Pacific Biosciences Of California, Inc. Q1 FY2022 Earnings Call

Good day and welcome to the PacBio First Quarter Fiscal 2022 Financial Results Conference Call. All participants will be in a listen-only mode. I would now like to turn the conference over to Todd Friedman, Director of Investor Relations. Please go ahead.

Thank you. Good afternoon, and welcome to PacBio's first quarter 2022 earnings conference call. Earlier today, we issued a press release outlining the financial results we will be discussing on today's call, a copy of which is available in the Investors section of our website at www.pacb.com, or is furnished on Form 8-K available on the Securities and Exchange Commission website at www.sec.gov. With me today are Christian Henry, President and Chief Executive Officer; and Susan Kim, Chief Financial Officer. Before we begin, I'd like to remind you that on today's call, we will be making forward-looking statements, including statements regarding predictions, progress, estimates, plans, expectations, intentions, guidance, and expectations for new products, technology and software development and launches, and the anticipated timing of such development and launches, expectations resulting from continued building and enablement of the HiFi ecosystem, expectations with respect to our partnerships and collaborations, estimates, intentions, and plans to use the company's cash and investments to fund current development and commercialization initiatives until achieving positive operating cash flow without the need to raise additional capital and other information. You should not place undue reliance on forward-looking statements because they are subject to assumptions, risks and uncertainties and could cause actual outcomes and results to differ materially from currently anticipated results. The challenges inherent in developing manufacturing, launching marketing, selling new products, and achieving anticipated new sales, competition, unforeseen increases in costs or expenses, interruptions, or delays in the supply of components or materials for or manufacturing of PacBio products and products under development, potential product performance and quality issues, and potential delays in development timelines. The impact of the COVID-19 pandemic and risks associated with international operations, among others. These risks and uncertainties, as well as other risks and uncertainties, are more fully described in our press release earlier today and in our Form 8-K, Form 10-Q and Form 10-K and other filings with the SEC. We disclaim any obligation to update or revise these forward-looking statements except as required by law. During the call, we will also present certain financial information on a non-GAAP basis. Management believes that non-GAAP financial measures taken in conjunction with U.S. GAAP financial measures provide useful information to compare our performance relative to forecast and strategic plans to benchmark our performance externally against competitors. Reconciliations between U.S. GAAP and non-GAAP results are presented in tables within our earnings release. 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 audio replay are cautioned that forward-looking statements made on today's call may differ or change materially after the completion of the call. I'll now turn the call over to Christian.

Good afternoon, everyone. Thank you for being here today as we review our results for the first quarter of 2022 and share our future outlook. I will begin by covering some business and commercial highlights, after which Susan will provide detailed insights on our financials and guidance, and then we will open the floor for questions. To start, I want to highlight three key takeaways from our discussion today. First, we are successfully executing our primary objective of rapidly increasing the install base of Sequel II and IIe systems, as demonstrated by another record quarter of instrument shipments. This expansion will facilitate more HiFi data entering the market. Second, we are making significant strides on our next generation of short and long-read sequencers. Our mid-throughput short-read SBB instrument is set for commercial release in the first half of next year, and we continue to believe it will be the most accurate short-read platform available. We are also on track with our internal milestones for developing our next-gen long-read sequencers. Third, PacBio is in a robust financial position, and based on our projections, we plan to support the company's current development and commercialization efforts using our existing cash and investments until we achieve positive operating cash flows, without needing to raise additional capital. Given the current volatility in equity markets, this positions us uniquely and favorably. Now, let's go over our Q1 results and how the team is poised to execute our 2022 plan. The first quarter marked a solid beginning to the year, landing at the higher end of our guidance with revenue of $33.2 million, a 14% increase compared to the same quarter last year. Based on our first quarter revenue, we project full-year revenues to be around $160 million to $170 million for 2022, equating to 23% to 30% growth. Susan will elaborate on that later. As mentioned in our previous call, first-quarter revenue was lower sequentially due to COVID-19-related challenges that affected customer operations and limited our team’s ability to engage with clients. Additionally, typical first-quarter seasonality was intensified by macroeconomic challenges that postponed some capital purchases. Despite these issues, I am happy to report that our team delivered another record quarter with 50 placements of Sequel II and IIe systems. This marks the third consecutive quarter with record placements, and over one-third of these placements were made to new PacBio instrument customers, emphasizing the growing appeal of HiFi sequencing. New customer applications span areas from gene editing to plant and animal research, reproductive health, and beyond. We are gaining momentum in system placements as a result of our heightened commercial presence, improved sales productivity, and significant product enhancements. Since launching our aggressive investment in early 2021, we have shipped more Sequel II and IIe systems than in the first two years since the platform’s introduction. While expanding our sales force may initially lead to lower revenue per sales representative, as new hires dedicate considerable time to prospecting for new opportunities, we see this as a necessary investment in building a sustainable sales pipeline in each territory. We believe this phase is temporary, and as our install base increases, it will drive consumable growth and boost revenue per representative in the medium term. Since consumables typically have higher gross margins than instruments, we expect to benefit from improved gross margin as our product mix evolves. Revenue per sales representative is only one measure of sales productivity, and we are making excellent progress in speeding up our sales cycle. For instance, last quarter we shared our instrument turns metric to assess sales productivity, noting that over 90% of instrument shipments were from sales made in the current quarter. This trend has continued, with nearly all of our instrument shipments in the first quarter being turned within that same quarter. In addition, we are excited to report that we delivered 18 additional Sequel IIe systems to the Broad Institute in the first quarter. Their investment in PacBio's HiFi technology enables them to tackle a range of whole genome and transcriptome sequencing initiatives, making them the largest install base of Sequel IIe systems worldwide. To further broaden our addressable applications, we launched significant enhancements to the Sequel II and IIe platform last month, and we are thrilled with the positive feedback from customers. Our new products facilitate the detection of DNA methylation directly on the sequencing instrument without additional workflow steps or costs, along with a library protocol and on-instrument analysis support for recombinant adeno-associated virus (RAAV) genome sequencing for gene therapy research applications, greatly simplifying library preparation processes. Lab technicians can now transition from DNA to sequencing within a single shift, and HiFi whole genome sequencing now requires even lower input, just one microgram per smart cell. These new methods are designed to be more scalable, allowing customers to operate at higher throughput. We believe our DNA methylation offering will significantly advance the field of epigenetics. Variations in DNA methylation contribute to traits just as genetic differences in DNA sequences do, and HiFi sequencing can now characterize both the genome and epigenome from a single sequencing library in a single run. Traditional methods for assessing the epigenome with short reads, such as whole genome sequencing, necessitate special separation and sample preparation, requiring separate runs for the genome and epigenome, which increases cost and time. Other long-read technologies do not match HiFi sequencing's accuracy, especially for insertion and deletion variants, or for distinguishing and phasing the two alleles, and require complex analyses to detect methylation. Our offering simplifies these processes, providing DNA methylation data directly from the sequencing instrument with no extra effort needed. Our new methylation offerings, in conjunction with existing workflows like Iso-Seq, illustrate our transformation into a multi-omic company. Children’s Mercy Kansas City is expanding its collaboration with us to incorporate these two features in their research study aimed at understanding the epigenetic and transcriptomic drivers of rare diseases, while also exploring related genomic variants. They have already shown that using HiFi has revealed four times more rare coding and structural variants than short-read sequencing, and we anticipate that adding PacBio methylation capabilities and isoform sequencing will further enhance the justification for HiFi. We also expect to improve our Iso-Seq offering later this year with a new kit designed to significantly increase throughput and enhance higher output transcriptomic research. In the first quarter, we added to our roster of clinical research collaborators and currently have over a dozen partnerships aimed at demonstrating the utility of HiFi across various applications. Additionally, we are pleased to introduce our new AAV protocol and analysis solution for AAV vector gene therapy research. AAV vector gene therapy is an exciting and rapidly growing field, with more than 150 companies currently working on AAV-based treatments. High accuracy and comprehensive visibility are crucial for the success of novel vector discovery, design, and quality control in gene therapy products. We believe HiFi sequencing can play a key role in gene therapy research due to its capacity to accurately sequence full-length AAV genomes. This is critical because qPCR short reads and less accurate long-read technologies can overlook significant changes that may be present in AAV sequences, potentially jeopardizing our customers' research. Over the past two quarters, we have provided eight instruments to new PacBio customers focusing on AAV, and more are in our sales pipeline. This feature exemplifies how we are creating end-to-end solutions tailored to meet our customers' specific application requirements. PacBio HiFi sequencing has long been a preferred technology in plant and animal research due to the complexities of their genomes and the value that highly accurate long reads provide for de novo assembly and reference genome development. Nonetheless, to facilitate broader adoption of HiFi sequencing in commercial agriculture, innovative, resource-efficient, high-throughput methods are necessary. To address this, we are collaborating with Corteva Agriscience to develop end-to-end workflows for plant testing and microbial sequencing that will support their seed development and crop protection endeavors. We expect these new high-throughput agricultural protocols to be made widely available to the community sometime in 2023. The length and accuracy of HiFi sequencing are essential for the development of new seed products, as these complex genomes are more challenging to sequence and assemble. Moving on, I'd like to take a moment to describe three critical advantages of using native DNA; molecular integrity, absence of amplification steps, and simpler sample preparation in bioinformatics workflow. First, because native DNA molecules that are extracted from cells are directly submitted to the sequencing, the DNA fragment can be much longer compared to synthetic approaches. Having longer and continuous sequences lead to greater continuity of information and improves the results in de novo genome assemblies, as well as metagenome communities, haplotype phasing, epigenetic phasing, and structural variant detection. Second, sequencing native DNA molecules by definition does not use DNA amplification or other molecular biology procedures, which are prone to biases and can introduce errors, fragmentation and other artifacts. Synthetic long reads require these procedures and risk confounding studies with artifacts that can provide potentially inaccurate information. Sequencing of native unaltered molecules enables our technology to look at genomes without these biases, resulting in better coverage and completeness, resolving diploid and polyploid genomes into fully phased alleles and achieving greater genome completeness. PacBio sequencing, therefore, accesses the whole genome, resolving structural variants in other regions of the genome considered difficult to sequence with short reads due to limitations of the sequencer itself, which cannot be overcome with synthetic long-read constructs. Further, amplification steps result in the complete loss of methylation information. Thus, by sequencing native DNA molecules, as I described earlier, PacBio provides both genetic and the epigenetic information simultaneously without any additional effort. And third, the sequencing of long native molecules significantly simplifies all workflow aspects from upfront sample and library preparation to bioinformatics at the back end. PacBio native long HiFi reads do not require bioinformatic correction steps, complicated reassembly steps, consensus computations from oversampling or subtraction from control samples. We have seen time and time again, over the past decade, numerous attempts at synthetic long-read approaches, which were all eventually abandoned. We believe native long reads will continue to provide the most accurate, contiguous and complete genomic and epigenomic information with ever-increasing applications. Nothing has highlighted the limitations of short-read sequencing and whole genome sequencing more than the landmark publications from the telomere-to-telomere consortium, which completed the final 8% of the genome. Something that short-read sequencing had been unable to do despite years of improvements in informatics and AI. So, I often get the question, why isn't HiFi and long-read sequencing ubiquitous today? Why are genomes still being sequenced at all with incomplete and insufficient technology? Cost, throughput, and accuracy have historically given short-read technologies the edge and made short-read the de facto winner over the past decade. But just a few years ago, with the launch of HiFi sequencing, PacBio became the leader in sequencing accuracy as evidenced by the data from the precision FDA and the association of biomolecular resource facilities. Our improvements in accuracy have enabled much broader adoption of long-read sequencing outside of its historical niche areas. We've now seen increased HiFi adoption in human applications, as we discuss the handful of clinical research collaborations in genetic disease and the growing list of customers conducting research in oncology, gene editing and reproductive health. We expect our next-generation long-read sequencers equipped with HiFi will overcome the remaining two barriers of adoption, cost and throughput, and mark the inflection point of large scale adoption of whole genome sequencing using HiFi. Moving on to short reads. We do remain on track to launch what we believe will be the most accurate short-read sequencer. We expect this sequencer will address other high growth areas in the genomics market where HiFi sequencing may not be necessary. As part of our strategy, we see this as the best way to address our customers' needs. We aim to develop the right instrument and chemistry for the right application and not force fit one sequencing technology to address the entire market. It is these transformative products we are developing along with the world-class team that we have built that give me confidence in PacBio's ability to deliver over the next several years. However, delivering on our mission requires substantial investment. In today's uncertain market and financing environment, we are extremely fortunate to have nearly $1 billion in cash on our balance sheet. And as I earlier mentioned, we intend to fund our current development and commercialization programs using cash and investments that we currently have on the balance sheet until we reach positive operating cash flow without the need to access the capital markets. Finally, I'd like to take a moment to update you on our collaboration with Invitae. As you may recall, we have partnered with Invitae to create an ultra high throughput sequencer capable of sequencing tens of thousands of whole genomes each year. The development of this new platform is going very well, and there continues to be great enthusiasm for the potential of adopting HiFi sequencing at scale in a clinical setting. However, given the difficult capital environment Invitae has asked us, and we are planning to amend our agreement such that Invitae will no longer make payments during the research and development phase of the collaboration. In exchange, the pricing of the platform and related consumables to Invitae will be increased to be more in line with our expected market price. The other aspects of the collaboration will continue. For example, we expect Invitae will continue to leverage their internal resources to assist in the development of scaled workflows, bioinformatics pipelines and other aspects of the project. As a result of this amendment, we believe Invitae will be on a more level playing field with other large scale users of our ultra high throughput system. We expect to complete the amendment during the second quarter. I want to reiterate that this proposed amendment is the result of the macroeconomic funding environment and does not reflect either company's enthusiasm for the collaboration, the development timelines, performance to date, or other product specifications. With that, I'll hand the call off to Susan to talk about our financial results in more detail.

Thank you, Christian. As discussed, we reported $33.2 million in product and service revenue in the first quarter of 2022, which represented an increase of 14% from $29.0 million in the first quarter of 2021, and was at the high end of our range. Instrument revenue in the first quarter was $15.6 million, an increase of 4% from $14.9 million in the first quarter of 2021. We delivered a record Sequel II and IIe systems during the first quarter growing the install base to 424 systems as of March 31. Turning to consumables, revenue of $12.7 million in the first quarter grew 22% from $10.4 million in the first quarter of last year, and Sequel II and IIe consumables represented approximately 85% of our total consumable revenue in the first quarter, with the rest from older systems and other consumables. Annualized pull-through per system on the Sequel II and IIe install base in the first quarter was approximately $115,000. In the first quarter, as we discussed on our last earnings call, we saw lower utilization largely due to the impact of COVID-19 on lab productivity. While we saw improvements in some regions towards the end of the quarter, the escalating cases in China and associated lockdowns impacted utilization throughout Q1. As we discussed before, our record placement in Sequel II and IIe may have a short-term impact on pull-through, especially as we onboard new customers. Finally, service and other revenue grew to $4.9 million in the first quarter compared to $3.7 million in the first quarter of 2021, reflecting our growing install base. Shifting to a regional view. America's revenue of $19.1 million grew 57% compared to the first quarter of 2021, as the region delivered a record number of systems and grew consumables and service revenue commensurate with a larger install base of Sequel II and IIe. Moving to Asia-Pacific, revenue of $8.4 million reflected a 1% decline over the prior year period with lower instrument revenue partially offset by growth in consumables. Consumable growth was somewhat muted in the region, with headwinds resulting from COVID-19 restrictions, particularly in China. Other parts of APAC saw strength, with record consumables in Japan and our first system placement in Australia since Q2 of 2020, countries where we've been expanding our commercial reach. Finally, EMEA revenue of $5.7 million was 32% lower compared to the prior year period as the region was most impacted by the surge in coronavirus cases earlier in the quarter, both at our customer sites, as well as among our own employees in EMEA. While COVID-19 impacted both instrument and consumable sales, the team still made great progress growing our reach with four countries in the region taking their first Sequel II or IIe including Israel, Serbia, Poland and Austria. We also delivered the first PacBio instrument to EMBL GeneCore, the European Molecular Biology Lab, which is preparing to launch HiFi sequencing services across microbiology, human, plant, and animal applications. Moving down to P&L. As a reminder, I will share both GAAP and non-GAAP results for gross margins, operating expenses, and net loss. I encourage you to review the GAAP reconciliation of these non-GAAP measures, which can be found in today's release for more information. GAAP gross profit of $14.2 million in the first quarter of 2022 represented a gross margin of 42.7%. Excluding amortization of intangible assets, first quarter 2022 non-GAAP gross profit of $14.3 million represented a gross margin of 43.2%, compared to a GAAP and non-GAAP gross profit of $13.0 million or 44.8% in the first quarter of last year. The decline was predominantly due to the mix of instruments, reflecting the largest volume of quarterly multi-instrument placements, as well as the Sequel I trade-in incentive in the quarter in Q1 2022, resulting in lower instrument average selling prices, partially offset by higher consumable volume. Moving on, GAAP operating expenses were $91.7 million in the first quarter of 2022. Excluding a credit of $1.1 million related to contingent consideration remeasurement, which was due primarily to an increase in the discount rate and expenses related to amortization of intangibles, non-GAAP operating expenses were $92.7 million. This represents a 99% increase from non-GAAP operating expenses of $46.7 million in the first quarter of last year, reflecting growth in headcount, operating expenses related to the acquisition of Omniome, and non-headcount related R&D spend. In terms of headcount, we ended the quarter with 774 employees compared to 728 at the end of 2021. GAAP and non-GAAP operating expenses in the first quarter included a total non-cash stock-based compensation of $20.9 million compared to $9.2 million in the first quarter of last year. GAAP net loss in the first quarter of 2022 was $81.5 million or $0.37 per share. Excluding change in fair value contingent consideration, amortization of intangible assets and the repayment of continuation advances to Illumina, non-GAAP net loss was $82.3 million, also representing $0.37 per share compared to a non-GAAP net loss of $35.4 million or $0.18 per share in the first quarter of 2021. Now turning to our balance sheet. We ended the first quarter with $963 million in unrestricted cash and investments compared with $1.04 billion at the end of 2021. Inventory balances increased in the first quarter to $29.6 million, representing 2.8 inventory turns compared with $24.6 million at the end of the fourth quarter of 2021, representing 3.6 inventory turns. The decline in inventory turns reflects our strategy of increasing safety stock levels to manage global supply chain risk, to continue to ensure we have the necessary raw materials to meet our customer demand. Accounts receivable increased in the first quarter to $27.9 million, reflecting a DSO of 71 days compared with $24.2 million at the end of the fourth quarter of 2021, reflecting a DSO of 62 days with the increase primarily due to more revenue booked later in the quarter. Long-term deferred revenue remained relatively flat compared to the fourth quarter of 2021 at just over $25 million, as we did not receive incremental cash from Invitae in the quarter, as Christian discussed earlier. Moving to guidance. For the full year 2022, we continue to expect revenue in the range of $160 million to $170 million, representing a growth rate of approximately 23% to 30% compared to 2021. This guidance assumes there are no more significant or prolonged disruptions related to COVID-19 or its variants, and it assumes the global supply chain constraints do not worsen. Specifically, our revenue guidance assumes the slower utilization we experienced in Q1 recovers and utilization in China improves by early summer. As such, our guidance assumes a back half of 2022 that is much stronger than the first half. Specifically for the second quarter, we expect revenue to grow sequentially compared to the $33.2 million reported in the first quarter of 2022, with sequential growth in both Americas and EMEA, partially offset by a slight decline in APAC due to the record consumables revenue quarter we experienced in Japan for Q1. Moving down the P&L, we expect the non-GAAP gross margin to be at the lower end of our previously guided range of between 45% and 47%, mainly reflecting increasing supply chain costs. For operating expenses, we expect the full year to now be in the range of $355 million to $365 million. The increase primarily reflects a non-recurring non-cash stock-based compensation expense true-up due to lower than expected employee attrition we observed in Q1. We continue to expect interest and other expenses to be approximately $15 million for the full year, reflecting interest expense and amortization of debt issuance costs for our convertible notes issued in 2021. We expect the weighted average share count for purposes of EPS for the full year to be approximately 225 million shares. With that, I will turn the call back to Christian.

Thank you, Susan. The team executed tremendously in the first quarter amidst one of the most trying macro environments we've ever seen. With a third year behind us, we believe that we are on track to meet our revenue target we set forth at the beginning of the year. Our product roadmap is full of exciting and innovative products that we can't wait to share with the genomics world. And by our estimate, we intend to fully commercialize these exciting new products using the cash and investments that we currently have on the balance sheet. In turn, we believe that will drive us to operating cash flow positive in the future. With that, I'd like to invite the operator to open the floor to Q&A.

We will now begin the question-and-answer session. And our first question today will come from Dan Brennan with Cowan. Please go ahead.

Thank you for taking the questions and congratulations. I have a couple of tactical questions for the short term and then some broader ones. I know there's been a lot of discussion about China, and you summarized it in your closing remarks. Can you clarify what happened in China in Q1? It seems like you're expecting things to be back on track by the end of Q2. What are your expectations for Q2 and the rest of the year regarding China?

Yeah. I think in Q1, China probably represented about 15% of the business. And for the rest of the year, we're hopeful that as it recovers, I suspect second quarter might be a little lighter than that, given the lockdowns in the environment right now. But as Susan pointed out, if things start to moderate in the summer, that gives us some good belief that we're going to achieve the $160 to $170 million outlined.

Got it. Thanks, Christian. I have one more tactical question. You mentioned it last quarter, but I didn't hear anything about it today. You have removed it from consideration, like emerging biopharma, which generated some excitement at the beginning of the year. I'm not entirely sure how significant it is as a percentage of your revenues, but I wanted to check in. Was there any impact, and what was the trend in that customer base as we started the year in the first quarter?

Yeah. I think it was consistent with what we were talking about back in January. Any of the smaller emerging companies that are not generating positive cash flows and that are sitting in this macro environment have definitely longer sales cycles right now. And they were that way throughout the first quarter. Quite frankly, I don't expect them to change over the balance of the year. We've considered that when we're talking about our guidance and how we're thinking we're going to build the business. Obviously, we're really excited in areas like AAD, where there are some smaller customers that have been rapidly adopting the products because the Sequel IIe really serves them well across what they're trying to do. But some of the emerging, more traditional pharmas, I still think that business is going to be tough for us until they manage their own balance sheets. I suspect that will improve as the world normalizes, but Q1 was a pretty big shock to the system for all of us.

Got it. And then, Christian, you spent a fair amount of time in the prepared remark, discussing all the advantages that native long-read sequencing platform has over something deemed to be synthetic. But I'm just wondering, like, did you see any pause at all? Is there any pent-up demand for placements, such that as we get through AGPT and we see more details about infinity, is there could there be either an unlock event with some customers that are on the sidelines right now, just maybe give a little color for kind of what the Salesforce was seeing during the first quarter?

Yeah. Obviously, I ask that question a lot and really have been laser-focused on it. And what we've seen is, in general, it hasn't really slowed the sales cycles down, perhaps maybe a little bit in Europe, more than in the United States and in APAC. I do think there's probably potential for a bit of an unlock as folks start to understand what other techniques might look like. But when you really sit and talk to the customers, they care back to me all the things I just pointed out on the in the prepared remarks that, if we're serious about doing long-read sequencing, we need to be using PacBio because there you just get the most complete information, you resolve the biology in a more detailed way. They know we are continuing to improve, as evidenced by the direct methylation launch we had just a few weeks ago. So, they see that there are significant limitations. But that doesn't mean they're not learning about this. At the end of the day, our growth is likely to be unhindered by Infinity.

Great. And then maybe one last question about the new high throughput platform. I think we expect to see some data or get a glimpse of it in the second half of this year. Could you remind us what specifically we will see and when? How should we approach this? Obviously, Sequel IIe is performing well, and there is a significant opportunity ahead. I think there's growing excitement around what the new platform could achieve. So, could you provide an update on what we will see and how we should consider the potential opportunity? There’s clearly an upgrade opportunity, but how do we think about the potential new customers this could attract to the long-read market?

Thank you for your question, Dan. One consistent observation we've made is that significant advances in long-read sequencing technology, such as improvements in accuracy and cost efficiency, tend to generate considerable market traction and initiate a replacement cycle. This attracts new customers, and our goal has always been to create a diverse product portfolio featuring various instruments across different price points and throughput capacities. This will allow a broader range of customers to benefit from the advantages of long reads and HiFi sequencing. We are currently focusing on higher-end options due to the substantial opportunities we see in whole genome sequencing, especially with high-throughput platforms aiming for costs below a thousand dollars, as we have previously mentioned. In terms of our development efforts, everything is progressing well, and our teams are dedicated. As I noted back in 2021 at JPM, these platforms may take a few years to deploy, but we are on track. We will likely share more details later this year, but for now, I prefer to keep some information under wraps.

And our next question will come from David Westenberg with Piper Sandler. Please go ahead.

Hi. Thank you for taking my question. My first question is a follow-up on the high throughput platform, particularly regarding the collaboration with Invitae. I understand it relates to Invitae's cash position, but I’m curious about how this platform is being funded if they are not providing any financial support and there hasn’t been a change to your guidance, aside from the $5 million in stock-based compensation. Is this potentially a funding event for 2023? I apologize if I'm being overly persistent.

No. It's a great question. It's probably good to take a moment to clarify. So, if you think about it, the way we're doing the accounting for the Invitae payments, what they really are, are prepayments for buying the actual system. And so, what we've been doing is as they pay us, we put that into deferred revenue while we continue to pay the R&D expense on our P&L. So the P&L doesn't change at all. We've been investing all along and recording R&D expense; we will continue to do that. And then, you've got this building deferred revenue. We are working with Invitae such that all we're really doing is changing the timing of when they make payments to give them some flexibility on their cash. It's important to understand what's really happening; we are increasing the pricing of the final product, so we'll actually capture more gross margin. If you look at the NPV of this particular project, we will make more profit and more cash flow under this amendment than we would otherwise have made. The other thing that's really beneficial to us is their pricing will be such that others will be able to compete with them a little better. They're still going to have incredible pricing. They're completely committed to the relationship and they're still investing their internal resources. It’s just we’ve reallocated how they pay for the machines by paying at the end of development instead of along the way. The R&D expense continues to be recorded as it has been.

Got it. Appreciate you. I had a gap in my coverage of you guys when signed. So, thanks for the reminder there. And then, in terms of pull-through, I think Susan laid out some of the Omicron in January and then kind of what was happening in China. Would you maybe give us a sense for what you had in pull-through in maybe March or April? I mean, I'm just trying to get a sense of, is this pull-through normalizing as we're heading further into the quarter and it looks like it's behind you or anything like that?

Well, I don't think we're going to give individual months, because any individual month could be an aberration. But what we can say is that pull-through is improving over what we reported in Q1. Pull-through is a metric that's dominated by both the enumerator and the denominator. At some level, as we sell more instruments per quarter, the pull-through will likely go down, particularly when we're selling to many new customers. In our executive business reviews this quarter, it was uncovered that the time to get a new customer to run their first chips or smart cells could be as much as 90 days from installation, because they're working on workflows, et cetera. As you're seeing us get many new customers, that puts pressure on the short-term pull-through, and as we sell more instruments, that obviously impacts the denominator. When we sell through a high throughput or high throughput capable customer, like the Broad Institute at such a large scale, that will likely help the pull-through, but it will be somewhat offset because they have great pricing from the volume. There's a lot of factors at play, but I think on balance, you're going to see the number improve from here.

Perfect. That was a really nice detailed answer there. I'm just going to ask really one, because I think it's going to be very short. The one-third of two new customers, was that inclusive or net of that big order to the Broad Institute?

That accounts for one-third of the 50 systems we ship. Thank you.

And our next question will come from Tejas Savant with Morgan Stanley. Please go ahead.

Hey, guys. Good evening. So, I want to go back to that Broad order you mentioned, Christian. As you sort of framed the guide on your 4Q call, was that sort of already contemplated or was that all upside, which came through late in the quarter? And then, as you think about your order funnel or your instrument backlog here heading into the back half of the year, can you just give us a sense for the breadth of the demand versus any other sort of large multi-unit orders that we should be thinking about?

A couple of key points. Regarding the Q1 guidance, we had anticipated some of the Broad order, but not all of it. We were somewhat cautious in our internal discussions because, with an order of that magnitude, the timing can be uncertain. Some of it was factored in, but not the entirety. Looking toward the latter half of the year, one exciting aspect is the number of identified opportunities for new instruments, which is at its highest level ever in the company's history. This indicates we have increased sales coverage for potential instrument sales to achieve our forecast. This improvement is primarily due to hiring more sales representatives who are actively prospecting. Overall, all three metrics related to sales productivity are showing positive trends for the company, building a solid foundation for long-term growth. Lastly, regarding the funnel, securing an 18-unit sale to the Broad, which now has 23 instruments in their fleet, serves as a flagship account that affirms our technology and applications, marking a significant achievement for us this quarter. Additionally, we value our partnership with the Broad because they are very collaborative and actively support our efforts.

Got it. That's very helpful. I appreciate the insights you've shared on China, Christian. One question we've been receiving is about the basis for your confidence. Are discussions with local government authorities or your key customers in that region influencing your belief that conditions will improve by summer? It seems like the situation is quite unpredictable, with lockdowns fluctuating in places like Shanghai and Beijing. I'm interested in your thought process behind the assumption of a summer recovery and the expected normalization of utilization and placements in the latter half of the year.

One of the reasons for our assumptions is that we recently hired an outstanding country manager for China, who is exceptional. His contributions were significant in achieving a strong quarter in instruments. We experienced many trade-ins from Sequel I to Sequel IIe. Our presence on the ground in China has never been better, which enhances our understanding of the market. However, as Susan mentioned, none of us can predict exactly when things will return to normal. We tend to lean towards optimism rather than extreme pessimism. Nonetheless, we also observe our business growing across the APAC region. Japan had an excellent quarter, and we made our first instrument sale in Australia. We're broadening our commercial reach. If China doesn't recover, it will undoubtedly impact our guidance. We have a substantial opportunity pipeline and will strive to address that and continue our growth.

Got it. And then one final one for me on, just traction for that HiFiViral kit. I think, in the last call, Christian, you'd mentioned sort of high single digit millions in COVID contributions. This year you'd expect that to skew more towards consumables. Is that a possibility of a little bit of upside there, given how that kit perhaps did, thanks to the Omicron variant, or how are you feeling about that contribution at this stage of the year?

I think it has potential to contribute, but I don't think it's going to be a significant contributor to make our year or not make our year. One of the reasons for that is, particularly in the United States, testing is down a bit or surveillance has been down a little bit. The time to implement new technology is uncertain, and some labs are keen on the assay, but they’re hesitant about further surveillance and funding. Although it has been an incredible learning experience for us, generated some good revenue, and allowed us into public health labs where we may not have had a chance before, I don't expect it to be a major contributor to our revenue for the balance of the year. I could be wrong if we have another surge, but that's kind of where we see it on that.

Got it. Very helpful. Thanks for the time guys.

Thank you.

And our next question will come from Kyle Mikson with Canaccord. Please go ahead.

Hey, guys. Thanks for taking the questions. Congrats on the quarter. I wanted to start with the next-gen kind of tools that need to be launching, hopefully soon. It has been three years or so since the launch of the 8M chip in the Sequel II, and like, earlier in the call, you're pretty vocal about developing at least a next-gen sequencer pretty soon, so that would probably require a higher density smart cell. I know that like whole genome costs and throughput are kind of like the critical factors. Are those metrics reasonable for the smart technology in the near term? Do you expect these new kind of PacBio products to launch in 2022 or is that more of a 2023 kind of story?

We have not said exactly when we're going to launch these products and when development will be finished. Clearly, the Sequel IIe is performing extremely well in the market, and customers are very excited about it. However, at some point, we will continue to advance the technology to the state you're talking about — orders of magnitude in levels of throughput, et cetera. I don't want to quote specific numbers today, but it is our mantra. We have to increase throughput significantly. We will unpack that more as the year goes on, the development programs are going very well, and we continue to hit our internal milestones. We're right on track for that. At the right time, we will unveil it more wholesomely, but we want to make sure we maximize our opportunity with the Sequel IIe platform while we have it.

That sounds great, Christian. Thank you for that. I would like to revisit the Omniome platform since the beta launch is currently taking place. Can you share more details about the specifications for the Omniome platform, particularly regarding the beta units? There has been discussion about flexibility in the marketplace. What is the expected number of flow cells per run and the cost per flow cell? Additionally, how should investors consider these metrics in relation to the existing short-read companies?

That's a good question, Kyle. I'm sure we'll talk about it more at AGBT. Hopefully, if you're there, we'll spend a lot of time on it, I'm sure. In a nutshell, we see the platform as being highly competitive with any of the emerging players. It'll be a mid-throughput system, as we've talked about. It will have accuracy Q40; 90% of the reads will be Q40 is our expectation right now. In terms of cost per gig, it will be competitive with the emerging players and the existing players. Accuracy is so much higher than the competition; we want to change the narrative. The price for answer matters because even if you're selling it at $5 to $7 a G, what really matters is how many Gs do you need to get that answer? That’s where we will shine more than the emerging players. On a straight cost per gig, it'll be competitive, but it's really about the offering to the customer. How many Gs of sequencing or how many samples can I put in a flow cell to get the answers I want? That drives the economics. The accuracy drives coverage, which means less sequencing, lowers costs, more speed. Those are all competitive advantages that I think will make the platform compelling.

Okay. That was great. I look forward to hearing more at AGBT. And maybe just finally, I want to touch on some of the new workflows that transformed the Sequel IIe like a five-base sequencer, without all the additional costs and time. I'm just kind of wondering what the five-base functionality does for your clinical efforts. Do you think that the direct methylation could improve diagnostic yield of long-read treatment for different diseases?

Absolutely. We'll stick with the Children's Mercy example for a minute. They were one of the early access users, and even the first runs they're getting, they're seeing allele-specific or haplotype-specific epigenetic profiles that give them indications and clues into disease. At a fundamental level, we are changing the narrative of what a complete genome is, what a clinical grade genome is. The utility from the genome, it's all of these different tools — structural variant analysis, methylation, epigenetic status, etc. Starting to see all this genetic picture in one assay with one informatics workflow is really changing the game and helping us resolve the biology. That’s going to be one of the core value propositions of long-read sequencing in general versus short-read, and as we get throughput and cost down, it would be surprising not to see a significant transition in clinical applications when you want to see more of the genome to understand what's going on.

Okay. That was great. Thanks a lot. Appreciate it. Congrats again.

Thank you.

And this will conclude our question-and-answer session. I'd like to turn the conference back over to Christian for any closing remarks.

Great. Thank you. Thanks everyone for the questions. After two years of limited travel, we're finally excited to get back on the road and interact with our customers and investors. Right now, we're in the midst of our discoveries road show, where we're traveling to 20 cities around the world to put HiFi sequencing on display. I invite you to look at our schedule on our events webpage and join us for one of our meetings, if you're available. We're also excited to see you at AGBT next month. We'll be having an investor meet and greet and panel Q&A with our leadership team to kick the event off. So, we hope you can make it. Thank you. We look forward to continuing to update you on our progress throughout the year.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your line at this time.