UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

Or

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission File Number 001-34899

 

Pacific Biosciences of California, Inc.

(Exact name of registrant as specified in its charter)

 

 

(650) 521-8000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒   No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No   ☒

 

Number of shares outstanding of the issuer’s common stock as of October 31, 2014: 71,356,003  

 

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TABLE OF CONTENTS

 

 

 

 

 

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PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Balance Sheets

(Unaudited)

 

See accompanying notes to the condensed consolidated financial statements.

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PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1. OVERVIEW

Pacific Biosciences of California, Inc. (referred to in this report as “Pacific Biosciences”, the “Company”, “we”, “us” or “our”) has commercialized high resolution genetic sequencing products that provide access to genetic information that was previously inaccessible. The PacBio RS II DNA Sequencing System helps scientists solve genetically complex problems. Based on our novel Single Molecule, Real-Time (SMRT) technology, our products enable: targeted sequencing to more comprehensively characterize genetic variations; de novo genome assembly to more fully identify, annotate, and decipher genomic structures; and DNA base modification identification to help characterize epigenetic regulation and DNA damage. By providing access to information that was previously inaccessible, we allow scientists to increase their understanding of biological systems.

The names “Pacific Biosciences,” “PacBio,” “SMRT,” “SMRTbell” and our logo are our trademarks.

 

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) of Pacific Biosciences of California, Inc. have been prepared on a consistent basis with the December 31, 2013 audited Consolidated Financial Statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein. Certain prior year amounts in the Financial Statements and notes thereto have been reclassified to conform to the current year presentation. The Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and, as permitted by such rules and regulations, omit certain information and footnote disclosures necessary to present the statements in accordance with U.S. generally accepted accounting principles (“GAAP”). These Financial Statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013. The results of operations for the nine-month period ended September 30, 2014 are not necessarily indicative of the results to be expected for the entire 2014 fiscal year or any future periods.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes to the financial statements. Our estimates include, but are not limited to, the valuation of inventory, the valuation of our financing derivative and the valuation of our long-term notes, the assumptions used to determine stock-based compensation, and estimates used to allocate proceeds received in revenue. We base our estimates on historical experience and various other assumptions that we believe are reasonable. Actual results could differ materially from these estimates.

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Fair Value of Financial Instruments

Assets and liabilities measured at fair value on a recurring basis

The following table sets forth the fair value of our financial assets and liabilities measured on a recurring basis as of September 30, 2014 and December 31, 2013:

 

 

 

Our cash deposits and money market funds are classified within Level 1 of the fair value hierarchy because they are valued using bank balances or quoted market prices. Our investments are classified as Level 2 instruments based on market pricing and other observable inputs. None of our investments are classified within Level 3 of the fair value hierarchy.

During the nine-month periods ended September 30, 2014 and 2013, there were no impairments of our investments.

The estimated fair value of the Financing Derivative liability (as defined in Note 6. Debt) was determined using Level 3 inputs, or significant unobservable inputs. Changes to the estimated fair value of the Financing Derivative are recorded in “Other income (expense), net” in the condensed consolidated statements of operations and comprehensive loss. The following table provides the changes in the estimated fair value of the Financial Derivative during the nine-month period ended September 30, 2014 (in thousands):

 

 

During the nine-month period ended September 30, 2014 there were no transfers between Level 1, Level 2, or Level 3 assets or liabilities reported at fair value on a recurring basis and valuation techniques did not change compared to established practice.

Financial assets and liabilities not measured at fair value on a recurring basis

The carrying amount of our accounts receivable, prepaid expenses, other current assets, accounts payable, accrued expenses and other liabilities, current,  approximate fair value due to their short maturities. The carrying value of our other liabilities, non-current approximates fair value due to the time to maturity and prevailing market rates.

We determined the estimated fair value of the Notes (as defined in Note 6. Debt) from the debt facility using Level 3 inputs, or significant unobservable inputs. The estimated fair value of the Notes was determined by comparing the difference between the estimated fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using an 18.8% and 20.4% weighted average market yield at September 30, 2014 and December 31, 2013, respectively. The estimated fair value and carrying value of the Notes are as follows (in thousands):

 

 

 

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Net Loss per Share

The following table presents the computation of our basic and diluted net loss per share (in thousands, except per share amounts):

 

 

The following were excluded from the computation of our diluted net loss per share for the periods presented because including them would have had an anti-dilutive effect:

 

 

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers,  requiring entities to recognize revenue to which it expects to be entitled for the transfer of promised goods or services to customers.  The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either a retrospective or cumulative effect transition method. The updated standard is effective for the Company in the first quarter of fiscal year 2017 and early adoption is not permitted. We are evaluating the impact of adopting this ASU on our financial statements and related disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.  This ASU introduces an explicit requirement for management to assess if there is substantial doubt about an entity’s ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances. Disclosures are required if conditions give rise to substantial doubt. This ASU is effective for the Company in the first quarter of fiscal 2017. We are currently assessing the potential effects of this ASU on our consolidated financial statements.

 

NOTE 3. CONTRACTUAL REVENUE

During September 2013 we entered into a Development, Commercialization and License Agreement (the “Roche Agreement”) with F. Hoffman-La Roche Ltd (“Roche”), pursuant to which we account for, and recognize as revenue, the up-front payment using the proportional performance method over the periods in which the delivery of elements of the agreement occurs. We recognize revenue using a straight line convention over the service periods of the deliverables as this method approximates our performance of services pursuant to the contract. Out of the $35.0 million upfront cash payment received, $1.7 million and $5.1 million have been recognized as contractual revenue for the three- and nine-month periods ended September 30, 2014, respectively, and $28.2 million remain deferred as of September 30, 2014 and will be recognized as contractual revenue over the estimated obligation periods.

In addition to the deliverables above, the Roche Agreement provides for additional payments totaling up to $40.0 million upon the achievement of certain development milestones. During August 2014, we achieved the first development milestone and we recorded the related $10.0 million as contractual revenue. Under the terms of the Roche Agreement, we may receive up to an additional $30.0 million based on the achievement of additional development milestones in future periods.

 

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NOTE 4. CASH, CASH EQUIVALENTS AND INVESTMENTS

The following table summarizes our investments as of September 30, 2014 and December 31, 2013 (in thousands):

 

 

The following table summarizes the contractual maturities of our cash equivalents and available-for-sale investments, excluding money market funds, as of September 30, 2014:

 

 

Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without call or prepayment penalties.

 

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NOTE 5. BALANCE SHEET COMPONENTS

 

Inventory, net

 

As of September 30, 2014 and December 31, 2013, our inventory, net, consisted of the following components:

 

 

NOTE 6. DEBT

Pursuant to a Facility Agreement (the “Facility Agreement”) we entered into with entities affiliated with Deerfield Management Company, L.P. (collectively, “Deerfield”) during February 2013, we issued promissory notes in the aggregate principal amount of $20.5 million (the “Notes”). The Notes bear simple interest at a rate of 8.75% per annum, payable quarterly in arrears commencing on April 1, 2013. In connection with the execution of the Facility Agreement, we issued warrants to purchase an aggregate of 5,500,000 shares of common stock immediately exercisable at an exercise price per share initially equal to $2.63 (the “Warrants”). In addition, we are required to maintain consolidated cash and cash equivalents on the last day of each calendar quarter of not less than $2.0 million. As security for our repayment of our obligations under the Facility Agreement, we granted to Deerfield a security interest in substantially all of our property.

Notes

The Notes and Warrants were initially recorded at a value of $14.1 million and $6.4 million, respectively, based upon the relative fair value allocation of the $20.5 million of proceeds.  The carrying value of the Notes at the inception of the debt was $12.8 million, resulting in an original issue discount of $7.7 million. As of September 30, 2014, $6.6 million remains to be amortized through February 2020, the maturity of the Notes.

Financing Derivative

A number of features embedded in the Notes issued pursuant to the Facility Agreement required accounting for as a derivative, including the indemnification of certain withholding taxes and the acceleration of debt upon (a) a qualified financing, (b) an Event of Default, (c) a Major Transaction, and (d) the exercise of the Warrant via offset to debt principal. These features represent a single derivative (the “Financing Derivative”) that was bifurcated from the debt instrument and accounted for as a liability at fair value, with changes in fair value between reporting periods recorded in other income (expense), net. The estimated fair value of the Financing Derivative was determined by comparing the difference between the estimated fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using an 18.8% and 20.4% weighted average market yield at September 30, 2014 and December 31, 2013, respectively. The estimated fair value of the Financing Derivative as of September 30, 2014 and December 31,  2013 was $0.7 million and $0.5 million, respectively.

 

 

NOTE 7. STOCKHOLDERS’ EQUITY AND SHARE-BASED COMPENSATION

Equity Offering

During the nine-month period ended September 30, 2014,  we issued 3.0 million shares of our common stock at an average price of $7.11 per share through our “at-the-market” offering, resulting in net proceeds of $20.8 million. As of September 30, 2014, under our “at-the-market” offering program,  $17.8 million of common stock remain available for future sales; however, we are not obligated to make sales under this program. 

From October 1, 2014 through November 3, 2014, we issued 1.8 million shares of our common stock at an average price of $6.41 per share through our “at-the-market” offering, resulting in net proceeds of $11.1 million.

Warrants

As of September 30, 2014, we had outstanding warrants to purchase an aggregate of 5,500,000 shares of common stock.

Equity Plans

As of September 30, 2014, we had three active equity compensation plans, the 2010 Equity Incentive Plan, or 2010 Plan, the

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2010 Outside Director Equity Incentive Plan, or 2010 Director Plan, and the 2010 Employee Stock Purchase Plan, or ESPP.

The following table summarizes stock option activity for all stock option plans for the nine-month period ended September 30, 2014 (in thousands, except per share amounts):

 

 

As of September 30, 2014, no shares of our common stock remain available for issuance under our ESPP. The ESPP provides for an annual increase to the shares available for issuance at the beginning of each calendar year equal to two percent of the common shares then outstanding. Shares issued under the ESPP totaled 1,325,507 and 1,519,366 shares during the nine-month periods ended September 30, 2014 and 2013, respectively.

Stock-based Compensation

Total stock-based compensation expense consists of the following (in thousands):

 

 

We estimated the fair value of employee stock options on the grant date using the Black-Scholes option pricing model. The estimated fair value of employee stock options is amortized on a straight-line basis over the requisite service period of the awards. The fair value of employee stock options was estimated using the following weighted average assumptions:

 

 

We estimate the value of the employee stock purchase rights on the grant date using the Black-Scholes option pricing model. The fair value of ESPP was estimated using the following assumptions:

 

 

 

 

 

 

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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 our condensed consolidated financial statements and the related notes included in this report and those in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties, including statements regarding our expected financial results in future periods. You should read the “Risk Factors” section of this report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

We develop, manufacture and market an integrated platform for high resolution genetic analysis. Combining advances in nanofabrication, biochemistry, molecular biology, surface chemistry and optics, we created a technology platform called single molecule, real-time, or SMRT, technology. Our initial focus is to offer our SMRT technology to the DNA sequencing market where we have developed a third generation sequencing platform, the PacBio RS II sequencing system. The PacBio RS II is an instrument that uses our proprietary consumables, including our SMRT Cells and reagent kits that are used to prepare and sequence DNA samples.

Basis of Presentation

Revenue

During the three- and nine-month periods ended September 30, 2014 and 2013, product revenue was primarily derived from the sale of PacBio RS II instruments and associated consumables. Service and other revenue was primarily derived from product maintenance agreements sold on our installed instruments. Contractual revenue relates to the quarterly amortization of $1.7 million from the non-refundable up-front payment of $35.0 million we received during September 2013 pursuant to the Roche Agreement. In addition, for the three- and nine-month periods ended September 30, 2014, contractual revenue also included $10.0 million relating to the achievement of a development milestone outlined in the Roche Agreement.    

As of September 30, 2014, our backlog was comprised of 20 instruments. We define backlog as purchase orders or signed contracts for systems from customers which we believe are firm and for which we have not yet recognized revenue.

Cost of Revenue

Cost of revenue reflects the direct cost of product components, third-party manufacturing services and our internal manufacturing overhead and customer service infrastructure costs incurred to produce, deliver, maintain and support our instruments, consumables, and services. There are no incremental costs associated with our contractual revenue; all product development costs are reflected in research and development expense.

Manufacturing overhead is predominantly comprised of labor costs. We determine and capitalize manufacturing overhead into inventory based on a standard cost model that approximates actual costs.  Prior to achieving manufacturing volumes that correlated with our estimated normal capacity  (the production levels expected to be achieved over a number of periods under normal circumstances with available resources), we based our capitalized overhead relative to our normal capacity.  Prior to achieving normal capacity, excess manufacturing resources were engaged in research and development activities, including; next generation products, internal use research products, and general support activities. As such, manufacturing costs in excess of amounts reflected in inventory were expensed as a component of research and development expense. During 2014, manufacturing volumes trended towards and then approximated normal capacity, and excess manufacturing resources contributing to research and development activities declined significantly.

Service costs include the direct costs of components used in support, repair and maintenance of customer instruments as well as the cost of personnel, materials and support infrastructure necessary to support the installed customer base. Prior to the fourth quarter of 2013, the capacity of our existing service infrastructure exceeded the number of installed customer instruments. Therefore, management estimated the capacity of the existing service infrastructure and recognized the service-related cost of revenue based on the installed base. As a result, prior to the fourth quarter of 2013, total service infrastructure costs exceeded the costs associated with the support of customer instruments and such excess costs were included as a component of sales, general and administrative expense. 

Research and Development Expense

Research and development expense consists primarily of expenses for personnel engaged in the development of our SMRT technology, the design and development of our future products and current product enhancements. These expenses also include prototype-related expenditures, development equipment and supplies, facilities costs and other related overhead.

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Sales, General and Administrative Expense 

Selling, general and administrative expenses include costs for sales, marketing and administrative personnel, sales and marketing activities, tradeshow expenses, legal expenses and general corporate expenses.

Interest Expense

Interest expense is primarily related to our debt facility and includes the amortization of debt discount and other related costs. To a lesser extent, amounts also include interest expense relating to our facility financing obligations resulting from a lease agreement entered into in 2010. We expect interest expense to increase during future periods as the recorded value accretes to the amount due at maturity.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest income earned on cash and investments, accretion of discounts and amortization of premiums related to investments, foreign currency translation, net gains or losses from disposal of fixed assets, net gains or losses resulting from changes in fair value of the Financing Derivative, and foreign income taxes.

Income Taxes

Since inception, we have incurred net losses and have not recorded any U.S. federal or state income tax benefits for such losses as they have been fully offset by valuation allowances.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our unaudited financial statements, which have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“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. On an ongoing basis, we evaluate our critical accounting policies and estimates. 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 material changes to our critical accounting policies and estimates discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Results of Operations

Comparison of the Three-month Periods Ended September 30, 2014 and 2013

 

 

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Revenue

Total revenue for the three-month period ended September 30, 2014 was $20.6 million compared to $7.4 million for the same period during 2013.  

Product revenue during the three-month period ended September 30, 2014 consisted of $3.5 million from sales of PacBio RS II instruments and $3.3 million from sales of consumables compared to $3.7 million from sales of instruments and $2.1 million from sales of consumables for the same period during 2013. Instrument revenue during the three-month period ended September 30, 2014 reflects the delivery of six PacBio RS II instruments as compared to six instruments and $0.5 million associated with instrument upgrades for the same period during 2013. 

Service and other revenue of $2.2 million and $1.6 million for the three-month periods ended September 30, 2014 and 2013, respectively, was primarily derived from product maintenance agreements sold on our installed instruments. 

Contractual revenue for the three-month period ended September 30, 2014 included the quarterly amortization of $1.7 million from the non-refundable up-front payment of $35.0 million we received in September 2013 pursuant to the Roche Agreement, and our achievement of a $10.0 million milestone pursuant to the Roche Agreement.

Gross Profit

Gross profit increased $12.0 million to $13.2 million for the three-month period ended September 30, 2014, resulting in a gross margin of 63.8%, compared to gross profit of $1.2 million and a gross margin of 16.7% for the three-month period ended September 30, 2013. The increase for both gross margin and gross profit is primarily due to the increase in Roche contractual revenue, specifically the $10.0 million relating to the achievement of a development milestone.

Cost of product revenue of $5.6 million for the three-month period ended September 30, 2014 reflects the costs primarily relating to the sale of six instruments and consumables shipped during the period while cost of product revenue of $4.6 million for the same period during 2013 reflects the costs primarily relating to the sale of six instruments and consumables shipped during the period. The increase of $1.0 million in cost of product revenue for the three-month period ended September 30, 2014 compared to the same period during 2013 was primarily due to the increase in consumable revenue and higher cost of product associated with instruments during three-month period ended September 30, 2014. 

Cost of service and other revenue for the three-month period ended September 30, 2014 increased to $1.9 million compared to $1.6 million for the same period during 2013. The increase in cost of service and other revenue reflected higher service costs for personnel, materials and support infrastructure necessary to support the rising install base of our instruments. 

Gross margin is expected to remain variable depending on the revenue mix; however in the short-term, we expect gross margin to decrease due to a higher mix of instrument revenue expected in the fourth quarter and the non-recurring nature of the milestone revenue recognized during the third quarter of 2014.

Research and Development Expense

During the three-month period ended September 30, 2014, research and development expense increased $1.3 million, or 12%, compared to the same period during 2013. The increase in research and development expense was primarily attributed to an increase of $1.1 million for higher product development expenses.  Research and development expense included stock-based compensation expense of $0.9 million and $0.8 million during the three-month periods ended September 30, 2014 and 2013, respectively. We anticipate quarterly research and development expenses to remain consistent with recent quarters for the remainder of 2014.

Sales, General and Administrative Expense

For the three-month period ended September 30, 2014, selling, general and administrative expense decreased $0.9 million, or 8%, compared to the same period during 2013. The decrease in sales, general and administrative expense was primarily attributed to a decrease of $1.3 million in professional fees primarily due to higher expenses incurred associated with the Roche Agreement during the three-month period ended September 30, 2013 as compared to the expenses associated with the Roche Agreement during the three- month period ended September 30, 2014. Sales, general and administrative expense included stock-based compensation expense of $1.3 million and $1.2 million during the three-month periods ended September 30, 2014 and 2013, respectively. We anticipate quarterly sales, general and administrative expenses to remain consistent with recent quarters for the remainder of 2014.

Interest Expense

Interest expense for the three-month period ended September 30, 2014 remained flat compared to the same period during 2013. Interest expense related primarily to the debt facility entered into during the three-month period ended March 31, 2013.

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Other Income (Expense), Net

Other income (expense), net consists primarily of interest income earned on cash and investments, accretion of discounts and amortization of premiums related to investments, net gains or losses on foreign currency transactions, net gains or losses resulting from changes in the estimated fair value of the Financing Derivative and foreign income taxes.

Comparison of the Nine-month Periods Ended September 30, 2014 and 2013