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EX-32.2 - EX-32.2 - PACIFIC BIOSCIENCES OF CALIFORNIA, INC.pacb-20170331xex32_2.htm
EX-32.1 - EX-32.1 - PACIFIC BIOSCIENCES OF CALIFORNIA, INC.pacb-20170331xex32_1.htm
EX-31.2 - EX-31.2 - PACIFIC BIOSCIENCES OF CALIFORNIA, INC.pacb-20170331xex31_2.htm
EX-31.1 - EX-31.1 - PACIFIC BIOSCIENCES OF CALIFORNIA, INC.pacb-20170331xex31_1.htm



 

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 March 31, 2017

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)

 

 



 

Delaware

16-1590339

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)



 

1305 O’Brien Drive

Menlo Park, CA 94025

94025

(Address of principal executive offices)

(Zip Code)

(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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 



 

 

 



 

 

 

Large accelerated filer

Accelerated filer   



 

 

 

Non-accelerated filer

(Do not check if a smaller reporting company)

Smaller reporting company



 

 

 



 

Emerging growth company



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 




 

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 April 30, 2017:  93,550,577  

2

 


 

TABLE OF CONTENTS







 



PAGE No.



 

PART I  - FINANCIAL INFORMATION

 



 

Item 1. Financial Statements (unaudited):

 



 

Condensed Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016 



 

Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three-Month Periods Ended March 31, 2017 and 2016 



 

Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2017 and 2016 



 

Notes to Condensed Consolidated Financial Statements 



 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 

18 



 

Item 3. Quantitative and Qualitative Disclosures About Market Risk 

26 



 

Item 4. Controls and Procedures 

26 



 

PART II. OTHER INFORMATION

 



 

Item 1. Legal Proceedings 

27 



 

Item 1A. Risk Factors 

28 



 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 

46 



 

Item 3. Default Upon Senior Securities 

46 



 

Item 4. Mine Safety Disclosures 

46 



 

Item 5. Other Information 

46 



 

Item 6. Exhibits 

46 



 



 

EXHIBIT INDEX 

48 







3

 


 

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Balance Sheets

(Unaudited)







 

 

 

 

 



 

 

 

 

 



March 31,

 

December 31,

(in thousands, except per share amounts)

2017

 

2016

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

$

28,982 

 

$

16,765 

Investments

 

27,068 

 

 

55,213 

Accounts receivable

 

10,441 

 

 

11,421 

Inventory

 

15,348 

 

 

15,634 

Prepaid expenses and other current assets

 

6,501 

 

 

9,978 

Total current assets

 

88,340 

 

 

109,011 

Property and equipment, net

 

42,449 

 

 

14,560 

Long-term restricted cash

 

4,500 

 

 

4,500 

Other long-term assets

 

219 

 

 

9,813 

Total assets

$

135,508 

 

$

137,884 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

$

8,221 

 

$

8,359 

Accrued expenses

 

17,246 

 

 

16,604 

Deferred service revenue, current

 

6,683 

 

 

7,130 

Other liabilities, current

 

167 

 

 

1,681 

Notes payable, current

 

3,123 

 

 

 —

Total current liabilities

 

35,440 

 

 

33,774 

Deferred service revenue, non-current

 

1,484 

 

 

1,297 

Deferred rent, non-current

 

14,148 

 

 

19 

Other liabilities, non-current

 

1,741 

 

 

1,664 

Notes payable, non-current

 

13,302 

 

 

16,106 

Financing derivative

 

208 

 

 

356 

Total liabilities

 

66,323 

 

 

53,216 



 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 



 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Preferred Stock, $0.001 par value:

 

 

 

 

 

Authorized 50,000 shares; No shares issued or outstanding 

 

 —

 

 

 —

Common Stock, $0.001 par value:

 

 

 

 

 

Authorized 1,000,000 shares; Issued and outstanding 93,540 and 92,677 shares at March 31, 2017 and December 31, 2016, respectively

 

94 

 

 

93 

Additional paid-in-capital

 

880,505 

 

 

872,114 

Accumulated other comprehensive income (loss)

 

(3)

 

 

Accumulated deficit

 

(811,411)

 

 

(787,544)

Total stockholders’ equity

 

69,185 

 

 

84,668 

Total liabilities and stockholders’ equity

$

135,508 

 

$

137,884 

See accompanying notes to the condensed consolidated financial statements.

4

 


 

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)











 

 

 

 

 

 



 

 

 

 

 

 



 

Three-Month Periods Ended March 31,

(in thousands, except per share amounts)

 

2017

 

2016

Revenue:

 

 

 

 

 

 

Product revenue

 

$

21,294 

 

$

12,379 

Service and other revenue

 

 

3,621 

 

 

3,152 

Contractual revenue

 

 

 —

 

 

3,596 

Total revenue

 

 

24,915 

 

 

19,127 

Cost of revenue:

 

 

 

 

 

 

Cost of product revenue

 

 

11,362 

 

 

6,880 

Cost of service and other revenue

 

 

4,616 

 

 

2,743 

Total cost of revenue

 

 

15,978 

 

 

9,623 

Gross profit

 

 

8,937 

 

 

9,504 

Operating expense:

 

 

 

 

 

 

Research and development

 

 

16,971 

 

 

16,361 

Sales, general and administrative

 

 

15,265 

 

 

11,708 

Total operating expense

 

 

32,236 

 

 

28,069 

Operating loss

 

 

(23,299)

 

 

(18,565)

Interest expense

 

 

(838)

 

 

(779)

Other income (expense), net

 

 

270 

 

 

(8)

Net loss

 

 

(23,867)

 

 

(19,352)

Other comprehensive loss:

 

 

 

 

 

 

Unrealized gain on investments

 

 

(8)

 

 

48 

Comprehensive loss

 

$

(23,875)

 

$

(19,304)



 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.26)

 

$

(0.23)

Shares used in computing basic and diluted net loss per share

 

 

92,970 

 

 

83,604 



 

 

 

 

 

 



See accompanying notes to the condensed consolidated financial statements.



5

 


 

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)









 

 

 

 

 



 

 

 

 

 



Three-Month Periods Ended March 31,

(in thousands)

2017

 

2016

Cash flows from operating activities

 

 

 

 

 

Net loss

$

(23,867)

 

$

(19,352)

Adjustments to reconcile net loss to net cash used in operating activities

 

 

 

 

 

Depreciation

 

2,850 

 

 

848 

Amortization of debt discount and financing costs

 

319 

 

 

268 

Stock-based compensation

 

4,984 

 

 

4,581 

Other items

 

(145)

 

 

74 

Changes in assets and liabilities

 

 

 

 

 

Accounts receivable

 

980 

 

 

(2,865)

Inventory

 

(149)

 

 

(2,119)

Prepaid expenses and other assets

 

3,377 

 

 

4,709 

Accounts payable

 

(89)

 

 

(39)

Accrued expenses

 

(4,763)

 

 

(3,350)

Deferred service revenue

 

(260)

 

 

(705)

Deferred contractual revenue

 

 —

 

 

(3,596)

Other liabilities

 

92 

 

 

1,279 

Net cash used in operating activities

 

(16,671)

 

 

(20,267)

Cash flows from investing activities

 

 

 

 

 

Purchase of property and equipment

 

(2,668)

 

 

(457)

Disposal of property and equipment

 

 —

 

 

111 

Purchase of investments

 

(10,419)

 

 

(43,383)

Sales of investments

 

3,662 

 

 

4,949 

Maturities of investments

 

34,905 

 

 

15,539 

Net cash provided by (used in) investing activities

 

25,480 

 

 

(23,241)

Cash flows from financing activities

 

 

 

 

 

Proceeds from issuance of common stock from equity plans

 

3,408 

 

 

3,423 

Proceeds from issuance of common stock from at-the-market equity offering, net of issuance costs

 

 —

 

 

26,536 

Net cash provided by financing activities

 

3,408 

 

 

29,959 

Net increase (decrease) in cash and cash equivalents

 

12,217 

 

 

(13,549)

Cash and cash equivalents at beginning of period

 

16,765 

 

 

33,629 

Cash and cash equivalents at end of period

$

28,982 

 

$

20,080 



 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities

 

 

 

 

 

Changes in unpaid property and equipment

$

5,356 

 

$

24 

Changes in deposits for property and equipment paid in prior period

$

9,694 

 

$

 —

Property and equipment paid by landlord

$

12,600 

 

$

 —



See accompanying notes to the condensed consolidated financial statements.

 

6

 


 

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1. OVERVIEW

We design, develop and manufacture sequencing systems to help scientists resolve genetically complex problems. Based on our novel Single Molecule, Real-Time (SMRT®) Sequencing technology, our products enable: de novo genome assembly to finish genomes in order to more fully identify, annotate and decipher genomic structures; full-length transcript analysis to improve annotations in reference genomes, characterize alternatively spliced isoforms and find novel genes; targeted sequencing to more comprehensively characterize genetic variations; and DNA base modification identification to help characterize epigenetic regulation and DNA damage. Our technology combines very high consensus accuracy and long read lengths with the ability to detect real-time kinetic information.

In September 2015, we announced that we had launched a new nucleic acid sequencing platform, the PacBio Sequel™ System (the “Sequel System”), which will provide higher throughput, more scalability, a reduced footprint and lower sequencing project costs compared to the PacBio® RS II System, while maintaining the existing benefits of our SMRT Technology.

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



NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Consolidation

Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, or U.S. GAAP, as set forth in the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC. The consolidated financial statements include the accounts of Pacific Biosciences and our wholly owned subsidiaries. All intercompany transactions and balances have been eliminated. Translation adjustments resulting from translating foreign subsidiaries’ results of operations and assets and liabilities into U.S. dollars are immaterial for all periods presented.

Use of Estimates

The preparation of financial statements in conformity with U.S. 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, revenue valuation, the valuation of a financing derivative and long-term notes, the valuation and recognition of share-based compensation, the delivery period for collaboration agreements, the useful lives assigned to long-lived assets, and the computation provisions for income taxes. Actual results could differ materially from these estimates.

During the first quarter of 2017, we recorded a charge to cost of revenue of $1.3 million relating to leased RS II instruments primarily due to a change in the estimated useful life of these instruments.

Fair Value of Financial Instruments

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.

The fair value hierarchy established under U.S. GAAP requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level input that is significant to the fair value measurement. The three levels of inputs that may be used to measure fair value are as follows:

 

 

 

Level 1: quoted prices in active markets for identical assets or liabilities;

 

 

 

Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

 

 

 

Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

We consider an active market as one in which transactions for the asset or liability occurs with sufficient frequency and volume to provide pricing information on an ongoing basis. Conversely, we view an inactive market as one in which there are few transactions

7

 


 

for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate, our non-performance risk, or that of our counterparty, is considered in determining the fair values of liabilities and assets, respectively.

We classify our cash deposits and money market funds within Level 1 of the fair value hierarchy because they are valued using bank balances or quoted market prices. We classify our investments as Level 2 instruments based on market pricing and other observable inputs. We did not classify any of our investments within Level 3 of the fair value hierarchy.

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the entire fair value measurement requires management to make judgments and consider factors specific to the asset or liability.

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 that were measured on a recurring basis as of March 31, 2017 and December 31, 2016 respectively (in thousands):







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



March 31, 2017

 

December 31, 2016

(in thousands)

Level 1

 

Level 2

 

Level 3

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Total

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

$

27,183 

 

$

 —

 

$

 —

 

$

27,183 

 

$

14,516 

 

$

 —

 

$

 —

 

$

14,516 

Commercial paper

 

 —

 

 

1,799 

 

 

 —

 

 

1,799 

 

 

 —

 

 

2,249 

 

 

 —

 

 

2,249 

US government & agency securities

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Total cash and cash equivalents

 

27,183 

 

 

1,799 

 

 

 —

 

 

28,982 

 

 

14,516 

 

 

2,249 

 

 

 —

 

 

16,765 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

 —

 

 

18,691 

 

 

 —

 

 

18,691 

 

 

 —

 

 

23,583 

 

 

 —

 

 

23,583 

Corporate debt securities

 

 —

 

 

6,346 

 

 

 —

 

 

6,346 

 

 

 —

 

 

10,739 

 

 

 —

 

 

10,739 

US government & agency securities

 

 —

 

 

2,004 

 

 

 —

 

 

2,004 

 

 

 —

 

 

20,579 

 

 

 —

 

 

20,579 

Asset backed securities

 

 —

 

 

27 

 

 

 —

 

 

27 

 

 

 —

 

 

312 

 

 

 —

 

 

312 

Total investments

 

 —

 

 

27,068 

 

 

 —

 

 

27,068 

 

 

 —

 

 

55,213 

 

 

 —

 

 

55,213 

Long-term restricted cash:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

4,500 

 

 

 —

 

 

 —

 

 

4,500 

 

 

4,500 

 

 

 —

 

 

 —

 

 

4,500 

Total assets measured at fair value

$

31,683 

 

$

28,867 

 

$

 —

 

$

60,550 

 

$

19,016 

 

$

57,462 

 

$

 —

 

$

76,478 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financing derivative

$

 —

 

$

 —

 

$

208 

 

$

208 

 

$

 —

 

$

 —

 

$

356 

 

$

356 

Total liabilities measured at fair value

$

 —

 

$

 —

 

$

208 

 

$

208 

 

$

 —

 

$

 —

 

$

356 

 

$

356 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



The estimated fair value of the Financing Derivative liability (as defined in “Note 6. Notes Payable’) was determined using Level 3 inputs, or significant unobservable inputs. Refer to “Note 6. Notes Payable” for a detailed description and valuation approach. 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 fair value of the Financial Derivative during the three-month period ended March 31, 2017 (in thousands):









 

 



 

 

Financing Derivative

Amount

Balance as of December 31, 2016

$

356 

Gain on change in estimated fair value

 

(148)

Balance as of March 31, 2017

$

208 



During the three-month period ended March 31, 2017, there were no transfers between Level 1, Level 2, or Level 3 assets or liabilities reported at fair value on a recurring basis and our valuation techniques did not change compared to the prior year.

8

 


 

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 current liabilities approximate fair value due to their short maturities. The carrying value of our facility financing obligation approximates fair value due to the time to maturity and prevailing market rates.

We determined the fair value of the Notes (as defined in “Note 6. Notes Payable”) from the debt facility we entered into during the first quarter of 2013 using Level 3 inputs, or significant unobservable inputs.  The value of the Notes was determined by comparing the difference between the fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using a 10.1% and 10.6% weighted average market yield at March 31, 2017 and December 31, 2016, respectively. Refer to “Note 6. Notes Payable” for additional details regarding the Notes. The estimated fair value and carrying value of the Notes are as follows (in thousands):

The estimated fair value and carrying value of the Notes are as follows (in thousands):









 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



March 31, 2017

 

December 31, 2016



Fair Value

 

Carrying Value

 

Fair Value

 

Carrying Value

Notes payable

$

20,083 

 

$

16,425 

 

$

19,788 

 

$

16,106 



Net Loss per Share

The following outstanding common stock options and warrants to purchase common stock were excluded from the computation of diluted net loss per share for the periods presented because including them would have had an anti-dilutive effect:







 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



 

Three Months Ended March 31,

 

 

(in thousands)

 

2017

 

2016

 

 

 

 

Options outstanding

 

26,656 

 

22,542 

 

 

 

 

Warrants to purchase common stock

 

 —

 

1,682 

 

 

 

 





Recent Accounting Pronouncements



Recently Adopted Accounting Standards

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which amends the current stock compensation guidance. The amendments simplify the accounting for the taxes related to stock based compensation, including adjustments to how excess tax benefits and a company's payments for tax withholdings should be classified. Furthermore, the amendments allow the entities to make an accounting policy election to either estimate forfeitures or recognize forfeitures as they occur. If an election is made, the change to recognize forfeitures as they occur must be adopted using a modified retrospective approach with a cumulative effect adjustment recorded to opening retained earnings. The standard is effective for fiscal periods beginning after December 15, 2016, with early adoption permitted.

We adopted this guidance as of January 1, 2017. Prior to adoption, the excluded windfall deductions for federal and state purposes were $6.0 million and $0.6 million, respectively. Upon adoption of ASU 2016-09, we recognized the excluded windfall deductions as a deferred tax asset with a corresponding offset to valuation allowance. The total deferred tax assets  were $321.5 million as of January 1, 2017, which was fully offset by a valuation allowance. Further, we did not elect an accounting policy change to record forfeitures as they occur and thus we continue to estimate forfeitures at each period. 

During 2016, we adopted ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15). ASU 2014-15 requires companies to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosure. Management performed such an assessment and concluded there was not substantial doubt about our ability to continue as a going concern.

Since our inception, we have financed our operations primarily through product sales, issuance of common stock and convertible preferred stock, in addition to our debt facility and payments from Roche pursuant to the terms of the Roche Agreement.

Cash, cash equivalents and investments at March 31, 2017 totaled $56.1 million, compared to $72.0 million at December 31, 2016. We believe that our existing cash, cash equivalents and investments will be sufficient to fund our projected operating requirements for at least 12 months; however, we plan to raise additional capital in the future. Our view regarding sufficiency of cash and liquidity is primarily based on our financial forecast for 2017 and into the first quarters of 2018, which is impacted by various assumptions regarding demand for our products. Generally, we expect demand for our products to increase for the remainder of 2017 and into 2018 as compared to 2016, and this expectation is included in forecasts of future cash and liquidity availability. These expectations are based on our current operating and financing plans, which are subject to change.

9

 


 

Factors that may affect our capital needs include, but are not limited to, slower than expected adoption of our products resulting in lower sales of our products and services; future acquisitions; our ability to obtain new collaboration and customer arrangements; the progress of our research and development programs; initiation or expansion of research programs and collaborations; litigation costs, including the costs involved in preparing, filing, prosecuting, defending and enforcing intellectual property rights; the purchase of patent licenses; the costs associated with the ongoing transition to our new facilities in Menlo Park, California; and other factors.

To the extent we raise additional funds through the sale of equity or convertible debt securities, the issuance of such securities will result in dilution to our stockholders. There can be no assurance that such funds will be available on favorable terms, or at all. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds by entering into collaboration or debt agreements on unattractive terms. Our inability to raise capital could have a material adverse effect on our business, financial condition and results of operations.



Recently Issued Accounting Standards

In February 2016, the FASB issued ASU 2016-02, Leases. The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases. ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, requiring an entity to recognize the amount of 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 the retrospective or the cumulative effect transition method. ASU 2014-09 is effective for periods beginning after December 15, 2017, with early adoption permitted but not earlier than the original effective date. Accordingly, the updated standard is effective for us in the first quarter of 2018. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

While we are continuing to assess all potential impacts of the new accounting standard, we currently believe the most significant impact relates to our accounting for the incremental cost of obtaining a contract with a customer (i.e., sales commission). Under current GAAP, the cost incurred to obtain a contract is recognized in the period the expense is incurred while under the new standard, the incremental costs to obtain the contract will be allocated to the performance obligations using the relative fair value of these obligations, recognized as an asset and amortized over the useful life of that asset. We are still in the process of evaluating the impact of this new standard on these arrangements. Due to the complexity of certain of our contracts, the actual revenue recognition treatment required under the new standard for these arrangements may be dependent on contract-specific terms and vary in some instances.



NOTE 3. CONTRACTUAL REVENUE

In September 2013, we entered into the “Roche Agreement” with Roche, pursuant to which we accounted for, and recognized as revenue, the up-front payment received thereunder using the proportional performance method over the periods in which the delivery of elements pursuant to the Roche Agreement occurs. We recognized revenue under the Roche Agreement using a straight-line convention over the service periods of the deliverables as this method approximated our performance of services pursuant to the Roche Agreement. Out of the $35.0 million upfront cash payment received, quarterly amortization of $1.7 million was recognized as contractual revenue from the fourth quarter of 2013 to the fourth quarter of 2014. Beginning in the three-month period ended March 31, 2015, we revised the estimated development period related to our contractual revenue amortization based on increasing certainty of the development time on a prospective approach and quarterly amortization of $3.6 million was recognized as contractual revenue for each of the four quarters of 2015 and for each of the first three quarters of 2016. As of September 30, 2016, the total deferred contractual revenue balance was $1.3 million, relating to the amount allocated to the deliverable of our participation on the joint steering committee. In December 2016, we received notice from Roche that Roche had elected to terminate the Roche Agreement for convenience and the termination became effective February 10, 2017, which was 60 days after the date of the notice in accordance with the terms of the Roche Agreement. Upon such notice in December 2016, no further participation on the joint steering committee was deemed necessary; as such, we recognized the entire remaining unamortized deferred revenue of $1.3 million as contractual revenue in the fourth quarter of 2016. As a result of Roche’s termination of the Roche Agreement, it may be more difficult for us to successfully market, sell and commercialize our products into the markets that Roche would have addressed under the Roche Agreement.

Further, the Roche Agreement provided for additional payments totaling $40.0 million upon the achievement of certain development milestones, all of which have previously been received and recognized as revenue. Consideration from development milestones is recognized in the period in which a milestone is achieved only if the milestone is considered substantive in its entirety. We achieved the first development milestone under the Roche Agreement and recognized the related $10.0 million as contractual

10

 


 

revenue during the year ended December 31, 2014. We achieved the second and the third (final) development milestones under the Roche Agreement and recognized the related $10.0 million and $20.0 million as contractual revenue during the three-month periods ended June 30, 2015 and December 31, 2015, respectively. There are no other milestones remaining to be achieved.



NOTE 4. CASH, CASH EQUIVALENTS AND INVESTMENTS

The following tables summarize our cash, cash equivalents and investments as of March 31, 2017 and December 31, 2016 (in thousands):







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



As of March 31, 2017 



 

 

Gross

 

Gross

 

 



Amortized

 

unrealized

 

unrealized

 

Fair



Cost

 

gains

 

losses

 

Value

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

$

27,183 

 

$

 —

 

$

 —

 

$

27,183 

Commercial paper

 

1,799 

 

 

 —

 

 

 —

 

 

1,799 

Total cash and cash equivalents

 

28,982 

 

 

 —

 

 

 —

 

 

28,982 

Investments:

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

18,691 

 

 

 

 

(2)

 

 

18,691 

Corporate debt securities

 

6,347 

 

 

 

 

(2)

 

 

6,346 

Asset backed securities

 

27 

 

 

 —

 

 

 —

 

 

27 

US government & agency securities

 

2,006 

 

 

 —

 

 

(2)

 

 

2,004 

Total investments

 

27,071 

 

 

 

 

(6)

 

 

27,068 

Total cash, cash equivalents and investments

$

56,053 

 

$

 

$

(6)

 

$

56,050 



 

 

 

 

 

 

 

 

 

 

 

Long-term restricted cash:

 

 

 

 

 

 

 

 

 

 

 

Cash

$

4,500 

 

$

 —

 

$

 —

 

$

4,500 



 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



As of December 31, 2016 



 

 

Gross

 

Gross

 

 



Amortized

 

unrealized

 

unrealized

 

Fair



Cost

 

gains

 

losses

 

Value

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

$

14,516 

 

$

 —

 

$

 —

 

$

14,516 

Commercial paper

 

2,249 

 

 

 —

 

 

 —

 

 

2,249 

Total cash and cash equivalents

 

16,765 

 

 

 —

 

 

 —

 

 

16,765 

Investments:

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

23,581 

 

 

 

 

(3)

 

 

23,583 

Corporate debt securities

 

10,741 

 

 

 

 

(3)

 

 

10,739 

Asset backed securities

 

312 

 

 

 —

 

 

 —

 

 

312 

US government & agency securities

 

20,574 

 

 

 

 

(2)

 

 

20,579 

Total investments

 

55,208 

 

 

13 

 

 

(8)

 

 

55,213 

Total cash, cash equivalents and investments

$

71,973 

 

$

13 

 

$

(8)

 

$

71,978 



 

 

 

 

 

 

 

 

 

 

 

Long-term restricted cash:

 

 

 

 

 

 

 

 

 

 

 

Cash

$

4,500 

 

$

 —

 

$

 —

 

$

4,500 



 

 

 

 

 

 

 

 

 

 

 



11

 


 

The following table summarizes the contractual maturities of our cash equivalents and available-for-sale investments, excluding money market funds, as of March 31, 2017:













 

 



 

 

(in thousands)

Fair Value

Due in one year or less

$

28,867 



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



NOTE 5.  BALANCE SHEET COMPONENTS



Inventory



As of March 31, 2017 and December 31, 2016,  our inventory consisted of the following components:







 

 

 

 

 



 

 

 

 

 



March 31,

 

December 31,

(in thousands)

2017

 

2016

Purchased materials

$

5,573 

 

$

4,817 

Work in process

 

5,967 

 

 

7,287 

Finished goods

 

3,808 

 

 

3,530 

Inventory

$

15,348 

 

$

15,634 



Prepaid Expenses and Other Current Assets

As of March 31, 2017 and December 31, 2016, our prepaid expenses and other current assets consisted of the following components:







 

 

 

 

 



March 31,

 

December 31,

(in thousands)

2017

 

2016

Receivable from Existing Landlord

$

2,437 

 

$

5,000 

Rent deposits for O'Brien building

 

2,160 

 

 

2,160 

Prepaid expenses

 

1,323 

 

 

2,342 

Other current assets

 

581 

 

 

476 

Prepaid expenses and other current assets

$

6,501 

 

$

9,978 



In  January 2017, we entered into a Third Lease Amendment Agreement with the Existing Landlord that increased the amount of the payments receivable from the Existing Landlord by $65,000. In February 2017 and March 2017, we received payments of $1,045,000 and $1,583,000, respectively, from the Existing Landlord, resulting in a balance of $2,437,000 remaining in “Receivable from Existing Landlord” as of March 31, 2017. Refer to “Note 7. Commitments and Contingencies” for additional details relating to our lease agreements.



Other Long-term Assets

As of March 31, 2017 and December 31, 2016, our other long-term assets consisted of the following components:









 

 

 

 

 



March 31,

 

December 31,

(in thousands)

2017

 

2016

Rent deposits and tenant improvements for O'Brien building

$

 —

 

$

9,641 

Other

 

219 

 

 

172 

Other long-term assets

$

219 

 

$

9,813 



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In January 2017 we moved into the O’Brien building, and accordingly, the $9.6 million tenant improvements balance recorded in “Other Long-term Assets” at December 31, 2016 was transferred into leasehold improvements under “Property and Equipment” in the three-month period ended March 31, 2017.  



Property and Equipment, Net

As of March 31, 2017 and December 31, 2016, our property and equipment, net, consisted of the following components:







 

 

 

 

 



March 31,

 

December 31,

(in thousands)

2017

 

2016

Building

$

1,160 

 

$

1,160 

Laboratory equipment and machinery

 

24,614 

 

 

23,337 

Leasehold improvements

 

38,109 

 

 

8,138 

Computer equipment

 

8,338 

 

 

7,170 

Software

 

4,600 

 

 

5,189 

Furniture and fixtures

 

2,390 

 

 

823 

Construction in progress

 

1,378 

 

 

5,772 



 

80,589 

 

 

51,589 

Less: Accumulated depreciation

 

(38,140)

 

 

(37,029)

Property and equipment, net

$

42,449 

 

$

14,560 



By the end of the first quarter of 2017, improvements associated with our O’Brien premises were substantially completed. As a result, during the first quarter of 2017 we capitalized $28.9 million of tenant improvements. As the premises were completed in phases during the first quarter 2017, tenant improvements were placed into service in phases once construction was substantially complete and the related asset was ready for its intended use. Refer to “Note 7. Commitments and Contingencies” for additional details.



NOTE 6. NOTES PAYABLE

Facility Agreement

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 5.5 million shares of common stock immediately exercisable at an exercise price per share initially equal to $2.63 (the “Warrants”). During the year ended December 31, 2016, warrants to purchase 5.5 million shares of common stock were net exercised, resulting in the issuance of approximately 4.2 million shares. The cashless net exercises of the warrants did not result in any additional funds being collected by us. As of December 31, 2016, no warrants remained outstanding.

In addition, the Facility Agreement requires us 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.

The Facility Agreement has a maximum term of seven years from inception. Subsequent to the date of the Facility Agreement, at the election of the holders of Notes representing a majority of the aggregate principal amount of the outstanding Notes, the Notes holders may elect to receive 25% of the net proceeds from any financing that includes an equity component, including without limitation, the sale or issuance of our common stock, options, warrants or other securities convertible or exchangeable for shares of our common stock, as payment of the Notes. This right is subject to certain exceptions set forth in the Facility Agreement. The Notes holders have the option to require us to repay the Notes if we complete a Major Transaction (as defined in the Facility Agreement), including a change of control or a sale of all or substantially all of our assets. Additionally, the principal balance of the Facility Agreement may become immediately due and payable upon an Event of Default (as defined in the Facility Agreement), in which case the Notes holders would have the right to require us to repay 100% of the principal amount of the loan, plus any accrued and unpaid interest thereon. The Facility Agreement does not provide for a prepayment of the Notes at our option.

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Financing Derivative

A number of features embedded in the Notes to the Facility Agreement required accounting for as a derivative, including the indemnification of certain withholding taxes and the acceleration of debt upon (i) a qualified financing, (ii) an event of default, (iii) a Major Transaction, and (iv) 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 fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using a 10.6% and 13.5% weighted average market yield at December 31, 2016 and December 31, 2015, respectively. The estimated fair value of the Financing Derivative as of December 31, 2016 and December 31, 2015 was $0.4 million and $0.6 million, respectively.

Notes

We initially recorded the Notes and Warrants at $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 March 31, 2017 and December 31, 2016, debt discount of $4.0 million and $4.3 million, respectively, remained to be amortized through February 2020, the maturity of the Notes.

As of March 31, 2017, $3.1 million out of the total $20.5 million principal payment was reclassified from Notes payable, non-current to Notes payable, current,  as that portion of the principal becomes due in the first quarter of 2018. 



NOTE 7.  COMMITMENTS AND CONTINGENCIES

Leases

In December 2009, we entered into a lease agreement for a manufacturing and office facility in Menlo Park. For the facility to meet our needs and operating requirements, substantial tenant improvements, including improvements to the structural elements and principal operating systems of the facility, were necessary. The lessor provided a tenant improvement allowance of $1.8 million to apply towards the necessary improvements and we remained obligated for additional amounts over the afforded allowance. Due to our involvement in and the nature of the renovations made to the facility and our obligations to fund the costs of renovations exceeding the incentives afforded to us, we account for the facility as if we are the owner. Accordingly, we recorded $3.0 million of building and leasehold improvement assets, reflecting the $1.2 million fair value of the facility prior to commencing renovations and the $1.8 million of landlord incentives within property and equipment, net and a corresponding liability recorded to facility financing obligation.

As a result of the lease amendment agreement described below, future rent expense associated with our existing Menlo Park facility leases was reduced to zero. The remaining long-term facility financing obligations associated with these leases, presented as “Other liabilities, non-current” on the condensed consolidated balance sheets at March 31, 2017 and December 31, 2016, were both $1.7 million.

Lease Amendment Agreement

On July 23, 2015, we entered into a Lease Amendment Agreement (the “Lease Amendment Agreement”) with Peninsula Innovation Partners, LLC (the “Existing Landlord”), which amends the terms and conditions of certain of our existing Menlo Park facility real property leases. The Lease Amendment Agreement provides for, among other things, amendments of the term for certain of the leases with the Existing Landlord, the termination of all renewal, expansion and extension rights contained in any of the existing leases with the Existing Landlord (including our options to extend the terms for certain of the existing leases for two consecutive five-year periods), as well as rent abatement for a specified period of time. As consideration for our agreement to amend the existing leases pursuant to the Lease Amendment Agreement, and subject to the terms and conditions contained therein, we became eligible to receive up to four payments of $5.0 million each from the Existing Landlord over time (the “Landlord Payments”), and rent abatement for the remainder of the lease. In the event that we breach any of the leases and fail to cure such breach within the time permitted, the Existing Landlord would have no obligation to make the final $5.0 million payment. On September 1, 2015, the permit process related to an architectural approval and a change of use permit with respect to our new premises at 1305 O’Brien Drive (formerly 1315 O’Brien Drive), Menlo Park, California (the “O’Brien Premises”) was completed, which satisfied the contingencies under the Lease Amendment Agreement. As a result, we recorded $23.0 million in “Gain on lease amendments” in the consolidated statements of operations and comprehensive loss for the three-month period ended September 30, 2015, reflecting that our rent payments were reduced to zero for the remaining term of our existing Menlo Park facility real property leases, and the aggregate of $20.0 million in Landlord Payments became receivable and any associated financing obligation was revalued. Of the $20.0 million remaining Landlord Payments, the first $5.0 million Landlord Payment was received in September 2015, the second $5.0 million Landlord Payment was received in February 2016 and the third $5.0 million Landlord Payment was received in August 2016.

14

 


 

In June 2016, we entered into a Second Lease Amendment Agreement with the Existing Landlord that modified the payment schedule for the final $5.0 million. At December 31, 2016, the final $5.0 million landlord payment was recorded in “Prepaid Expenses and Other Current Assets” in the condensed consolidated balance sheets.

In January 2017, we entered into a Third Lease Amendment Agreement with the Existing Landlord that increased the amount of the final $5.0 million landlord payment by $65,000. In February 2017 and March 2017, we received payments of $1,045,000 and $1,583,000, respectively, resulting in a remaining balance of $2,437,000 in “Prepaid Expenses and Other Current Assets” in the condensed consolidated balance sheets at March 31, 2017.

O’Brien Lease Agreement

On July 22, 2015, we entered into a new lease agreement (the “O’Brien Lease”) with respect to the O’Brien Premises. The term of the O’Brien Lease is one hundred thirty-two (132) months, commencing on the date that is the later of April 15, 2016 or the date on which the O’Brien Premises landlord has substantially completed certain shell improvements and tenant improvements. In December 2016, we entered into an amendment to the O’Brien Lease which defined the commencement date of the lease to be October 25, 2016, notwithstanding that such substantial completion did not occur until the first quarter of 2017. Base monthly rent will be abated for the first six (6) months of the lease term and thereafter will be $540,000 per month during the first year of the lease term, with specified annual increases thereafter until reaching $711,000 per month during the last twelve (12) months of the lease term. We were required to pay $2.2 million in prepaid rent which will be applied to the monthly rent installments due for the first to fourth months after the rent abatement period; and, as such, $2.2 million was recorded in “Prepaid expense and other current assets” in the condensed consolidated balance sheet as of both Mach 31, 2017 and December 31, 2016. We were required to establish a deposit of $4.5 million in the form of a letter of credit in October 2015; and, as such, $4.5 million was recorded in “Long-term restricted cash” in the condensed consolidated balance sheet as of both Mach 31, 2017 and December 31, 2016.

The landlord was obligated to construct certain warm shell improvements at the landlord’s cost and expense and provide us with a tenant improvement allowance in the amount of $12.6 million. Construction was completed in phases and we began moving into the O’Brien Premises during January 2017. By the end of the first quarter of 2017, improvements associated with the entire O’Brien Premises were substantially completed. As a result, during the first quarter of 2017 we capitalized $28.9 million of tenant improvements, of which $12.6 million was paid by the landlord as a tenant improvement allowance. As the $12.6 million tenant improvement allowance is accounted for as a lease incentive, $12.6 million was recorded to “Deferred rent, non-current”, which will be amortized over the lease term of approximately 11 years. In addition, as the premises were completed in phases during the first quarter 2017, tenant improvements were placed into service in phases once construction was substantially complete and the related asset was ready for its intended use.

As of March 31, 2017, the future annual minimum lease payments for the O’Brien lease were as follows:





 

 



Amount

Years ending December 31,

(in thousands)

remaining of 2017

$

4,251 

2018

 

6,822 

2019

 

6,930 

2020

 

7,056 

2021

 

7,272 

Thereafter

 

46,710 

Total minimum lease payments

$

79,041 



Rent expense was $1.6 million and $53,000 for the three-month periods ended March 31, 2017 and 2016, respectively.



Legal

On November 2, 2016, we filed a complaint against Oxford Nanopore Technologies Ltd., Oxford Nanopore Technologies, Inc. (“ONT Inc.”) and Metrichor, Ltd. (“Metrichor” and, together with ONT Inc., “ONT”) with the U.S. International Trade Commission (“USITC”) for patent infringement.  On December 5, 2016, the USITC provided notice that an investigation had been instituted based on the complaint.  We are seeking exclusionary relief with respect to several ONT products, including ONT’s MinION and PromethION devices. The complaint is based on our U.S. Patent No. 9,404,146, entitled “Compositions and methods for nucleic acid sequencing” which covers novel methods for sequencing single nucleic acid molecules using linked double-stranded nucleic acid templates, providing improved sequencing accuracy.  On March 1, 2017, we filed an amended complaint to add a second patent in the same patent family, U.S. Patent No. 9,542,527, which was granted on January 10, 2017, to the investigation.  We are seeking, among other things, an exclusion order permanently barring entry of infringing ONT products into the United States, and a cease and desist order preventing ONT from advertising and selling infringing products in the United States.

15

 


 

On February 2, 2017, we filed a claim in the High Court of England and Wales against Oxford Nanopore Technologies Ltd. (“ONT Ltd.”) and Metrichor for infringement of Patent EP(UK) 3 025 542, which is in the same patent family as the patents asserted in the USITC action referred to above.  We are seeking remedies including injunctive relief, damages, and costs.

On March 15, 2017, we filed a complaint in the U.S. District Court for the District of Delaware against ONT Inc. for patent infringement. The complaint is based on our U.S. Patent No. 9,546,400, entitled “Nanopore sequencing using n-mers” which covers novel methods for nanopore sequencing of nucleic acid molecules using the signals from multiple monomeric units. This patent was granted on January 17, 2017. We are seeking remedies including injunctive relieve, damages and costs.

On April 21, 2017, ONT Ltd. and Harvard University filed a claim against us in the High Court of England and Wales for infringement of Patent EP(UK) 1 192 453, a patent owned by Harvard University and entitled “Molecular and atomic scale evaluation of biopolymers,” and for which ONT Ltd. alleges it holds an exclusive license.  ONT Ltd. and Harvard University are seeking remedies including injunctive relief, damages, and costs. On April 25, 2017, ONT Ltd. announced that it also had filed a claim against us in the District Court of Mannheim, Germany, for infringement of the same patent.

Litigation is inherently unpredictable, and it is too early in the proceedings to predict the outcome of these lawsuits or any impact they may have on us. As such, the estimated financial effect associated with these complaints cannot be made as of this 10-Q filing time.

From time to time, we may also be involved in a variety of other claims, lawsuits, investigations and proceedings relating to securities laws, product liability, patent infringement, contract disputes, employment and other matters that arise in the normal course of our business. In addition, third parties may, from time to time, assert claims against us in the form of letters and other communications. We record a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We currently do not believe that the ultimate outcome of any of the matters described above is probable or reasonably estimable, or that these matters will have a material adverse effect on our business; however, the results of litigation and claims are inherently unpredictable. Regardless of the outcome, litigation can have an adverse impact on us because of litigation and settlement costs, diversion of management resources and other factors.



NOTE 8. STOCKHOLDERS’ EQUITY

Equity Offering

During the three-month period ended March 31, 2016, we issued 3.1 million shares of our common stock at an average price of $8.80 per share through our “at-the-market” offering, resulting in net proceeds of $26.5 million.

During the three-month period ended March 31, 2017 we did not issue any shares pursuant to our “at-the-market” offering program; however, in February 2017, we filed an additional prospectus supplement pursuant to which we may offer and sell, from time to time, additional shares of our common stock having an aggregate offering price of up to $60.0 million. 

We pay a commission equal to 3% of the gross proceeds from the sale of shares of our common stock under the sales agreement. We are not obligated to sell shares of our common stock under the sales agreement.

Subject to certain exceptions set forth in our existing Facility Agreement, holders of our Notes may elect to receive 25% of the net proceeds from financing activities that include an equity component as prepayment of the Notes to be applied first, to accrued and unpaid interest and second, to principal. However, in April 2017 holders representing a majority of the aggregate principal amount of the outstanding Notes waived such right in connection with the issuance and sale of shares of common stock under our current “at-the-market” offering.

Warrants

In connection with the execution of the Facility Agreement, we issued immediately exercisable warrants to purchase 5.5 million shares of common stock at an exercise price per share initially equal to $2.63, all of which were outstanding at December 31, 2015. The number of shares of common stock into which the warrants are exercisable and the exercise price will be adjusted to reflect any stock splits, payment of stock dividends, recapitalizations, reclassifications or other similar adjustments in the number of outstanding shares of common stock. The exercise price may also be adjusted to reflect certain dividends or other distributions, including distributions of stock or other securities, property or options by way of a dividend, spin off, reclassification, corporate rearrangement or similar transaction.  

During the three-month periods ended March 31, 2016, warrants to purchase 3,818,000 shares of common stock were net exercised, resulting in the issuance of approximately 3.0 million shares with all warrants being fully net exercised by December 31, 2016. As of March 31, 2017, no warrants remained outstanding.

Equity Plans

As of March 31, 2017, we had three active equity compensation plans: the 2010 Equity Incentive Plan, the 2010 Outside

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Director Equity Incentive Plan, and the 2010 Employee Stock Purchase Plan (“ESPP”).

The following table summarizes stock option activity for all our stock option plans for the three-month period ended March 31, 2017 (in thousands, except per share amounts):





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

 

Stock Options Outstanding



 

 

 

 

 

 

 

Weighted



Shares available

 

Number

 

 

 

 

average



for grant

 

of shares

 

Exercise price

 

exercise price

Balances, December 31, 2016

6,835 

 

22,501 

 

$

 1.1616.00 

 

$

6.30 

Additional shares reserved 

4,634 

 

 

 

 

 

 

 

 

Options granted

(4,708)

 

4,708 

 

 

4.785.27 

 

 

5.26 

Options exercised

—  

 

(114)

 

 

1.164.55

 

 

2.70 

Options canceled

439 

 

(439)

 

 

1.1611.64 

 

 

7.34 

Balances, March 31, 2017

7,200 

 

26,656 

 

$

 1.1616.00 

 

$

6.11 



Shares issued under our ESPP totaled 750,005 and 668,566 shares during the three-month periods ended March 31, 2017 and 2016, respectively. As of March 31, 2017,  1,841,595 shares of our common stock remain available for issuance under our ESPP.

Stock-Based Compensation

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





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



Three-Month Periods Ended March 31,

 

 

 



2017

 

2016

 

 

 

 

 

Cost of revenue

$

523 

 

$

499 

 

 

 

 

 

 

 

Research and development

 

2,030 

 

 

1,910 

 

 

 

 

 

 

 

Sales, general and administrative

 

2,431 

 

 

2,172 

 

 

 

 

 

 

 

Total stock-based compensation expense

$

4,984 

 

$

4,581 

 

 

 

 

 

 

 



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:





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



Three-Month Periods Ended March 31,

 

 

 

 

Stock Option

2017

 

2016

 

 

 

 

 

 

Expected term in years

6.1

 

6.1

 

 

 

 

 

 

Expected volatility

70%

 

70%

 

 

 

 

 

 

Risk-free interest rate

2.1%

 

1.5%

 

 

 

 

 

 

Dividend yield

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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





 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



Three-Month Periods Ended March 31,

 

 

 

ESPP

2017

 

2016

 

 

 

 

 

Expected term in years

0.5-2.0

 

0.5-2.0

 

 

 

 

 

Expected volatility

70%

 

70%

 

 

 

 

 

Risk-free interest rate

0.8%-1.3%

 

0.5%-0.9%

 

 

 

 

 

Dividend yield

 

 

 

 

 

 









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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 Quarterly Report on Form 10-Q and those in our Annual Report on Form 10-K for the year ended December 31, 2016. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to our products, plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties, including statements regarding our expected financial results in future periods. The words “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “projects,” “seeks,” “should,” “target,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. You should read the “Risk Factors” section of this Quarterly Report on Form 10-Q for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. We do not assume any obligation to update any forward-looking statements.

Overview

We design, develop and manufacture sequencing systems to help scientists resolve genetically complex problems. Based on our novel Single Molecule, Real-Time (SMRT®) sequencing technology, our products enable: de novo genome assembly to finish genomes in order to more fully identify, annotate and decipher genomic structures; full-length transcript analysis to improve annotations in reference genomes, characterize alternatively spliced isoforms in important gene families, and find novel genes; targeted sequencing to more comprehensively characterize genetic variations; and real-time kinetic information for epigenome characterization. Our technology provides high accuracy, ultra-long reads, uniform coverage, and is the only DNA sequencing technology that provides the ability to simultaneously detect epigenetic changes.  PacBio® sequencing systems, including consumables and software, provide a simple, fast, end-to-end workflow for SMRT sequencing.

In September 2015, we announced that we had launched a new nucleic acid sequencing platform, the PacBio Sequel™ System, which provides higher throughput, more scalability, a reduced footprint and lower sequencing project costs compared to the PacBio® RS II System, while maintaining the existing benefits of our SMRT Sequencing Technology. As a result, our first quarter product and service revenue grew by over 60% in 2017 compared to 2016, and we now have an installed base of over 300 PacBio systems. However, due to current uncertainty regarding United States government funding, our sales to customers who rely on such funding have been and may continue to be negatively impacted.

Basis of Presentation

Revenue