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, 2022 filed with the U.S. Securities and Exchange Commission, or the SEC, on February 28, 2023, 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. 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 that enable scientists and clinical researchers to improve their understanding of the genome and ultimately, 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 technology and our emerging Sequencing by Binding ("SBB") short-read sequencing technology. Our products address solutions across a broad set of research applications including human genomics, 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, 2023, our commercial team consisted of approximately 196 employees, including 59 quota-carrying representatives, many with advanced degrees in biology and significant experience in the genomics industry. Strategic Objectives Our 2023 strategic objectives are to: • Drive rapid adoption of Revio TM by converting existing Sequel ® II/IIe customers and attracting new PacBio customers • Demonstrate Onso’s extraordinary level of accuracy in the field and show how it can transform research in needle-in-haystack applications 20 Table of Contents • Progress development of ultra-high-throughput and benchtop long-read sequencers and next generation SBB TM short-read sequencer • Leverage current infrastructure to drive toward positive cash flow • Expand partnerships across ecosystem and workflow to drive customer adoption of SBB short-read sequencing and HiFi long-read sequencing We will continue to leverage our commercial organization and make significant improvements in the efficiency and usability of our products to seek to reach a broader customer base. We believe the commercial investments we have recently made 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, our new HiFi long-read sequencing system. We began taking orders in the fourth quarter of 2022 and commenced commercial Revio shipments in the first quarter of 2023. To address the oncology research markets with a highly differentiated alternative to existing third-party short-read sequencing products already on the market, we are also progressing development of Onso TM , our SBB short-read platform. We began taking orders in the first quarter of 2023 and we believe we remain on track for commercial shipment in the second quarter of 2023. We continue to believe that with the capabilities of our HiFi chemistry and SMRT TM 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 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. In the past, we were negatively impacted by the COVID-19 pandemic and we may be negatively impacted by any future resurgence of the COVID-19 pandemic. Additionally, macroeconomic dynamics including rising inflation, global supply chain constraints, volatile capital markets, competition, exchange rates and lockdown restrictions associated with COVID-19 have adversely impacted our customers and lengthened customer sales cycles. We expect these factors to continue to impact our revenues and results of operations throughout 2023, the size and duration of which is significantly uncertain, and as a result, we cannot reasonably estimate the future impact to our operations and financial results. 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, 2023 consolidated financial results include the following: • Revenue increased $5.7 million, or 17%, to $38.9 million for the three months ended March 31, 2023, as compared to $33.2 million for the three months ended March 31, 2022. The increase was primarily driven by the launch of Revio in the first quarter ended March 31, 2023, which is sold at a higher average selling price than our previous Sequel II and IIe platform. We ended the quarter with an installed base of 32 Revio systems and we shipped 6 Sequel IIe systems in the quarter. • Gross profit as a percentage of revenue (gross margin) was 25% for the three months ended March 31, 2023, compared to 43% for the three months ended March 31, 2022. Gross margin declined due in part to instrument mix, as Revio instruments sold during the quarter had a lower margin primarily due to loyalty discounts provided and higher initial manufacturing costs, as well as adjustments of approximately $3.5 million primarily relating to excess consumables inventory resulting from a faster-than-expected decline in demand of Sequel II/IIe consumables due to the product transition to Revio. Our gross margin in future periods will depend on several factors, including new product transitions and offerings, strategic product pricing; product mix as a result 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. 21 Table of Contents • Loss from operations increased $13.7 million, or 18%, to $91.3 million for the three months ended March 31, 2023, as compared to $77.5 million for the three months ended March 31, 2022, driven primarily by an increase of $9.3 million of operating expenses, including a $4.0 million decrease in research and development expenses and a $13.3 million increase in the change in the fair value of the contingent consideration, and a decline in gross profit of $4.4 million. • Cash, cash equivalents, and short-term investments were $874.9 million at March 31, 2023, which represents a 13% increase compared to the balance at December 31, 2022. Results of Operations Comparison of the Three months ended March 31, 2023 and 2022 (in thousands, except percentages) Three Months Ended March 31, 2023 2022 $ Change % Change Revenue: Product revenue $ 34,654 $ 28,244 $ 6,410 23 % Service and other revenue 4,246 4,929 (683) (14) % Total revenue 38,900 33,173 5,727 17 % Cost of Revenue: Cost of product revenue 25,164 14,820 10,344 70 % Cost of service and other revenue 3,792 4,015 (223) (6 %) Amortization of intangible assets 183 183 — — % Total cost of revenue 29,139 19,018 10,121 53 % Gross profit 9,761 14,155 (4,394) (31 %) Operating Expense: Research and development 48,939 52,937 (3,998) (8) % Sales, general and administrative 39,818 39,804 14 — % Change in fair value of contingent consideration 12,256 (1,063) 13,319 (1253) % Total operating expense 101,013 91,678 9,335 10 % Operating loss (91,252) (77,523) (13,729) 18 % Interest expense (3,630) (3,697) 67 (2) % Other income (expense), net 6,867 (279) 7,146 (2561 %) Net loss $ (88,015) $ (81,499) $ (6,516) 8 % Revenue Revenue increased $5.7 million, or 17%, to $38.9 million for the three months ended March 31, 2023, as compared to $33.2 million for the three months ended March 31, 2022. Instrument revenue increased $5.2 million, or 33%, to $20.7 million for the three months ended March 31, 2023, as compared to $15.6 million for the three months ended March 31, 2022, primarily due to the sale of 32 newly launched Revio systems that have a higher average selling price. We expect sales volumes and the installed base of Revio instruments to grow, reflecting customer demand for the new product. As a result of this new product launch, we anticipate installed base and sales volumes of Sequel II/IIe to decline compared to recent quarters. Consumables revenue increased $1.3 million, or 10%, to $14.0 million for the three months ended March 31, 2023, as compared to $12.7 million for the three months ended March 31, 2022. The increase in consumable sales was primarily due to higher Revio and Sequel II/IIe consumables sales attributable to the growth in the instrument installed base as compared to the same period in the prior year. Service and other revenue decreased $0.7 million, or 14%, to $4.2 million for the three months ended March 31, 2023, as compared to $4.9 million for the three months ended March 31, 2022, primarily due to the change in 22 Table of Contents our terms of the warranty provided with the instrument during the first quarter of 2022 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, and no longer recognize a component of the instrument revenue in service and other revenue over the warranty period. We expect service revenue to continue to decline during the remainder of the year as we anticipate customers transitioning their service contracts to Revio following the standard warranty period, with fewer customers renewing Sequel service contracts. Cost of Revenue, Gross Profit and Gross Margin Cost of product revenue increased $10.3 million, or 70%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The cost of product revenue increased primarily due to higher overall product costs, as well as adjustments of approximately $3.5 million primarily relating to excess consumables inventory resulting from a faster-than-expected decline in demand of Sequel II/IIe consumables due to the product transition to Revio. Gross profit decreased $4.4 million, or 31%, to $9.8 million for the three months ended March 31, 2023, compared to $14.2 million for the three months ended March 31, 2022. Gross margin was 25% for the three months ended March 31, 2023, compared to gross margin of 43% for the three months ended March 31, 2022. The decrease in gross margin was due in part to instrument mix, as Revio instruments sold during the quarter had a lower margin primarily due to loyalty discounts provided and higher initial manufacturing costs, as well as adjustments of approximately $3.5 million primarily relating to excess consumables inventory resulting from a faster-than-expected decline in demand of Sequel II/IIe consumables due to the product transition to Revio. While we expect gross margin to expand during the remainder of the year, gross margin could fluctuate depending on the pace at which Sequel II/IIe usage declines and Revio manufacturing is scaled. Research and Development Expense Research and development expense decreased by $4.0 million, or 8%, to $48.9 million for the three months ended March 31, 2023, compared to the $52.9 million for three months ended March 31, 2022. The decrease was primarily driven by the transition of Revio from development to commercialization. Research and development expense included share-based compensation expense of $6.7 million and $9.0 million during the three months ended March 31, 2023 and 2022, respectively. Sales, General and Administrative Expense Sales, general and administrative expense remained consistent at $39.8 million for each of the three months ended March 31, 2023 and 2022. Sales, general, and administrative expense included share-based compensation expense of $9.3 million and $12.0 million during the three months ended March 31, 2023 and 2022, respectively. The decrease in share-based compensation expense of $2.7 million was primarily offset by an increase in marketing expenses of $2.3 million during the three months ended March 31, 2023 as compared to the three months ended March 31, 2022. Change in Fair Value of Contingent Consideration Change in fair value of contingent consideration of $12.3 million during the three months ended March 31, 2023, 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 probabilities of milestone achievement, as well as the passage of time. Interest Expense Interest expense for the three months ended March 31, 2023, was $3.6 million compared to $3.7 million for the three months ended March 31, 2022 and was primarily comprised of interest on the Convertible Senior Notes. Other Income (Expense), net Other income (expense), net for the three months ended March 31, 2023, was $6.9 million compared to $(0.3) million for the three months ended March 31, 2022. The $7.1 million increase was primarily due to investment income. 23 Table of Contents 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. January 2023 Public Offering On January 27, 2023, we issued and sold an aggregate of 20,125,000 shares of our common stock at a purchase price of $10.00 per share pursuant to an automatic shelf registration statement filed on Form S-3 with the Securities and Exchange Commission, resulting in aggregate gross proceeds of approximately $201.3 million. After deducting underwriting discounts and commissions and offering costs paid or payable by us of approximately $12.1 million, the net proceeds from the offering were approximately $189.2 million. As of March 31, 2023, we had cash, cash equivalents and investments of $874.9 million compared to $772.3 million as of December 31, 2022. 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 March 31, 2023. 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. Summary of Cash Flows Three Months Ended March 31, (in thousands) 2023 2022 Cash used in operating activities $ (94,691) $ (79,029) Cash (used in) provided by investing activities (72,553) 42,053 Cash provided by financing activities 195,989 5,215 Net increase (decrease) in cash, cash equivalents and restricted cash $ 28,745 $ (31,761) 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 three months ended March 31, 2023, of $94.7 million was due primarily to a $88.0 million net loss that included non-cash items such as share-based compensation of $18.0 million, change in estimated fair value of contingent consideration of $12.3 million, depreciation expense of $2.8 million, amortization of right-of-use assets of $1.5 million. This was offset by the accretion of discount and amortization of premium on marketable securities, net of $2.2 million and $43.1 million in net changes to operating assets and liabilities. Cash flow impact from changes in net operating assets and liabilities were primarily driven by increases in inventory, accounts receivable and prepaid and other assets, as well as decreases in accrued expenses, other liabilities and operating lease liabilities. These uses of cash were partially offset by an increase in accounts payable. 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 share-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. Cash flow impact from changes in net operating assets and liabilities were primarily driven by decreases in accrued expenses, other liabilities and operating 24 Table of Contents lease liabilities, as well as increases in inventory, accounts receivable and prepaid and other assets. These uses of cash were partially offset by increases in accounts payable and deferred revenue. Investing Activities Our investing activities consist primarily of capital expenditures and investment purchases, sales, and maturities. Cash used in investing activities for the three months ended March 31, 2023, was due to $164.5 million of maturities and sales of investments offset by $233.3 million in purchases of investments, and $3.7 million in purchases of property and equipment. 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. Financing Activities Cash provided by financing activities during the three months ended March 31, 2023 primarily resulted from $189.2 million in net proceeds related to the issuance of common stock from the underwritten public equity offering and $7.2 million from the issuance of common stock through our equity compensation plans. 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. 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, 2022. 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 March 31, 2023, 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 25 Table of Contents 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 5 . 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, 2023.