20160331 Q1

Table of Contents



 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2016

Or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission File Number 001-34899

 

Pacific Biosciences of California, Inc.

(Exact name of registrant as specified in its charter)

 

 



 

Delaware

16-1590339

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)



 

1380 Willow Road

Menlo Park, CA 94025

94025

(Address of principal executive offices)

(Zip Code)

(650) 521-8000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes    No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 



 

 

 

Large accelerated filer

Accelerated filer   



 

 

 

Non-accelerated filer

(Do not check if a smaller reporting company)

Smaller reporting company



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  



Number of shares outstanding of the issuer’s common stock as of April 30, 2016:  87,168,677

  


 

Table of Contents

 

TABLE OF CONTENTS







 



PAGE No.



 

PART I. FINANCIAL INFORMATION

 



 

Item 1. Financial Statements (unaudited):

 



 

Condensed Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015 



 

Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three- Month Periods Ended March 31, 2016 and 2015 



 

Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2016 and 2015 



 

Notes to Condensed Consolidated Financial Statements 



 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 

15 



 

Item 3. Quantitative and Qualitative Disclosures About Market Risk 

21 



 

Item 4. Controls and Procedures 

21 



 

PART II. OTHER INFORMATION

 



 

Item 1. Legal Proceedings 

22 



 

Item 1A. Risk Factors 

22 



 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 

37 



 

Item 3. Default Upon Senior Securities 

37 



 

Item 4. Mine Safety Disclosures 

37 



 

Item 5. Other Information 

37 



 

Item 6. Exhibits 

37 



 



 

EXHIBIT INDEX 

39 







2

 


 

Table of Contents

 

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Balance Sheets

(Unaudited)





 

 

 

 

 

 



 

 

 

 

 

 



 

March 31,

 

December 31,

(in thousands except par value amounts)

 

2016

 

2015

Assets

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

20,080 

 

$

33,629 

Investments

 

 

71,451 

 

 

48,641 

Accounts receivable

 

 

8,009 

 

 

5,245 

Inventory

 

 

12,162 

 

 

10,955 

Prepaid expenses and other current assets

 

 

7,351 

 

 

12,071 

Total current assets

 

 

119,053 

 

 

110,541 

Property and equipment, net

 

 

9,093 

 

 

8,548 

Long-term restricted cash

 

 

4,500 

 

 

4,500 

Other long-term assets

 

 

7,529 

 

 

7,518 

Total assets

 

$

140,175 

 

$

131,107 



 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Accounts payable

 

$

4,734 

 

$

4,749 

Accrued expenses

 

 

12,201 

 

 

15,551 

Deferred service revenue, current

 

 

6,371 

 

 

6,815 

Deferred contractual revenue, current

 

 

7,260 

 

 

10,822 

Other liabilities, current

 

 

1,444 

 

 

241 

Total current liabilities

 

 

32,010 

 

 

38,178 

Deferred service revenue, non-current

 

 

882 

 

 

1,143 

Deferred contractual revenue, non-current

 

 

1,278 

 

 

1,312 

Other liabilities, non-current

 

 

1,462 

 

 

1,386 

Notes payable

 

 

15,216 

 

 

14,948 

Financing derivative

 

 

551 

 

 

600 

Total liabilities

 

 

51,399 

 

 

57,567 



 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 



 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

Preferred Stock, $0.001 par value:

 

 

 

 

 

 

Authorized 50,000 shares; No shares issued or outstanding 

 

 

 —

 

 

 —

Common Stock, $0.001 par value:

 

 

 

 

 

 

Authorized 1,000,000 shares; Issued and outstanding 86,986 shares at March 31, 2016 and 79,983 shares at December 31, 2015 

 

 

87 

 

 

80 

Additional paid-in capital

 

 

821,169 

 

 

786,636 

Accumulated other comprehensive income (loss)

 

 

41 

 

 

(7)

Accumulated deficit

 

 

(732,521)

 

 

(713,169)

Total stockholders’ equity

 

 

88,776 

 

 

73,540 

Total liabilities and stockholders’ equity

 

$

140,175 

 

$

131,107 

See accompanying notes to the condensed consolidated financial statements.

3

 


 

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PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)









 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

Three-Month Periods Ended March 31,

 

 

(in thousands, except per share amounts)

 

2016

 

2015

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

 

$

12,379 

 

$

11,308 

 

 

 

 

 

 

Service and other revenue

 

 

3,152 

 

 

2,741 

 

 

 

 

 

 

Contractual revenue

 

 

3,596 

 

 

3,596 

 

 

 

 

 

 

Total revenue

 

 

19,127 

 

 

17,645 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Cost of product revenue

 

 

6,880 

 

 

9,732 

 

 

 

 

 

 

Cost of service and other revenue

 

 

2,743 

 

 

1,986 

 

 

 

 

 

 

Total cost of revenue

 

 

9,623 

 

 

11,718 

 

 

 

 

 

 

Gross profit

 

 

9,504 

 

 

5,927 

 

 

 

 

 

 

Operating expense:

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

16,361 

 

 

14,483 

 

 

 

 

 

 

Sales, general and administrative

 

 

11,708 

 

 

10,772 

 

 

 

 

 

 

Total operating expense

 

 

28,069 

 

 

25,255 

 

 

 

 

 

 

Operating loss

 

 

(18,565)

 

 

(19,328)

 

 

 

 

 

 

Interest expense

 

 

(779)

 

 

(697)

 

 

 

 

 

 

Other expense, net

 

 

(8)

 

 

(148)

 

 

 

 

 

 

Net loss

 

 

(19,352)

 

 

(20,173)

 

 

 

 

 

 

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on investments

 

 

48 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(19,304)

 

$

(20,166)

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.23)

 

$

(0.27)

 

 

 

 

 

 

Shares used in computing basic and diluted net loss per share

 

 

83,604 

 

 

74,149 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



See accompanying notes to the condensed consolidated financial statements.



4

 


 

Table of Contents

 

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)







 

 

 

 

 



 

 

 

 

 



Three-Month Periods Ended March 31,

(in thousands)

2016

 

2015

Cash flows from operating activities

 

 

 

 

 

Net loss

$

(19,352)

 

$

(20,173)

Adjustments to reconcile net loss to net cash used in operating activities

 

 

 

 

 

Depreciation

 

848 

 

 

908 

Amortization of debt discount and financing costs

 

268 

 

 

220 

Stock-based compensation

 

4,581 

 

 

3,255 

Other items

 

74 

 

 

(69)

Changes in assets and liabilities

 

 

 

 

 

Accounts receivable

 

(2,865)

 

 

(1,881)

Inventory

 

(2,119)

 

 

(2,122)

Prepaid expenses and other assets

 

4,709 

 

 

43 

Accounts payable

 

(39)

 

 

983 

Accrued expenses

 

(3,350)

 

 

(2,003)

Deferred service revenue

 

(705)

 

 

609 

Deferred contractual revenue

 

(3,596)

 

 

(3,596)

Other liabilities

 

1,279 

 

 

(85)

Net cash used in operating activities

 

(20,267)

 

 

(23,911)

Cash flows from investing activities

 

 

 

 

 

Purchase of property and equipment

 

(457)

 

 

(717)

Disposal of property and equipment

 

111 

 

 

 —

Purchase of investments

 

(43,383)

 

 

(25,265)

Sales of investments

 

4,949 

 

 

6,817 

Maturities of investments

 

15,539 

 

 

34,464 

Net cash provided by (used in) investing activities

 

(23,241)

 

 

15,299 

Cash flows from financing activities

 

 

 

 

 

Proceeds from issuance of common stock from equity plans

 

3,423 

 

 

2,434 

Proceeds from issuance of common stock from at-the-market equity offering, net of issuance costs

 

26,536 

 

 

 —

Net cash provided by financing activities

 

29,959 

 

 

2,434 

Net decrease in cash and cash equivalents

 

(13,549)

 

 

(6,178)

Cash and cash equivalents at beginning of period

 

33,629 

 

 

36,449 

Cash and cash equivalents at end of period

$

20,080 

 

$

30,271 



 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities

 

 

 

 

 

Inventory transferred to property and equipment

$

912 

 

$

 —



See accompanying notes to the condensed consolidated financial statements.

 

5

 


 

Table of Contents

 

PACIFIC BIOSCIENCES OF CALIFORNIA, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1. OVERVIEW

Pacific Biosciences of California, Inc. (the “Company,” “we,” “us,” or “our,”) designs, develops and manufactures 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 is the only DNA sequencing technology that provides the ability to simultaneously detect epigenetic changes.  PacBio® sequencing systems, including consumables and software, provide a simple, fast, end-to-end workflow for SMRT Sequencing.

In September 2015, we announced that we had launched a new nucleic acid sequencing platform, the PacBio Sequel™ System, which will provide higher throughput, more scalability, a reduced footprint and lower sequencing project costs compared to the PacBio® RS II System, while maintaining the existing benefits of our SMRT Technology.

The names “Pacific Biosciences,” “PacBio,” “SMRT,” “SMRTbell,” “Sequel” and our logo are our trademarks.



NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

In the opinion of management, our accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) have been prepared on a consistent basis with our December 31, 2015 audited Consolidated Financial Statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein. Certain prior year amounts in the Financial Statements and notes thereto have been reclassified to conform to the current year’s presentation. The Financial Statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and, as permitted by such rules and regulations, omit certain information and footnote disclosures necessary to present the statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). These Financial Statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015. The results of operations for the three-month period ended March 31, 2016 are not necessarily indicative of the results to be expected for the entire year or any future periods.

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, revenue valuation, the valuation of a financing derivative and long-term notes, the valuation and recognition of share-based compensation, the delivery period for collaboration agreements, the useful lives assigned to long-lived assets, and the computation provisions for income taxes. Actual results could differ materially from these estimates.  

Fair Value of Financial Instruments

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 measured on a recurring basis as of March 31, 2016 and December 31, 2015, respectively:









 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 (in thousands)

March 31, 2016

 

December 31, 2015



Level 1

 

Level 2

 

Level 3

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Total

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

$

12,031 

 

$

 —

 

$

 —

 

$

12,031 

 

$

22,034 

 

$

 —

 

$

 —

 

$

22,034 

Commercial paper

 

 —

 

 

8,049 

 

 

 —

 

 

8,049 

 

 

 —

 

 

8,595 

 

 

 —

 

 

8,595 

US government & agency securities

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

3,000 

 

 

 —

 

 

3,000 

Total cash and cash equivalents

 

12,031 

 

 

8,049 

 

 

 —

 

 

20,080 

 

 

22,034 

 

 

11,595 

 

 

 —

 

 

33,629 

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Table of Contents

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

 —

 

 

22,232 

 

 

 —

 

 

22,232 

 

 

 —

 

 

15,903 

 

 

 —

 

 

15,903 

Corporate debt securities

 

 —

 

 

6,838 

 

 

 —

 

 

6,838 

 

 

 —

 

 

1,265 

 

 

 —

 

 

1,265 

US government & agency securities

 

 —

 

 

41,084 

 

 

 —

 

 

41,084 

 

 

 —

 

 

28,136 

 

 

 —

 

 

28,136 

Asset backed securities

 

 —

 

 

1,297 

 

 

 —

 

 

1,297 

 

 

 —

 

 

3,337 

 

 

 —

 

 

3,337 

Total investments

 

 —

 

 

71,451 

 

 

 —

 

 

71,451 

 

 

 —

 

 

48,641 

 

 

 —

 

 

48,641 

Long-term restricted cash:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

4,500 

 

 

 —

 

 

 —

 

 

4,500 

 

 

4,500 

 

 

 —

 

 

 —

 

 

4,500 

Total assets measured at fair value

$

16,531 

 

$

79,500 

 

$

 —

 

$

96,031 

 

$

26,534 

 

$

60,236 

 

$

 —

 

$

86,770 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financing derivative

$

 —

 

$

 —

 

$

551 

 

$

551 

 

$

 —

 

$

 —

 

$

600 

 

$

600 

Total liabilities measured at fair value

$

 —

 

$

 —

 

$

551 

 

$

551 

 

$

 —

 

$

 —

 

$

600 

 

$

600 



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.

During the three-month periods ended March 31,  2016 and 2015, there were no impairments of our investments.

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. Changes to the estimated fair value of the Financing Derivative are recorded in “Other income (expense), net” in the condensed consolidated statements of operations and comprehensive loss.

The following table provides the changes in the estimated fair value of the Financing Derivative during the three-month period ended March 31, 2016 (in thousands):





 

 



 

 

Financing Derivative

Amount

Balance as of December 31, 2015

$

600 

Gain on change in estimated fair value

 

(49)

Balance as of March 31, 2016

$

551 



During the three-month period ended March 31, 2016 there were no transfers between Level 1, Level 2, or Level 3 assets or liabilities reported at fair value on a recurring basis and the valuation techniques used did not change compared to our established practice.

Financial assets and liabilities not measured at fair value on a recurring basis

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 carrying value of our other liabilities, non-current, approximates fair value due to the time to maturity and prevailing market rates.

We determined the estimated fair value of the Notes (as defined in Note 6. Notes Payable) using Level 3 inputs, or significant unobservable inputs. The estimated fair value of the Notes was determined by comparing the difference between the estimated fair value of the Notes with and without the Financing Derivative by calculating the respective present values from future cash flows using a  weighted average market yield of 13.3% and 13.5% at March 31, 2016 and December 31, 2015, respectively. 



The estimated fair value and carrying value of the Notes are as follows (in thousands):







 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



March 31, 2016

 

December 31, 2015



Fair Value

 

Carrying Value

 

Fair Value

 

Carrying Value

Notes payable

$

18,278 

 

$

15,216 

 

$

18,037 

 

$

14,948 



Net Loss per Share

The following outstanding common stock options and warrants to purchase common stock were excluded from the computation of diluted net loss per share for the periods presented because including them would have had an anti-dilutive effect:





 

 

 

 

 

 

 

 

7

 


 

Table of Contents

 



 

 

 

 

 

 

 

 



 

Three Months Ended March 31,

 

 

(in thousands)

 

2016

 

2015

 

 

 

 

Options outstanding

 

22,542 

 

18,796 

 

 

 

 

Warrants to purchase common stock

 

1,682 

 

5,500 

 

 

 

 



Recent Accounting Pronouncements



Recently Adopted Accounting Standards

In July 2015, the Financial Accounting Standards Board (“FASB”) FASB issued Accounting Standards Update (“ASU’) No. 2015-11, Simplifying the Measurement of Inventory, which simplifies the subsequent measurement of inventory by replacing today’s lower of cost or market test with a lower of cost and net realizable value test. The guidance applies only to inventories for which cost is determined by methods other than last-in first-out (LIFO) and the retail inventory method (RIM). Entities that use LIFO or RIM will continue to use existing impairment models (e.g., entities using LIFO would apply the lower of cost or market test). ASU 2015-11 is effective for annual report periods beginning after December 15, 2016 and is effective for us in the first quarter of 2017. Early adoption is permitted as of the beginning of an interim or annual reporting period. The new guidance must be applied prospectively after the date of adoption. We have elected to early adopt ASU 2015-11 effective for the three-month period ended March 31, 2016, as permitted by the standard. The early adoption of this update did not have a material impact on our condensed consolidated financial statements.



Recently Issued Accounting Standards

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which amends the current stock compensation guidance. The amendments simplify the accounting for the taxes related to stock based compensation, including adjustments to how excess tax benefits and a company's payments for tax withholdings should be classified. The standard is effective for fiscal periods beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. The guidance in ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases. ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or the cumulative effect transition method. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date of the new revenue standard for periods beginning after December 15, 2016 to December 15, 2017, with early adoption permitted but not earlier than the original effective date. Accordingly, the updated standard is effective for us in the first quarter of 2018. We are currently evaluating the new guidance to determine the impact it may have to our condensed consolidated financial statements.



NOTE 3. CONTRACTUAL REVENUE

During September 2013, we entered into a Development, Commercialization and License Agreement (the “Roche Agreement”) with F. Hoffman-La Roche Ltd (“Roche”), pursuant to which we account for, and recognize as revenue, the up-front payment received thereunder using the proportional performance method over the periods in which the delivery of elements pursuant to the Roche Agreement occurs. We recognize revenue under this agreement using a straight-line convention over the service periods of the deliverables as this method approximates our performance of services pursuant to the agreement. Out of the $35.0 million upfront cash payment received, quarterly amortization of $1.7 million has been recognized as contractual revenue from the fourth quarter of 2013 to the fourth quarter of 2014. Beginning in the three-month period ended March 31, 2015, we revised the estimated development period related to our contractual revenue amortization based on increasing certainty of the development time on a prospective approach and quarterly amortization of $3.6 million has been recognized as contractual revenue for each of the four quarters of 2015 and for the first quarter of 2016. 

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Further, the Roche Agreement provides for additional payments totaling up to $40.0 million upon the achievement of certain development milestones. Consideration from development milestones is recognized in the period in which a milestone is achieved only if the milestone is considered substantive in its entirety. We achieved the first development milestone under the Roche Agreement and recorded the related $10.0 million as contractual revenue during the year ended December 31, 2014. We achieved the second and third (final) development milestones under the Roche Agreement and recognized the related $10.0 million and $20.0 million as contractual revenue during the three-month period ended June 30, 2015 and December 31, 2015, respectively.



NOTE 4. CASH, CASH EQUIVALENTS AND INVESTMENTS

The following tables summarize our cash, cash equivalents and investments as of March 31, 2016 and December 31, 2015 (in thousands):





 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



March 31, 2016



 

 

Gross

 

Gross

 

 



Amortized

 

unrealized

 

unrealized

 

Fair



Cost

 

gains

 

losses

 

Value

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

$

12,031 

 

$

 —

 

$

 —

 

$

12,031 

Commercial paper

 

8,049 

 

 

 —

 

 

 —

 

 

8,049 

Total cash and cash equivalents

 

20,080 

 

 

 —

 

 

 —

 

 

20,080 

Investments:

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

22,227 

 

 

 

 

(2)

 

 

22,232 

Corporate debt securities

 

6,836 

 

 

 

 

(1)

 

 

6,838 

Asset backed securities

 

1,297 

 

 

 —

 

 

 —

 

 

1,297 

US government & agency securities

 

41,050 

 

 

34 

 

 

 —

 

 

41,084 

Total investments

 

71,410 

 

 

44 

 

 

(3)

 

 

71,451 

Total cash, cash equivalents and investments

$

91,490 

 

$

44 

 

$

(3)

 

$

91,531 



 

 

 

 

 

 

 

 

 

 

 

Long-term restricted cash:

 

 

 

 

 

 

 

 

 

 

 

Cash

 

4,500 

 

 

 —

 

 

 —

 

 

4,500 

Total long-term restricted cash

$

4,500 

 

$

 —

 

$

 —

 

$

4,500 



 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



December 31, 2015



 

 

Gross

 

Gross

 

 



Amortized

 

unrealized

 

unrealized

 

Fair



Cost

 

gains

 

losses

 

Value

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

$

22,034 

 

$

 —

 

$

 —

 

$

22,034 

Commercial paper

 

8,595 

 

 

 —

 

 

 —

 

 

8,595 

US government & agency securities

 

3,000 

 

 

 —

 

 

 —

 

 

3,000 

Total cash and cash equivalents

 

33,629 

 

 

 —

 

 

 —

 

 

33,629 

Investments:

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

15,903 

 

 

 

 

(2)

 

 

15,903 

Corporate debt securities

 

1,266 

 

 

 —

 

 

(1)

 

 

1,265 

Asset backed securities

 

3,337 

 

 

 —

 

 

 —

 

 

3,337 

US government & agency securities

 

28,142 

 

 

 

 

(10)

 

 

28,136 

Total investments

 

48,648 

 

 

 

 

(13)

 

 

48,641 

Total cash, cash equivalents and investments

$

82,277 

 

$

 

$

(13)

 

$

82,270 



 

 

 

 

 

 

 

 

 

 

 

Long-term restricted cash:

 

 

 

 

 

 

 

 

 

 

 

Cash

 

4,500 

 

 

 —

 

 

 —

 

 

4,500 

Total long-term restricted cash

$

4,500 

 

$

 —

 

$

 —

 

$

4,500 



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The following table summarizes the contractual maturities of our cash equivalents and available-for-sale investments, excluding money market funds, as of March 31, 2016:







 

 



 

 

(in thousands)

Fair Value

Due in one year or less

$

79,500 



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.  INVENTORY



As of March 31, 2016 and December 31, 2015,  our inventory consisted of the following components:





 

 

 

 

 



 

 

 

 

 



March 31,

 

December 31,

(in thousands)

2016

 

2015

Purchased materials

$

4,633 

 

$

4,041 

Work in process

 

4,799 

 

 

3,576 

Finished goods

 

2,730 

 

 

3,338 

Inventory

$

12,162 

 

$

10,955 











NOTE 6. NOTES PAYABLE

Pursuant to a Facility Agreement (the “Facility Agreement”) we entered into with entities affiliated with Deerfield Management Company, L.P. (collectively, “Deerfield”) during February 2013, we issued promissory notes in the aggregate principal amount of $20.5 million (the “Notes”). The Notes bear simple interest at a rate of 8.75% per annum, payable quarterly in arrears commencing on April 1, 2013. In connection with the execution of the Facility Agreement, we issued warrants to purchase an aggregate of 5,500,000 shares of common stock immediately exercisable at an exercise price per share initially equal to $2.63 (the “Warrants”). During the three-month period ended March 31, 2016, warrants to purchase 3,818,000 shares of common stock were exercised. As of March 31, 2016, we had outstanding exercisable warrants to purchase an aggregate of 1,682,000 shares of common stock. In addition, the Facility Agreement requires 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 to Deerfield a security interest in substantially all of our property.

The Facility Agreement has a maximum term of seven years from inception.  Subsequent to the date of the Facility Agreement, at the election of the holders of Notes representing a majority of the aggregate principal amount of the outstanding Notes, the Notes holders may elect to receive 25% of the net proceeds from any financing that includes an equity component, including without limitation, the sale or issuance of our common stock, options, warrants or other securities convertible or exchangeable for shares of our common stock, as payment of the Notes. This right is subject to certain exceptions set forth in the Facility Agreement. The holders of Notes have waived this right with respect to our sales of stock under our current “at-the-market” offering. The Notes holders have the option to require us to repay the Notes if we complete a Major Transaction (as defined in the Facility Agreement), including a change of control or a sale of all or substantially all of our assets. Additionally, the principal balance of the Facility Agreement may become immediately due and payable upon an Event of Default (as defined in the Facility Agreement), in which case the Notes holders would have the right to require us to repay 100% of the principal amount of the loan, plus any accrued and unpaid interest thereon. The Facility Agreement does not provide for a prepayment of the Notes at our option.

 Financing Derivative

A number of features embedded in the Notes to the Facility Agreement 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, 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 13.3% and 13.5% weighted average market yield at March 31, 2016 and December 31, 2015, respectively.  The estimated fair value of the

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Financing Derivative as of both March 31, 2016 and December 31, 2015 was $0.6 million.

Notes

We initially recorded the Notes and Warrants at $14.1 million and $6.4 million, respectively, based upon the relative fair value allocation of the $20.5 million of proceeds. The carrying value of the Notes at the inception of the debt was $12.8 million, resulting in an original issue discount of $7.7 million. As of March 31, 2016 and December 31, 2015,  a  debt discount of $5.2 million and $5.4 million, respectively, remained to be amortized through February 2020, the maturity of the Notes.



NOTE 7.  LEASES

In December 2009 we entered into a lease agreement for a manufacturing and office facility in Menlo Park. In order for the facility to meet our needs and operating requirements, substantial tenant improvements, including improvements to the structural elements and principal operating systems of the facility, were necessary. The lessor provided a tenant improvement allowance of $1.8 million to apply towards the necessary improvements and we remained obligated for additional amounts over the afforded allowance. Due to our involvement in and the nature of the renovations made to the facility and our obligations to fund the costs of renovations exceeding the incentives afforded to us, we account for the facility as if we are the owner. Accordingly, we recorded $3.0 million of building and leasehold improvement assets, reflecting the $1.2 million fair value of the facility prior to commencing renovations and the $1.8 million of landlord incentives within property and equipment, net and a corresponding liability recorded to facility financing obligation.

As a result of the lease amendment agreement described below, future rent expense associated with our existing Menlo Park facility leases was reduced to zero. The remaining long-term facility financing obligations associated with these leases, presented as “Other liabilities, non-current” on the condensed consolidated balance sheets at March 31, 2016 and December 31, 2015, were $1.5 million and $1.4 million, respectively. 

Lease Amendment Agreement

On July 23, 2015, we entered into a Lease Amendment Agreement (the “Lease Amendment Agreement”) with Peninsula Innovation Partners, LLC (the “Existing Landlord”), which amends the terms and conditions of certain of our existing Menlo Park facility real property leases. The Lease Amendment Agreement provides for, among other things, amendments of the term for certain of the existing leases, the termination of all renewal, expansion and extension rights contained in any of the existing leases with the Existing Landlord (including our options to extend the terms for certain of the existing leases for two consecutive five-year periods), as well as rent abatement for a specified period of time. As consideration for our agreement to amend the existing leases pursuant to the Lease Amendment Agreement, and subject to the terms and conditions contained therein, we became eligible to receive up to four payments of $5.0 million each from the Existing Landlord over time (the “Landlord Payments”), and rent abatement for the remainder of the lease. In the event that we breach any of the leases and fail to cure such breach within the time permitted, the Existing Landlord would have no obligation to make the final $5.0 million payment. On September 1, 2015, the permitting process related to an architectural approval and a change of use permit with respect to our proposed new premises at 1315 O’Brien Drive, Menlo Park, California (the “O’Brien Premises”) was completed, which satisfied the contingencies under the Lease Amendment Agreement. As a result, we recorded $23.0 million in “Gain on lease amendments” in the consolidated statements of operations and comprehensive loss for the three-month period ended September 30, 2015, reflecting that our rent payments were reduced to zero for the remaining term of our existing Menlo Park facility real property leases, the aggregate of $20.0 million in Landlord Payments became receivable and any associated financing obligation was revalued. Of the $20.0 million in Landlord Payments, the first $5.0 million Landlord Payment was received in September 2015 and the second $5.0 million Landlord Payment was received in February 2016. At March 31, 2016, the third $5.0 million Landlord Payment was recorded as a short term receivable in “Prepaid Expenses and Other Current Assets” and the final $5.0 million was recorded in “Other Long-term Assets” in the condensed consolidated balance sheets. We do not believe that there are any remaining performance obligations relating to the remaining Landlord Payments.

O’Brien Lease Agreement

On July 22, 2015, we entered into a new lease agreement (the “O’Brien Lease”) with respect to the O’Brien Premises. The term of the O’Brien Lease is one hundred thirty-two (132) months, commencing on the date that is the later of April 15, 2016 or the date on which the O’Brien Premises landlord has substantially completed certain shell improvements and tenant improvements. Based on the currently agreed construction schedule, the O’Brien Lease will commence no earlier than June 15, 2016 and we believe that substantial completion of the improvements will occur no earlier than August 1, 2016. Base monthly rent will be abated for the first six (6) months of the lease term and thereafter will be $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. We were required to pay $2,160,000 in prepaid rent which will be applied to the monthly rent installments due for the first to fourth months after the rent abatement period. We were required to establish a deposit of $4.5 million in the form of a letter of credit in October 2015; and, as such, $4.5 million was recorded in “Long-term restricted cash” in the condensed consolidated balance sheet as of both March 31, 2016

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and December 31, 2015.  The landlord is obligated to construct certain shell improvements at the landlord’s cost and expense and provide us with improvement allowances in the amount of $12.6 million.

Under the O’Brien Lease, we expect to pay approximately $80 million in rent and $24 million in operating expenses over the expected lease term. In addition to the lease payments, we are also required to reimburse the landlord for certain improvement costs in excess of the tenant improvement allowances provided. These improvement costs, along with the costs associated with the anticipated move to the O’Brien Premises, are expected to be substantial in nature. These future expenditures are expected to be partially offset by the $10.0 million of future Landlord Payments from our Existing Landlord as described above.



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NOTE 8. STOCKHOLDERS’ EQUITY AND SHARE-BASED COMPENSATION

Equity Offering

During the three-month period ended March 31, 2016, we issued 3.1 million shares of our common stock at an average price of $8.80 per share through our “at-the-market” offering, resulting in net proceeds of $26.5 million. As of March 31, 2016,  $2.6 million of common stock remained available for future sales; however, we are not obligated to make any such sales under this program. 

Subject to certain exceptions set forth in our existing Facility Agreement, holders of our Notes may elect to receive 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 February 2016 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 under our current “at-the-market” offering.

Warrants

In connection with the execution of the Facility Agreement, we issued immediately exercisable warrants to purchase 5,500,000 shares of common stock at an exercise price per share initially equal to $2.63, all of which were outstanding at December 31, 2015. The number of shares of common stock into which the warrants are exercisable and the exercise price will be adjusted to reflect any stock splits, payment of stock dividends, recapitalizations, reclassifications or other similar adjustments in the number of outstanding shares of common stock. The exercise price may also be adjusted to reflect certain dividends or other distributions, including distributions of stock or other securities, property or options by way of a dividend, spin off, reclassification, corporate rearrangement or similar transaction. 

During the three-month period ended March 31, 2016, warrants to purchase 3,818,000 shares of common stock were net exercised, resulting in approximately 3.0 million shares issued. The cashless exercise of the above warrants did not result in any additional funds being collected.

As of March 31, 2016, we had outstanding exercisable warrants to purchase an aggregate of 1,682,000 shares of common stock. 

Equity Plans

As of March 31, 2016, we had three active equity compensation plans: the 2010 Equity Incentive Plan, the 2010 Outside Director Equity Incentive Plan, and the 2010 Employee Stock Purchase Plan (“ESPP”).

The following table summarizes stock option activity for all our stock option plans for the three-month period ended March 31, 2016  (in thousands, except per share amounts):





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



 

 

Stock Options Outstanding



 

 

 

 

 

 

 

Weighted



Shares available

 

Number

 

 

 

 

average



for grant

 

of shares

 

Exercise price

 

exercise price

Balances, December 31, 2015

5,814 

 

19,468 

 

$

 0.7016.00 

 

$

5.69 

Additional shares reserved 

4,799 

 

 

 

 

 

 

 

 

Options granted

(3,388)

 

3,388 

 

 

7.8712.85 

 

 

8.69 

Options exercised

—  

 

(245)

 

 

0.707.59

 

 

3.11 

Options canceled

69 

 

(69)

 

 

1.1612.85 

 

 

5.52 

Balances, March 31, 2016

7,294 

 

22,542 

 

$

 0.7016.00 

 

$

6.17 



Shares issued under our ESPP totaled 668,566 and 532,217 shares during the three-month periods ended March 31,  2016 and 2015, respectively.  As of March 31, 2016,  1,328,736 shares of our common stock remain available for issuance under our ESPP.

Stock-based Compensation

Total stock-based compensation expense consists of the following (in thousands):





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



Three-Month Periods Ended March 31,

 

 

 



2016

 

2015

 

 

 

 

 

Cost of revenue

$

499 

 

$

298 

 

 

 

 

 

 

 

Research and development

 

1,910 

 

 

1,255 

 

 

 

 

 

 

 

Sales, general and administrative

 

2,172 

 

 

1,702 

 

 

 

 

 

 

 

Total stock-based compensation expense

$

4,581 

 

$

3,255 

 

 

 

 

 

 

 

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We estimated the fair value of employee stock options on the grant date using the Black-Scholes option pricing model. The estimated fair value of employee stock options is amortized on a straight-line basis over the requisite service period of the awards. The fair value of employee stock options was estimated using the following weighted average assumptions:





 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



Three-Month Periods Ended March 31,

 

 

 

 

Stock Option

2016

 

2015

 

 

 

 

 

 

Expected term in years

6.1

 

6.1

 

 

 

 

 

 

Expected volatility

70%

 

70%

 

 

 

 

 

 

Risk-free interest rate

1.5%

 

1.6%

 

 

 

 

 

 

Dividend yield

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



We estimate the value of employee stock purchase rights on the grant date using the Black-Scholes option pricing model. The fair value of shares to be purchased under our ESPP was estimated using the following assumptions:





 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



Three-Month Periods Ended March 31,

 

 

 

ESPP

2016

 

2015

 

 

 

 

 

Expected term in years

0.5-2.0

 

0.5-2.0

 

 

 

 

 

Expected volatility

70%

 

70%

 

 

 

 

 

Risk-free interest rate

0.5%-0.9%

 

0.1%-0.6%

 

 

 

 

 

Dividend yield

 

 

 

 

 

 



















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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with our condensed consolidated financial statements and the related notes included in this Quarterly Report on Form 10-Q and those in our Annual Report on Form 10-K for the year ended December 31, 2015. Some of the information contained in this discussion and analysis or set forth elsewhere in this report, including information with respect to our products, plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties, including statements regarding our expected financial results in future periods. You should read the “Risk Factors” section of this Quarterly Report on Form 10-Q for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

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 is the only DNA sequencing technology that provides the ability to simultaneously detect epigenetic changes.  PacBio® sequencing systems, including consumables and software, provide a simple, fast, end-to-end workflow for SMRT Sequencing.

In September 2015, we announced that we had launched a new nucleic acid sequencing platform, the SequelTM System, which will provide higher throughput, more scalability, a reduced footprint and lower sequencing project costs compared to the PacBio® RS II System, while maintaining the existing benefits of our SMRT Technology.

Basis of Presentation

Revenue

During the three- month periods ended March 31, 2016 and 2015, product revenue was primarily derived from the sale of Sequel and RS II instruments and associated consumables. Service and other revenue was primarily derived from product maintenance agreements sold on our installed instruments. Contractual revenue was derived from the quarterly amortization from the non-refundable up-front payment of $35.0 million that we received in September 2013 pursuant to the Roche Agreement. 

In addition, the Roche Agreement provides for additional payments totaling up to $40.0 million upon the achievement of certain development milestones. Consideration from development milestones is recognized in the period in which a milestone is achieved only if the milestone is considered substantive in its entirety. We achieved the first development milestone under the Roche Agreement and recorded the related $10.0 million as contractual revenue during the year ended December 31, 2014. We achieved the second and third (final) development milestones under the Roche Agreement and recognized the related $10.0 million and $20.0 million as contractual revenue during the three-month period ended June 30, 2015 and December 31, 2015, respectively.

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 costs. We determine and capitalize manufacturing overhead into inventory based on a standard cost model that approximates actual costs.  Prior to achieving manufacturing volumes that correlated with our estimated normal capacity (the production levels expected to be achieved over a number of periods under normal circumstances with available resources), we based our capitalized overhead relative to our normal capacity.  Prior to achieving normal capacity, excess manufacturing resources were engaged in research and development activities, including next generation products, internal use research products, and general support activities. As such, manufacturing costs in excess of amounts reflected in inventory were expensed as a component of research and development expense.

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 the installed customer base.

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Research and Development Expense

Research and development expense consists primarily of expenses for personnel engaged in the development of our SMRT 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.

Sales, General and Administrative Expense 

Selling, general and administrative expenses include costs for sales, marketing and administrative personnel, sales and marketing activities, tradeshow expenses, legal expenses, regulatory fees and general corporate expenses.

Interest Expense

Interest expense is primarily related to our debt facility and includes the amortization of debt discount and other related costs. To a lesser extent, amounts also include interest expense relating to our facility financing obligations resulting from a lease agreement entered into in 2010. We expect interest expense to increase during future periods as the recorded value of our debt facility accretes to the amount due at maturity.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest income earned on cash and investments, accretion of discounts and amortization of premiums related to investments, net gains or losses on foreign currency transactions, net gains or losses resulting from changes in the estimated fair value of the financing derivative and foreign income taxes.

Income Taxes

Except for the three-month period ended September 30, 2015, we have incurred net losses in every quarter since inception and have not recorded any U.S. federal or state income tax benefits for such losses as they have been fully offset by valuation allowances.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our unaudited Financial Statements, which have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). The preparation of these Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

There have been no material changes to the critical accounting policies and estimates discussed in our Annual Report on Form 10-K for the year ended December 31, 2015.



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Results of Operations

Comparison of the three-month periods ended March 31, 2016 and 2015





 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 



Three-Month Periods Ended March 31,

 

$ Change

 

% Change

(in thousands, except percentages)

2016

 

2015

 

 

 

 

 



 

(unaudited)

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

Product revenue

$

12,379 

 

$

11,308 

 

$

1,071 

 

9% 

Service and other revenue

 

3,152 

 

 

2,741 

 

 

411 

 

15% 

Contractual revenue

 

3,596 

 

 

3,596 

 

 

 —

 

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