Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2020

Summary of Significant Accounting Policies [Abstract]

Summary of Significant Accounting Policies

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Consolidation

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, 2019 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state the information set forth herein. 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, 2019. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results to be expected for the entire year or any future periods.

The condensed consolidated financial statements include the accounts of Pacific Biosciences and our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated.

COVID-19

We are subject to risks and uncertainties as a result of the novel coronavirus pandemic (COVID-19). The extent of the impact of the COVID-19 pandemic on our business is highly uncertain as responses to the pandemic can change quickly and information is rapidly evolving. We considered the impact of COVID-19 on the assumptions and estimates used to determine the results reported and asset valuations as of September 30, 2020.

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 and Reverse Termination Fee 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.

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:

Level 1: quoted prices in active markets for identical assets or liabilities;

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

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.

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 September 30, 2020 and December 31, 2019 respectively:



	September 30, 2020								December 31, 2019
(in thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents:
Cash and money market funds	$	41,784	$	—	$	—	$	41,784	$	18,644	$	—	$	—	$	18,644
Commercial paper		—		24,244		—		24,244		—		10,983		—		10,983
U.S. Treasury security		—		3,000		—		3,000		—		—		—		—
Total cash and cash equivalents		41,784		27,244		—		69,028		18,644		10,983		—		29,627
Investments:
Commercial paper		—		105,380		—		105,380		—		16,971		—		16,971
Corporate debt securities		—		21,195		—		21,195		—		2,501		—		2,501
U.S. government & agency securities		—		10,097		—		10,097		—		—		—		—
U.S. Treasury security		—		2,850		—		2,850		—		—		—		—
Total investments		—		139,522		—		139,522		—		19,472		—		19,472
Long-term restricted cash:
Cash		3,500		—		—		3,500		4,000		—		—		4,000
Total assets measured at fair value	$	45,284	$	166,766	$	—	$	212,050	$	22,644	$	30,455	$	—	$	53,099

Liabilities
Financing Derivative	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Continuation Advances		—		—		—		—		—		—		—		—
Total liabilities measured at fair value	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Estimated fair value of the Financing Derivative liability

The estimated fair value of the Financing Derivative liability (as defined in the “Notes payable, current” section in “Note 5. Balance Sheet Components”) 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, net” in the consolidated statements of operations and comprehensive loss.

The estimated fair value of the Financing Derivative was determined by comparing the difference between the fair value of the Notes from the debt facility that we entered into during the first quarter of 2013 (the “Notes”) with and without the Financing Derivative by calculating the respective present values from future cash flows using a 6.5% discount rate at December 31, 2019. The estimated fair value of the Financing Derivative as of December 31, 2019 was $0.

In February 2020, upon maturity of the Notes, the Financing Derivative was extinguished. Refer to the “Notes payable, current” section in “Note 5. Balance Sheet Components” for a detailed description and valuation approach.

Estimated fair value of the Continuation Advances liability

In accordance with the terms of the Merger Agreement, we received Continuation Advances of $18.0 million and $34.0 million from Illumina during the fourth quarter of 2019 and the first quarter of 2020, respectively.

We determined that the Continuation Advances, which are subject to repayment under certain circumstances as discussed below, constitute a financial liability.

The fair value option was elected for the financial liability because management believes that among all measurement methods allowed by Accounting Standards Codification, or 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 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 September 30, 2020 and December 31, 2019:

we enter into a Change of Control Transaction within two years following March 31, 2020; or

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.

As a result, the estimated fair value of the liability associated with the contingent repayment of the Continuation Advances received in the first quarter of 2020 was assessed to be zero as of March 31, 2020, June 30, 2020 and September 30, 2020, respectively, with a resulting non-operating gain of $34.0 million recorded as “Gain from Continuation Advances from Illumina” for the quarter ended March 31, 2020. We recorded a similar gain of $18.0 million in 2019 for the Continuation Advances received during the fourth quarter of 2019.

For the quarter ended September 30, 2020, 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.

Net Loss per Share

The following outstanding common stock options, restricted stock units (“RSUs”), with time-based vesting and RSUs with performance-based vesting, 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. See Note 7. Stockholders’ Equity for detailed information on RSUs with time-based vesting and RSUs with performance-based vesting.


	Nine Months Ended September 30,
(in thousands)	2020	2019
Options to purchase common stock	19,921	23,048
RSUs with time-based vesting	5,971	1,094
RSUs with performance-based vesting	94	138

Concentration and Other Risks

For the three and nine months ended September 30, 2020, Gene Company Limited accounted for approximately 18% and 14%, respectively, of our total revenue during the period with no other customer exceeding 10% during those periods. For the three and nine months ended September 30, 2019, Gene Company Limited accounted for approximately 14% and 18% of our total revenue, respectively, with no other customer exceeding 10% during those periods. Gene Company Limited is our primary distributor in China.

Recent Accounting Pronouncements

Recently Adopted Accounting Standards

In June 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“Topic 326”), which replaces existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost. We adopted Topic 326 on January 1, 2020, using a modified retrospective transition method, which requires a cumulative-effect adjustment to the opening balance of retained earnings/accumulated deficit to be recognized on the date of adoption with prior periods not restated. The cumulative-effect adjustment recorded on January 1, 2020, is shown below (in thousands):


Balance Sheets	Balance at December 31, 2019		Adjustments Due to Topic 326		Balance at January 1, 2020
Assets
Accounts receivable	$	15,266	$	(32)	$	15,234
Liabilities and Stockholders' Equity
Accumulated deficit		(1,066,240)		(32)		(1,066,272)

The adoption of Topic 326 did not have a material impact on our financial statements and our bad debt expense was immaterial as of September 30, 2020. Please see the description of our “Credit Losses” accounting policy in the “Significant Accounting Policies” section below.

Significant Accounting Policies

With the exception of the change for the accounting of credit losses as a result of the adoption of Topic 326, there have been no new or material changes to the significant accounting policies discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, that are of significance, or potential significance, to us.

Credit Losses

Trade accounts receivable. The allowance for doubtful accounts is based on our assessment of the collectability of customer accounts. We regularly review the allowance by considering factors such as the age of the accounts receivable balances, customer creditworthiness, customer industry, and current and forecasted economic conditions that may affect a customer’s ability to pay.

Available-for-sale debt securities. Our investment portfolio at any point in time contains investments in cash deposits, money market funds, commercial paper, corporate debt securities and US government and agency securities. We regularly review the securities in an unrealized loss position and evaluate the current expected credit loss by considering factors such as significance of loss, historical experience, market data, issuer-specific factors, and current economic conditions and concluded that an allowance for credit losses was not required as of September 30 2020.

Although we have historically not experienced significant credit losses, our exposure to credit losses may increase if our customers are adversely affected by changes in economic pressures or uncertainty associated with local or global economic recessions, disruption associated with the current COVID-19 pandemic, or other customer-specific factors.