Notes to Consolidated Financial Statements
NOTE 1. OVERVIEW
We design, develop and manufacture sequencing systems to help scientists resolve genetically complex problems. Based on our novel Single Molecule, Real-Time (SMRT®) sequencing technology, our products enable: de novo genome assembly to finish genomes in order to more fully identify, annotate and decipher genomic structures; full-length transcript analysis to improve annotations in reference genomes, characterize alternatively spliced isoforms in important gene families, and find novel genes; targeted sequencing to more comprehensively characterize genetic variations; and real-time kinetic information for epigenome characterization. Our technology provides high accuracy, ultra-long reads, uniform coverage and the ability to simultaneously detect epigenetic changes. PacBio® sequencing systems, including consumables and software, provide a simple and fast end-to-end workflow for SMRT sequencing.
Our current products include the Sequel II instrument and SMRT Cell 8M, which together are capable of sequencing up to approximately eight million DNA molecules simultaneously, and the previous generation Sequel instrument and Sequel SMRT Cell 1M, which together are capable of sequencing up to approximately one million DNA molecules simultaneously.
Our customers and our scientific collaborators have published numerous peer-reviewed articles in journals including Nature, Science, Cell, PNAS and The New England Journal of Medicine highlighting the power and applications of SMRT sequencing in projects such as finishing genomes, structural variation discovery, isoform transcriptome characterization, rare mutation discovery and the identification of chemical modifications of DNA related to virulence and pathogenicity. Our research and development efforts are focused on developing new products and further improving our existing products including continuing chemistry and sample preparation improvements to increase throughput and expand our supported applications. By providing access to genetic information that was previously inaccessible, we enable scientists to confidently increase their understanding of biological systems.
PacBio® sequencing systems, including consumables and software, provide a simple and fast end-to-end workflow for SMRT sequencing. The names “Pacific Biosciences,” “PacBio,” “SMRT,” “SMRTbell,” “Sequel” and our logo are our trademarks.
NOTE 2. TERMINATION OF MERGER WITH ILLUMINA
On November 1, 2018, we entered into a Merger Agreement with Illumina and FC Ops Corp. We, Illumina and Merger Subsidiary entered into the Amendment on September 25, 2019. The Amendment, among other things, extended the End Time (as defined in the Merger Agreement) to December 31, 2019. Additionally, Illumina had until December 18, 2019 to exercise its unilateral right to extend the End Time to March 31, 2020. In addition, the Amendment provided that Illumina would make payments to us of $6.0 million on or before each of October 1, 2019, November 1, 2019 and December 2, 2019. If Illumina elected to further extend the End Time to March 31, 2020, then, except under limited situations, Illumina would be required to make payments to us of $6.0 million on or before each of January 2, 2020, and March 2, 2020, and a payment of $22.0 million on or before February 3, 2020.
On December 17, 2019, the U.S. Federal Trade Commission publicly announced that it had authorized legal action to block the Merger.
On December 18, 2019, we received written notice from Illumina pursuant to which Illumina exercised its right under Section 10.01(b)(i) of the Merger Agreement, to extend the End Time to March 31, 2020. In accordance with the terms of the Merger Agreement , we received Continuation Advances totaling $18.0 million from Illumina during the fourth quarter of 2019, which are reflected in the “Gain from Continuation Advances from Illumina” line in the consolidated statements of operations and comprehensive loss for the year ended December 31, 2019.
On January 2, 2020, we, Illumina and Merger Subsidiary entered into the Termination Agreement to terminate the Merger Agreement. As part of our agreement to terminate the Merger Agreement, Illumina subsequently paid us the Reverse Termination Fee from which we expect to pay our financial advisor associated fees of approximately $10 million. In addition, Illumina paid us the additional Continuation Advances of $6 million in January 2020 and $22 million in February 2020 and is scheduled to make a final Continuation Advance to us of $6 million in March 2020.
However, pursuant to the Termination Agreement, in the event that, on or prior to September 30, 2020, we enter into a definitive agreement providing for, or consummate, a Change of Control Transaction (as defined in the Termination Agreement), then we will repay the Reverse Termination Fee (without interest) to Illumina in connection with the consummation of such Change of Control Transaction. If such Change of Control Transaction is not consummated by the two-year anniversary of the execution of the definitive agreement for such Change of Control Transaction, then we will not be required to repay the Reverse Termination Fee.
In addition, up to the full amount of the Continuation Advances paid to us are repayable without interest to Illumina if, within two years of March 31, 2020, we enter into a Change of Control Transaction or raise at least $100 million in equity in a single transaction or debt financing (that may have multiple closings), with the amount repayable dependent on the amount raised by us. Please refer to “Note 3 Summary of Significant Accounting Policies” for additional accounting considerations relating to the Continuation Advances received.
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, or U.S. GAAP, as set forth in the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC. The consolidated financial statements include the accounts of Pacific Biosciences and our wholly owned subsidiaries. All intercompany transactions and balances have been eliminated. Translation adjustments resulting from translating foreign subsidiaries’ results of operations and assets and liabilities into U.S. dollars are immaterial for all periods presented.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes to the financial statements. Our estimates include, but are not limited to, the valuation of inventory, the determination of stand-alone selling prices for revenue recognition, the valuation of a financing derivative and long-term notes, the probability of repaying the Continuation Advances to Illumina, the valuation and recognition of share-based compensation, the expected renewal period for service contracts to derive the amortization period for capitalized commissions, the useful lives assigned to long-lived assets, the computation of provisions for income taxes and the determination of the internal borrowing rate used in calculating the operating lease right-of-use assets and operating lease liabilities. Actual results could differ materially from these estimates.
During 2017, we recorded a charge to cost of service and other revenue of $1.6 million relating to leased RS II instruments primarily due to a change in the estimated useful life of these instruments. The charge of $1.6 million increased loss per share by $0.01 for the year ended December 31, 2017.
Accounting changes
In February 2016, the FASB issued ASU 2016-02 regarding ASC Topic 842 Leases and in July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements. We refer to the new guidance as “ASC 842”. On January 1, 2019, we adopted the ASC 842 using a modified retrospective approach, which requires the recognition of right-of-use assets and related operating and finance lease liabilities on the consolidated balance sheet. As permitted by ASC 842, we elected the adoption date of January 1, 2019, which is the date of initial application. As a result,
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the consolidated balance sheet prior to January 1, 2019 was not restated and continues to be reported under ASC Topic 840, Leases, or “ASC 840”, which did not require the recognition of right-of-use assets and operating lease liabilities on the consolidated balance sheet and;
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·
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the expense recognition for operating leases under ASC 842 remained substantially consistent with ASC 840.
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Fair Value of Financial Instruments
The carrying amount of our accounts receivable, prepaid expenses, other current assets, accounts payable, accrued expenses and other liabilities, current, approximate fair value due to their short maturities.
The fair value hierarchy established under U.S. GAAP requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are as follows:
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Level 1: quoted prices in active markets for identical assets or liabilities;
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·
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Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
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·
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Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
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We consider an active market as one in which transactions for the asset or liability occurs with sufficient frequency and volume to provide pricing information on an ongoing basis. Conversely, we view an inactive market as one in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate, our non-performance risk, or that of our counterparty, is considered in determining the fair values of liabilities and assets, respectively.
We classify our cash deposits and money market funds within Level 1 of the fair value hierarchy because they are valued using bank balances or quoted market prices. We classify our investments as Level 2 instruments based on market pricing and other observable inputs. We did not classify any of our investments within Level 3 of the fair value hierarchy.
Assets and liabilities measured at fair value are classified in their entirety based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the entire fair value measurement requires management to make judgments and consider factors specific to the asset or liability.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table sets forth the fair value of our financial assets and liabilities that were measured on a recurring basis as of December 31, 2019 and 2018, respectively (in thousands):
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December 31, 2019
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December 31, 2018
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(in thousands)
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Level 1
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Level 2
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Level 3
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Total
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Level 1
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Level 2
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Level 3
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Total
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Assets
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Cash and cash equivalents:
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Cash and money market funds
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$
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18,644
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$
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—
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$
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—
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$
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18,644
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$
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18,844
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$
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—
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$
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—
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$
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18,844
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Commercial paper
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—
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10,983
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—
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10,983
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—
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—
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—
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—
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Total cash and cash equivalents
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18,644
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10,983
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—
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29,627
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18,844
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—
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—
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18,844
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Investments:
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Commercial paper
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—
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16,971
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—
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16,971
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—
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53,469
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—
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53,469
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Corporate debt securities
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—
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2,501
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—
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2,501
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—
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10,214
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—
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10,214
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US government & agency securities
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—
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—
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—
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—
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—
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19,827
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—
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19,827
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Total investments
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—
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19,472
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—
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19,472
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—
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83,510
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—
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83,510
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Long-term restricted cash:
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Cash
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4,000
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—
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—
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4,000
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4,500
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—
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—
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4,500
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Total assets measured at fair value
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$
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22,644
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$
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30,455
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$
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—
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$
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53,099
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$
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23,344
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$
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83,510
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$
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—
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$
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106,854
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Liabilities
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Financing derivative
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$
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—
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$
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—
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$
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—
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$
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—
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$
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—
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$
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—
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$
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16
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$
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16
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Continuation Advances
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—
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—
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—
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—
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—
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—
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—
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—
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Total liabilities measured at fair value
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$
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—
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$
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—
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$
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—
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$
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—
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$
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—
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$
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—
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$
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16
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$
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16
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Estimated fair value of the Financing Derivative liability
The estimated fair value of the Financing Derivative liability (as defined in “Note 6. Notes Payable’) was determined using Level 3 inputs, or significant unobservable inputs. Refer to “Note 6. Notes Payable” for a detailed description and valuation approach. Changes to the estimated fair value of the Financing Derivative are recorded in “Other income (expense), net” in the consolidated statements of operations and comprehensive loss.
The following table provides the changes in the fair value of the Financing Derivative for the years ended December 31, 2019 and 2018 (in thousands), respectively:
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Financing Derivative
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Amount
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Balance as of December 31, 2017
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$
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183
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Gain on change in fair value of Financing Derivative
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(167)
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Balance as of December 31, 2018
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16
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Gain on change in fair value of Financing Derivative
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(16)
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Balance as of December 31, 2019
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$
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—
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Estimated fair value of the Continuation Advances liability
On November 1, 2018, we entered into a Merger Agreement with Illumina and FC Ops Corp. We, Illumina and Merger Subsidiary entered into the Amendment on September 25, 2019. In accordance with the terms of the Merger Agreement, we received Continuation Advances totaling $18.0 million from Illumina during the fourth quarter of 2019.
We determined that the $18.0 million of Continuation Advances received from Illumina in 2019, which are subject to repayment under certain circumstances as discussed above, constitute a financial liability.
The fair value option was elected for the financial liability because management believes that among all measurement methods allowed by ASC 825, Financial Instruments, the fair value option would most fairly represent the value of such a financial liability. Management applied the income approach to estimate the fair value of this financial liability. The estimated fair value of the liability related to the Continuation Advances received in 2019 was determined using Level 3 inputs, or significant unobservable inputs. Management estimated that there would be no future cash outflows associated with this financial instrument because the probabilities of either of the following events occurring and requiring repayment to Illumina were evaluated as being remote as of December 31, 2019:
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We enter into a Change of Control Transaction (as defined in the Termination Agreement) within two years following March 31, 2020;
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We raise $100 million or more in a single equity or debt financing (that may have multiple closings) within two years following March 31, 2020.
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As a result, the estimated fair value of the liability associated with the contingent repayment of the $18.0 million of Continuation Advances received in the fourth quarter of 2019 was assessed to be zero as of December 31, 2019, with a resulting non-operating gain of $18.0 million recorded as “Gain from Continuation Advances from Illumina” in the consolidated statements of operations and comprehensive loss for the year ended December 31, 2019.
For the year ended December 31, 2019, there were no transfers between Level 1, Level 2, or Level 3 assets or liabilities reported at fair value on a recurring basis and our valuation techniques did not change compared to the prior year.
Financial Assets and Liabilities Not Measured at Fair Value on a Recurring Basis
We determined the fair value of the Notes (as defined in “Note 6. Notes Payable”) from the Facility Agreement we entered into during the first quarter of 2013 using Level 3 inputs, or significant unobservable inputs. The value of the Notes was determined by comparing the difference between the fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using a 6.5% and 9.6% weighted average market yield at December 31, 2019 and December 31, 2018, respectively. Refer to “Note 6. Notes Payable” for additional details regarding the Notes. The estimated fair value and carrying value of the Notes are as follows (in thousands):
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December 31, 2019
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December 31, 2018
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Fair Value
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Carrying Value
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Fair Value
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Carrying Value
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Long-term notes payable
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$
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16,038
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$
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15,871
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$
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15,915
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$
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14,659
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Cash and Cash Equivalents
We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Investments
We have designated all investments as available-for-sale and therefore, such investments are reported at fair value, with unrealized gains and losses recognized in accumulated other comprehensive income (loss) (“OCI”) in stockholders’ equity. The cost of marketable securities is adjusted for the amortization of premiums and discounts to expected maturity. Premium and discount amortization is included in other income, net. Realized gains and losses, as well as interest income, on available-for-sale securities are also included in other income, net. The cost of securities sold is based on the specific identification method. We include all of our available-for-sale securities in current assets.
All of our investments are subject to a periodic impairment review. We recognize an impairment charge when a decline in the fair value of our investments below the cost basis is judged to be other-than-temporary. Factors considered in determining whether a loss is temporary include the length of time and the extent to which an investment’s fair value has been less than its cost basis, the financial condition and near-term prospects of the investee, the extent of the loss related to credit of the issuer, the expected cash flows from the security, our intent to sell the security and whether or not we will be required to sell the security before the recovery of its amortized cost. During the years ended December 31, 2019, 2018 and 2017, we did not have any impairment charges on our investments as it is more likely than not that we will recover their amortized cost basis upon sale or maturity.
Concentration and Other Risks
The counterparties to the agreements relating to our investment securities consist of various major corporations, financial institutions, municipalities and government agencies of high credit standing. Our accounts receivable are derived from net revenue to customers and distributors located in the United States and other countries. We perform credit evaluations of our customers’ financial condition and, generally, require no collateral from our customers. We regularly review our accounts receivable including consideration of factors such as historical experience, credit quality, the age of the accounts receivable balances and current economic conditions that may affect a customer’s ability to pay. We have not experienced any significant credit losses to date.
For the years ended December 31, 2019, 2018 and 2017, one customer, Gene Company Limited, accounted for approximately 17%, 26% and 31% of our total revenue, respectively.
As of December 31, 2019 and 2018, 55% and 50% of our accounts receivable were from domestic customers, respectively. As of December 31, 2019 and 2018, one customer, Gene Company Limited, represented approximately 11% and 14% of our net accounts receivable, respectively. We currently purchase several key parts and components used in the manufacture of our products from a limited number of suppliers. Generally, we have been able to obtain an adequate supply of such parts and components. However, an extended interruption in the supply of parts and components currently obtained from our suppliers could adversely affect our business and consolidated financial statements.
Inventory
Inventories are stated at the lower of average cost or net realizable value. Cost is determined using the first-in, first-out (“FIFO”) method. Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess or obsolete balances.
Property and Equipment, Net
Property and equipment are stated at cost, net of accumulated depreciation and any impairment charges. Depreciation is computed using the straight-line method over the estimated useful life of the asset, generally two to three years for computer equipment, three to five years for software, three to seven years for furniture and fixtures and three to five years for lab equipment. Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life of the related asset. Major improvements are capitalized, while maintenance and repairs are expensed as incurred.
Long-term Restricted Cash
As required under the lease agreement for our corporate offices, we were required to establish a letter of credit for the benefits of the landlord and to submit $4.5 million as a deposit for the letter of credit in October 2015. Subsequently, pursuant to the terms of the 1305 O’Brien Lease, at May 1, 2019, the $4.5 million in restricted cash was reduced to $4.0 million. As such, $4.0 million and $4.5 million was recorded in “Long-term restricted cash” in the consolidated balance sheet as of December 31, 2019 and 2018, respectively.
Pursuant to the terms of the O’Brien Lease, the letter of credit balance of $4.0 million at December 31, 2019 will be reduced again in May 2020 by $500,000, resulting in a letter of credit balance of $3.5 million.
Impairment of Long-Lived Assets
We periodically review property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is impaired or the estimated useful lives are no longer appropriate. Fair value is estimated based on discounted future cash flows. If indicators of impairment exist and the undiscounted projected cash flows associated with such assets are less than the carrying amount of the asset, an impairment loss is recorded to write the asset down to its estimated fair value. To date, we have not recorded any impairment charges.
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 primarily consists of revenue earned from product maintenance agreements with some additional revenue from instrument lease agreements and grant revenue.
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. Taxes we collect concurrent with revenue-producing activities are excluded from revenue.
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 (“SSP”). The SSP is determined based on observable prices at which we separately sell the products and services. If a SSP is not directly observable, then we will estimate the SSP 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.
Contract liabilities and contract assets - Contract liabilities consist of deferred revenue. We record deferred revenues when cash payments are received or due in advance of our performance for product maintenance agreements. Deferred revenue is recognized over the related performance period, generally one to three years, on a straight-line basis as we are standing ready to provide services and a time-based measure of progress best reflects the satisfaction of the performance obligation.
As of December 31, 2019, we had a total of $0.6 million of deferred commissions included in “Prepaid expenses and other current assets” which is recognized as the related revenue is recognized. Additionally, as a practical expedient, we expense costs to obtain a contract as such costs are incurred if the amortization period would have been a year or less.
Contract assets as of December 31, 2019 and December 31, 2018 were not material.
Instrument lease agreements - Instrument leases are generally classified as operating-type leases and revenue from these leases is recognized on a straight-line basis over the respective lease term, once the lessee takes (or has the right to take) control/possession of the property under the lease. Effectively, this occurs once the installation is complete and control of the instrument is transferred to our customers.
Other practical expedients and exemptions - Customers generally are invoiced upon acceptance of the system, which is also the start of the one-year service period. As such, there is typically not more than a one-year difference between the receipt of cash and the provision of services. Therefore, we apply the practical expedient and do not account for any potential significant financing benefit. However, it is noted that some customers will pre-order extended service periods at the time of the initial system sale. These customers may choose to make quarterly or annual payments or prepay multiple years of service upfront but there is no pricing difference between these different payment options. As such, no significant financing component is believed to exist with any of our existing arrangements.
Cost of Revenue
Cost of revenue reflects the direct cost of product components, third-party manufacturing services and our internal manufacturing overhead and customer service infrastructure costs incurred to produce, deliver, maintain and support our instruments, consumables, and services. There are no incremental costs associated with our contractual revenue; all product development costs are reflected in research and development expense.
Manufacturing overhead is predominantly comprised of labor and facility costs. We determine and capitalize manufacturing overhead into inventory based on a standard cost model that approximates actual costs.
Service costs include the direct costs of components used in support, repair and maintenance of customer instruments as well as the cost of personnel, materials, shipping and support infrastructure necessary to support our installed customer base.
Research and Development
Research and development expense consists primarily of expenses for personnel engaged in the development of our SMRT Sequencing technology, the design and development of our future products and current product enhancements. These expenses also
include prototype-related expenditures, development equipment and supplies, facilities costs and other related overhead. We expense research and development costs during the period in which the costs are incurred. However, we defer and capitalize non-refundable advance payments made for research and development activities until the related goods are received or the related services are rendered.
Operating Leases
We lease administrative, manufacturing and laboratory facilities under operating leases. Lease agreements may include rent holidays, rent escalation clauses and tenant improvement allowances. We recognize scheduled rent increases on a straight-line basis over the lease term beginning with the date we take possession of the leased space. Leasehold improvements are capitalized at cost and depreciated over the shorter of their expected useful life or the life of the lease. On January 1, 2019, we adopted ASC 842, which requires the recognition of the right-of-use assets and related operating and finance lease liabilities on the consolidated balance sheet. Prior to that, we recorded tenant improvement allowances as deferred rent liabilities and amortized the deferred rent over the term of the lease to rent expense on the statements of operations and comprehensive loss.
Leases with terms of 12 months or less are expensed on a straight-line basis over the term and are not recorded in the consolidated balance sheets.
Income Taxes
We account for income taxes under the asset and liability method, which requires, among other things, that deferred income taxes be provided for temporary differences between the tax bases of our assets and liabilities and the amounts reported in the financial statements. In addition, deferred tax assets are recorded for the future benefit of utilizing net operating losses and research and development credit carryforwards. A full valuation allowance is provided against our net deferred tax assets as it is more likely than not that the deferred tax assets will not be fully realized.
We review our positions taken relative to income taxes. To the extent our tax positions are more likely than not going to result in additional taxes, we would accrue the estimated amount of tax related to such uncertain positions.
Stock-based Compensation
Stock-based compensation expense for all stock-based compensation awards, including stock options, restricted stock units, and shares issued under the 2010 Employee Stock Purchase Plan (“ESPP”), is based on the grant date fair value. The fair value for restricted stock units is based on grant date stock price, the fair value for stock option and ESPP shares is estimated using the Black-Scholes option pricing model with assumptions described in detail below:
Expected Term. Starting January 1, 2018, we determined the expected term using historical option experience. We determined expected term based on historical exercise patterns and an expectation of the time it will take for employees to exercise options still outstanding. Prior to 2018, we did not believe that we were able to rely on our historical employee exercise behavior to provide accurate data for estimating our expected term for use in determining the fair value of these options due to limited trading history. Therefore, for the period prior to 2018, the expected term of options is estimated based on the simplified method.
Expected Volatility. Starting January 1, 2018, we estimate the volatility of our common stock at the date of grant based on the historical volatility of our common stock. Prior to 2018, we did not have sufficient trading history to solely rely on the volatility of our own common stock for establishing expected volatility. Therefore, we based our expected volatility on the historical stock volatilities of our common stock as well as several comparable publicly listed companies over a period equal to the expected term of the options.
Risk-Free Rate. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the stock option.
Dividends. We have never paid any cash dividends on our common stock and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model.
Expected Forfeiture Rate. We estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior and other factors. The impact from a forfeiture rate adjustment will be recognized in full in the period of adjustment, and if the actual number of future forfeitures differs from that which was estimated, we may be required to record adjustments to stock-based compensation expense in future periods.
Other Comprehensive Income (loss)
Other comprehensive income (loss) is comprised of unrealized gains (losses) on our investment securities.
Recent Accounting Pronouncements
Recently Issued Accounting Standards
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU simplifies the accounting for income taxes by clarifying and amending existing guidance related to the recognition of franchise tax, the evaluation of a step up in the tax basis of goodwill, and the effects of enacted changes in tax laws or rates in the effective tax rate computation, among other clarifications. The standard will be effective for our annual reporting periods beginning after December 15, 2020, including interim reporting periods within those fiscal years. We are evaluating the impact of adopting this new accounting guidance on our consolidated financial statements.
In August 2018, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. The guidance is effective for annual and interim reporting periods beginning after December 15, 2019. We plan to adopt ASU 2018-13 on January 1, 2020. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and determined it will not have a material impact.
In June 2016, the Financial Accounting Standards Board, or FASB, issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, or ASU 2016-13, which changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which will generally result in earlier recognition of allowances for losses. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019 and early adoption is permitted for annual and interim periods beginning after December 15, 2018. We plan to adopt ASU 2016-13 on January 1, 2020. We have evaluated the effect that this guidance will have on our Consolidated Financial Statements and determined it will not have a material impact.
Recently Adopted Accounting Standards
Adoption of ASU 2018-07
In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, to simplify the accounting for nonemployee share-based payment transactions by expanding the scope of Accounting Standards Codification, or ASC, Topic 718, Compensation - Stock Compensation, to include share-based payment transactions for acquiring goods and services from nonemployees. Under the new standard, most of the guidance on stock compensation payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. We adopted this standard beginning on January 1, 2019 and the adoption of this standard did not have a material impact on our consolidated financial statements for the year ended December 31, 2019.
Adoption of ASU 2018-02
In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, that allows for an entity to elect to reclassify the income tax effects on items within accumulated other comprehensive income resulting from U.S. tax reform to retained earnings. We adopted this standard beginning on January 1, 2019 and the adoption of this standard did not have a material impact on our consolidated financial statements for the year ended December 31, 2019.
Adoption of ASC 842
On January 1, 2019, we adopted the FASB ASC, Topic 842, Leases, or ASC 842, which requires the recognition of the right-of-use assets and related operating and finance lease liabilities on the consolidated balance sheet. As permitted by ASC 842, we elected the adoption date of January 1, 2019, which is the date of initial application. As a result, the consolidated balance sheet prior to January 1, 2019 was not restated and continues to be reported under ASC Topic 840, Leases, or ASC 840, which did not require the recognition of right-of-use or operating lease liabilities on the consolidated balance sheet. The expense recognition for operating leases under ASC 842 is substantially consistent with ASC 840. As a result, there is no significant difference in our results of operations presented in our consolidated statements of operations and comprehensive loss for each period presented.
We adopted ASC 842 using a modified retrospective approach for leases existing at January 1, 2019. The adoption of ASC 842 had a substantial impact on our balance sheet. The most significant impact was the recognition of the operating lease right-of-use assets and the liability for operating leases. Accordingly, adoption of this standard resulted in the recognition of operating lease right-of-use assets of $35.5 million and operating lease liabilities of $49.2 million comprised of $3.4 million of current operating lease liabilities and $45.8 million of non-current operating lease liabilities on the consolidated balance sheet as of January 1, 2019.
As permitted under ASC 842, we elected several practical expedients that permit us:
|
·
|
|
to not reassess whether a contract is or contains a lease;
|
|
·
|
|
to not reassess the lease classification;
|
|
·
|
|
to not reassess the initial direct costs as of the adoption date;
|
|
·
|
|
to not recognize right-of-use assets and lease liabilities for short-term leases that have a term of 12 months or less; and
|
|
·
|
|
to not separate non-lease components for real estate leases.
|
The application of the practical expedients did not have a significant impact on the measurement of the operating lease liabilities.
Service and other revenue can include some revenue from instrument lease agreements. Instrument leases are generally classified as operating-type leases and revenue from these leases is recognized on a straight-line basis over the respective lease term. Lease income was not material in fiscal 2018 or for the year ended December 31, 2019.
Disclosures related to the amount and timing of cash flows arising from operating leases are included in “Leases” section of Note 7. Commitments and Contingencies.
NOTE 4. CASH AND CASH EQUIVALENTS AND INVESTMENTS
The following table summarizes our cash, cash equivalents and investments as of December 31, 2019 and 2018 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2019
|
|
|
|
Gross
|
|
Gross
|
|
|
|
Amortized
|
|
unrealized
|
|
unrealized
|
|
Fair
|
|
Cost
|
|
gains
|
|
losses
|
|
Value
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
Cash and money market funds
|
$
|
18,644
|
|
$
|
—
|
|
$
|
—
|
|
$
|
18,644
|
Commercial paper
|
|
10,983
|
|
|
—
|
|
|
—
|
|
|
10,983
|
Total cash and cash equivalents
|
|
29,627
|
|
|
—
|
|
|
—
|
|
|
29,627
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
16,971
|
|
|
1
|
|
|
(1)
|
|
|
16,971
|
Corporate debt securities
|
|
2,496
|
|
|
5
|
|
|
—
|
|
|
2,501
|
Total investments
|
|
19,467
|
|
|
6
|
|
|
(1)
|
|
|
19,472
|
Total cash, cash equivalents and investments
|
$
|
49,094
|
|
$
|
6
|
|
$
|
(1)
|
|
$
|
49,099
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term restricted cash:
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
4,000
|
|
$
|
—
|
|
$
|
—
|
|
$
|
4,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2018
|
|
|
|
Gross
|
|
Gross
|
|
|
|
Amortized
|
|
unrealized
|
|
unrealized
|
|
Fair
|
|
Cost
|
|
gains
|
|
losses
|
|
Value
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
Cash and money market funds
|
$
|
18,844
|
|
$
|
—
|
|
$
|
—
|
|
$
|
18,844
|
Total cash and cash equivalents
|
|
18,844
|
|
|
—
|
|
|
—
|
|
|
18,844
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
53,493
|
|
|
—
|
|
|
(24)
|
|
|
53,469
|
Corporate debt securities
|
|
10,223
|
|
|
3
|
|
|
(12)
|
|
|
10,214
|
US government & agency securities
|
|
19,830
|
|
|
—
|
|
|
(3)
|
|
|
19,827
|
Total investments
|
|
83,546
|
|
|
3
|
|
|
(39)
|
|
|
83,510
|
Total cash, cash equivalents and investments
|
$
|
102,390
|
|
$
|
3
|
|
$
|
(39)
|
|
$
|
102,354
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term restricted cash:
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
4,500
|
|
$
|
—
|
|
$
|
—
|
|
$
|
4,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the contractual maturities of our cash equivalents and available-for-sale investments, excluding money market funds, as of December 31, 2019:
|
|
|
|
|
|
(in thousands)
|
Fair Value
|
Due in one year or less
|
$
|
30,455
|
Due after one year through five years
|
|
—
|
Total
|
$
|
30,455
|
|
|
|
Substantially all of our marketable debt investments are classified as current based on the nature of the investments and their availability for use in current operations.
Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without call or prepayment penalties.
NOTE 5. BALANCE SHEET COMPONENTS
Inventory
As of December 31, 2019 and 2018, our inventory consisted of the following components:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
(in thousands)
|
2019
|
|
2018
|
Purchased materials
|
$
|
3,966
|
|
$
|
6,222
|
Work in process
|
|
4,594
|
|
|
7,341
|
Finished goods
|
|
4,752
|
|
|
4,315
|
Inventory
|
$
|
13,312
|
|
$
|
17,878
|
For the year ended December 31, 2019, approximately $5.1 million and $0.5 million of inventory reserves due to excess or obsolesce were charged to cost of goods and cost of service, respectively. For the year ended December 31, 2018 approximately $2.0 million and $0.1 million of inventory reserves due to excess or obsolesce were charged to cost of goods and cost of service, respectively.
Property and Equipment, Net
As of December 31, 2019 and 2018, our property and equipment, net, consisted of the following components:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
(in thousands)
|
2019
|
|
2018
|
Laboratory equipment and machinery
|
$
|
25,173
|
|
$
|
24,111
|
Leasehold improvements
|
|
29,902
|
|
|
29,821
|
Computer equipment
|
|
11,851
|
|
|
9,484
|
Software
|
|
4,747
|
|
|
4,734
|
Furniture and fixtures
|
|
2,422
|
|
|
2,422
|
Construction in progress
|
|
193
|
|
|
608
|
|
|
74,288
|
|
|
71,180
|
Less: Accumulated depreciation
|
|
(44,218)
|
|
|
(37,107)
|
Property and equipment, net
|
$
|
30,070
|
|
$
|
34,073
|
Depreciation expense during the years ended December 31, 2019, 2018 and 2017was $7.3 million, $7.2 million and $8.4 million, respectively.
Accrued Expenses
As of December 31, 2019 and 2018, our accrued expenses consisted of the following components:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
(in thousands)
|
2019
|
|
2018
|
Salaries and benefits
|
$
|
9,748
|
|
$
|
8,523
|
Accrued product development costs
|
|
67
|
|
|
561
|
Accrued Tenant Improvements for Menlo Park building
|
|
998
|
|
|
694
|
Inventory accrual
|
|
229
|
|
|
499
|
Accrued professional services and legal fees
|
|
943
|
|
|
1,588
|
Other
|
|
1,257
|
|
|
958
|
Accrued expenses
|
$
|
13,242
|
|
$
|
12,823
|
Deferred Revenue
As of December 31, 2019, we had a total of $9.6 million of deferred revenue from our service contracts, $7.6 million of which was recorded as “deferred revenue, current” to be recognized over the next year and the remaining $2.0 million was recorded as “deferred revenue, non-current” to be recognized in the next 2 to 4 years.
Revenue recognized during the year ended December 31, 2019 includes $6.5 million of previously deferred revenue that was included in “deferred revenue, current” as of December 31, 2018.
NOTE 6. NOTES PAYABLE
Facility Agreement
Under the terms of the Facility Agreement, we received $20.5 million and issued promissory notes in the aggregate principal amount of $20.5 million. The Notes bear simple interest at a rate of 8.75% per annum, payable quarterly in arrears commencing on April 1, 2013 and on the first business day of each January, April, July and October thereafter. The Facility Agreement has a maximum term of seven years. We received net proceeds of $20.0 million, representing $20.5 million of gross proceeds, less a $500,000 facility fee, before deducting other expenses of the transaction. On June 23, 2017, pursuant to a partial exercise by the Notes holders of their right to elect to receive up to 25% of the net proceeds from any financing that includes an equity component, we paid $4.5 million of outstanding principal, together with accrued and unpaid interest, to one of the Note holders with proceeds from our underwritten public equity offering. As of December 31, 2019, a balance of $16.0 million aggregate principal amount of debt remained outstanding under the Facility Agreement and presented as “Notes payable, current” on the consolidated balance sheet as of December 31, 2019
The Facility Agreement also contained various representations and warranties, and affirmative and negative covenants, customary for financings of this type, including restrictions on our ability to incur additional indebtedness or liens on our assets, except as permitted under the Facility Agreement. In addition, the Facility Agreement required us to maintain consolidated cash and cash equivalents on the last day of each calendar quarter of not less than $2.0 million. As security for our repayment of our obligations under the Facility Agreement, we granted the lenders a security interest in substantially all of our property and interests in property.
Subject to certain exceptions set forth in the Facility Agreement, holders representing a majority of the aggregate principal amount of the outstanding Notes issued pursuant to the Facility Agreement could elect to receive up to 25% of the net proceeds from any financing that includes an equity component. To the extent that we raise additional capital in the future through the sale of common stock, including without limitation, sales of common stock pursuant to an “at-the-market” offering program, we may be obligated, at the election of the holders of the Notes, to pay 25% of the net proceeds from any such financing activities as partial payment of the Notes.
In February 2020, we repaid the remaining outstanding principal of $16.0 million and interest to Deerfield and the Facility Agreement was terminated.
Financing Derivative
A number of features embedded in the Notes required accounting for as a derivative, including the indemnification of certain withholding taxes and the acceleration of debt upon (i) a qualified financing, (ii) an event of default, (iii) a Major Transaction (as such term is defined in the Facility Agreement), and (iv) the exercise of the warrant via offset to debt principal. These features represent a single derivative (the “Financing Derivative”) that was bifurcated from the debt instrument and accounted for as a liability at fair value, with changes in fair value between reporting periods recorded in other income (expense), net.
The estimated fair value of the Financing Derivative was determined by comparing the difference between the fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using a 6.5% and 9.6% weighted average market yield at December 31, 2019 and 2018, respectively. The estimated fair value of the Financing Derivative as of December 31, 2019 and 2018 were $0 and $16,000, respectively.
As of both December 31, 2019 and December 31, 2018, we had an outstanding principal amount of $16.0 million for the Notes, net of debt discount of $0.2 million and $1.3 million, respectively, resulting in a net $15.8 million and $14.7 million recorded as “Notes payable, current” and Notes payable, non-current” on the consolidated balance sheets as of December 31, 2019 and 2018, respectively, with repayment of all outstanding principal due in 2020.
In February 2020, we repaid the remaining outstanding principal of $16.0 million and interest to Deerfield and the debt agreement was terminated.
As of December 31, 2019, payments due under the Facility Agreement, which include interest and principal, are as follows:
|
|
|
|
Amount
|
Years ending December 31,
|
(in thousands)
|
2020
|
$
|
16,491
|
Total remaining payments
|
|
16,491
|
Less: interest and discounts
|
|
(620)
|
Notes payable
|
$
|
15,871
|
NOTE 7. COMMITMENTS AND CONTINGENCIES
Lease
As of January 1, 2019, we leased approximately 180,000 square feet in 1305 O’Brien Drive, Menlo Park, California, where we house our headquarters, research and development, service and support functions, and our in-house manufacturing operations for which the right of use assets totaled $35.3 million. We also leased a sales office facility in Singapore and engineering support facilities in Allen, Texas for which the right of use assets totaled $0.2 million as of January 1, 2019.
On July 22, 2015, we entered into a lease agreement with respect to our facility located at 1305 O’Brien Drive, Menlo Park, California. The term of the O’Brien Lease is one hundred thirty-two (132) months. In December 2016, we entered into an amendment to the O’Brien Lease which defined the commencement date of the lease to be October 25, 2016, notwithstanding that such substantial completion did not occur until the first quarter of 2017. Base monthly rent was abated for the first six (6) months of the lease term and thereafter was $540,000 per month during the first year of the lease term, with specified annual increases thereafter until reaching $711,000 per month during the last twelve (12) months of the lease term. If the rent is not received within five days of the due date there will be an additional sum equal to 5% of the amount overdue as a late charge. Any amount not paid within 10 days after receipt of landlord’s written notice will bear interest from the date due until paid, at the lesser rate of (1) the prime rate of interest as published in the Wall Street Journal, plus 2% or (2) the maximum rate allowed by law, in addition to the late payment charge. We were required to establish a letter of credit for the benefits of the landlord and to submit $4.5 million as a deposit for the letter of credit in October 2015. Subsequently pursuant to the terms of the O’Brien Lease, at May 1, 2019, the $4.5 million in restricted cash was reduced to $4.0 million. As such, $4.0 million and $4.5 million was recorded in “Long-term restricted cash” in the consolidated balance sheet as of December 31, 2019 and 2018, respectively. Pursuant to the terms of the O’Brien Lease, the letter of credit balance of $4.0 million at December 31, 2019 will be reduced again in May 2020 by $500,000.
All of our leases are operating leases. Operating lease assets and liabilities are reflected within “Operating lease right-of-use assets, net”, “Operating lease liabilities, current” and “Operating lease liabilities, non-current” on the consolidated balance sheets. These assets and liabilities are recognized at the commencement date based on the present value of remaining minimum lease payments over the lease term using our estimated secured incremental borrowing rates at the effective date of January 1, 2019. Lease payments included in the measurement of the lease liability comprise the base rent per the term of the Lease. Lease expense for these leases is recognized on a straight-line basis over the lease term, with variable lease payments, such as common area maintenance fees, recognized in the period those payments are incurred.
We often have options to renew lease terms for buildings. For the O’Brien Lease, the renewal option is 5 years and the rent will be based on fair market value at the time of renewal and was not included in the lease term. In addition, certain lease arrangements may be terminated prior to their original expiration date at our discretion. We evaluate renewal and termination options at the lease commencement date to determine if we are reasonably certain to exercise the option on the basis of economic factors. The weighted average remaining lease term for our operating leases as of December 31, 2019 was 7.8 years.
The discount rate implicit within our leases is generally not determinable and therefore we determine the discount rate based on our incremental borrowing rate. The incremental borrowing rate for our leases is determined based on lease term and currency in which lease payments are made, adjusted for impacts of collateral. The weighted average discount rate used to measure our operating lease liabilities as of December 31, 2019 was 7.9%.
The following table presents information as to the amount and timing of cash flows arising from our operating leases as of December 31, 2019:
|
|
|
|
|
|
Maturity of Lease Liabilities
|
Amount
|
Years ending December 31,
|
(in thousands)
|
2020
|
$
|
7,150
|
2021
|
|
7,306
|
2022
|
|
7,488
|
2023
|
|
7,704
|
2024
|
|
7,920
|
Thereafter
|
|
23,598
|
Total undiscounted operating lease payments
|
|
61,166
|
Less: imputed interest
|
|
(15,365)
|
Present value of operating lease liabilities
|
$
|
45,801
|
|
|
|
Balance Sheet Classification
|
|
|
Operating lease liabilities, current
|
$
|
3,837
|
Operating lease liabilities, non-current
|
|
41,964
|
Total operating lease liabilities
|
$
|
45,801
|
Cash Flows
An initial right-of-use asset of $35.5 million was recognized on the consolidated balance sheet as of January 1, 2019 with the adoption of the new lease accounting standard. Cash paid for amounts included in the present value of operating lease liabilities was $7.0 million for the year ended December 31, 2019 and included in operating cash flow.
Operating Lease Costs
Operating lease costs were $6.2 million for the year ended December 31, 2019, primarily related to our operating leases, but also include immaterial amounts for variable lease payments.
Rent expense for the years ended December 31, 2019, 2018 and 2017 was $6.2 million, $6.2 million and $6.3 million, respectively. We are also required to pay our share of operating expenses with respect to the facilities in which we operate.
Contingencies
We may become involved in legal proceedings, claims and assessments from time to time in the ordinary course of business. We accrue liabilities for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.
In addition, we had other purchase commitments of an estimated amount of approximately $15.5 million as of December 31, 2019, consisting 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, and acquisition and licensing of intellectual property. 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.
Legal Proceedings
USITC Proceedings
On November 2, 2016, we filed a complaint against Oxford Nanopore Technologies Ltd. (“ONT Ltd.”), Oxford Nanopore Technologies, Inc. (“ONT Inc.”) and Metrichor, Ltd. (“Metrichor” and, together with ONT Ltd. and ONT Inc., “ONT”) with the U.S. International Trade Commission (“USITC”) for patent infringement. On December 5, 2016, the USITC provided notice that an investigation had been instituted based on the complaint. We sought exclusionary relief with respect to several ONT products, including ONT’s MinION and PromethION devices. The complaint was based on our U.S. Patent No. 9,404,146, entitled “Compositions and methods for nucleic acid sequencing” which covers novel methods for sequencing single nucleic acid molecules using linked double-stranded nucleic acid templates, providing improved sequencing accuracy. On March 1, 2017, we filed an amended complaint to add a second patent in the same patent family, U.S. Patent No. 9,542,527, which was granted on January 10, 2017, to the investigation. We sought, among other things, an exclusion order permanently barring entry of infringing ONT products into the United States, and a cease and desist order preventing ONT from advertising and selling infringing products in the United States. On May 23, 2017, the Administrative Law Judge (“ALJ”) assigned to the matter issued an order construing certain claim terms of the asserted patents. On June 8, 2017, ONT filed a summary determination motion to terminate the proceedings based on the ALJ’s claim construction decision, and we did not oppose the motion. The ALJ granted the motion on July 19, 2017, and, on July 31, 2017, we filed a petition to review with the USITC to correct what we believe was an incorrect construction of the claims. On September 5, 2017, the USITC issued a notice granting our petition to review the ALJ’s claim construction decision. On February 7, 2018, the USITC issued a notice indicating that it had determined to adopt the ALJ’s claim construction and terminating the investigation. On February 13, 2018, we filed a petition to appeal the USITC’s ruling to the U.S. Court of Appeals for the Federal Circuit. (“Federal Circuit”). An oral hearing for this appeal was held on February 8, 2019. On February 12, 2019, the Federal Circuit filed a judgement affirming the USITC claim construction under Federal Circuit Rule 36 without a written opinion.
U.S. District Court Proceedings
On March 15, 2017, we filed a complaint in the U.S. District Court for the District of Delaware against ONT Inc. for patent infringement (C.A. No. 17-cv-275 (“275 Action”)). The complaint is based on our U.S. Patent No. 9,546,400 (the “’400 Patent”), entitled “Nanopore sequencing using n-mers” which covers novel methods for nanopore sequencing of nucleic acid molecules using the signals from multiple monomeric units. This patent was granted on January 17, 2017. We are seeking remedies including injunctive relief, damages and costs. On August 23, 2018, we filed an amended complaint, adding ONT Ltd. as a defendant in the 275 Action. On August 15, 2019, the judge granted our motion to amend the complaint in the 275 Action to add allegations of willful infringement by ONT Inc. and ONT Ltd.
On September 25, 2017, we filed a second complaint in the U.S. District Court for the District of Delaware against ONT Inc. for patent infringement (C.A. No. 17-cv-1353 (“1353 Action”)). The complaint is based on our U.S. Patent No. 9,678,056 (the “’056 Patent”) entitled “Control of Enzyme Translation in Nanopore Sequencing”, granted June 13, 2017, and U.S. Patent No. 9,738,929 (the “’929 Patent”) entitled “Nucleic Acid Sequence Analysis”, granted August 22, 2017. We are seeking remedies including injunctive relief, damages and costs. On March 28, 2018, we added a claim for infringement of our U.S. Patent No. 9,772,323 (the “’323 Patent”), entitled
“Nanopore sequencing using n-mers.” On August 23, 2018 we filed an amended complaint, adding ONT Ltd. as a defendant in the 1353 Action. On August 15, 2019, the judge granted our motion to amend the complaint in the 1353 Action to add allegations of willful infringement by ONT Inc. and ONT Ltd.
A claim construction (or “Markman”) hearing for the U.S. District Court matters was held on December 17, 2018. On March 6, 2019, a claim construction order construing various claim terms in the patents in suit was issued. On January 8, 2020, the Court held a summary judgement and expert testimony admissibility (or “Daubert”) hearing. On February 19, 2020, the Court issued its summary judgement and Daubert opinions. All of our claims survived summary judgement. A trial for the U.S. District Court matters is scheduled to begin on March 9, 2020.
Unrelated to the preceding matters, on September 26, 2019, Personal Genomics of Taiwan, Inc. (“PGI”) filed a complaint in the U.S. District Court for the District of Delaware against us for patent infringement (C.A. No. 19-cv-1810). The complaint is based on PGI’s U.S. Patent No. 7,767,441. We plan to vigorously defend in this matter. On November 20, 2019, we filed our answer to the complaint, denying infringement and seeking a declaratory judgement of invalidity of the ‘441 Patent. A trial for this matter is scheduled to begin on March 14, 2022.
UK and German Court Proceedings
On February 2, 2017, we filed a claim in the High Court of England and Wales against ONT Ltd. and Metrichor for infringement of Patent EP(UK) 3 045 542 (the “’542 Patent”), which is in the same patent family as the patents asserted in the USITC action referred to above. We sought remedies including injunctive relief, damages, and costs. On August 31, 2017, we added a claim for infringement of a newly granted divisional, EP(UK) 3 170 904 (the “’904 Patent”). On December 22, 2017, ONT Ltd. added to the action a request for declaration of non-infringement of its 1D2 product. A trial for these matters was scheduled to occur in May 2018.
On April 21, 2017, ONT Ltd. and Harvard University filed a claim against us in the High Court of England and Wales for infringement of Patent EP(UK) 1 192 453 (the “’453 Patent”), a patent owned by Harvard University and entitled “Molecular and atomic scale evaluation of biopolymers,” and for which ONT Ltd. alleges it holds an exclusive license. ONT Ltd. and Harvard University sought remedies including injunctive relief, damages, and costs. On April 25, 2017, ONT Ltd. announced that it also had filed a claim against us in the District Court of Mannheim, Germany, for infringement of the German version of the patent. On December 6, 2017, we filed a cross-complaint in the German infringement matter alleging ONT Ltd.’s infringement in Germany of our ’542 Patent. The trial date for the German infringement matter and cross-complaint was set for July 27, 2018. A trial for the UK matter was scheduled to occur in March 2019.
On May 8, 2018, the parties entered a settlement of all UK and German court proceedings pending as of such date. Under the terms of the settlement, ONT agreed not to make, dispose of, use or import any “2D” nanopore sequencing products, or to induce or assist others to carry out a “2D” sequencing process, in the UK or Germany, through the end of 2023. During this time, we agreed not to assert the ’542 Patent and ’904 Patent against either ONT or its customers in the UK or Germany. Accordingly, the High Court of England and Wales entered an order staying our UK action against ONT through the end of 2023. As part of the settlement, ONT and Harvard University dismissed their UK and German actions under the ’453 Patent and agreed not to assert the ’453 Patent against us or our customers through the end of 2023. We correspondingly agreed to dismiss our separate German nullity action seeking to invalidate the ’453 Patent, which expires on June 22, 2020.
Related to these proceedings, on August 15, 2017, ONT Ltd. filed a notice of opposition to our ’542 Patent with the European Patent Office, and on August 16, 2017, an anonymous party filed a second notice of opposition to the same patent, each alleging invalidity of the patent. On April 5, 2018, we filed our response to the combined opposition. On January 22, 2019, an oral hearing in the matter occurred and the European Patent Office rendered a decision in favor of the opponents. We believe the European Patent Office errored in its decision and we are appealing the decision. The ’542 Patent will remain in effect while the appeal is pending. Our settlement agreement with ONT Ltd. and Harvard University will also remain in effect regardless of the outcome of the appeal.
Also related to these proceedings, on May 16, 2018, ONT Ltd. filed a notice of opposition to our ’904 Patent with the European Patent Office alleging invalidity of the ’904 Patent. On October 11, 2018, we filed our response to the opposition. On July 16, 2019, an oral hearing in the matter occurred and the European Patent Office rendered a decision in favor of the opponents. We believe the European Patent Office erred in its decision and we are appealing the decision. The ’904 Patent will remain in effect while the appeal is pending. Our settlement agreement with ONT Ltd. and Harvard University will also remain in effect regardless of the outcome of the appeal.
Litigation is inherently unpredictable, and, except for events that have already occurred, it is too early in the foregoing proceedings, including the U.S. District Court Proceedings, to predict the outcome of these proceedings, or any impact they may have on us. As such, the estimated financial effect associated with these complaints cannot be made as of the date of filing of this Annual Report on Form 10-K. Litigation is a significant ongoing expense with an uncertain outcome, and has been in the past and may in the future be a material expense for us. Management believes this investment is important to protect our intellectual property position, even recognizing the uncertainty of the outcome.
Other Proceedings
From time to time, we may also be involved in a variety of other claims, lawsuits, investigations and proceedings relating to securities laws, product liability, patent infringement, contract disputes, employment and other matters that arise in the normal course of
our business. In addition, third parties may, from time to time, assert claims against us in the form of letters and other communications. We record a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. We currently do not believe that the ultimate outcome of any of the matters described above is probable or reasonably estimable, or that these matters will have a material adverse effect on our business; however, the results of litigation and claims are inherently unpredictable. Regardless of the outcome, litigation can have an adverse impact on us because of litigation and settlement costs, diversion of management resources and other factors.
Indemnification
Pursuant to Delaware law and agreements entered into with each of our directors and officers, we may have obligations, under certain circumstances, to hold harmless and indemnify each of our directors and officers against losses suffered or incurred by the indemnified party in connection with their service to us, and judgements, fines, settlements and expenses related to claims arising against such directors and officers to the fullest extent permitted under Delaware law, our bylaws and certificate of incorporation. 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 fund raising 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 such third parties and us in connection with such fund raising efforts. To the extent that any such indemnification obligations apply to the lawsuits described above, any associated expenses incurred are included within the related accrued litigation expense amounts. No additional liability associated with such indemnification obligations has been recorded at December 31, 2019.
NOTE 8. INCOME TAXES
We are subject to income taxes in the United States and certain states in which we operate, and we use estimates in determining our provisions for income taxes. Significant management judgement is required in determining our provision for income taxes, deferred tax assets and liabilities and valuation allowances recorded against net deferred tax assets in accordance with U.S. GAAP. These estimates and judgements occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in the current or subsequent period.
We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position’s sustainability and is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and we will determine whether the factors underlying the sustainability assertion have changed and the amount of the recognized tax benefit is still appropriate.
During the years ended December 31, 2019, 2018 and 2017 income before taxes from U.S. operations were ($84.8) million, ($103.1) million and ($92.7) million, respectively, and income before taxes from foreign operations was $0.9 million, $0.8 million and $1.0 million, respectively.
Income tax provision (benefit) related to continuing operations differ from the amounts computed by applying the statutory income tax rate of 21% to pretax loss as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
2019
|
|
|
2018
|
|
|
2017
|
|
Statutory tax rate
|
21.0
|
%
|
|
21.0
|
%
|
|
35.0
|
%
|
State tax rate, net of federal benefit
|
4.9
|
|
|
3.5
|
|
|
8.6
|
|
Stock-based compensation
|
(0.8)
|
|
|
(1.6)
|
|
|
(1.9)
|
|
Tax credits
|
2.2
|
|
|
2.0
|
|
|
3.6
|
|
Remeasurement of deferred taxes due to tax reform
|
-
|
|
|
-
|
|
|
(123.3)
|
|
Other
|
0.2
|
|
|
(0.1)
|
|
|
0.3
|
|
Change in valuation allowance
|
(27.5)
|
|
|
(24.8)
|
|
|
77.7
|
|
Total
|
-
|
%
|
|
-
|
%
|
|
-
|
%
|
Deferred income taxes reflect the net tax effects of loss and credit carry forwards and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets for federal and state income taxes are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
Deferred tax assets:
|
2019
|
|
2018
|
Net operating loss carryforwards
|
$
|
226,911
|
|
$
|
212,424
|
Research and development credits
|
|
45,853
|
|
|
42,635
|
Accruals and reserves
|
|
8,024
|
|
|
4,774
|
Stock-based compensation
|
|
16,219
|
|
|
14,582
|
Deferred rent
|
|
—
|
|
|
3,315
|
ASC842 Operating lease liability
|
|
10,837
|
|
|
—
|
Total deferred tax assets
|
|
307,844
|
|
|
277,730
|
Less: Valuation allowance
|
|
(298,658)
|
|
|
(275,540)
|
Total deferred tax assets:
|
|
9,186
|
|
|
2,190
|
Fixed assets
|
|
(1,425)
|
|
|
(2,190)
|
ASC842 Operating lease right-of-use assets
|
|
(7,761)
|
|
|
—
|
Total deferred tax liabilities
|
|
(9,186)
|
|
|
(2,190)
|
Net deferred tax assets
|
$
|
—
|
|
$
|
—
|
At December 31, 2019, we maintained a full valuation allowance against all of our deferred tax assets which totaled $298.7 million, including net operating loss carryforwards and research and development credits of $226.9 million and $45.9 million, respectively.
Due to uncertainties surrounding the realization of deferred tax assets through future taxable income, we have provided a full valuation allowance and, therefore, have not recognized any benefits from net operating losses and other deferred tax assets.
A valuation allowance is recorded when it is more likely than not that all or some portion of the deferred income tax assets will not be realized. We regularly assess the need for a valuation allowance against our deferred income tax assets by considering both positive and negative evidence related to whether it is more likely than not that our deferred income tax assets will be realized. In evaluating our ability to recover our deferred income tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred income tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. Accordingly, we have provided a full valuation allowance against our net deferred tax assets as of December 31, 2019 and 2018, respectively.
For the year ended December 31, 2019 and 2018, our valuation allowance increased to $298.7 million and 275.5 million, respectively, primarily because of an increase to our net operating losses, and credits and changes in book to tax timing differences.
As of December 31, 2019, we had a net operating loss carryforward for federal income tax purposes of approximately $889.6 million, portion of which will begin to expire in 2024. We had a total state net operating loss carryforward of approximately $609.4 million, which have expiration dates of 2025 and beyond. Utilization of some of the federal and state net operating loss and credit carryforwards are subject to annual limitations due to the “change of ownership” provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitations may result in the expiration of net operating losses and credits before utilization.
We have federal credits of approximately $36.4 million, which will begin to expire in 2024 if not utilized and state research credits of approximately $36.8 million which have no expiration date. These tax credits are subject to the same limitations discussed above.
As of December 31, 2019, our total unrecognized tax benefit was $22.0 million.
A reconciliation of the beginning and ending unrecognized tax benefit balance is as follows (in thousands):
|
|
|
|
|
|
Balance as of December 31, 2016
|
$
|
16,785
|
Decrease in balance related to tax positions taken in prior year
|
|
—
|
Increase in balance related to tax positions taken during current year
|
|
2,001
|
Balance as of December 31, 2017
|
|
18,786
|
Decrease in balance related to tax positions taken in prior year
|
|
—
|
Increase in balance related to tax positions taken during current year
|
|
1,661
|
Balance as of December 31, 2018
|
$
|
20,447
|
Decrease in balance related to tax positions taken in prior year
|
|
—
|
Increase in balance related to tax positions taken during current year
|
|
1,532
|
Balance as of December 31, 2019
|
$
|
21,979
|
Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of December 31, 2019 and 2018, we had no accrued interest or penalties due to our net operating losses available to offset any tax adjustment. If total unrecognized tax benefits were realized in the future, it would not result in any tax benefit as we currently have a full valuation allowance. We file U.S. federal and various state income tax returns. For U.S. federal and state income tax purposes, the statute of limitations currently remains open for the years ending December 31, 2016 to present and December 31, 2015 to present, respectively. In addition, all of the net operating losses and research and development credit carryforwards that may be utilized in future years may be subject to examination. We are not currently under examination by income tax authorities in any jurisdiction.
On December 22, 2017, the 2017 Tax Cuts and Jobs Act (Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018.
NOTE 9. STOCKHOLDERS’ EQUITY
Preferred Stock
Our Certificate of Incorporation, as amended and restated in October 2010 in connection with the closing of our initial public offering, authorizes us to issue 1,000,000,000 shares of $0.001 par value common stock and 50,000,000 shares of $0.001 par value preferred stock. As of December 31, 2019 and 2018, there were no shares of preferred stock issued or outstanding.
Common Stock
Common stockholders are entitled to dividends when and if declared by our board of directors. There have been no dividends declared to date. The holder of each share of common stock is entitled to one vote.
“At-the-Market” Offering
For the year ended December 31, 2017, we issued 3.2 million shares of our common stock at an average price of $3.86 per share through our “at-the-market” offering program, resulting in net proceeds of $11.9 million.
We terminated our “at-the-market” offering program in June 2017. We paid a commission equal to 3% of the gross proceeds from the sale of shares of our common stock under the sales agreement.
Underwritten Public Equity Offerings
In August 2017, we filed a shelf registration statement on Form S-3 with the SEC pursuant to which we may, from time to time, sell up to an aggregate of $150.0 million of our common stock, preferred stock, depository shares, warrants, units or debt securities. On August 18, 2017, the registration statement was declared effective by the SEC, which allows us to access the capital markets for the three-year period following this effective date.
In June 2017, we issued and sold a total of 17.7 million shares of our common stock at a price to the public of $3.10 per share in an underwritten public offering. We paid a commission equal to 4% of the gross proceeds from the sale of shares of our common stock under the underwriting agreement. The total proceeds to us from the offering, after deducting the underwriting commission and offering expenses, were approximately $52.5 million.
For the year ended December 31, 2018, we issued 30.6 million shares of our common stock through our two underwritten public offerings with an average offering price of $3.38 per share. The total net proceeds to us from the two offerings, after deducting the underwriting commissions and offering expenses, were approximately $97.5 million.
Subject to certain exceptions set forth in the Facility Agreement, holders of our Notes may elect to receive up to 25% of the net proceeds from financing activities that include an equity component as prepayment of the Notes to be applied first, to accrued and unpaid interest and second, to principal. However, in both February 2018 and September 2018, holders representing a majority of the aggregate principal amount of the outstanding Notes waived such right in connection with the issuance and sale of shares of common stock in our public offering. In June 2017, pursuant to a partial exercise by the Notes holders of this right, we repaid $4.5 million of outstanding principal, together with accrued and unpaid interest, to one of the Notes holders with proceeds from our underwritten public equity offering.
Equity Plans
As of December 31, 2019, we had two active equity plans: 1) the 2010 Equity Incentive Plan or “2010 Plan” and 2) the 2010 Outside Director Equity Incentive Plan or “2010 Director Plan”, both of which we adopted upon the effectiveness of our initial public offering in October 2010. The 2010 Employee Stock Purchase Plan or “2010 ESPP Plan” was terminated after the completion of the purchase period ended March 1, 2019. Prior to the adoption of these plans, we granted options pursuant to the 2004 Equity Incentive Plan and 2005 Stock Plan. Upon termination of the predecessor plans, the shares available for grant at the time of termination and shares subsequently returned to the plans upon forfeiture or option termination, were transferred to the successor plan in effect at the time of share return. Under the 2010 Plan, with the approval of the Compensation Committee of the Board of Directors, we may grant restricted stock, Restricted Stock Units (“RSU”), stock appreciation rights and new shares of common stock upon exercise of stock options.
2010 Equity Incentive Plan and Outside Director Equity Incentive Plan
Stock options granted under the 2010 Plan may be either Incentive Stock Option (“ISO”) or Non-Qualified Stock Option (“NSO”). ISOs may be granted only to employees. NSOs may be granted to employees, consultants and directors. Stock options under the 2010 Plan may be granted with a term of up to ten years and at prices no less than the fair market value of our common stock on the date of grant. To date, stock options granted to existing employees generally vest over four years on a monthly basis and stock options granted to new employee vest at a rate of 25% upon the first anniversary of the vesting commencement date and 1/48th per month thereafter
Stock options granted under the 2010 Director Plan provide for the grant of NSOs. Stock options under the 2010 Plan may be granted with a term of up to ten years and at prices no less than the fair market value of our common stock on the date of grant. To date, stock options granted to existing directors generally vest over one year on a monthly basis and stock options granted to new directors generally vest over three years at a rate of one-third upon the first anniversary of the vesting commencement date and 1/36th per month thereafter.
As of December 31, 2019 and 2018, we had an aggregate of 20.5 million and 11.3 million shares of common stock, respectively, reserved and available for future issuance under the 2010 Plan and 2010 Director Plan.
In January 2020, an additional 7.7 million shares were reserved under the 2010 Plan and an additional 1.5 million shares were reserved under the 2010 Director Plan.
Stock Options
For the year ended December 31, 2019, no stock options were granted. The following table summarizes stock option activity for the year ended December 31, 2019 (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options Outstanding
|
|
|
Number
|
|
|
|
|
Weighted average
|
|
|
of shares
|
|
Exercise price
|
|
exercise price
|
Balances, December 31, 2018
|
|
25,176
|
|
$
|
1.16 – 16.00
|
|
$
|
5.66
|
Additional shares reserved
|
|
|
|
|
|
|
|
|
Options granted
|
|
—
|
|
|
—
|
|
|
—
|
Options exercised
|
|
(1,199)
|
|
$
|
1.16 – 7.05
|
|
$
|
4.78
|
Options canceled
|
|
(1,280)
|
|
$
|
2.54 – 16.00
|
|
$
|
8.01
|
Balances, December 31, 2019
|
|
22,697
|
|
$
|
1.16 – 16.00
|
|
$
|
5.57
|
The expired options during the year ended December 31, 2019 totaled 0.9 million with exercise price range from $2.54 to $16.00 and a weighted average exercise price per share of $9.90.
The following table summarizes information with respect to stock options outstanding and exercisable under the plans at December 31, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
|
|
|
Weighted average
|
|
|
|
|
|
|
|
|
|
|
|
Number
|
|
remaining contractual
|
|
Weighted average
|
|
Number
|
|
Weighted average
|
|
Exercise price
|
outstanding
|
|
life (Years)
|
|
exercise price
|
|
vested
|
|
exercise price
|
|
$
|
0.00 – 1.60
|
414,207
|
|
2.87
|
|
$
|
1.18
|
|
414,207
|
|
$
|
1.18
|
|
$
|
1.60 – 3.20
|
5,720,080
|
|
6.38
|
|
$
|
2.54
|
|
3,680,040
|
|
$
|
2.54
|
|
$
|
3.20 – 4.80
|
3,110,896
|
|
3.88
|
|
$
|
4.02
|
|
2,858,193
|
|
$
|
4.02
|
|
$
|
4.80 – 6.40
|
5,935,013
|
|
6.12
|
|
$
|
5.46
|
|
4,895,635
|
|
$
|
5.46
|
|
$
|
6.40 – 8.00
|
2,554,434
|
|
5.19
|
|
$
|
7.21
|
|
2,525,441
|
|
$
|
7.21
|
|
$
|
8.00 – 9.60
|
3,061,742
|
|
4.63
|
|
$
|
8.77
|
|
2,938,483
|
|
$
|
8.77
|
|
$
|
9.60 – 11.20
|
1,224,700
|
|
4.94
|
|
$
|
10.20
|
|
1,224,700
|
|
$
|
10.20
|
|
$
|
11.20 – 12.80
|
423,252
|
|
1.08
|
|
$
|
12.10
|
|
423,252
|
|
$
|
12.10
|
|
$
|
12.80 – 14.40
|
163,250
|
|
1.00
|
|
$
|
13.71
|
|
163,210
|
|
$
|
13.71
|
|
$
|
14.40 – 16.00
|
89,000
|
|
0.80
|
|
$
|
15.99
|
|
89,000
|
|
$
|
15.99
|
|
|
|
22,696,574
|
|
5.30
|
|
$
|
5.57
|
|
19,212,161
|
|
$
|
5.90
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value of the outstanding and exercisable options presented in the table above totaled $20.0 million and $14.5 million, respectively. The aggregate intrinsic value represents the total pretax intrinsic value (i.e., the difference between $5.14, our closing stock price on the last trading day of our fourth quarter of 2019 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2019. The aggregate intrinsic value changes at each reporting date based on the fair market value of our common stock. The weighted average remaining contractual life for exercisable options is 4.86 years.
The vested and expected to vest options as of December 31, 2019 totaled 21,231,000, with aggregate intrinsic value of $17.8 million, weighted average exercise price per share of $5.69 and weighted average remaining contractual life of 5.13 years.
The total intrinsic value of stock options exercised during the years ended December 31, 2019, 2018 and 2017 was $2.6 million, $5.3 million and $1.7 million, respectively.
The total fair value of stock options vested during the years ended December 31, 2019, 2018 and 2017 was $2.9 million, $3.9 million and $6.4 million, respectively.
Time-based RSUs
Beginning in the three months ended March 31, 2018, the Compensation Committee of the Board of Directors has approved awards of RSUs with time-based vesting under the 2010 Plan to certain employees. Each RSU represents one equivalent share of our common stock to be awarded after the vesting period. These RSUs vest over four years at a rate of 25% annually. The fair value for these RSUs is based on the closing price of our common stock on the date of grant. We measure compensation expense for these RSUs at fair value on
the date of grant and recognize the expense over the expected vesting period on a straight-line basis. The RSUs do not entitle participants to the rights of holders of common stock, such as voting rights, until the shares are issued. RSUs that are expected to vest are net of estimated future forfeitures.
The following table summarizes the time-based RSUs activity for the year ended December 31, 2019 (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
Weighted average
|
|
Number
|
|
grant date
|
|
of shares
|
|
fair value
|
RSUs outstanding at December 31, 2018
|
371
|
|
$
|
3.20
|
RSUs granted
|
900
|
|
|
7.06
|
RSUs vested
|
(127)
|
|
|
4.35
|
RSUs forfeited
|
(58)
|
|
|
5.86
|
Unvested RSUs outstanding at December 31, 2019
|
1,086
|
|
$
|
6.12
|
For the years ended December 31, 2019, we recognized compensation expense of $4.9 million related to time-based RSUs.
Performance-based RSUs
During 2018, the Compensation Committee of the Board of Directors approved awards of RSUs with performance-based vesting under the 2010 Plan to certain employees. Each RSU represents one equivalent share of our common stock to be awarded upon vesting at the end of the performance periods, if specific performance goals set by the Compensation Committee of the Board of Directors are achieved. No RSUs with performance-based vesting will vest if the performance goals are not met. The fair value of these RSUs is based on the closing price of our common stock on the date of grant. We make a quarterly probability assessment as to whether the performance goals will be achieved. Changes in our assessment of the probability of vesting results in adjustments to stock-based compensation, which may include either a cumulative catch-up of expense or a reduction of expense depending on whether the likelihood of vesting has increased or decreased, that is recognized in the period such determination is made. The RSUs do not entitle participants to the rights of holders of common stock, such as voting rights, until the shares are issued. RSUs that are expected to vest are net of estimated future forfeitures.
The following table summarizes the performance-based RSUs activity for the year ended December 31, 2019 (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
Weighted average
|
|
Number
|
|
grant date
|
|
of shares
|
|
fair value
|
PSUs outstanding at December 31, 2018
|
586
|
|
$
|
2.58
|
PSUs granted
|
—
|
|
|
—
|
PSUs vested
|
(204)
|
|
|
2.57
|
PSUs forfeited
|
(244)
|
|
|
2.57
|
Unvested PSUs outstanding at December 31, 2019
|
138
|
|
$
|
2.63
|
2010 Employee Stock Purchase Plan
We adopted the ESPP in October 2010. Our ESPP permits eligible employees to purchase common stock at a discount through payroll deductions during defined offering periods. Each offering period will generally consist of four purchase periods, each purchase period being approximately six months. The price at which the stock is purchased is equal to the lower of 85% of the fair market value of the common stock at the beginning of an offering period or at the end of a purchase period. Each offering period will generally end and the shares will be purchased twice yearly on March 1 and September 1. If the stock price at the end of the purchase period is lower than the stock price at the beginning of the offering period, that offering period will then be terminated and new offering period comes to place.
For the years ended December 31, 2019, 2018 and 2017, 1,306,329 shares, 1,674,960 shares and 1,289,663 shares of common stock were purchased under the ESPP, respectively. As of December 31, 2019, 3,651,066 shares of our common stock remain available for issuance under our ESPP. Pursuant to the terms of the Merger Agreement, the ESPP was terminated after the completion of the purchase period ended March 1, 2019.
Since the Merger Agreement has been terminated, we will begin offerings under the ESPP again starting with the offering period on March 1, 2020.
The ESPP provides for an annual increase to the shares available for issuance at the beginning of each calendar year equal to 2% of the common shares then outstanding. During January 2020, an additional 3.1 million shares were reserved under the ESPP.
Stock-based Compensation
Total stock-based compensation expense consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2019
|
|
2018
|
|
2017
|
Cost of revenue
|
$
|
1,857
|
|
$
|
3,124
|
|
$
|
2,311
|
Research and development
|
|
7,699
|
|
|
10,076
|
|
|
8,506
|
Sales, general and administrative
|
|
6,845
|
|
|
9,953
|
|
|
9,535
|
Total stock-based compensation expense
|
$
|
16,401
|
|
$
|
23,153
|
|
$
|
20,352
|
As of December 31, 2019 and 2018, $0.3 million and $0.7 million of stock-based compensation cost was capitalized in inventory on our consolidated balance sheets, respectively.
The tax benefit of stock-based compensation expense was immaterial for the years ended December 31, 2019, 2018 and 2017.
Stock Options
We estimated the fair value of employee stock options using the Black-Scholes option pricing model. The fair value of employee stock options is being amortized on a straight-line basis over the requisite service period of the awards. For the year ended December 31, 2019, we did not grant any stock option. For the years ended December 31, 2018 and 2017, the weighted average fair value at grant date per stock option was $1.50 and $3.08, respectively. We recorded stock-based compensation expense for stock options of $11.0 million, $15.5 million and $17.2 million for the years ended December 31, 2019, 2018 and 2017, respectively.
For the years ended December 31, 2019, 2018 and 2017, the fair value of employee stock options was estimated using the following weighted average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
2019
|
|
2018
|
|
2017
|
Expected term (years)
|
|
|
—
|
|
|
5.2 years
|
|
|
6.1 years
|
Expected volatility
|
|
|
—
|
|
|
66.8%
|
|
|
70.0%
|
Risk-free interest rate
|
|
|
—
|
|
|
2.6%
|
|
|
2.1%
|
Dividend yield
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2019, $5.6 million of total unrecognized compensation expense related to stock options was expected to be recognized over a weighted-average period of 1.5 years. Future option grants will increase the amount of compensation expense to be recorded in those future periods.
Cash received from option exercises for the years ended December 31, 2019, 2018 and 2017 was $5.9 million, $6.3 million and $3.6 million, respectively.
ESPP
We estimated the fair value of shares to be issued under the ESPP using the Black-Scholes option pricing model. For the years ended December 31, 2019, 2018 and 2017, weighted average fair value at grant date for shares to be issued under the ESPP was $0, $1.47 and $2.28, respectively. We recorded stock-based compensation expense for ESPP of $0.5 million, $6.8 million and $3.1 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Pursuant to the Merger Agreement, the ESPP was terminated after the completion of the purchase period ended March 1, 2019. As a result, approximately $2.5 million of ESPP expense was accelerated and recognized in the fourth quarter of 2018. In addition, for the year ended December 31, 2019 there were no offerings after March 1, 2019 and as such, there were no new Black-Scholes calculations performed to calculate the fair value of new purchase rights granted for the three months ended March 31, 2019 and for the year ended December 31, 2019.
For the years ended December 31, 2019, 2018 and 2017, the fair value of shares to be issued under the ESPP was estimated using the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
2019
|
|
2018
|
|
2017
|
Expected term (years)
|
|
|
—
|
|
|
0.5 - 2.0
|
|
|
0.5 - 2.0
|
Expected volatility
|
|
|
—
|
|
|
65% - 67%
|
|
|
70.0%
|
Risk-free interest rate
|
|
|
—
|
|
|
1.3%-2.7%
|
|
|
0.8%-1.4%
|
Dividend yield
|
|
|
—
|
|
|
—
|
|
|
—
|
Cash received through the ESPP for the years ended December 31, 2019, 2018 and 2017 was $2.7 million, $3.4 million and $5.3 million, respectively.
NOTE 10. NET LOSS PER SHARE
The following options outstanding, time-based RSUs and performance-based RSUs were excluded from the computation of diluted net loss per share for the periods presented because the effect of including such shares would have been antidilutive:
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
(in thousands)
|
2019
|
|
2018
|
|
2017
|
Options to purchase common stock
|
22,697
|
|
25,176
|
|
25,404
|
RSUs with time-based vesting
|
1,086
|
|
371
|
|
—
|
RSUs with performance-based vesting
|
138
|
|
586
|
|
—
|
NOTE 11. SEGMENT AND GEOGRAPHIC INFORMATION
We are organized as, and operate in, one reportable segment: the development, manufacturing and marketing of an integrated platform for genetic analysis. Our chief operating decision-maker is our Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of evaluating financial performance and allocating resources, accompanied by information about revenue by geographic regions. Our assets are primarily located in the United States of America and not allocated to any specific region and we do not measure the performance of geographic regions based upon asset-based metrics. Therefore, geographic information is presented only for revenue. Revenue by geographic region is based on the ship to address on the customer order.
A summary of our revenue by geographic location for the years ended December 31, 2019, 2018 and 2017 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
(in thousands)
|
2019
|
|
2018
|
|
2017
|
North America
|
$
|
44,681
|
|
$
|
35,598
|
|
$
|
40,641
|
Europe (including the Middle East and Africa)
|
|
19,600
|
|
|
13,958
|
|
|
14,026
|
Asia Pacific
|
|
26,610
|
|
|
29,070
|
|
|
38,801
|
Total
|
$
|
90,891
|
|
$
|
78,626
|
|
$
|
93,468
|
A summary of our revenue by category for the years ended December 31, 2019, 2018 and 2017 is as follows:
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
(in thousands)
|
2019
|
|
2018
|
|
2017
|
Instrument revenue
|
$
|
45,126
|
|
$
|
28,492
|
|
$
|
38,626
|
Consumable revenue
|
|
32,616
|
|
|
37,863
|
|
|
41,404
|
Product revenue
|
|
77,742
|
|
|
66,355
|
|
|
80,030
|
Service and other revenue
|
|
13,149
|
|
|
12,271
|
|
|
13,438
|
Total revenue
|
$
|
90,891
|
|
$
|
78,626
|
|
$
|
93,468
|
NOTE 12. UNAUDITED SELECTED QUARTERLY FINANCIAL DATA
The following tables summarize the unaudited quarterly financial data for the last two fiscal years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2019 Quarter Ended
|
(in thousands, except per share data)
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
Total revenue
|
$
|
16,425
|
|
$
|
24,621
|
|
$
|
21,915
|
|
$
|
27,930
|
|
Total gross profit
|
|
5,117
|
|
|
9,613
|
|
|
6,914
|
|
|
12,932
|
|
Total operating expenses
|
|
35,251
|
|
|
33,993
|
|
|
35,028
|
|
|
30,849
|
|
Loss from operations
|
|
(30,134)
|
|
|
(24,380)
|
|
|
(28,114)
|
|
|
(17,917)
|
|
Gain from Continuation Advances (1)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
18,000
|
|
Net loss
|
|
(30,324)
|
|
|
(24,596)
|
|
|
(29,123)
|
|
|
(91)
|
|
Basic and diluted net loss per share
|
$
|
(0.20)
|
|
$
|
(0.16)
|
|
$
|
(0.19)
|
|
$
|
(0.0)
|
|
Weighted average shares used in computing net loss per share
|
|
151,274
|
|
|
152,776
|
|
|
152,983
|
|
|
153,051
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2018 Quarter Ended
|
(in thousands, except per share data)
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
Total revenue
|
$
|
19,362
|
|
$
|
21,578
|
|
$
|
18,160
|
|
$
|
19,526
|
|
Total gross profit
|
|
7,296
|
|
|
8,862
|
|
|
3,192
|
|
|
5,746
|
|
Total operating expenses
|
|
31,245
|
|
|
30,607
|
|
|
27,862
|
|
|
36,369
|
|
Loss from operations
|
|
(23,949)
|
|
|
(21,745)
|
|
|
(24,670)
|
|
|
(30,623)
|
|
Net loss
|
|
(24,179)
|
|
|
(22,540)
|
|
|
(25,044)
|
|
|
(30,799)
|
|
Basic and diluted net loss per share
|
$
|
(0.20)
|
|
$
|
(0.17)
|
|
$
|
(0.19)
|
|
$
|
(0.21)
|
|
Weighted average shares used in computing net loss per share
|
|
123,768
|
|
|
131,882
|
|
|
135,130
|
|
|
149,314
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) In accordance with the terms of the Merger Agreement, during the fourth quarter of 2019 we received Continuation Advances totaling $18.0 million from Illumina. Please see “Note 2 Termination of Merger with Illumina” for additional information.
NOTE 13. SUBSEQUENT EVENTS
On January 2, 2020, we, Illumina and Merger Subsidiary entered into the Termination Agreement. As part of our agreement to terminate the Merger Agreement, Illumina subsequently paid us a $98.0 million termination fee, from which we expect to pay our financial advisor associated fees of approximately $10 million. In addition, as previously agreed to pursuant to the terms of the Merger Agreement, Illumina paid us additional Continuation Advances of $6 million in January 2020 and $22 million in February 2020 and is scheduled to make a final Continuation Advance to us of $6 million in March 2020. However, pursuant to the Termination Agreement, in the event that, on or prior to September 30, 2020, we enter into a definitive agreement providing for, or consummate, a Change of Control Transaction (as defined in the Termination Agreement), then we will repay the Reverse Termination Fee (without interest) to Illumina in connection with the consummation of such Change of Control Transaction. If such Change of Control Transaction is not consummated by the two-year anniversary of the execution of the definitive agreement for such Change of Control Transaction, then we will not be required to repay the Reverse Termination Fee. In addition, up to the full amount of the Continuation Advances paid to us are repayable without interest to Illumina if, within two years of March 31, 2020, we enter into a Change of Control Transaction or raise at least $100 million in equity in a single transaction or debt financing (may have multiple closings), with the amount repayable dependent on the amount raised by us.
In February 2020, upon the maturity of the Facility Agreement, we repaid the remaining outstanding principal of $16.0 million and interest to Deerfield.