# PACIFIC BIOSCIENCES OF CALIFORNIA, INC. (PACB) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from PACIFIC BIOSCIENCES OF CALIFORNIA, INC.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1299130/000129913022000030/pacb-20211231x10k.htm
Accession: 0001299130-22-000030
Filing date: 2022-02-28
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/PACB/
All MD&A years: /company/PACB/mda/
Next year: /company/PACB/mda/fy2022/ (FY 2022)

ITEM 7. 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 consolidated financial statements and the related notes included in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should read the “Risk Factors” section of this Annual Report on Form 10-K 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.

Our Management’s Discussion and Analysis (MD&A) is organized in the following sections:

Overview and Outlook

Results of Operations

Liquidity and Capital Resources

Critical Accounting Policies and Estimates

Quantitative and Qualitative Disclosure of Market Risk

Recent Accounting Pronouncements

Contractual Obligations

Off Balance Sheet Arrangements

Overview and Outlook

About PacBio

We are a premier life science technology company that is designing, developing and manufacturing advanced sequencing solutions to help scientists and clinical researchers resolve genetically complex problems. 

Our products and technology under development stem from two highly differentiated core technologies focused on accuracy, quality and completeness which include our existing HiFi long read sequencing and our emerging SBB short read sequencing technologies. Our products address solutions across a broad set of research applications including human germline sequencing, plant and animal sciences, infectious disease and microbiology, oncology, and other emerging applications. 

Our focus is on providing our customers with advanced sequencing technologies with higher throughput and improved workflows that we believe will enable dramatic advancements in routine healthcare.

Our customers include academic and governmental research institutions, commercial testing and service laboratories, genome centers, public health labs, hospitals and clinical research institutes, contract research organizations (CROs), pharmaceutical companies and agricultural companies.

As of December 31, 2021, our commercial team is comprised of over 178 employees, including 48 commissionable employees, many with advanced degrees in biology and significant experience in the genomics industry.

In 2021, we grew revenues by 65% as compared to December 31, 2020, driven by increased sales of our sequencing platforms and newly developed products as well as through strategic business acquisitions. We have added to our leadership team, expanded our critical commercial and research and development capabilities, and achieved development milestones toward commercialization of new and enhanced technologies. These achievements in 2021 focused on building a foundation for growth, that we will leverage to continue to focus on strategic, future-oriented execution as an organization, with our products and for our customers.

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2022 Strategic Objectives

2021 was a productive year for us as we set out to transform the company, scale the business and drive adoption for our advanced sequencing technologies.

Our 2022 strategic objectives include:  

Execution – leveraging commercial investment to drive continued HiFi and Sequel II/IIe adoption; 

Progress our product pipeline – continue developing our future higher throughput HiFi sequencing platform and differentiated short-read technology; and 

Delight our customers – deepening our customer relationships and expanding customer collaborations across existing and rapidly expanding new applications for our technology. 

We will continue to leverage our commercial organization and make significant improvements in efficiency and usability of our Sequel II/IIe to seek to reach a broader customer base. We believe the commercial investments we have made in 2021 and will continue to make in 2022 will further help drive growth in our business.  We employed 48 quota-carrying field sales personnel as of December 31, 2021, and we expect to continue to grow the number of quota-carrying field sales personnel throughout 2022.  In 2021, we sought to increase the awareness of our products and the number of potential customers. In 2022, we expect to continue to expand our sales, general and administrative departments to invest in our growth.    

To increase the adoption of HiFi sequencing, we have various development programs in progress to expand our product portfolio as well as increase the throughput and improve the usability of our existing sequencing technologies. Our focus for 2022 will be to progress these programs to accelerate new platform launches in the near to mid-term as well as increase application for our technologies. In an effort to address the oncology markets with a highly differentiated alternative, we are also progressing our short read platform development with a goal of launching our SBB short read sequencing platform in the first half of 2023.  As a result, we expect our research and development expense to increase significantly in 2022 as compared to 2021. 

We continue to believe that with the capabilities of our HiFi chemistry and SMRT technology, we can be a market leader in whole-genome clinical sequencing. Leading institutions have adopted our products to study rare and inherited disease. We believe the market opportunity for clinical sequencing is significant and could drive substantial revenue growth for the company. We plan to pursue an expanding pipeline of other potential customer collaborations where the technologies being developed or applications being considered extend beyond whole-genome clinical sequencing. Collaborative arrangements will likely increase through 2022, ultimately adding to the awareness of our products and service offerings and driving new applications for use of our technology.   

Financial Overview

The COVID-19 pandemic and efforts to control its spread have significantly curtailed the movement of people, goods, and services worldwide, including in the regions in which we sell our products and services and conduct our business operations. Due to the uncertain scope and duration of the pandemic, we cannot reasonably estimate the future impact to our operations and financial results.

In response to local stay-at-home orders and in alignment with CDC recommendations, we have limited our manufacturing and commercial operations. We have and will continue to provide consumables, instruments, and support to scientists at government, academic, and commercial labs that remain open. To aid in containing the spread of COVID-19, we have implemented remote-work options and are limiting employee travel. We are monitoring this rapidly evolving situation.

Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact to our business as a result of its global economic impact, including any recession that has occurred or may occur in the future. Specifically, difficult macroeconomic conditions, decreases in discretionary capital spending, increased and prolonged unemployment or a decline in consumer confidence as a result of the COVID-19 pandemic could have a continuing adverse effect on the demand for some of our products. Such economic disruption could have a material adverse effect on our business, results of operations and liquidity. The degree of impact of COVID-19 on our business will depend on several factors, such as the

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duration and the extent of the pandemic, as well as actions taken by governments, businesses and consumers in response to the pandemic, all of which continue to evolve and remain uncertain at this time.

See the Risk Factors section for further discussion of the possible impact of the COVID-19 pandemic on our business.

Key highlights of our 2021 consolidated financial results include the following:

Revenue increased $51.6 million, or 65%, to $130.5 million for the year ended December 31, 2021, as compared to $78.9 million for the year ended December 31, 2020, driven primarily by an increase in instrument and consumable revenue. We expect revenue to grow in 2022 compared to 2021 and 2020. However, our future revenues largely depend on the rate of sales of our sequencing instruments, which are a leading indicator of future sales of consumables. We expect instrument placements to continue to grow as we expand our sales globally through our expanded sales force, through application of technology in new markets and through offering new features and solutions. In turn, we expect that this will continue to increase our sales of consumables and related services.

Gross profit as a percentage of revenue (gross margin) was 45.1% in 2021 compared to 41.3% for the year ended December 31, 2020. The improved gross margin percentage was primarily due to higher sales volumes and increased utilization of our products during the year ended December 31, 2021, compared to 2020. Our gross margin in future periods will depend on several factors, including: strategic product pricing; product mix; sales of higher-margin consumables; supply chain constraints increasing the cost of raw materials; manufacturing capacity and production volumes impacting the cost of inventory; freight costs; warranty costs; and excess or obsolete inventories.

Loss from operations increased $105.8 million or 101%, to $210.2 million for the year ended December 31, 2021, as compared to $104.4 million for the year ended December 31, 2020, driven primarily by an increase of $132.1 million of operating expenses, including $31.1 million of merger-related expenses incurred in connection with the acquisitions of Omniome, Inc. and Circulomics, Inc. in 2021. We expect the loss from operations to continue to grow due to continued increases in operating expenses, as we further invest in product commercialization, product development efforts and incur a full year of operating expenses associated with the acquisition of Omniome. See Note 2. Business Acquisitions for further details.

Cash, cash equivalents and short-term investments were $1.04 billion at December 31, 2021, which represents an increase of 228% compared to the balance at December 31, 2020.

A detailed discussion of our comparison between 2021 and 2020 is presented below. A discussion of the changes in our results of operations between the years ended December 31, 2020 and December 31, 2019, has been omitted from this Annual Report on Form 10-K but may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission on February 26, 2021, which is incorporated herein by reference, and which is available free of charge on the SEC’s website at www.sec.gov and our corporate website (www.pacb.com).

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Results of Operations

Comparison of the Years Ended December 31, 2021 and 2020

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Revenue

Revenue increased $51.6 million, or 65%, to $130.5 million for the year ended December 31, 2021, as compared to $78.9 million for the year ended December 31, 2020, driven primarily by an increase in instrument and consumable revenue.

Instrument revenue increased $27.0 million, or 79%, to $61.3 million for the year ended December 31, 2021, as compared to the year ended December 31, 2020, primarily due to an increase in instruments sold. During the year ended December 31, 2021, our installed base was 374 Sequel II and Sequel IIe systems compared to the 203 systems in the year ended December 31, 2020. We expect the number of Sequel II/IIe placements to continue to grow during 2022, reflecting our increased commercial presence and customer demand.

Consumables revenue increased $21.0 million, or 68%, to $52.2 million for the year ended December 31, 2021, as compared to the year ended December 31, 2020. The increase in consumable sales was primarily attributable to higher Sequel II/IIe consumables sales from growth of the installed base.

Service and other revenue increased $3.5 million, or 26%, to $17.0 million for the year ended December 31, 2021, primarily due to product services contracts sold on the growing installed base.

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Cost of revenue, gross profit and gross margin

Cost of product revenue increased by $20.9 million, or 59%, to $56.4 million for the year ended December 31, 2021, compared to $35.4 million for the year ended December 31, 2020. The increase in cost of product revenue was primarily due to higher sales.

Cost of service and other revenue increased by $4.1 million, or 37%, to $15.0 million for the year ended December 31, 2021, compared to $10.9 million for the year ended December 31, 2020, primarily due to higher service volumes from our growing installed base and increased stock-based compensation expense.

Gross profit increased $26.3 million, or 81%, to $58.9 million for the year ended December 31, 2021, compared to the year ended December 31, 2020. Gross margin was 45.1%, for the year ended December 31, 2021, compared to gross margin of 41.3% for the year ended December 31, 2020. The improved gross margin percentage was primarily due to higher sales volumes and increased factory utilization during the year ended December 31, 2021, compared to 2020, which was more adversely impacted by the impact of the COVID-19 pandemic.

The global shortage of semiconductors, which has been reported since early 2021, has caused challenges for us in our supply chain and resulted in some cost increases that have and may continue to adversely impact margins. During these periods of shortages or delays, the price of components may increase, or the components may not be available at all. We may not be able to secure enough components at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed. Accordingly, our revenue and gross margins could suffer until other sources can be developed.

Research and Development Expense

Research and development expense increased by $48.7 million, or 76%, to $112.9 million for the year ended December 31, 2021, compared to the year ended December 31, 2020. This change was primarily driven by an increase of $29.0 million in personnel expenses, due to an increase in headcount, including the acquired workforce from the Omniome acquisition, and an increase of $14.3 million of product development costs. Research and development expense included stock-based compensation expense of $20.3 million and $7.1 million during the twelve months ended December 31, 2021 and 2020, respectively.

We will continue to focus a significant portion of our resources on developing new products and solutions, including improving the efficiency and usability of existing products, developing new solutions, software, workflows and applications leveraging our core technologies. We have and expect to continue to collaborate with strategic partners to develop sequencing solutions and expand the application of our technology. We intend to continue to significantly invest in research and development efforts into the foreseeable future. We expect research and development expenses to increase significantly in 2022, due to continued product development, research collaboration efforts, the acquisition of Omniome and our intent to continue to hire additional personnel in research and development. We also expect to continue to incur costs associated with products being developed in connection with the Invitae collaboration.

Sales, General and Administrative Expense

Sales, general and administrative expense increased by $51.3 million, or 71%, to $124.1 million for the year ended December 31, 2021, compared to the year ended December 31, 2020. This change was primarily driven by an increase of $53.6 million in salaries and related expense due to increased headcount, which included quota-carrying sales representatives and executive hires, which was partially offset by a decrease of $6.6 million in consulting and professional services fees. Sales, general and administrative expense included stock-based compensation expense of $35.4 million and $8.2 million during the twelve months ended December 31, 2021 and 2020, respectively.

Sales, general and administrative expense is planned to increase significantly in 2022 as we expect to increase quota-carrying sales representatives, increase headcount as part of our business expansion and incur incremental costs in connection with the acquisition of Omniome.

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Merger-related expenses

Merger-related expenses of $31.1 million during the year ended December 31, 2021, consist of $12.2 million of transaction costs arising from the acquisitions of Omniome and Circulomics and $18.9 million of stock-based compensation expense resulting from the acceleration of certain equity awards in connection with the Omniome merger. We recognized $18.9 million of stock-based compensation expense for the acceleration that was not attributable to pre-combination services, consisting of $6.3 million that was settled in shares of our common stock, $7.4 million that was settled in cash and $5.2 million related to contingent consideration.

Change in fair value of contingent consideration

Change in fair value of contingent consideration of $1.1 million during the year ended December 31, 2021, represents the remeasurement impact of the contingent consideration of $200 million (composed of $100 million in cash and $100 million in shares of our common stock) that is due upon the achievement of a milestone, defined as the first commercial shipment to a customer of a nucleotide sequencing platform, utilizing SBB technology.

Gain from Reverse Termination Fee from Illumina

As part of the Termination Agreement, Illumina paid us a Reverse Termination Fee of $98.0 million in the first quarter of 2020. Pursuant to the Termination Agreement, in the event that, on or prior to September 30, 2020, we entered into a definitive agreement providing for, or consummated, a Change of Control Transaction, then we may have been required to repay the Reverse Termination Fee (without interest) to Illumina in connection with the consummation of such Change of Control Transaction. We deferred the gain from the Reverse Termination Fee from Illumina until the date when the associated contingency was resolved. On October 1, 2020, the contingency clauses lapsed and we recorded the $98.0 million as a part of other income.

(Loss) Gain from Continuation Advances from Illumina

As part of the Termination Agreement, Illumina paid us Continuation Advances of $18.0 million during the fourth quarter of 2019 and $34.0 million during the first quarter of 2020. We recorded the $34.0 million as part of other income in the year ended December 31, 2020.

Up to the full $52.0 million of Continuation Advances paid to us were repayable without interest to Illumina if, within two years of March 31, 2020, we entered into, or consummated a Change of Control Transaction or raised at least $100 million in a single equity or debt financing (that may have multiple closings), with the amount repayable dependent on the amount raised by us.

Resulting from the issuance and sale of $900 million of 1.50% Convertible Senior Notes due February 15, 2028, $52.0 million of Continuation Advances were paid without interest to Illumina in February 2021 and recorded as other expense in the year ended December 31, 2021.

Interest Expense

Interest expense for the year ended December 31, 2021, was $12.5 million compared to $0.3 million for the year ended December 31, 2020, primarily due to the interest incurred on the $900 million of 1.50% Convertible Senior Notes due February 15, 2028 that we issued on February 16, 2021.

Other Income, Net

The decrease in Other income, net was primarily driven by a $0.8 million foreign exchange loss for the year ended December 31, 2021, compared to a $1.0 million foreign exchange gain recognized for the year ended December 31, 2020.

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Benefit from Income Taxes

A deferred income tax benefit of $93.6 million for the year ended December 31, 2021, is related to the release of the valuation allowance for deferred tax assets due to the recognition of deferred tax liabilities in connection with the Omniome and Circulomics acquisitions. We maintain a full valuation allowance on the net deferred tax assets of our U.S. entities as we have concluded that it is more likely than not that we will not realize our deferred tax assets. Accordingly, this benefit from income taxes is reflected on our Consolidated Statements of Operations and Comprehensive (Loss) Income for the year ended December 31, 2021.

Liquidity and Capital Resources

Our primary sources of liquidity, other than our holdings of cash, cash equivalents, and investments, has primarily been through the issuance of debt or equity securities, together with cash flow from operating activities. We have historically incurred, and expect to continue to incur, operating losses and generate negative cash flows from operations on an annual basis due to the investments we intend to make as described in Results of Operations above, and as a result, we may require additional capital resources to execute our strategic initiatives to grow our business.

Cash, cash equivalents and investments

As of December 31, 2021, we had $1.04 billion in cash, cash equivalents and investments, compared to $318.8 million at December 31, 2020. The increase was attributable to the net proceeds from our issuance of $900 million of 1.50% Convertible Senior Notes on February 16, 2021, and $300 million of common stock in a private placement on September 20, 2021. This increase was partially offset by the payment of $319.8 million, net of cash acquired, in the acquisitions of Omniome and Circulomics in the third quarter of 2021, repayment of $52 million of Continuation Advances to Illumina in the first quarter of 2021 and $111.2 million cash used in operating activities for the twelve months ended December 31, 2021.

Convertible Senior Notes

At December 31, 2021, we had $900 million of principal Convertible Senior Notes outstanding which mature on February 15, 2028, subject to earlier conversion, redemption or repurchase.

On February 9, 2021, we issued convertible notes due 2028 (Notes) with an aggregate principal of $900 million. The net proceeds from the issuance, after deducting offering expenses, were $895.6 million. The Notes are governed by an indenture (the “Indenture”) between the Company and U.S. Bank National Association, as trustee. The Notes bear interest at a rate of 1.50% per annum. Interest on the Notes is payable semi-annually in arrears on February 15 and August 15 commencing on August 15, 2021. The Notes will mature on February 15, 2028, subject to earlier conversion, redemption or repurchase. The proceeds from the issuance of the convertible notes will be used to fund operations, strategic investments and capital requirements.

The Notes are convertible at the option of the holder at any time until the second scheduled trading day prior to the maturity date, including in connection with a redemption by the Company. The Notes are convertible into shares of our common stock based on an initial conversion rate of 22.9885 shares of common stock per $1,000 principal amount of the Notes (which is equal to an initial conversion price of $43.50 per share), in each case subject to customary anti-dilution and other adjustments as a result of certain extraordinary transactions. Upon conversion of the Notes, we may elect to settle such conversion obligation in shares, cash or a combination of shares and cash.

With certain exceptions, upon a change of control of the Company or the failure of our common stock to be listed on certain stock exchanges, the holders of the Notes may require that we repurchase all or part of the principal amount of the Notes at a purchase price of par plus unpaid interest up to, but excluding, the maturity date.

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The Indenture includes customary “events of default,” which may result in the acceleration of the maturity of the Notes under the Indenture. The Indenture also includes customary covenants for convertible notes of this type.

See Note 7. Convertible Senior Notes for further details.

Acquisitions

On September 20, 2021, we acquired Omniome, a San Diego-based company developing a highly differentiated, proprietary short-read DNA sequencing platform capable of delivering high accuracy results, for total consideration of $714.8 million, consisting of $315.7 million in cash, $249.4 million in shares of PacBio common stock, and contingent consideration with a fair value of $168.6 million. Out of the total payment, approximately $18.9 million, comprised of $7.4 million of cash, 226,811 shares of PacBio common stock with a fair value of $6.3 million and $5.2 million of contingent consideration, was accounted for as a one-time post acquisition stock-based compensation expense. See Note 2. Business Acquisitions for further details. 

With regards to the contingent consideration with a fair value of $168.6 million, we are required to pay Omniome stockholders an additional payment of $200 million, composed of $100 million in cash and $100 million in shares of our common stock, upon the achievement of a milestone, defined as the first commercial shipment to a customer of a nucleotide sequencing platform, comprising both an instrument and related consumables, that utilizes SBB technology.

Private Placement of Common Stock

On July 19, 2021, we entered into a purchase agreement with certain qualified institutional buyers and institutional accredited investors, pursuant to which we agreed to sell an aggregate of 11,214,953 shares of common stock, at a price of $26.75 per share, for aggregate gross proceeds of approximately $300 million. The transaction closed on September 20, 2021. We registered the private placement shares for resale following the closing of the merger.

Invitae Collaboration Arrangement

On January 12, 2021, we entered into a multi-year Development and Commercialization Agreement with Invitae Corporation (“Invitae”). Pursuant to the Development Agreement, Invitae is providing certain funding to us to develop products relating to production-scale high-throughput sequencing (“Program Products”). If Program Products become commercially available, Invitae may purchase the Program Products. In addition to selling the Program Products to Invitae, we will have the right to broadly commercialize Program Products for sale to other customers.

Under the Development Agreement, we are conducting a program to develop and will subsequently manufacture the Program Products. Invitae is funding certain development costs we incur in connection with the Program Products (“Program Development Costs”) and will receive preferred pricing on the Program Products as further described in Note 3. Invitae Collaboration Arrangement.

In certain termination circumstances, (i) we will be obligated to refund all or a portion of the development costs advanced by Invitae and/or (ii) we will owe Invitae a share of the revenue that may be generated from the sale of the Program Products to third parties if and when they are commercialized, until such time as Invitae has recouped the amounts paid to us, and in certain circumstances, a mutually agreed return.

We have incurred and expect to incur significant development costs over the duration of the Development Agreement. There can be no assurances that the development program will be successful or that the Program Products will become ready for commercial sale.

All amounts received from Invitae are initially deferred and accumulated in deferred revenue, non-current. As of December 31, 2021, we have recognized payments received from Invitae of $23.5 million in deferred revenue, non-current, on the Consolidated Balance Sheet.

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Additional Capital Requirements

We anticipate that our existing cash, cash equivalents and investments will be sufficient to fund our projected operating and capital requirements for at least the next 12 months from the date of filing of this Annual Report on Form 10-K for the year ended December 31, 2021. Operating needs include planned costs to operate our business, including costs to fund working capital and capital expenditures.  Recent and expected working and other capital requirements, in addition to the above matters, include:

Our purchase orders and contractual obligations of approximately $68.7 million as of December 31, 2021, which consist of open purchase orders and contractual obligations in the ordinary course of business, including commitments with contract manufacturers and suppliers for which we have not received the goods or services. A majority of these purchase obligations are due within a year. Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services.

Our research and development expenditures were $112.9 million in 2021 and $64.2 million in 2020, and we expect to increase our investment in research and development in 2022, including enhancements of our existing products, continued development of a commercial product leveraging our acquired SBB technology, continued development of products in connection with our Invitae collaboration and new technology and products.

Cash outflows for capital expenditures were $5.9 million in 2021 and $1.0 million in 2020.  We expect capital expenditures to increase in fiscal 2022 to support the increase in manufacturing and expansion of our business.

Amounts related to future lease payments for operating lease obligations at December 31, 2021, totaled $57.7 million, with $11.3 million expected to be paid within the next 12 months.

Amounts due under the term loan acquired in connection with Omniome at December 31, 2021, totaled $3.9 million, with $1.6 million expected to be paid within the next 12 months. Please see Note 6. Balance Sheet Components for additional information.

Payments made to 3rd party collaborators to help advance our technologies and the capabilities of our products. We may also choose to drive investments to help create an ecosystem of customers, partners and collaborators whose expertise and offerings complement and enhance the capabilities and utility of our technology and increase genomic data available on our platforms.

Payments related to licensing and other arrangements are cancelable license agreements with third parties for certain patent rights and technology. Under the terms of these agreements, we may be obligated to pay royalties based on revenue from the sales of licensed products, or minimum royalties, whichever is greater, and license maintenance fees. The future license maintenance fees and minimum royalty payments under the license agreements are not deemed to be material. At this time, obligations for future royalties under our license agreements are not estimable or probable.

Our capital needs may be impacted by the pace of adoption of our products, which affects the sales of our products and services; 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; the purchase of patent licenses; manufacturing costs; service costs; the impact of product quality; litigation costs, including the costs involved in preparing, filing, prosecuting, defending and enforcing intellectual property rights; costs of developing new and enhanced products; acquisitions of complementary businesses, technologies or assets; macroeconomic impacts of COVID-19; and other factors.

If economic, financial, business or other factors adversely affect our ability to fund our projected operating cash requirements, we may be required to obtain funding through traditional or alternative sources of financing.  We cannot be certain that funds will be available on favorable terms, or at all. If we are required and unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected.

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Cash Flow Summary

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Operating Activities

Our primary uses of cash in operating activities are for the development of future products and product enhancements, manufacturing, and support functions related to our sales, general and administrative activities.

We used $111.2 million of cash in operating activities for the year ended December 31, 2021, compared to cash provided by operating activities of $19.5 million for the year ended December 31, 2020.

Cash used in operating activities for the year ended December 31, 2021, of $111.2 million was due primarily to a $181.0 million net loss, which includes a $93.6 million deferred income tax benefit, that was partially offset by a loss of $52.0 million from Continuation Advances repaid to Illumina that is considered a financing activity, non-cash items such as stock-based compensation of $73.4 million, depreciation of $7.2 million, amortization of right-of-use assets of $4.0 million and a net cash inflow from changes in operating assets and liabilities of $20.7 million. The change in net operating assets and liabilities was primarily attributable to increases of $25.7 million in deferred revenue, an increase of $15.1 million in accrued expenses and an increase of $6.4 million in accounts payable partially offset by an increase of $12.4 million in inventory, an increase of $7.2 million in accounts receivable, an increase of $1.0 million in prepaid expenses and other assets and a decrease of $5.0 million in operating lease liabilities.

Cash provided by operating activities for the year ended December 31, 2020, was $19.5 million, reflecting net income of $29.4 million which included a gain from the Reverse Termination Fee received from Illumina of $98.0 million and a gain from the Continuation Advances from Illumina of $34.0 million. However, the Continuation Advances are considered a financing activity and therefore an associated $34.0 million adjustment has been reflected to cash provided by operating activities. The net income of $29.4 million included non-cash expense items such as stock-based compensation of $17.5 million and depreciation of $6.4 million. The change in net operating assets and liabilities was primarily attributed to an increase of $4.1 million in accrued expenses and an increase of $5.0 million in other liabilities, partially offset by a decrease of $5.1 million in accounts payable.

Investing Activities

Our investing activities consist primarily of business acquisitions, capital expenditures and investment purchases, sales and maturities. We used $678.5 million of cash for investing activities for the year ended December 31, 2021, compared to $219.3 million for the same period in 2020.

Cash used in investing activities for the year ended December 31, 2021, was due primarily to net purchases of investments of $352.8 million, cash paid, net of cash acquired, of $319.8 million for the acquisitions of Omniome and Circulomics and purchases of property and equipment of $5.9 million.

Cash used in investing activities for the year ended December 31, 2020, was due primarily to net purchases of investments of $218.3 million and purchases of property and equipment of $1.0 million.

Financing Activities

Cash provided by financing activities was $1.17 billion and $251.8 million for the year ended December 31, 2021 and 2020, respectively.

Cash provided by financing activities during the year ended December 31, 2021, resulted from net proceeds of $895.5 million from our February 2021 issuance of $900 million of 1.50% Convertible Senior Notes after deducting debt issuance costs, net proceeds of $294.8 million from our September 2021 private placement of common stock after deducting issuance

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costs and proceeds of $31.8 million from the issuance of common stock through our equity compensation plans, partially offset by $52.0 million of Continuation Advances repaid to Illumina.

Cash provided by financing activities during the year ended December 31, 2020, resulted from net proceeds of $187.5 million from our August 2020 and November 2020 underwritten public equity offerings after deducting underwriter commissions and paid offering expenses, $34.0 million of Continuation Advances from Illumina and proceeds of $46.4 million from the issuance of common stock through our equity compensation plans, partially offset by $16.0 million we repaid for the remaining outstanding principal to Deerfield upon the maturity of the Facility Agreement.

Off-Balance Sheet Arrangements

As of December 31, 2021, we did not have any off-balance sheet arrangements.

In the ordinary course of business, we enter into standard indemnification arrangements. Pursuant to these arrangements, we indemnify, hold harmless, and agree to reimburse the indemnified parties for losses suffered or incurred by the indemnified party in connection with any trade secret, copyright, patent or other intellectual property infringement claim by any third party with respect to its technology, or from claims relating to our performance or non-performance under a contract, any defective products supplied by us, or any acts or omissions, or willful misconduct, committed by us or any of our employees, agents or representatives. The term of these indemnification agreements is generally perpetual after the execution of the agreement. The maximum potential amount of future payments we could be required to make under these agreements is not determinable because it involves claims that may be made against us in future periods but have not yet been made. To date, we have not incurred costs to defend lawsuits or settle claims related to these indemnification agreements.

We also enter and have entered into indemnification agreements with our directors and officers that may require us to indemnify them against liabilities that arise by reason of their status or service as directors or officers, except as prohibited by applicable law. In addition, we may have obligations to hold harmless and indemnify third parties involved with our fundraising efforts and their respective affiliates, directors, officers, employees, agents or other representatives against any and all losses, claims, damages and liabilities related to claims arising against such parties pursuant to the terms of agreements entered into between us and such third parties in connection with such fundraising efforts. To the extent that such indemnification obligations apply to the lawsuits described in Note 8. Commitments and Contingencies of this Form 10-K, any associated expenses incurred are included within the related accrued litigation expense amounts. No additional liability associated with such indemnification agreements has been recorded as of December 31, 2021.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our Consolidated Financial Statements, which we have prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, cost of revenue, and operating expenses, and related disclosure of contingent assets and liabilities. Management based its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgements about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements.

Revenue Recognition

Our revenue is generated primarily from the sale of products and services. Product revenue primarily consists of sales of our instruments and related consumables; Service and other revenue consist primarily of revenue earned from product maintenance agreements.

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We account for a contract with a customer when there is a legally enforceable contract between us and the customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Revenues are recognized when control of the promised goods or services is transferred to our customers or services are performed, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

Our instrument sales are generally sold in a bundled arrangement and commonly include the instrument, instrument accessories, installation, training, and consumables. Additionally, our instrument sale arrangements generally include a one year period of service. For such bundled arrangements, we account for individual products and services separately if they are distinct, that is, if a product or service is separately identifiable from other items in the bundled package and if a customer can benefit from it on its own or with other resources that are readily available to the customer. Our customers cannot benefit from our instrument systems without installation, and installation can only be performed by us or qualified distributors. As a result, the system and installation are considered to be a single performance obligation recognized after installation is completed except for sales to qualified distributors, in which case the system is distinct and recognized when control has transferred to the distributor which typically occurs upon shipment.

The consideration for bundled arrangements is allocated between separate performance obligations based on their individual standalone selling price. We determine the best estimate of standalone selling price using average selling prices over a 12-month period combined with an assessment of current market conditions. If the standalone selling price is not directly observable, we rely on estimates by considering multiple factors including, but not limited to, overall market conditions, including geographic or regional specific factors, internal costs, profit objectives, pricing practices and other observable inputs.

We recognize revenues as performance obligations are satisfied by transferring control of the product or service to the customer or over the term of a product maintenance agreement with a customer. Our revenue arrangements generally do not provide a right of return. Revenue is recorded net of discounts, distributor commissions, and sales taxes collected on behalf of governmental authorities.

Inventories

Inventories are stated at the lower of cost or net realizable value on a first-in, first-out (“FIFO”) basis. The cost basis of our inventory is reduced for any products that are considered excessive or obsolete based upon assumptions about future demand, market conditions and the release of new products that may supersede old ones. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required, which could have a material adverse effect on the results of our operations.

Goodwill and Intangible Assets

We make assumptions and estimates in determining the fair value of assets acquired and liabilities assumed in a business combination. The determination of fair value of intangible assets, which represents a significant portion of the purchase price in most acquisitions, requires the use of significant judgment relating to the fair value, whether the asset should be amortized, and if so, the period and method by which the intangible asset should be amortized. The Company estimates the fair value of the acquisition-related intangible assets primarily using the income approach, which discounts expected future cash flows to present value at the dates of the acquisition. Expected future cash flows utilize significant assumptions such as assumed revenue growth, discount rate and obsolescence factors

Finite-lived intangible assets, our developed technology and customer relationships, are capitalized and amortized over the lesser of the terms of the agreement or estimated useful life. We regularly review the carrying amount of our finite-lived intangible assets to determine whether indicators of impairment may exist which warrant adjustments to carrying values or estimated useful lives. We make judgements about the recoverability of finite-lived assets when events or changes in circumstances indicate that an impairment may exist. An impairment loss would be recognized when the sum of the expected future undiscounted net cash flows is less than the carrying amount of the asset. Should impairment exist, the impairment loss would be measured based on the excess of the carrying amount of the asset over the asset’s fair value.

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Goodwill is evaluated for impairment annually in the second quarter of each year, and when events occur, or circumstances change that would more likely than not reduce the fair value of the asset below its carrying value. Qualitative factors that might require an interim evaluation include unexpected adverse business conditions, economic factors, unanticipated technological changes or competitive activities, loss of key personnel and acts by governments or courts. When impairment seems more likely than not during our qualitative assessment, we perform the quantitative assessment where we compare the fair value of the reporting unit with the carrying values, including goodwill. If the carrying amounts of the reporting units exceed the fair values, we will record an impairment loss based on the difference.

Indefinite-lived intangible assets, our In-Process Research and Development (IPR&D), is not subject to amortization and is assessed for impairment on, at least, an annual basis in the second quarter of each year. We review indefinite-lived intangible assets for impairment using a qualitative assessment. When impairment seems more likely than not during our qualitative assessment, we will proceed with a quantitative assessment where we estimate the fair value. Recoverability of indefinite-lived intangible assets is measured by comparing the carrying amount of the asset to its fair value. We make judgements about the recoverability of indefinite-lived assets when events or changes in circumstances indicate that an impairment may exist. Upon the commercialization of an IPR&D asset, it is reclassified to developed technology, which is a finite-lived intangible asset, and amortized over its estimated useful life.

Estimates of discounted future cash flows require assumptions related to revenue and operating income growth rates, discount rates and other factors. We consider peer revenues and earnings trading multiples from companies that have operational and financial characteristics that are similar to the asset under measurement and estimated weighted average costs of capital. Different assumptions from those made in our analysis could materially affect projected cash flows and the evaluation of assets for impairment.

We acquired $11.4 million of finite-lived intangible assets, $400.0 million of IPR&D and $410.0 million of goodwill in connection with the acquisitions of Omniome and Circulomics in the third quarter of 2021. We will perform the first annual quantitative goodwill and IPR&D impairment test in the second quarter of 2022. Through the review of qualitative factors in the fourth quarter of 2021, we noted no indications of impairment.

Contingent Consideration

In connection with the acquisition of Omniome in the third quarter of 2021, we entered into an arrangement where we are obligated to pay $200 million in cash and equity dependent upon the achievement of a milestone event upon the first commercial shipment of products developed from our acquired sequencing technology. See Note 2. Business Acquisitions for further information.

The contingent consideration liability was measured at fair value as of the acquisition date and is remeasured periodically at each reporting date, with changes in fair value recorded as change in fair value of contingent consideration in the statement of operations. The initial measurement and post-acquisition remeasurement require estimates and assumptions using a scenario-based method that considers a range of potential outcomes and assigned probabilities of occurrence for each outcome. Outcomes are discounted to present value, which is then weighted by the probability of each scenario to determine the total fair value of the contingent consideration payment as of each reporting period. Refer to Note 5. Financial Instruments for further discussion on valuation assumptions.

Recent Accounting Pronouncements

Please see Note 1. Organization and Significant Accounting Policies, subsection titled “Recent Accounting Pronouncements”, in Part II, Item 8 of this Annual Report on Form 10-K for information regarding applicable recent accounting pronouncements.