Pacific Biosciences of California, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The company designs and sells DNA sequencing systems based on its Single Molecule, Real-Time (SMRT) technology, including the Sequel platform, instruments, consumables and services. Financial statements received an unqualified audit opinion; management and the auditor reported effective internal control over financial reporting.
Financial performance and position
| Metric | FY2016 | FY2015 |
|---|---|---|
| Total revenue | $90.7 million | $92.8 million |
| Product revenue | $64.6 million | $37.5 million |
| Service and other revenue | $14.0 million | $10.9 million |
| Contractual revenue | $12.1 million | $44.4 million |
| Gross profit / reported gross margin | $44.2 million / 48.7% | $53.5 million / 57.6% |
| Operating loss | $71.2 million | $29.1 million |
| Net loss | $74.4 million | $31.7 million |
| Net loss per share | $0.83 | $0.42 |
| Cash used in operating activities | $67.9 million | $47.9 million |
- Product revenue rose 72%, including instrument revenue growth of 119% to $41.0 million and consumables growth of 26% to $23.7 million. Management attributed consumable growth partly to a larger installed base.
- Reported gross margin declined, but FY2015 included $30.0 million of Roche milestone revenue at a 100% margin. Excluding that milestone, management said FY2016 gross profit and margin increased significantly, primarily due to higher-margin Sequel sales; no adjusted margin figure is provided.
- Research and development expense was $67.6 million, up 12%; sales, general and administrative expense was $47.8 million, up 6%. The company reported $19.6 million of stock-based compensation.
- Year-end cash, cash equivalents and investments totaled $72.0 million, down from $82.3 million; this excludes $4.5 million of restricted cash. Working capital was $75.2 million. Total assets were $137.9 million and total liabilities were $53.2 million.
- Notes payable had a $16.1 million carrying value. The notes bear 8.75% interest, are secured by substantially all company property, and require at least $2.0 million of cash and cash equivalents at each quarter-end. Contractual debt payments, including interest, totaled $25.8 million.
- Investing activities used $14.9 million; financing activities provided $65.9 million, including $58.2 million net proceeds from at-the-market (ATM) stock sales. Outstanding common shares at year-end were 92.7 million.
Material changes and unusual items
- Total revenue fell 2% year over year despite strong product growth, principally because Roche contractual revenue fell by $32.3 million. FY2015 included $30.0 million of Roche milestone payments; all milestones had been received by the end of 2015.
- Roche gave notice in December 2016 to terminate its collaboration agreement; termination became effective February 10, 2017. The company recognized the remaining $1.3 million of deferred Roche revenue in FY2016 and expects no contractual revenue in 2017. Management warned that the loss may make commercialization in Roche-targeted markets more difficult.
- FY2015 operating results included a one-time $23.0 million gain on lease amendments. The gain, alongside Roche milestone revenue, makes reported year-over-year losses and margins less comparable.
- Operating cash use increased by $20.0 million. Factors included the net loss, reduced deferred contractual revenue, and increases in inventory and accounts receivable.
- The company issued approximately 6.5 million shares through its ATM program in 2016, raising $58.2 million net. In February 2017, it registered an additional ATM offering of up to $60.0 million.
Outlook, risks and contingencies
- Management expected 2017 product revenue to increase, based on anticipated system shipments and Sequel utilization. It expected 2017 gross margin to be lower than FY2016 because there was no scheduled contractual revenue to amortize, and expected R&D and SG&A expenses to increase.
- Management believed existing cash, cash equivalents and investments would fund projected operating requirements for at least 12 months, while also stating that it planned to raise additional capital. This outlook depends on operating and financing assumptions and could change.
- Instrument backlog was approximately $11.0 million at year-end, down from $16.7 million. Management expected conversion to revenue during 2017, but customers may delay or cancel orders.
- Key operating risks include scaling Sequel and SMRT Cell manufacturing, product reliability and quality, supplier concentration, the headquarters and manufacturing transition, and competition from better-resourced sequencing companies. Manufacturing disruptions or defects could delay deliveries and pressure revenue and margins.
- The company is pursuing patent-infringement actions against Oxford Nanopore Technologies in the U.S. and U.K. It stated that the outcomes and financial effects were not reasonably estimable; litigation outcomes are unpredictable and may consume resources.
- The new O’Brien lease entails approximately $79.5 million of minimum operating lease payments in the contractual-obligations schedule, plus operating expenses and potential improvement and relocation costs. The company disclosed total contractual obligations of $123.4 million, including $18.0 million of purchase commitments.
- The company has substantial accumulated losses, expects continued losses and negative operating cash flow, and may need further financing. Additional equity funding could dilute shareholders; debt covenants and collateral may constrain financing flexibility.
Investor verification priorities
- Track Sequel shipments, customer utilization, consumables revenue and the conversion of the $11.0 million backlog into recognized revenue.
- Compare actual 2017 product growth and margins with management’s outlook, separating recurring product economics from Roche-related revenue and other unusual items.
- Monitor cash burn, available liquidity, financing activity and dilution, including the potential use of the $60.0 million ATM program and debt-related proceeds provisions.
- Verify manufacturing yields, SMRT Cell quality, supplier continuity and the costs and timing of the facility transition.
- Follow the effect of Roche’s termination on commercialization plans and any replacement partnerships, and assess developments and costs in the patent litigation.