations to hold harmless and indemnify third parties involved with our fundraising efforts and their respective affiliates, directors, officers, employees, agents or other representatives against any and all losses, claims, damages and liabilities related to claims arising against such parties pursuant to the terms of agreements entered into between us and such third parties in connection with such fundraising efforts. 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 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.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.