Pacific Biosciences of California, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. The company develops and manufactures DNA sequencing systems based on its SMRT technology. Its Sequel platform, launched in 2015, is intended to offer higher throughput and lower project costs than the RS II system. Financial amounts below are in U.S. dollars; millions are rounded.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $20.7m | $24.9m | $39.9m | $42.6m |
| Product revenue | $13.6m | $8.8m | $26.0m | $20.1m |
| Service and other revenue | $3.6m | $2.5m | $6.7m | $5.3m |
| Contractual revenue | $3.6m | $13.6m | $7.2m | $17.2m |
| Gross profit / margin | $10.6m / 51.3% | $14.5m / 58.2% | $20.1m / 50.5% | $20.4m / 48.0% |
| Operating loss | $(18.1)m | $(11.4)m | $(36.6)m | $(30.7)m |
| Net loss | $(18.5)m | $(11.9)m | $(37.9)m | $(32.1)m |
| Basic and diluted loss per share | $(0.21) | $(0.16) | $(0.44) | $(0.43) |
Q2 product revenue included $8.6m from Sequel and RS II instruments and $5.0m from consumables. Management attributed instrument and consumables growth to new installations and a larger installed base. Q2 total revenue fell 17% year over year, principally because the prior-year quarter included a $10m Roche development milestone. All Roche development milestones had been achieved by the end of 2015; the remaining contractual revenue primarily reflects amortization of the upfront payment.
Reported Q2 gross margin was lower than the prior-year quarter largely because the 2015 comparison included the $10m milestone at 100% margin. Management said gross profit and margin increased compared with the prior-year quarter after excluding that milestone, citing a shift toward higher-margin Sequel instruments. Six-month gross margin improved from 48.0% to 50.5%.
Operating expenses rose 11% in both the quarter and first half. Six-month R&D increased 15% to $33.9m and SG&A increased 6% to $22.9m. Higher compensation, headcount, stock-based compensation and Sequel development contributed to the increases. Six-month stock-based compensation was $9.6m, versus $6.6m in 2015.
Cash, liquidity and debt
- At June 30, cash and cash equivalents were $24.8m and investments were $77.7m, totaling $102.5m; $4.5m of restricted cash was held separately. Cash and investments were $82.3m at December 31, 2015.
- Current assets were $138.1m and current liabilities were $33.8m. The company reported total liabilities of $53.3m and stockholders’ equity of $108.1m.
- For the six months, operating activities used $39.2m of cash, compared with $31.4m used in 2015. Investing activities used $32.4m, while financing activities provided $62.7m. Cash and cash equivalents decreased $8.9m to $24.8m.
- Operating cash use reflected the net loss, a $7.2m reduction in deferred contractual revenue, and increases in receivables ($5.2m) and inventory ($4.5m), partly offset by noncash stock compensation and depreciation.
- Notes payable had a $15.5m carrying value at June 30. The notes bear 8.75% simple interest, are secured by substantially all company property, and include a $2.0m minimum quarter-end cash covenant. Their original aggregate principal was $20.5m; the filing reports estimated fair value of $19.3m. The notes mature in February 2020.
The company raised $58.2m net through its at-the-market equity offering during the first half by issuing 6.5m shares; no shares remained available under that offering at June 30. 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.
Outlook, commentary and material risks
- Management expected product revenue to increase during the remainder of 2016. It also expected full-year R&D and SG&A expenses to exceed 2015 levels; quarterly amounts could vary.
- The company was transitioning manufacturing and operations to a new Menlo Park facility. The new lease was expected to commence in Q3 2016, with a 132-month term. Management estimated approximately $80m in rent and $24m in operating expenses over the lease term, in addition to potentially substantial improvement and relocation costs. Future landlord payments of $10m were expected to partly offset expenditures.
- Key risks include Sequel adoption and performance, manufacturing scale-up and SMRT Cell supply, product reliability, competition, uncertain customer purchasing cycles, continued operating losses and cash burn, and potential need for additional financing and dilution. The company emphasized that Sequel deliveries were still limited and the transfer of SMRT Cell production to a high-volume manufacturer could involve delays or quality issues.
- Roche-related revenue is lower following completion of all development milestones. The filing cautions that Roche could become a significant customer if it commercializes products under the agreement, creating customer concentration and quarterly revenue variability.
- The Deerfield debt agreement includes restrictions and potential acceleration upon specified events; holders may elect to receive 25% of net proceeds from certain equity-linked financings as partial debt repayment. The company reported no off-balance-sheet arrangements. It said ordinary-course legal matters were not expected to have a material adverse effect, while noting litigation outcomes are inherently uncertain.
Most important facts for investors to verify
- Whether Sequel installations, consumables demand and product revenue meet management’s stated expectations, and whether manufacturing yields and quality improve.
- Cash burn and working-capital trends, including receivables and inventory growth, against the company’s estimate that current liquid resources cover at least 12 months.
- The effect of completed Roche milestones on reported revenue and the potential for future Roche customer concentration.
- Costs, timing and operational risks associated with the new facility and manufacturing transition, including the expected landlord payments.
- Potential dilution or financing constraints following the completed ATM capacity, along with the secured debt’s covenants, interest expense and acceleration provisions.