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Edited Transcript of PACB earnings conference call or presentation 2-Aug-17 8:30pm GMT

Thomson Reuters StreetEvents

Q2 2017 Pacific Biosciences of California Inc Earnings Call

MENLO PARK Aug 30, 2017 (Thomson StreetEvents) -- Edited Transcript of Pacific Biosciences of California Inc earnings conference call or presentation Wednesday, August 2, 2017 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ben Gong

* Michael W. Hunkapiller

Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President

* Susan K. Barnes

Pacific Biosciences of California, Inc. - CFO, Principal Accounting Officer and EVP

* Trevin Rard

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Conference Call Participants

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* Aurko Joshi

* David Michael Westenberg

CL King & Associates, Inc., Research Division - Senior VP & Senior Equity Analyst

* Joseph P. Munda

First Analysis Corporation - Analyst

* Tejas Rajeev Savant

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Pacific Biosciences of California, Inc., Second Quarter 2017 Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Ms. Trevin Rard.

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Trevin Rard, [2]

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Good afternoon, and welcome to the Pacific Biosciences Second Quarter 2017 Conference Call. Earlier today, we issued a press release outlining the financial results we'll be discussing on today's call, a copy of which is available on the Investors section of our website at www.pacb.com, or alternatively, as furnished on the Form 8-K, available on the Securities and Exchange Commission website at www.sec.gov.

With me today are Mike Hunkapiller, our Chief Executive Officer; Susan Barnes, our Chief Financial Officer; and Ben Gong, our Vice President of Finance and Treasurer.

Before we begin, I'd like to remind you that on today's call, we may be making forward-looking statements, including plans and expectations relating to our financial projections, products and other future events. You should not place undue reliance on forward-looking statements because they are subject to assumptions, risks and uncertainties, and may differ materially from actual results. These results and uncertainties are more fully described in our Securities and Exchange Commission filings, including our most recently filed reports on Form 10-K and Form 10-Q. Pacific Biosciences undertakes no obligation to update forward-looking statements.

In addition, please note that today's call is being recorded and will be available for audio replay on the Investors section of our website shortly after the call. Investors electing to use the auto-replay are cautioned that forward-looking statements made on today's call may differ or change materially after the completion of the live call.

I'd now like to turn the call over to Mike.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [3]

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Thanks, Trevin. Good afternoon, and thank you for joining us today.

Starting with highlights of our Q2 financial results, total product and service revenue for the quarter was $20.1 million, up 17% compared with $17.2 million in Q2 of last year. Q2 revenues were sequentially lower than the first quarter of this year, as we had anticipated and advised on our previous call. Year-to-date, we generated $45 million in product and service revenue, up 38% compared with $32.7 million for the first half of 2016. Consumable revenue for the second quarter was $9.4 million, up 87% from $5.0 million recorded in Q2 2016. Year-to-date, we generated $18.1 million in consumable revenue, also up 87% compared with $9.7 million for the first half of 2016.

Consumable revenue growth was driven by significant growth in Sequel instrument utilization, along with a higher install base of instruments. The consumable revenue we are generating from the Sequel install base now exceeds that from the RS II install base. Furthermore, the average consumable revenue per instrument for Sequel is also now higher than what we've historically generated on the RS II platform.

Instrument revenue for the second quarter was $7.1 million, down from $8.6 million recorded in Q2 2016. However, year-to-date, instrument revenue was up 21% from $16.3 million in 2016 to $19.8 million in 2017. As we mentioned last quarter, the number of instrument installations can vary quarter to quarter due to timing of when our customer sites are ready for their installs.

During the second quarter, we raised approximately $65 million in cash through a combination of a follow-on stock offering and issuance using the at-the-market tool, which we've used in the past. This helped bolster our cash balance to over $102 million at the end of June. We have no current plans to raise additional capital through either the use of the at-the-market tool or a follow-on offering.

Turning now to recent sales highlights, we continue to see significant strength in our China business. Our sales into China now represent approximately 25% of our total sales. Novogene starting operating a fleet of up to 10 Sequel Systems this past quarter, and they quickly ramped up utilization on those systems.

Novogene announced multiple initiatives recently that we expect to drive usage on their Sequel Systems. They're partnering with the Global Ant Genomics Alliance, which is aiming to sequence up to 300 species of ants to provide a comprehensive look at genomic diversity across ant genera. Novogene also announced plans to build a database of structural variants in 1,000 Chinese individuals using PacBio sequencing in an ongoing effort to improve precision medicine in Chinese populations. Furthermore, we were delighted this afternoon to announce that Novogene has recently placed an order for 10 more Sequel Systems, which will soon double their current capacity. With this purchase, Novogene will be the largest SMRT Sequencing center in the world.

Last quarter, we mentioned that in Q1 we did not have any U.S. government-funded orders for Sequel Systems. In Q2, we saw some relief in U.S. government funding, which led to a number of Sequel System orders, though many U.S. customers still have concerns about fiscal year 2018 government funding levels. We continue to expect 2017 product and service revenue growth relative to 2016 of 35% to 45%.

Turning now to our product development activities. We released a major software update, Version 5.0, last month, containing improved analysis tools for structural variation and minor variant detection. This release also included improved protocols for sequencing amplicons, which is performed extensively in targeted sequencing and Iso-Seq applications. Recent results from customers using these new protocols to sequence amplicons have been quite promising, with one customer seeing average read lengths of 33,000 base pairs and another seeing 15 gigabases of data from a single SMRT cell. Although these results are at the high end of overall results, average read lengths greater than 20 kilobases and sequencing yield of greater than 10 gigabases from similar samples are becoming relatively common and represent a substantial increase in both parameters relative to those in our previous software release. We expect to have most Sequel customers updated to Version 5.0 during the current quarter.

We also continue to work on enhancements to our sample prep protocols, sequencing chemistry and analysis software as part of our program to double the throughput from a wide variety of sample types by the end of this year. We expect to introduce these enhancements at various times over the current and next quarter. As part of these efforts, we are developing a simplified sample prep kit that can both decrease the time and labor involved with sequencing library preps and improve the quality of long-insert libraries used in de novo genome assembly and structural variant analyses. Also, we are planning for a sequencing chemistry release near the end of this year that should provide longer average read lengths for all sample types and an increased number of sequence reads per SMRT cell.

We are continuing to work on the new version of the Sequel SMRT Cell that has 8x the capacity of the existing Sequel SMRT Cell. We continue to target release of that product by the end of 2018. As we mentioned previously, we are targeting to deliver a 30-fold improvement in throughput over the next 2 years, which would enable us to provide high-quality human-sized genomes for about $1,000 and low-coverage genomes for structural variant analysis for just a few hundred dollars.

In past quarterly calls, we have highlighted the use of SMRT Sequencing by our customers to improve the assembly and genome imitation of the genomes of numerous plant and animal species. This continues to be a growing and important segment of our market. Since our last call, several additional studies have appeared in scientific print. These include, among others, analyses of bread wheat, blueberry, maize, sunflower, spinach, bladderwort, chicken, barley and Manila clam. While these studies were conducted using our RS II sequencing system, recent reports at scientific meetings of assembly of cotton and water buffalo genomes were based on Sequel Sequencing, and we expect to see a rapidly growing number of reports and publications from Sequel data based on the growth of Sequel utilization over the last 6 months.

Also on our last call, we highlighted pioneering efforts to study the impact of genome structural variation in humans. Since then, we have seen growth in interest in this area as well, with one example being the announcement from Novogene to initiate a 1,000-person study in China. We've also seen continuing interest in publications in targeted sequencing applications that could lead to diagnostic tests based on SMRT Sequencing. The example is a recent publication in the Journal of Pharmacogenomics from the Icahn School of Medicine at Mount Sinai describing sequencing of CYP2D6 gene, which is important in pharmacogenetic testing of drug metabolism. That concludes my initial remarks.

I'll now turn it over to Susan to provide more details on our financial results.

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Susan K. Barnes, Pacific Biosciences of California, Inc. - CFO, Principal Accounting Officer and EVP [4]

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Thank you, Mike, and good afternoon, everyone. I will begin my remarks today with a financial overview of our second quarter that ended June 30, 2017. I will then provide details on our operating results for the quarter and the year, with a comparison to Q2 of 2016 and 2016 year-to-date respectively. I will conclude my remarks with a brief discussion of our balance sheet, including a summary of the financing activities we completed last quarter.

Starting with our second quarter 2017 and year-to-date financial highlights, during the quarter, we recognized revenue of $20.1 million and incurred a net loss of $25.5 million. We ended the quarter with $102.6 million in cash and investments. Our cash balance was substantially higher than our March 31, 2017, balance. This is primarily due to proceeds received from our follow-on offering as well as some funds raised earlier in the quarter from our ATM facility. I will describe this activity in more detail later in my prepared remarks.

Turning to revenue. The $20.1 million for product, service and other revenue in Q2 of 2017 was $2.9 million higher than the $17.2 million of product, service and other revenue in Q2 of 2016. In Q2 2016, we also recognized $3.6 million of Roche-related contractual revenue. Including this contractual revenue, total revenue was $20.7 million in 2016. Year-to-date, product, service and other revenue in 2017 was $45 million, up 38% compared to the $32.7 million recognized year-to-date in 2016. Year-to-date 2016 total revenue was $39.9 million, which includes $7.2 million of Roche contractual revenue.

Breaking down the revenue. Instrument revenue recognized in Q2 2017 was $7.1 million, down $1.5 million from $8.6 million recognized in Q2 of 2016. Year-to-date, instrument revenue was $19.8 million in 2017, up 21% compared to the $16.3 million recognized during the same period last year. Consumable revenue continues to be strong, increasing 87% to $9.4 million for the quarter, up from $5 million reported during the second quarter of 2016.

This substantial year-over-year revenue increases highlights the continued consumable sales momentum that has now resulted in 6 consecutive quarters of consumable revenues growth. Year-to-date, consumable revenue has increased 87% to $18 million in 2017, compared to $9.7 million in the first half of 2016. Service and other revenue was $3.6 million in the quarter, relatively flat compared to the $3.5 million in Q2 of 2016. Year-to-date service revenue increased to $7.2 million from $6.7 million year-to-date in 2016.

With regards to gross profit and margin, in Q2 of 2017, we generated a gross profit of $8 million, resulting in a gross margin of approximately 40%. This compares to an adjusted gross profit of $7 million and 41% gross margin in Q2 2016, excluding the $3.6 million of Roche contractual revenue recorded in Q2 of 2016. Year-to-date gross profit in 2017 was $16.9 million with gross margin of 38%.

In the first half of 2017, we incurred $1.6 million in charges related to the change in the useful life of RS II leased instruments as we executed a smooth transaction of some of those customers from RS to Sequel instruments. Excluding these charges, year-to-date adjusted gross profit would have been $18.5 million with a corresponding gross margin of approximately 41%. This compares to an adjusted gross profit of $13 million and gross margin of 40% for the first half of 2016, excluding the $7.2 million of Roche contractual revenue recognized in the first half of 2016.

Moving to operating expenses. Operating expenses in the second quarter of 2017 totaled $32.4 million compared to $28.7 million in Q2 of 2016. Year-to-date operating expenses in 2017 were $64.6 million, $7.8 million higher than the $56.8 million incurred in the first half of 2016. Noncash stock-based compensation included in the operating expenses was $4.4 million in Q2 of 2017 versus $4.5 million in Q2 of 2016.

Breaking down our operating expenses. R&D expenses in the quarter were $16.9 million, down from $17.5 million incurred in Q2 of 2016. Most of this decrease was related to the higher chip development cost expensed in the early part of 2016. R&D expenses year-to-date were $33.8 million in 2017, flat compared to the $33.9 million incurred in the first half of 2016. R&D expenses in the quarter included $2 million of noncash stock-based compensation expense again flat compared to the $2.1 million of expense in Q2 of 2016.

Sales, general and administrative expenses in the quarter were $15.5 million compared to $11.2 million in Q2 of 2016. Year-to-date SG&A expenses were $30.8 million compared to $22.9 million in the first half of 2016. As was the case last quarter, the move to our new facility in Menlo Park in Q1 impacted expenses in SG&A. Additionally, SG&A expenses were higher year-over-year as a result of legal and compensation costs. Compensation costs rose primarily due to hiring in our sales and sales support organizations. SG&A expenses in the second quarter of 2017 included $2.4 million of noncash stock-based compensation expense relatively flat compared to the $2.3 million of noncash stock-based compensation expense recognized in Q2 of 2016.

Finally, in Q2 2017, we recorded $1.1 million of net interest and other expense compared to $400,000 recorded in Q2 2016. Year-to-date, we recorded $1.7 million in net interest and other expenses compared to $1.2 million for the first half of 2016. The increase in expense is primarily due to a revaluation of the derivative associated with our debt, which resulted from a principal repayment of $4.5 million that we made in June of 2017.

Turning to our balance sheet. As I mentioned at the beginning of my comments, our balance of cash investments was $102.6 million at the end of the second quarter compared with $56.1 million at the end of the first quarter. Much of this change in cash during the quarter was represented by 3 financing activities. We received $11.9 million of funding from the ATM early in the quarter. We then closed the ATM upon execution of a follow-on equity offering in June that netted cash proceeds of $52.7 million. We also paid down $4.5 million in principal out of the $20.5 million debt we took on in Q1 of 2013, leaving a remaining principal of $16 million. Inventory balances were higher in the quarter, $17.3 million in Q2, up from $15.3 million at the end of Q1. Accounts receivable decreased in Q2 to $9.5 million from $10.4 million at the end of Q1. This concludes my remarks on the financial results for the quarter.

I would like to turn the call over to Ben.

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Ben Gong, [5]

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Thank you, Susan. I'll be providing an updated forecast of our 2017 financial performance.

Starting with revenue, we continue to target a 35% to 45% growth in product and service revenue for the year. As mentioned earlier, our revenue growth for the first half of 2017 was 38%, which is right within this range.

Moving on to gross margin. If we exclude the $1.6 million in costs associated with the leased RS II instruments, our adjusted gross margin for the first half of the year came in as expected at approximately 41%. Assuming our revenues increase as anticipated, we continue to expect our gross margin to increase. By the end of the year, we are targeting our gross margin percentage to get to the mid-40%.

Now moving on to operating expenses. Our Q2 operating expense came in right in line with our previous forecast. We continue to forecast year-over-year operating expense growth of 13% to 15%. As a reminder, we started recognizing rent and depreciation expenses associated with our new facility in Q1, and as anticipated, this drove a significant increase in operating expense for this year. These incremental expenses are largely fixed and a majority of this increase represents noncash expense.

Now with regard to our cash usage, excluding the net proceeds from the follow-on and ATM and the repayment of $4.5 million in debt this past quarter, we used approximately $13.5 million in cash during Q2. With our cash and investments balance at over $100 million, we have no current plans to raise additional capital. We closed out the at-the-market facility last quarter and we have no current plans to file a new at-the-market facility.

Earlier today, we filed a new S3 shelf which is targeted to be in place by the time our existing S3 shelf expires later this year. While we have no current plans to open a new ATM, we may want to have the flexibility to enter into a clinical distribution agreement with a partner who would also like to take an equity position. We are not negotiating any such agreement at this time. However, we have mentioned on previous calls that we're interested in engaging with regional partners who can provide assistance in obtaining local regulatory approvals for marketing and selling our products for clinical applications in various countries.

That concludes our prepared remarks, and we'll now open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Amanda Murphy from William Blair.

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Aurko Joshi, [2]

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This is Aurko in for Amanda. I just want to take a quick jump in the consumables side, and I was wondering if you would comment on if there were any decommissions on the RS II platform, legacy base, to start?

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Ben Gong, [3]

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Yes, Aurko. This is Ben. So the ones that were definitely taken out of service were the ones that were previously leased and then had a sort of natural maturity, if you will, of around a year afterwards, we took back most of those in Q1, and then the remainder were in Q2 and that's why there was a small charge in Q2 associated with that. Other than that, it's kind of tough to judge, but some of our customers that have both RS II systems and Sequel Systems are beginning to shift over some of that volume to the Sequel, but it's still pretty early to judge at what rate that's going to be.

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Aurko Joshi, [4]

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Got it. And then just a follow-up and it's not really related is, what gives you confidence in the pipeline for the next couple of quarters? I recall that in the last quarter you said U.S. government tend to place orders in Q3, but could you help us put -- get some more confidence in the pipeline perhaps in 2017 and 2018?

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Ben Gong, [5]

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Sure. I mean, the pipeline just got a little bit better based on the announcement that we made earlier today with the Novogene order. We don't give specifics on the pipeline. We try to give you a sense for our confidence in that with the revenue guidance. And as Mike mentioned before, we did have several orders in the second quarter from U.S. government-funded entities, maybe a more normalized rate that is compared to what we've seen in the past.

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Aurko Joshi, [6]

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Got it. And then lastly, are those -- are you sensing that there are many more multi-unit orders to come? And among those orders, more similar to Novogene or (inaudible)?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [7]

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We certainly have expectations of having that, and one of the things that we've seen with Sequel given that it is more tuned to a large volume in terms of number of samples that one can run and so forth, that it's more amenable to bigger programs and projects. And in particular, with the commercial service providers, which there are a large number in Asia, we would hope to see a continuing expansion of their use of the technology.

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Operator [8]

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Your next question comes from the line of Tycho Peterson from JPMorgan.

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Tejas Rajeev Savant, JP Morgan Chase & Co, Research Division - Analyst [9]

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This is Tejas on for Tycho. First of all, Mike, maybe I missed this in your prepared remarks, but did you give an updated installed base number in your comments?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [10]

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I didn't. Maybe Ben can give you the latest numbers.

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Ben Gong, [11]

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All right, Tejas, this is Ben. The installed base of systems, it's well over 300. Again, we're not giving specifics on the numbers of installs quarter by quarter, but we did install a decent number of Sequel Systems this past quarter, so it's well over 300 at this point.

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Tejas Rajeev Savant, JP Morgan Chase & Co, Research Division - Analyst [12]

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Got it, okay. And then, Mike, just following up on that earlier question on U.S. government spending, what are you hearing from your customers now that NIH budgets for this year are better than expected, but there's still uncertainty around next year? There's also this sort of budget flush dynamic in 3Q. So I mean, are you hearing people kind of, like, open up the purse strings here a little bit?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [13]

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Well, as I pointed out in my presentation, we did see them loosening it up in terms of orders in Q2. I think, if I can give my reading of the tea leaves, I think confidence around NIH funding is reasonably good. You had one budget committee recommending a modest increase for NIH funding next year compared to this year, and they didn't wind up having any cuts this year. I think the concern, as we tried to emphasize last time, is still a little bit more with government-funded agencies that are direct purchasers of the system. And that's an area that's been a good source of customer purchases by us historically. We did see some of those making purchases in the last quarter, and we've continued talks with others. They would like a little more insight into what's going to happen next year. They do have money that's in their current budget that they have to spend over the next quarter, perhaps, but they would like to see before they pull too much of the trigger on that, versus their desires, to get a sense of what's going to happen in 2018. And I think they've -- they don't feel that the draconian cuts, in most cases, are going to come. There's an agency or 2 that are worried. They are somewhat concerned that they'll be stuck without a formal budget well past the start of the fiscal year, given the pace with which Congress has not taken up much of the spending appropriations yet. But certainly, they're a little more upbeat than they were, say, in January.

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Tejas Rajeev Savant, JP Morgan Chase & Co, Research Division - Analyst [14]

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Got it. No, that's actually helpful. And then on the Novogene collaboration that you announced a little while ago, can you just lay out a bit of a road map here in terms of, perhaps, key milestones to expect? It's probably a little bit early, but I just wanted to figure out if there's anything that we should be expecting either in 2017 or 2018. And then, was this sort of incremental 10-unit purchase kind of, like, factored into that collaboration, perhaps through some sort of special pricing sort of agreement, or perhaps discounting on consumables in return for a volume sort of commitment from them? Any color on that would be helpful.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [15]

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Well, I'm not going to go into details, obviously, on specific terms of a particular sale. I think most companies in this space would tell you that they do take into account volume of purchases in a broad sense when they negotiate deals with people. In terms of the collaborative part, that didn't factor into any purchases. That was based on the systems that they had already installed. They announced a couple of projects independent of the announcement that we made on the collaboration, and most notably, they really want to scale up and being involved in the personalized medicine initiatives within China, and the first start of that is their fairly large-scale structural variant survey of the Chinese population. And we agreed, we provided them early access to the efforts we're making to support that kind of analysis, both with sample prep, which needs to be much more streamlined in order to get to handling that many samples over a relatively short period of time, and some other things. So we and/or they will make appropriate announcements at the right time.

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Tejas Rajeev Savant, JP Morgan Chase & Co, Research Division - Analyst [16]

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Got it. And then…

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [17]

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And I will emphasize that these are not reagent rental instruments. They weren't in the first group and they aren't in the second group. They are straight instrument purchases, along with a fairly easy-to-commit-to, in one sense, from their perspective, set of reagent purchases, because we now have a couple of months of run rate building up from them, and we know that they clearly have the ability to come up with the samples to do pretty much fulltime effective utilization of their system. So they've done a good job of sort of scouting out what their customer base is requesting of them, to run samples on the Sequel platform.

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Tejas Rajeev Savant, JP Morgan Chase & Co, Research Division - Analyst [18]

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Got it. And then one final one from me, Mike, I know you've called out China for a couple of quarters now as a key area of spend for PacBio. How should we think about utilization on your placements in China? I mean, is it sort of radically different than the rest of your Sequel portfolio, and if so, how do you see that ramping -- I mean, how quickly will it catch up? Because every once in a while we hear about purchasers in China are just making these vanity purchases ahead of, like, big government projects and so on.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [19]

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Well, I try to point out that Novogene was able to ramp up very quickly with what was certainly our largest install of Sequel Systems done during the quarter. So and I just mentioned, is that they seem to know -- because they are for profit service labs. So I don't think they're likely to be buying vanity purchases, particularly at the level -- even if you argue that 10 was one the first time, I don't know that they would do that a second time if they didn't feel that they had the business to support the operation of the system. So they have a large group of the NovaSeq platforms from Illumina as well for other kinds of projects that they run, so they are a substantial service provider in China. One thing that I think is somewhat unique about China in our business, compared to other parts of the world, is that there are several large service providers there who are for profit who have chosen to focus a lot of their offerings on our SMRT technology, and they have a good sense of what their needs are from prospective customers that come to them with samples. And they've been able to ramp up more quickly than smaller operations who, I don't think, had the -- if they're an academic, they go from project to project, and sometimes they have a project to do, sometimes they don't, but it's more internally generated. And so those big commercial service labs, whether they're in China or elsewhere, tend to ramp up faster than an individual purchaser who's dependent on themselves for providing samples to a large degree.

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Ben Gong, [20]

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Tejas, this is Ben. I would just add, in general, for us, people with multiple systems utilize their systems at a higher rate than customers that only have one system.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [21]

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But I would -- yes, we've mentioned in the past that our largest user in the U.S. is Histogenetics, which is, again, a commercial operation focused on the HLA Typing arena, but again, they're a for profit organization, so they have a sense to balance the purchases of instruments and the use of those with the samples coming in to them. So those are very attractive customers for us in that regard.

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Operator [22]

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Your next question comes from the line of Joe Munda from First Analysis.

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Joseph P. Munda, First Analysis Corporation - Analyst [23]

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Can you hear me okay?

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Ben Gong, [24]

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Yes.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [25]

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Yes.

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Joseph P. Munda, First Analysis Corporation - Analyst [26]

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Mike, real quick, the commentary on China, you guys have mentioned 25% of revenue, is that year-to-date or is that for Q2?

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Ben Gong, [27]

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This is Ben. Probably not too different either way you look at it, quite frankly. The last quarter we had mentioned that it was over 20% over the past couple of quarters and the momentum continues to build there as evidenced by this latest order from Novogene. So yes, probably not too different either way you look at it.

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Joseph P. Munda, First Analysis Corporation - Analyst [28]

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Okay, okay. In regards to instruments, I guess, can you give us an update of what the backlog looks like? Is it being worked through? Some color there would be very helpful.

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Ben Gong, [29]

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Yes, so we're trying hard not to be too specific on either the quantity of orders that we're sort of taking and therefore the backlog. But again, we try to take that into account when we give the forecast for the year, taking into, also, account, and I'll take this opportunity to highlight something that Mike mentioned on the call. The reason for the sequential decline from Q1 revenues to Q2 revenues is, sometimes the timing of the install of the systems, which is subject to site readiness, can be a little bit lumpy, and so we tended to, generally speaking, install more in Q1 than some people might have otherwise expected. And that led to installing fewer systems in Q2.

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Joseph P. Munda, First Analysis Corporation - Analyst [30]

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Okay. And Mike, can you…

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [31]

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And that's why we kind of mentioned that in our first quarter conference call.

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Joseph P. Munda, First Analysis Corporation - Analyst [32]

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Okay. No, that's helpful. Mike, in regards to your statement about Histogenetics, did they place any orders in the -- did they add to their fleet in the quarter? Any commentary there?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [33]

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Well, they increased their usage because they had purchased some Sequel Systems earlier in the year and they got those into operation and they've started utilizing them at a reasonable level as well. I'm not going to go into additional purchases for them at this point. I'll let them make that announcement.

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Joseph P. Munda, First Analysis Corporation - Analyst [34]

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Okay, okay. And then my last question, Mike, to the extent you can, can you give us an update on the IP disagreements with Oxford? Where you're at as far as that whole situation is concerned?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [35]

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It's underway. Predicting timing on IP's issues is not trivial because we have multiple ones going on, both here in the U.S. at the ITC and in district court case. We have ITC action going -- or not ITC, but a similar action going on in the U.K. They take their time going through the process. You have ups and downs and you have all these interim rulings on definition of terms or interpretation of claims and so forth that are kind of frustrating for someone with a technical background, although I've been through a lot of IP deals. And the judges have their own schedule, so we don't tend to want to make too much of a comment on that during the process because it's not so useful, but we'll make appropriate announcements as they -- as significant events happen.

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Operator [36]

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Your next question comes from the line of David Westenberg from CL King.

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David Michael Westenberg, CL King & Associates, Inc., Research Division - Senior VP & Senior Equity Analyst [37]

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So the first one, can you just give a little bit more clarity on what you're looking for in terms of the distributor partner and with kicking in equity position?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [38]

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Well -- it’s Mike. So the one in particular we mentioned was in China, and I think we've talked about this before. The issue in China is that it's far easier, almost necessary, in order to get Chinese FDA regulatory clearance, to have that done with a Chinese company. And so the impetus for having a partner there and focusing on it, in addition to the size of the market, has to do with the regulatory structure associated with diagnostic sales. And so we've announced before that that's an area that we probably would look for a partner just because of those 2 issues and continue to work at that. I mean, it's -- and there are other places in the world where it's sometimes easier to go it by yourself than do it. But China is one of those countries as are a couple of others in Europe and Asia. Having a good partner there is a much faster way to get through the process.

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David Michael Westenberg, CL King & Associates, Inc., Research Division - Senior VP & Senior Equity Analyst [39]

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Got it. And then just one more, in terms of your reiterating in the guidance, what gives you confidence? Is it orders? Is it consumable utilization? Is it the backlog? Just kind of get color into what you see in the back half of the year that you like.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [40]

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Well, it's all of the above. I mean, obviously, we have a long way to go to fill out all the orders that would be required to do that. Certainly, the consumables utilization is a strong point and, not just from the perspective of we kind of get a sense that that's going to be a buffer to our sales, but it also means that people are getting very positive results out of the system and they wind up being much more aggressive backups when customers, other prospective customers, go to them to ask for recommendations. And so we see that as a very positive sign, both in terms of the immediate utilization of those systems, but also in the prospects for completing, getting in orders from other people. This is still an area where your customers do a lot of your selling for you. And yes, Susan just mentioned, which I talked about in my presentation, that one of the other things that gives us even an increasing confidence relative to the utilization and the referencing from the customers is that the response so far from the performance of the new software platform, which is a little bit more than just a software has been really gratifying. So…

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Susan K. Barnes, Pacific Biosciences of California, Inc. - CFO, Principal Accounting Officer and EVP [41]

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Right. They're seeing the read length and the throughput that Mike mentioned, obviously, their (inaudible), as a result, it's starting to move in the direction that we guided for the year. So that's very positive as well.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [42]

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Those parameters are not just on total throughput but on read length, from an average perspective, are well past what we ever saw with the RS II system. And if you remember, we started off with the Sequel where we were actually a little worse in terms of read length than we were on the RS II. And so seeing these kind of read lengths, which directly impacts throughput, is a big deal from our perspective in terms of demonstrating the performance of the system.

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Operator [43]

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(Operator Instructions) Your next question comes from the line of Amanda Murphy from William Blair.

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Aurko Joshi, [44]

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It's me again. I had a quick question, if you could answer, what the split between new long-read adopters and existing long-read customers was in the quarter, perhaps, in terms of a percentage. And then I was wondering among the new customers, are you seeing Oxford Nanopore in the marketplace or competition with them?

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Ben Gong, [45]

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Yes, I think it was certainly a healthy number…

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [46]

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Yes, I would say -- in the past, we said it was roughly 50-50 new customers in terms of orders and -- but as opposed to people who already had either an RS or other Sequels. I think that is maybe starting to tilt a little in terms of new customers because you do kind of get past that. I mean, it may get skewed a little bit this quarter or in the next report when we -- because of the Novogene purchase. But in terms of Oxford, I think it's mostly the same thing we said before. It does cause delays in the tender process, frequently, mostly focused in Europe. I don't know that we've seen a huge change there. I mean, they -- to my knowledge, they still haven't shipped any of their Ion systems that are actually operating. So we tend to focus on what we do, and we're necessary, in a sales situation, to draw the distinction about data from our systems on related projects to whatever the customer's working on and what they do, and we usually do that very favorably. So it's not that it doesn't come up in sales situations, particularly in tenders, but I don't think we've seen a tremendous impact from them on us.

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Aurko Joshi, [47]

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Got it. And then, just another (inaudible). Do you expect a kind of bolus of orders following -- when the new chip comes out? Or is, perhaps, is (inaudible) still required for adoption?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [48]

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Well, are you talking about the chip at the end of 2018?

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Aurko Joshi, [49]

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Yes, or the next, even. Like, I mean, how are you thinking about the order placements as they relate to that?

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [50]

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Well, it's an upgrade on the chip, and it's that upgrade to the system to give it more computing power, among other things. But I don't think that's impacting sales in the short term. It's performance of the current system and the improvements that we'll make on it up until then. It's -- the way we would look at that, it's basically a continued cycle of improvement in a general sense, and it's part of that process. And we do it through improvements in the chemistry, the software, sample prep, and in the case of the Sequel, we have the ability to get that added boost of performance through the increased density on the chip. But they're all part of the same kind of process of continually increasing the throughput. And so each step along that way gives us access to more market share, more samples within a particular application area that get within the cost constraints of whatever the project is. And so it's an evolutionary project, or program, that's step-wise. It's not a giant leap each time. That said, an 8-fold increase in that one spot gets us down to where we get far more cost-competitive in doing things like resequencing of large numbers of human genomes, for which we're not really competitive at this point. And that's why we focused on ones that don't have the -- quite the constraints of that in terms of cost. In structural variant analysis, it's -- you don't need nearly the coverage you do for de novo assembly, so we can already fit into that arena quite well. But as the cost per sample goes down, we open up a bigger and bigger market.

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Operator [51]

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I'm showing no further questions at this time. I would now like to turn the conference back over to the presenters.

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Michael W. Hunkapiller, Pacific Biosciences of California, Inc. - Executive Chairman, CEO and President [52]

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Okay, in closing, I'd like to take the opportunity to acknowledge the people in the PacBio organization for their hard work and enthusiasm in driving growth in our business. It's been rewarding to see the immediate improvements our customers have seen with the Version 5.0 software release. Thanks to all the team members who have been working on that release, and it was a good part of the company, and to those who continue to support the ongoing rollout.

As always, we remain steadfast in our commitment to bringing the unique advantages of our SMRT technology and products to our customers and the scientific community in general. We believe that SMRT Sequencing provides the industry's most complete and accurate picture of genomes due to its superior performance and sequencing accuracy, uniformity of coverage, extremely long read lengths, and ability to characterize DNA-based modifications.

Furthermore, by providing scientists with an ability to obtain a comprehensive set of sequence information within a single experiment, SMRT Sequencing is often the lowest cost and the only research tool available to meet their needs.

Thank you for joining us, and we look forward to talking again in 3 months' time.

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Operator [53]

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This concludes today's conference call. (Operator Instructions)