Pacific Biosciences of California, Inc. — Q3 2016 Form 10-Q
Business context and reporting period. The company designs and manufactures DNA sequencing systems based on its Single Molecule, Real-Time (SMRT) technology. This unaudited quarterly report covers the three and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. The Sequel platform is replacing the RS II as the expected system for nearly all new installations.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $25.1 million | $13.9 million | $65.0 million | $56.5 million |
| Gross profit | $12.6 million | $6.6 million | $32.8 million | $27.0 million |
| Gross margin | 50.3% | 47.1% | 50.4% | 47.8% |
| Operating income (loss) | $(16.7) million | $2.6 million | $(53.4) million | $(28.1) million |
| Net income (loss) | $(17.5) million | $1.8 million | $(55.3) million | $(30.3) million |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $(55.0) million | $(47.2) million |
- Revenue mix: Q3 product revenue was $18.1 million, service and other revenue $3.5 million, and contractual revenue $3.6 million. Nine-month amounts were $44.0 million, $10.2 million, and $10.8 million, respectively.
- Costs and expenses: Nine-month R&D expense was $51.4 million and SG&A was $34.8 million. Stock-based compensation totaled $14.7 million for the nine-month period, versus $9.8 million a year earlier.
- Cash and liquidity: At September 30, cash and cash equivalents were $22.8 million and investments were $64.5 million, totaling $87.3 million; an additional $4.5 million was restricted long-term cash. Current assets were $122.5 million and current liabilities $32.1 million. Management stated existing cash, cash equivalents and investments were expected to fund projected operating requirements for at least 12 months, while noting additional capital may be needed.
- Debt: Notes payable had a carrying value of $15.8 million, compared with $14.9 million at year-end 2015; disclosed fair value was $19.4 million. The notes bear 8.75% annual interest, mature by February 2020, are secured by substantially all company property, and include a $2.0 million minimum quarter-end cash covenant.
- Balance sheet: Total assets were $150.6 million, total liabilities $52.0 million, and stockholders’ equity $98.7 million. Inventory increased to $16.5 million from $11.0 million at December 31, 2015.
Material changes versus prior comparable periods
- Q3 revenue rose 80%, driven mainly by instrument sales: product revenue increased 138% to $18.1 million. Management attributed higher consumables and service revenue to a larger installed base.
- Nine-month revenue increased 15%, even though contractual revenue fell by $10.0 million because the comparable 2015 period included a Roche development milestone. Product revenue rose 59% and service revenue rose 27%.
- Gross margin improved in both comparisons. Management attributed the improvement primarily to a shift from RS II to higher-margin Sequel instruments.
- Operating and net results worsened against Q3 2015, which included a $23.0 million gain on lease amendments. The prior-year quarter’s reported profit was largely attributable to this one-time item; Q3 2016 had no such gain.
- Nine-month net loss widened by $25.1 million. Operating expenses increased, including R&D up 12% and SG&A up 7%; the comparison also reflects the absence of the prior-year $23.0 million lease gain.
- Cash used in operations increased to $55.0 million from $47.2 million. In 2016, working-capital outflows included higher receivables and inventory and a $10.8 million reduction in deferred contractual revenue.
- The company raised $58.2 million net through its at-the-market offering during the first half of 2016, issuing 6.5 million shares; no offering shares remained available at September 30. Common shares outstanding were 92.6 million, versus 80.0 million at December 31, 2015.
Outlook, commentary, risks and unusual items
- Management expected 2016 product revenue to exceed 2015 product revenue and anticipated nearly all new system installations would be Sequel. It also expected full-year 2016 R&D and SG&A expenses to exceed 2015 levels. The filing gives no specific numeric revenue or earnings forecast.
- Management expected less than $0.1 million of contractual revenue in Q4 2016; approximately $1.3 million remained deferred for amortization through 2026. All Roche development milestones had been achieved, so the prior milestone revenue is not recurring.
- The company reported continuing losses and expected substantial losses and negative operating cash flow for the foreseeable future. It warned that slower product adoption, R&D needs, facility-transition costs and other factors could increase capital needs; further equity financing could dilute shareholders.
- Key operating risks include adoption and performance of the recently launched Sequel system; production quality, yield and scale-up of Sequel SMRT Cells and consumables; reliance on limited or single-source suppliers; customer budget and sales-cycle uncertainty; competition; and execution of the headquarters and manufacturing transition.
- The new O’Brien lease was expected to commence in Q4 2016. The company estimated approximately $80 million in rent and $24 million in operating expenses over the lease term, with potentially substantial additional improvement and moving costs. The $4.5 million letter-of-credit deposit was recorded as restricted cash.
- On November 2, 2016, after quarter-end, the company filed a patent-infringement complaint against Oxford Nanopore entities with the U.S. International Trade Commission, seeking exclusion and cease-and-desist orders. The financial effect could not be estimated; the company said litigation outcomes are unpredictable and may consume resources.
- Management said disclosure controls were effective at a reasonable-assurance level and reported no material changes in internal control over financial reporting during the quarter. The filing reported no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether Sequel installations, consumables demand and gross-margin improvement continued after Q3, and whether instrument and consumable manufacturing met quality and volume requirements.
- Whether liquidity and the stated 12-month funding outlook remain adequate given cash burn, capital spending, lease-transition costs and potential financing needs.
- The precise debt principal outstanding and applicable repayment or financing-trigger provisions; the filing reports carrying value but does not clearly state quarter-end principal outstanding.
- Whether remaining landlord payments are collected as scheduled and the timing and final cost of the new facility transition.
- Any developments in the Roche relationship, the Oxford Nanopore proceeding, and other intellectual-property or commercial contingencies.
- The effects of share issuance, equity compensation and any future financing on dilution and per-share results.