Pacific Biosciences of California, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 26, 2019. The filing also reports unaudited fourth-quarter results. Pacific Biosciences develops and sells SMRT genetic sequencing systems, consumables and related services.
Business context and reporting period
The company’s principal commercial platform was the Sequel System. Its Sequel II System and SMRT Cell 8M were in early access beginning January 2019. Management said five early-access sites had installed and operated systems and expected commercial shipments in early Q2 2019.
On November 1, 2018, the company agreed to be acquired by Illumina for $8.00 per share in cash. Stockholders approved the merger in January 2019, but FTC review and other regulatory conditions remained outstanding as of the filing.
Financial results and liquidity
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Total revenue | $78.6 million | $93.5 million |
| Product revenue | $66.4 million | $80.0 million |
| Service and other revenue | $12.3 million | $13.4 million |
| Gross profit / margin | $25.1 million / 31.9% | $34.7 million / 37.1% |
| Operating expenses | $126.1 million | $124.4 million |
| Operating loss | $(101.0) million | $(89.8) million |
| Net loss | $(102.6) million | $(92.2) million |
| Basic and diluted loss per share | $(0.76) | $(0.87) |
| Cash, cash equivalents and investments at year-end | $102.4 million | $62.9 million |
| Working capital at year-end | $104.8 million | $73.0 million |
FY 2018 cash used in operating activities was $66.4 million; investing activities used $38.4 million, including net investment purchases; financing activities provided $107.2 million, principally from $97.5 million net proceeds from two equity offerings. The company had $18.8 million in cash and cash equivalents, $83.5 million in investments, and $4.5 million in restricted cash at year-end.
Debt principal outstanding was $16.0 million, bearing 8.75% interest and due in February 2020; its balance-sheet carrying value was $14.7 million. The debt is secured by substantially all company property and includes financial and operating covenants. Contractual debt payments, including interest, totaled $17.9 million. Operating lease commitments were $68.0 million, and other purchase commitments were approximately $13.1 million.
Fourth-quarter 2018 revenue was $19.5 million, gross profit $5.7 million, operating expenses $36.4 million and net loss $30.8 million, or $0.21 per share.
Material changes versus comparable periods
- Revenue fell 16% year over year. Product revenue declined 17%, primarily because customers postponed instrument purchases ahead of the Sequel II and SMRT Cell 8M launches; lower RS II consumables also more than offset growth in Sequel consumables.
- Gross margin fell to 31.9% from 37.1%. Management cited lower product revenue, a $3.1 million inventory reserve for older consumables amid product transitions, and higher period costs from lower production volume. Improved Sequel reliability reduced service costs.
- Operating loss widened by $11.2 million. SG&A increased 7%, including $4.7 million of additional merger-related legal and professional fees; R&D declined 4%.
- One distributor, Gene Company Limited, accounted for 26% of FY 2018 revenue, down from 31% in 2017. Revenue outside the United States was $44.7 million, or 57% of total revenue.
- Equity offerings raised approximately $97.5 million net and increased shares outstanding. The company reported 150.2 million shares outstanding at year-end.
Outlook, risks and unusual items
- Management expected Sequel II and SMRT Cell 8M commercial shipments in early Q2 2019 and expected R&D expense to remain flat in 2019. SG&A was expected to fluctuate with merger-related costs. These are forward-looking expectations, not guaranteed outcomes.
- Management believed existing cash, cash equivalents and investments would fund projected operating requirements for at least 12 months from the filing date, but stated that additional capital might be needed. The company continued to expect substantial losses and negative operating cash flow.
- The proposed Illumina transaction was expected to close in mid-2019, subject to regulatory clearance. The FTC’s second request extended review; closing, timing and approval conditions were not assured. A $43 million termination fee could apply in specified circumstances if the merger agreement ended.
- Customer concentration, purchase delays, product adoption and manufacturing quality or capacity, single-source suppliers, competition and pricing pressure, and access to financing are material business risks. The company also faces ongoing ONT patent litigation; management said the ultimate financial effect could not be estimated. The Federal Circuit affirmed an adverse USITC claim construction in February 2019, while U.S. district-court patent matters remained pending.
- Merger-related stock-plan changes resulted in approximately $2.5 million of accelerated ESPP expense in Q4 2018. The company also recorded $3.1 million of inventory reserves for older consumables. Five merger-related shareholder lawsuits were dismissed after supplemental disclosures and an agreement to pay $300,000 in plaintiffs’ attorneys’ fees.
- The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective as of year-end.
Important facts for investors to verify
- Whether the Illumina merger received all required regulatory approvals, closed, or was delayed or terminated, and whether any termination fee or conditions applied.
- Sequel II launch timing, early customer performance, production yields and quality, and conversion of the $4.6 million instrument backlog into revenue.
- Revenue trends and purchasing dependence on Gene Company Limited, including the distributor’s share of revenue and receivables.
- Cash burn, financing needs, debt covenant compliance and the February 2020 debt repayment obligation.
- Subsequent gross margin, inventory reserve levels, product-transition effects and progress in reducing manufacturing and service costs.
- Developments in ONT litigation and patent challenges, including any resulting costs, injunctions, settlements or changes to intellectual property rights.