PACIFIC BIOSCIENCES OF CALIFORNIA, INC. 10-Q

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 into 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 September 30, 2022, our commercial team was comprised of over 192 employees, including 54 quota-carrying representatives, many with advanced degrees in biology and significant experience in the genomics industry. 25 Table of Contents Strategic Objectives Our 2022 strategic objectives include:  Execution - leveraging commercial investment to drive continued HiFi, Sequel II/IIe, and new product 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 products to seek to reach a broader customer base. We believe the commercial investments we have already made and expect to continue to make during the remainder of 2022 will further help drive growth in our business. 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. In October 2022, we announced Revio TM , our new HiFi long-read sequencing system. We will begin taking orders in the fourth quarter of 2022 with shipments expected to commence in the first quarter of 2023. To address the oncology research markets with a highly differentiated alternative to our long-read technology and existing third party short-read sequencing products already on the market, we are also progressing development of Onso TM , our SBB short-read platform, with shipments expected to commence in the first half of 2023. 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 partner 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 Broader macroeconomic dynamics including rising inflation, global supply chain constraints, volatile capital markets, competition and lockdown restrictions associated with COVID-19 have adversely impacted our customers and lengthened customer sales cycles. Additionally, lock downs in China have led to lower than previously anticipated revenue in the Asia-Pacific region as customers have difficulty accessing labs and lower sample volumes from which to sequence. We expect some headwinds from a strengthening U.S. dollar which impacts our revenue denominated in EUR and GBP but also impacts purchasing power of our customers in Asia as a stronger U.S. dollar makes buying our products more expensive. Ongoing global supply chain constraints and rising inflation are also increasing our costs; therefore, we expect these costs to impact gross margins and cash flow. Due to the rising costs from global supply chain constraints and rising inflation, we are moderating our hiring with the aim of reducing our operating expenses growth in 2022. We will continue to prioritize investments to develop and commercialize our new products, prioritizing opportunities that will generate a return over the near to mid-term. The degree of further adverse impacts 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 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 some 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. See the Risk Factors section for further discussion of the possible impact of the COVID-19 pandemic on our business. 26 Table of Contents Key highlights of the nine months ended September 30, 2022 consolidated financial results include the following:  Revenue increased $6.5 million, or 7%, to $101.0 million for the nine months ended September 30, 2022, as compared to $94.5 million for the nine months ended September 30, 2021, driven primarily by an increase in consumable and service revenue from the growth of our installed base of Sequel II/IIe instruments. Future revenue growth is, in part, dependent on the sales of sequencing instruments, which are a leading indicator of consumables sales. While we expect to continue to sell Sequel II/IIe instruments during the remainder of 2022 and beyond, we anticipate the launch of our new long-read instrument, Revio TM , will impact sales of our Sequel IIe platform. Further, we may continue to experience an impact from lengthening sales cycles due to global macroeconomic factors.  Gross profit as a percentage of revenue (gross margin) was 43.5% for the nine months ended September 30, 2022, compared to 44.5% for the nine months ended September 30, 2021. G ross margin declined due primarily to a decrease in instrument volume and average selling price as well as higher overall product costs. Our gross margin in future periods will depend on several factors, including new product transitions, strategic product pricing; product mix; sales of higher-margin consumables; supply chain constraints and inflation 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 $74.4 million or 51%, to a loss of $220.1 million for the nine months ended September 30, 2022, as compared to a loss of $145.8 million for the nine months ended September 30, 2021, driven primarily by an increase of $76.2 million in operating expenses, including a $80.1 million increase in research and development expenses, primarily due to the Omniome acquisition and the establishment of an advanced research organization, and a $29.0 million increase in sales, general, and administrative expenses, partially offset by a $30.7 million decrease in non-recurring merger-related costs incurred in 2021 and a $2.2 million gain related to the 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 $834.3 million at September 30, 2022, which represents a 20.1% decrease compared to the balance at December 31, 2021. 27 Table of Contents Results of Operations Comparison of the Three months ended September 30, 2022 and 2021 Three Months Ended September 30, 2022 2021 $ Change % Change Revenue: (in thousands, except percentages) Product revenue $ 27,509 $ 30,502 $ (2,993) (10%) Service and other revenue 4,802 4,385 417 10% Total revenue 32,311 34,887 (2,576) (7%) Cost of revenue: Cost of product revenue 15,568 15,530 38 0% Cost of service and other revenue 3,012 3,870 (858) (22%) Amortization of intangible assets 184 123 61 50% Total cost of revenue 18,764 19,523 (759) (4%) Gross profit 13,547 15,364 (1,817) (12%) Operating expense: Research and development 47,092 27,508 19,584 71% Sales, general and administrative 36,795 31,606 5,189 16% Merger-related expenses — 30,726 (30,726) (100%) Change in fair value of contingent consideration 4,280 — 4,280 100% Total operating expense 88,167 89,840 (1,673) (2%) Operating loss (74,620) (74,476) (144) 0% Interest expense (3,664) (3,673) 9 0% Other income (loss), net 1,313 (133) 1,446 1087% Loss before benefit from income taxes (76,971) (78,282) 1,311 2% Benefit from income taxes – (94,824) 94,824 100% Net (loss) income $ (76,971) $ 16,542 $ (93,513) (565%) Revenue Revenue decreased $2.6 million, or 7%, to $32.3 million for the three months ended September 30, 2022, as compared to $34.9 million for the three months ended September 30, 2021. Instrument revenue decreased $4.5 million, or 28%, to $11.4 million for the three months ended September 30, 2022, as compared to $15.9 million for the three months ended September 30, 2021, primarily due to fewer instruments sold and a lower average selling price of instruments. We believe some of this decrease was driven by customer delays in instrument purchases as customers anticipated the launch of our new long-read platform, the Revio TM . At September 30, 2022, our installed base was 494 Sequel II and Sequel IIe systems compared to the 326 systems at September 30, 2021. We expect the installed base of Sequel II/IIe instruments to continue to grow, reflecting our increased commercial presence and customer demand; however, we anticipate that sales volumes of Sequel II/IIe may decline as compared to recent quarters as a result of the announcement of Revio TM and its anticipated availability for shipment in the first quarter of 2023. Consumables revenue increased $1.5 million, or 10%, to $16.1 million for the three months ended September 30, 2022, as compared to $14.6 million for the three months ended September 30, 2021. The increase in consumable sales was primarily due to higher Sequel II/IIe consumables sales attributable to the growth in the instrument installed base d espite annualized pull-through declining for the three months ended September 30, 2022 as compared to the same period in the prior year . Service and other revenue increased $0.4 million, or 10%, to $4.8 million for the three months ended September 30, 2022, as compared to $4.4 million for the three months ended September 30, 2021, primarily due to service contracts sold on the growing installed base. Cost of Revenue, Gross Profit and Gross Margin Cost of product revenue increased slightly for the three months ended September 30, 2022, compared to the three months ended September 30, 2021. Cost of services and other revenue decreased primarily due to lower service personnel costs. 28 Table of Contents Gross profit decreased $1.8 million, or 12%, to $13.5 million for the three months ended September 30, 2022, compared to $15.4 million for the three months ended September 30, 2021. Gross margin was 41.9% for the three months ended September 30, 2022, compared to gross margin of 44.0% for the three months ended September 30, 2021. The decrease in gross margin was primarily driven by lower sales volume and average selling price as well as higher overall product costs, which was partially offset by consumables volumes and lower service revenue costs. We expect our gross margin will trend slightly lower during the remainder of the year due in part to new product transitions, the impacts of inflation, and increased supply chain costs. The global shortage of semiconductors and rising inflation continues to be a challenge 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. 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 $19.6 million, or 71%, to $47.1 million for the three months ended September 30, 2022, compared to the $27.5 million for three months ended September 30, 2021. The increase was primarily driven by an increase of $9.0 million in product development costs and an increase of $6.8 million in personnel expenses due to an increase in headcount, including the acquired workforce from the Omniome acquisition. In addition, facilities and information technology related expenses increased by $3.2 million during the three months ended September 30, 2022 compared to the three months ended September 30, 2021, primarily due to expenses related to our operational expansion. Research and development expense included stock-based compensation expense of $7.5 million and $5.2 million during the three months ended September 30, 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. Sales, General and Administrative Expense Sales, general and administrative expense increased by $5.2 million, or 16%, to $36.8 million for the three months ended September 30, 2022, compared to $31.6 million for the three months ended September 30, 2021. The increase was primarily driven by an increase of $1.5 million in travel expenses, an increase of $1.5 million in personnel expenses, and an increase of $0.7 million in facilities and information technology related expenses. Sales, general, and administrative expense included stock-based compensation expense of $10.5 million and $9.9 million during the three months ended September 30, 2022 and 2021, respectively. We anticipate sales, general, and administrative expense to continue to increase primarily as a result of the new product commercialization efforts. Change in Fair Value of Contingent Consideration Change in fair value of contingent consideration of $4.3 million during the three months ended September 30, 2022, represents the remeasurement impact of the contingent consideration liability 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. The increase in contingent consideration liability was primarily due to changes in the probability of achieving the milestone, as well as the passage of time. Interest Expense Interest expense for the three months ended September 30, 2022, was $3.7 million compared to $3.7 million for the three months ended September 30, 2021 and was primarily comprised of interest on the Convertible Senior Notes. Benefit from Income Taxes A deferred income tax benefit of $94.8 million for the three 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 29 Table of Contents 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, 2022 and 2021 Nine Months Ended September 30, 2022 2021 $ Change % Change Revenue: (in thousands, except percentages) Product revenue $ 85,928 $ 82,338 $ 3,590 4% Service and other revenue 15,023 12,156 2,867 24% Total revenue 100,951 94,494 6,457 7% Cost of revenue: Cost of product revenue 45,887 41,449 4,438 11% Cost of service and other revenue 10,619 10,828 (209) (2%) Amortization of intangible assets 550 123 427 347% Total cost of revenue 57,056 52,400 4,656 9% Gross profit 43,895 42,094 1,801 4% Operating expense: Research and development 150,377 70,323 80,054 114% Sales, general and administrative 115,851 86,804 29,047 33% Merger-related expenses — 30,726 (30,726) (100%) Change in fair value of contingent consideration (2,221) — (2,221) (100%) Total operating expense 264,007 187,853 76,154 41% Operating loss (220,112) (145,759) (74,353) (51%) Loss from continuation advances from Illumina — (52,000) 52,000 100% Interest expense (11,042) (9,051) (1,991) (22%) Other income, net 1,290 92 1,198 1302% Loss before benefit from income taxes (229,864) $ (206,718) (23,146) (11%) Benefit from income taxes — (94,824) 94,824 100% Net loss $ (229,864) (111,894) $ (117,970) (105%) Revenue Revenue increased $6.5 million, or 7%, to $101.0 million for the nine months ended September 30, 2022, as compared to $94.5 million for the nine months ended September 30, 2021, driven primarily by an increase in consumable and service revenue from the growth in the installed base of Sequel II/IIe instruments. In consideration of the non-refundable payments received from Invitae pursuant to the Original Agreement of $23.5 million, we will provide Invitae with credits in connection with Invitae’s anticipated purchase of certain currently available and in-development sequencing systems (instruments and consumables). During the nine months ended September 30, 2022, Invitae purchased certain currently available instruments, for which $3.7 million of revenue was recognized as product revenue under the terms of the Amended and Restated Agreement. Instrument revenue decreased $2.5 million, or 6%, to $42.6 million for the nine months ended September 30, 2022, as compared to $45.1 million for the nine months ended September 30, 2021, primarily due to fewer instruments sold and a lower average selling price of instruments. We believe some of this decrease was driven by customer delays in instrument purchases as customers anticipated the launch of our new long-read platform, the Revio TM . At September 30, 2022, our installed base was 494 Sequel II and Sequel Ile systems compared to the 326 systems at September 30, 2021. We expect the installed base of Sequel II/IIe instruments to continue to grow, reflecting our increased commercial presence and customer demand; however, we anticipate that sales volumes may decline as compared to recent quarters as a result of the announcement of Revio TM and its anticipated availability for shipment in the first quarter of 2023. Consumables revenue increased $6.1 million, or 16%, to $43.3 million for the nine months ended September 30, 2022, as compared to $37.2 million for the nine months ended September 30, 2021. The increase in consumable sales was primarily due to higher Sequel II/IIe consumables sales attributable to the growth in the instrument installed base d espite annualized pull-through declining for the nine months ended September 30, 2022 as compared to the same period in the prior year . Service and other revenue increased $2.9 million, or 24%, to $15.0 million for the nine months ended September 30, 2022, a s compared to $12.2 million for the nine months ended September 30, 2021, primarily due to service contracts sold on the growing installed base. 30 Table of Contents Cost of Revenue, Gross Profit and Gross Margin Cost of product revenue increased by $4.4 million, or 11%, to $45.9 million for the nine months ended September 30, 2022, compared to $41.4 million for the nine months ended September 30, 2021. The increase in cost of product revenue was primarily due to higher overall product costs. Cost of service and other revenue decreased by $0.2 million, or 2%, to $10.6 million for the nine months ended September 30, 2022, compared to $10.8 million for the nine months ended September 30, 2021. Gross profit increased $1.8 million, or 4%, to $43.9 million for the nine months ended September 30, 2022, compared to $42.1 million the nine months ended September 30, 2021. Gross margin was 43.5% for the nine months ended September 30, 2022, compared to gross margin of 44.5% for the nine months ended September 30, 2021. The decrease in gross margin percentage was primarily due to a decrease in instrument sales volume and average selling price as well as higher product costs, which was partially offset by consumables volumes and higher service and other revenues during the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. We expect our gross margin will trend slightly lower during the remainder of the year due in part to new product transitions and the impacts of inflation and increased supply chain costs. The global shortage of semiconductors 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 surge in COVID-19 infections in 2022, the Chinese government 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 $80.1 million, or 114%, to $150.4 million for the nine months ended September 30, 2022, compared to $70.3 million for the nine months ended September 30, 2021. This change was primarily driven by an increase of $35.6 million in personnel expenses, including the acquired workforce from the Omniome acquisition, and an increase of $32.2 million of product development costs. In addition, facilities and information technology related expenses increased $10.2 million to support our operational expansion during the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. Research and development expense included stock-based compensation expense of $24.2 million and $12.5 million during the nine months ended September 30, 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 expect research and development expenses for the year ending 2022 to increase, when compared to 2021, due to continued product development,   a full year of expenses associated with the acquisition of Omniome and our intent to hire additional personnel in research and development. We anticipate that our spend during the remainder of 2022 will decline due to new product transitions. Additionally, we have collaborated and expect to continue to collaborate with strategic partners to develop sequencing solutions and expand the application of our technology. Sales, General and Administrative Expense Sales, general and administrative expense increased by $29.0 million, or 33%, to $115.9 million for the nine months ended September 30, 2022, compared to $86.8 million for the nine months ended September 30, 2021. The increase was primarily driven by an increase of $12.4 million in personnel costs, an increase of $5.0 million related to consulting and professional services, an increase of $4.1 million in travel related expenses, an increase of $3.8 million in marketing and business expenses, and an increase of $2.9 million in facilities expenses and information technology related expenses. Sales, general and administrative expense included stock-based compensation expense of $32.7 million and $25.6 million during the nine months ended September 30, 2022 and 2021, respectively. W e anticipate sales, general, and administrative expense to continue to increase primarily as a result of the new product commercialization efforts. 31 Table of Contents Change in Fair Value of Contingent Consideration Change in fair value of contingent consideration of $2.2 million during the nine months ended September 30, 2022, represents the remeasurement impact of the contingent consideration liability 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. The decrease in contingent consideration liability was primarily due to the increase in discount rates. 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 nine months ended September 30, 2021. Interest Expense Interest expense for the nine months ended September 30, 2022 was $11.0 million compared to $9.1 million for the nine months ended September 30, 2021. The increase was primarily due to the nine months of interest incurred on the $900 million of 1.50% Convertible Senior Notes due February 15, 2028 that we issued on February 16, 2021 during the nine months ended September 30, 2022 compared to only seven months of interest during the nine months ended September 30, 2021. Benefit from Income Taxes A deferred income tax benefit of $94.8 million for the 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 nine months ended September 30, 2021. 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 September 30, 2022, we had cash, cash equivalents and investments of $834.3 million compared to $1.04 billion as of December 31, 2021. We believe that our existing cash, cash equivalents and investments will be sufficient to fund our projected operating requirements beyond the next 12 months from the date of filing of this Quarterly Report on Form 10-Q for the quarter ended September 30, 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; 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. ‎ 32 Table of Contents Summary of Cash Flows Nine Months Ended September 30, (in thousands) 2022 2021 Cash used in operating activities $ (202,645) $ (79,472) Cash provided by (used in) investing activities 35,680 (744,284) Cash provided by financing activities 8,803 1,168,257 Net (decrease) increase in cash, cash equivalents and restricted cash $ (158,162) $ 344,501 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. Cash used in operating activities for the nine months ended September 30, 2022, of $202.6 million was due primarily to a $229.9 million net loss that included non-cash items such as stock-based compensation of $60.7 million, depreciation expense of $6.9 million, amortization of right-of-use assets of $5.2 million, amortization of premium and accretion of discount on marketable securities, net of $1.1 million, partially offset by a $2.2 million decrease in liability due to the change in estimated fair value of contingent consideration, and a net cash outflow due to $45.6 million in net changes to operating assets and liabilities. The change in net operating assets and liabilities was primarily attributable to a $20.7 million increase in inventory, a $11.1 million increase in accrued expenses, a $5.9 million increase in operating lease liabilities, a $5.7 million increase in prepaid expenses and other assets, and a $3.6 million increase in deferred revenue, partially offset by a $1.5 million decrease in accounts receivable a $1.5 million increase in accounts payable. 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 expense 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. Investing Activities Our investing activities consist primarily of capital expenditures and investment purchases, sales, and maturities. Cash provided by investing activities for the nine months ended September 30, 2022, was due to $355.4 million of maturities and sales of investments offset by $307.9 million in purchases of investments, and $11.8 million in purchases of property and equipment. 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. Financing Activities Cash provided by financing activities during the nine months ended September 30, 2022 primarily resulted from proceeds of $10.0 million from the issuance of common stock through our equity compensation plans partially offset by $1.2 million of principal payoff of notes. 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. 33 Table of Contents 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 that 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 first quarter of 2022, 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, 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 I, Item 1 of this Quarterly Report on Form 10-Q for information regarding applicable recent accounting pronouncements Off-Balance Sheet Arrangements As of September 30, 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 September 30, 2022. 34 Table of Contents