Pacific Biosciences Of California, Inc. Q2 FY2023 Earnings Call

Thanks MJ. Good afternoon and welcome to PacBio's second quarter 2023 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 on the Investors section of our website at www.pacb.com or as 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. Biosciences and its products and technologies and active patients with respect to: You should not place undue reliance on forward-looking statements because they are subject to assumptions, risks and uncertainties that could cause our actual results to differ materially from those projected or discussed, including those inherent in developing and commercializing new products. We refer you to our documents that we have filed with the SEC, including our most recent forms 10-Q and 10-K, and our recent press release to better understand the risks and uncertainties that could cause actual results to differ. 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. Non-GAAP information is not prepared under a comprehensive set of accounting rules and should only be used to supplement an understanding of the company's operating results as reported under U.S. GAAP. Management believes that non-GAAP financial measures, combined with U.S. GAAP financial measures, provide useful information to compare our performance relative to forecasts and strategic plans, and benchmark our performance externally against competitors. Reconciliations between historical U.S. GAAP and non-GAAP results are presented in tables within our earnings release. For future periods, we are unable to reconcile the non-GAAP gross margin and non-GAAP operating expenses without unreasonable efforts due to the uncertainty regarding among other matters certain acquisition related events that may arise during the year, including amortization of developed technology. We will also discuss our recently announced acquisitions of Apton Biosystems. For more information, we have posted a presentation which can be found on the Investors section of our website at www.capb.com. Please note that today's call is being recorded and will be available for replay on the Investors section of our website shortly after the call. Investors electing to use the audio replay are cautioned as forward-looking statements made on today's call may defer or change materially after completion of the live call. We will be hosting a question-and-answer session after our prepared remarks and we ask that analysts please limit themselves to one question, so that we could accommodate everybody in the queue. I will now turn the call over to Christian.

Thank you, everyone joining our call. In today's prepared remarks, I'll update you on several aspects of our business. First, I'll discuss PacBio's record performance in the second quarter and highlight our commercial activities. Second, I'll comment on Revio's field performance and customer update in its first full quarter since launch. Next, I'll highlight our recent commercial launch of Onso and our acquisition of Apton Biosystems, which was announced earlier today and then Susan will take us through the financials and guidance in more detail. And finally, at the close with half a year behind us, I'll share how we are executing against our 2023 priorities I set forth at the beginning of the year. Starting with Q2 performance, the rapid adoption of Revio drove another record quarter for PacBio as we grew revenue by 34% compared to the second quarter of last year, and we exceeded $40 million in quarterly revenue for the first time in our history with each region posting record revenue. The team did an excellent job of scaling manufacturing and ramping installations which enabled us to ship 45 Revios for revenue and brought our installed base to 77 Revio Systems as of June 30. Additionally, we exited the quarter with a healthy backlog of Revio instruments. Revio's momentum and our ability to meet customer demand have further increased our confidence to raise our revenue expectations for 2023. We now expect full-year revenue to be between $185 million and $190 million, representing 44% to 48% growth over 2022. Sequel IIb: New customers in the quarter also included the Medical University of Innsbruck, which marks the first Revio in Austria. The customer plans to consolidate multi-approach workflows used to analyze difficult genes that included short-read sequencing, Sanger sequencing, and PCR and streamline it into targeted long-read panels utilizing HiFi sequencing. New customer orders in the quarter also included the first instrument order in Indonesia from the YSDF Foundation. The Group collaborates with academic institutions and hospitals across the country to promote genomic research and improve health. They ordered the Revio, Onso bundle to match the best-suited sequencing approach with the appropriate sequencing application. They plan to use long-reads in human whole genome sequencing to build a genomic repository across the diverse Indonesian population, as well as metagenomics, and targeted applications in difficult-to-sequence genes. The customer plans to leverage the accuracy of sequencing by binding on Onso to develop targeted panels for liquid biopsy. Revio's increased throughput, accuracy, and direct methylation detection continue to expand the long-read sequencing into population genomics programs. In the second quarter, Sample, a leading genomic service provider and biorepository based in New Jersey, received its first Revio and is set to begin sequencing a group of samples for a large-scale population genetics program funded by the Department of Veteran Affairs. The program released data from over 1000 PacBio genomes, marking an important milestone as the influx of long-read data into the public research domain can facilitate new discoveries, inspiring further research and interest in long-read genomes, which is the type of momentum we believe will drive HiFi adoption. Customer utilization and Revio's field performance in the second quarter indicate a robust start to the product launch. Customers are increasing their Revio usage, with about $6 million of our total $13.7 million in consumables revenue attributed to Revio during the quarter. This strength derives from higher expected utilization from early customers and some customers stocking up on consumables in preparation for larger upcoming projects. Notably, it was encouraging to see customers placing larger standing orders for consumables during the quarter, suggesting they expect a steady stream of samples to keep their Revio operational in the future. It's important to note that while our utilization and ordering trends are positive, they are still in the early stages and represent just the first wave of Revio customers. I anticipate we will have a clearer understanding of normalized Revio demand sometime next year. In terms of field performance, customers sequencing libraries of 15 KB and larger are consistently meeting our specification of approximately 90 Gigabases per SMRT cell. The heart failure rate is improving and remains well below our launch targets. Later this year, we expect to release system updates that will enhance functionality and further boost performance. Overall, Revio is demonstrating its reliability in the field. As customers increase their sequencing activities on Revio, it's thrilling to witness the initial wave of scientific publications stemming from this new instrument. In one preprint, researchers from Washington University and the University of Maryland reported that accurate, long-read whole genome sequencing on the PacBio Revio system is reliable and can achieve 30x genome coverage in one SMRT cell. They also observed consistency across SMRT cells in coverage, variation detection, methylation, and de novo assemblies. In another preprint, researchers from the International Weed Consortium, composed of 24 institutions, reported on the sequencing of 80 plant species with Revio, noting that this enabled pan-genomic analysis aimed at developing sustainable and effective weed control methods and providing insights into environmental threats that could significantly diminish crop yields. Additionally, the study compared the latest PacBio HiFi and nanopore methods. Consistent with previous reports, they observed that nanopore data resulted in a much higher error rate in indel calling than HiFi data, and that certain variant classes had lower precision with duplex nanopore data compared to standard nanopore data. Customers are pleased not only with Revio and its game-changing throughput and economics but also with the quality of service that PacBio provides. With that, I am pleased that our annual customer survey was completed in the quarter resulting in a final Net Promoter score of 62. This demonstrates our commitment to delighting our customers and we look forward to continuing to offer best-in-class support to all of our customers around the globe. Switching gears from long-read to short-read, I'm excited to announce that earlier today we shipped our first commercial Onso system. The sequencing by binding or SBB chemistry, which is at the core of the Onso system, was the early-stage technology we acquired from Omniome less than two years ago with the promise of delivering customers an extraordinary level of sequencing accuracy. I congratulate the entire team at PacBio for developing this technology into a highly differentiated platform designed to offer customer sequencing accuracy of 90% of bases at Q40 plus levels or one error in every 10,000 bases, a specification that we believe no other sequencer currently advertises. This is a truly monumental moment for PacBio as it's our second sequencer launched in less than six months. We believe it positions PacBio as the only sequencing company to offer systems specifically designed for both long and short-read sequencing and marks the next step in our strategic journey to becoming a multiplatform, multi-omic company that aims to deliver solutions across the genomics ecosystem. One of the first Onso systems is going to the Translational Genomics Research Institute or TGen, an early collaborator who found that SBB demonstrated the ability to accurately detect ultralow variance without the need for high complexity error correction in a broad range of applications including infectious disease and liquid biopsy. Now that we are shipping commercially, we plan to scale manufacturing throughout the second half of 2023. Additionally, PacBio expects to complete the installation of this Onso instrument and ship related consumables later this month. The milestone payment associated with PacBio's acquisition of Omniome will be triggered once both the Onso instrument and related consumables have been shipped. Onso is expected to address a significant portion of the short-read sequencing market, particularly where researchers are looking to find and understand very rare variants. As these discoveries are made, we believe that these researchers will then want to scale their experiments which will require a highly accurate high throughput, short-read sequencing platform. Therefore, our strategy is to develop a multiproduct portfolio with both mid and high throughput short-read platforms based on our SBB chemistry. As a result of our strategy, I'm pleased to share that earlier today we announced that we entered into an agreement to acquire Apton Biosystems, a Bay Area-based company developing a high throughput short-read sequencer using state-of-the-art clustering, chemistry, optics, and image processing. In working with Apton over the past few months, we found that Apton's sequencing platform is capable of generating SBB quality data in a high throughput sequencing system. As a combined company, we expect to integrate and further optimize the extraordinary accuracy of SBB chemistry with Apton's advanced optics and imaging technologies to develop a differentiated high throughput sequencer. When launched, we expect this platform to deliver billions of reads per flow cell sequencing output on par with other high throughput offerings while providing differentiated accuracy and compelling economics. Increasing density and throughput is one of the key development challenges in launching a high throughput sequencer and Apton will give us a significant head start in that development. We are bringing over several talented engineers and scientists from Apton's lean organization and have already started planning the development of this next generation sequencer. Of course, many of you may be wondering how this acquisition will impact our operating expenses going forward. Developing a high throughput short-read sequencer has always been on our product roadmap and the acquisition will accelerate our development of a high throughput sequencer and is likely to reduce our overall R&D expenses required to develop the system. Therefore, we remain committed to delivering on our long-range targets while keeping OpEx under 5% compound annual growth through 2026, and this acquisition is not expected to deviate PacBio from that target. In fact, Susan will discuss shortly that we expect operating expenses to be lower than previously anticipated in 2023.

Thank you, Christian. As discussed, we reported $47.6 million in products, service and other revenue in the second quarter of 2023, which represented an increase of 34.1% from $35.5 million in the second quarter of 2022. Instrument revenue in the second quarter was $29.9 million, an increase of 91.6% from $15.6 million in the second quarter of 2022. The continued momentum of Revio primarily drove the increase in revenue as we shipped 45 Revio systems for revenue in the quarter. We ended the quarter with an installed base of 77 Revio systems. Higher ASPs in the quarter were in part due to the lower customer loyalty discount extended to customers in addition to more new customers who ordered their first Revio in Q2 relative to Q1. Turning to consumables, revenue of $13.7 million in the second quarter declined 5.7% from $14.6 million in the second quarter of last year, with approximately 44% of consumable revenue coming from Revio systems and the remainder from other systems and other consumables. We expect Sequel II and IIe as a percent of total consumables to decline throughout 2023 as we continue shipping Revio and customers transition to the new platform. Finally, service and other revenue was $3.9 million in the second quarter compared to $5.3 million in the second quarter of 2022. From a regional perspective, as Christian mentioned earlier, all regions posted record revenue in the second quarter. America's revenue of $24.0 million grew 10% compared to the second quarter of 2022. Increased instrument placements with higher ASPs more than offset a year-over-year decline in consumables and services related to customers transitioning to the new platform. Instruments include continued adoption from children's hospitals as SickKids became the first customer to receive a Revio in Canada and plans to utilize HiFi long-reads for its cystic fibrosis variant calling project. For Asia Pacific, revenue of $12.9 million grew 61% over the prior year with both instrument and consumable revenue growth. We are pleased to see such strong performance from all regions in addition to China achieving record revenue in the quarter. Additionally, we're excited to have onboarded a new distributor DKSH, who will provide improved sales, marketing, and after-sales support in Southeast Asia as well as best-in-class supply chain and warehousing. We're seeing progress with the new distributor as they have already booked an order for Revio, Onso bundle in the quarter. And other customers in APAC are showing signs of initial interest in the Onso platform with over 50% of our Onso orders coming from the region. Finally, EMEA revenue of $10.7 million grew 87% over the prior year period, driven by instrument growth, which included customers like the University of Oslo, who's been a PacBio user for over a decade and with Revio they intend to sell their services to scientists and researchers across the country. Moving down to P&L, a GAAP gross profit of $15.5 million in the second quarter of 2023 represented a gross margin of 33% compared to a GAAP gross profit of $16.2 million in the second quarter of 2022, which represented a gross margin of 46%. Second quarter 2023 non-GAAP gross profit of $15.7 million represented a non-GAAP gross margin of 33% compared to a non-GAAP gross profit of $16.4 million or 46% in the second quarter of last year. Gross margin declined year-over-year due in part to instrument mix as Revio instruments sold during the quarter had a lower margin primarily due to loyalty discounts provided and higher initial manufacturing costs. Non-GAAP gross margin in the second quarter improved sequentially from the first quarter largely due to higher average selling prices from lower average customer loyalty discounts in addition to more new customers who purchased their first Revio system. While we expect gross margin to expand during the remainder of the year, gross margin could fluctuate depending on the pace at which Sequel IIe demand declined, Revio ASP improved and unit manufacturing and material cost declined. GAAP operating expenses were $88.7 million in the second quarter of 2023 compared to $84.2 million in the second quarter of 2022. Non-GAAP operating expenses were $86.7 million in the second quarter of 2023, representing a 3% decrease from non-GAAP operating expenses of $89.6 million in the second quarter of 2022. The increase in GAAP operating expenses primarily reflects an increase in the fair value of the contingent consideration liability during the second quarter of 2023 of $2.0 million related to the milestone payment to Omniome shareholders compared to a decrease of $5.4 million in fair value of contingent consideration in the second quarter of 2022. Non-GAAP operating expenses declined year-over-year, primarily driven by lower R&D expenses resulting from the transition of Revio from development to commercialization, partially offset by increased sales and marketing expenses primarily related to increased investment in the commercial organizations. Regarding headcount, we ended the quarter with 818 employees compared to 793 at the end of Q1 2023 and 782 at the end of the second quarter of 2022. Operating expenses in the second quarter included non-cash share-based compensation of $16.7 million compared to $18.0 million in the second quarter of last year. GAAP net loss in the second quarter of 2023 was $69.8 million or net loss of $0.28 per share compared to a GAAP net loss of $71.4 million in the second quarter of 2022 or net loss of $0.32 per share. Non-GAAP net loss was $65.6 million representing $0.26 per share in the second quarter of 2023 compared to a non-GAAP net loss of $76.6 million representing $0.34 per share in the second quarter of 2022. Turning to our balance sheet items, we ended the second quarter with $829.9 million in unrestricted cash and investments compared with $874.9 million at the end of the first quarter of 2023. The change in cash primarily reflects our operating loss with interest income offsetting expenses associated with our convertible note exchange. Inventory balances increased in the second quarter to $67.6 million, representing 2.0 inventory turns compared with $52.0 million at the end of the first quarter of 2023, representing 2.1 inventory turns. The increase in inventory primarily reflects purchases of Revio, Onso instrument, and consumables inventories. Accounts receivable decreased in the second quarter to $24.0 million compared with $29.6 million at the end of the first quarter of 2023, resulting in our DSO of 51 days declining in the second quarter compared to a DSO of 56 days in the first quarter of 2023. Turning to guidance, as discussed earlier, given the continued momentum in Revio, we are increasing our guidance for 2023. We now expect revenue to be $185 million to $190 million representing a growth rate of approximately 44% to 48% compared to 2022. This represents an increase of $10 million at the midpoint. Our guidance assumes modest sequential growth in Revio system placements in the third and fourth quarters. Moving down to P&L, we expect 2023 non-GAAP gross margin which will exclude the amortization of intangible assets to be in the range of 32% to 34%. We expect margin expansion beyond 2023 as Revio placements will help drive a mix shift toward higher margin consumables and higher volume and manufacturing efficiencies driving lower unit costs. We now expect non-GAAP operating expenses to grow less than previously expected at 3% to 4% growth compared to 2022. As mentioned earlier today, PacBio acquired Apton for upfront consideration of approximately $85 million in an all-stock transaction consisting of approximately 6.3 million shares of PacBio common stock, plus an additional $25 million in stock or cash at PacBio’s option payable in connection with the achievement of $50 million in cumulative revenue related to the commercialization of a high throughput sequencer based on Apton technology, for an overall transaction valued up to approximately $110 million.

Thank you, Susan. With half the year now behind us, I wanted to provide a status update on our five strategic priorities for 2023. Our first goal was to drive rapid adoption of Revio by converting existing Sequel II and IIe customers and attracting new customers. In the first half of this year, 40% of our system orders were to new PacBio instrument customers. Looking at the pipeline in the second half, we continue to expect about 40% to be new customers, which exceeds our expectations. Further, as shown by our ramp in Revio consumables and decline in Sequel II consumables, customers are eager to begin sequencing on the new platform. With the beta program complete and commercial shipments underway, we look forward to getting Q40 plus accuracy into more customer labs and continuing to hear customer success stories. While commercializing Revio and Onso was a top priority this year, it was just as important that we drive our development efforts towards the next generation of long and short-read sequencers. We continue to make progress on future long-reads, shifting R&D resources from Revio onto the development of our bench top long-read and our ultrahigh throughput long-read systems. Further, Apton now gives us significant head start in developing the high throughput version of Onso, which will allow us to address one of the largest parts of the sequencing market. And as I've been communicating, I expect PacBio to deliver new and differentiated instruments at a much faster cadence than the organization had previously delivered. Next was expanding partnerships across the ecosystem and workflow to drive SBB and HiFi customer adoption. Earlier this year, we launched the PacBio compatible program and signed on nearly 20 partners across extraction and library prep automation, sample prep, and secondary and tertiary analysis. We expect to sign several more partners this year and we've already seen several examples where these collaborations have led to increased PacBio sequencing. Last but certainly not least is our drive toward our goal of being cash flow positive during 2026. On top of executing on our product launch, the PacBio team has done an excellent job of improving our financial position. We achieved record revenues in the second quarter with an expectation of 46% growth this year at the midpoint of our updated guidance. As discussed, we also expect operating expense growth for the year to be 3% to 4% over 2022 levels, which is below our 5% compound annual growth target through 2026. Additionally, we further strengthened our financial position in the second quarter by exchanging a significant portion of our notes due in 2028 and extending the duration of our debt while lowering our coupon payment. As you can see, it's been an exciting and rewarding first half of the year for us at PacBio and we look forward to sharing more as the year progresses. And with that, I'd like to open up the call to questions. Operator?

Thank you very much. We will now begin the question-and-answer session. Today's first question comes from Matt Sykes with Goldman Sachs. Please go ahead.

Hi, good afternoon. Thanks for taking my questions. Congrats on the quarter. Maybe I just want to start out with sort of a high level question on the Apton acquisition. Christian, you talked about being able to leverage the scale up of Onso customers eventually into high throughput. But I'm also wondering, does this open up an additional market for you within short-read that Onso cannot address and that you think has the growth and the size that would warrant the investment that you're making in terms of R&D and development?

Yes, Matt, thank you for your question and for the congratulations on the quarter. This definitely expands our market opportunities, which aligns with our core strategy of developing a multi-product, multi-omic portfolio. This approach allows us to cater to customers with varying demand levels and tailor our solutions to the specific challenges they face. Onso effectively targets the mid-throughput segment of the market, especially due to its high accuracy. With fewer reads, you can accomplish more work thanks to this accuracy. We're planning to apply the same SBB chemistry from Onso to the Apton platform, enabling us to target the high end of the market. We believe that once we establish this system, we will be able to offer a product that can provide billions of reads per flow cell, per run, with very competitive costs compared to other options available. Thus, your observation is correct; part of our strategy is that Apton will allow us to access segments of the market that Onso may not reach, effectively enhancing our short-read offerings.

The next question comes from Kyle Mikson with Canaccord. Please go ahead.

Yes. Hi guys. Thanks for taking the questions. Congrats on the quarter and the acquisition and Congrats to John Hannah over there at Apton, I saw you guys. So I guess just two-part questions. First on the guidance, would you mind just talking about Christian, Susan, what you're sort of baking in terms of the macro environment in the second half of the year? It is kind of evolving, it's quite fluid, but you guys seem to be a little bit more optimistic. And then secondly, on Apton, I mean I guess, just what does PacBio kind of bring to the table to enable Apton to go from like this kind of stuff mode situation to kind of competing with leading an emerging company in like Illumina Ultima? Thanks.

Thank you, Kyle, for the questions. Starting with our guidance, we've been reviewing our forecasts and assessing our performance so far this year. We're observing strong momentum with Revio, supported by a solid backlog, which positions us well given the current economic landscape. One surprising aspect has been the rapid adoption of Revio by our customers, which is driving consumable revenue and encouraging for the latter half of the year. Although the macro environment is challenging, particularly in markets like China, we are experiencing strong demand. Our customer base in China is relatively small, so we haven't felt the impact from macroeconomic challenges as some larger companies might. We've analyzed our current performance, backlog, order forecast, and the influx of new customers with Revio, and this new customer acquisition is key for driving growth not only in 2023 but also in 2024 and beyond. That's our outlook. If we move on to Apton, PacBio brings significant advantages to Apton. We offer scale, a robust commercial channel, and extensive experience in executing and developing excellent products. In fact, we've showcased this capability; in less than two years since the Omniome acquisition, we have successfully brought the product to market, which is proving to be exceptional. We're genuinely enthusiastic about it. We've had extensive discussions about Revio over the past six months, and we've successfully launched both products within shortly after each other. The Apton team recognizes this achievement. Importantly, the Apton instrument and its capabilities are already in place. Our evaluations have confirmed that SBB Chemistry functions well on the platform from the start. This is advantageous as it significantly accelerates our product development, allowing us to begin with a functioning instrument that we can refine the chemistry for. We can optimize the instrument to align with our industrial design, expertise, and manufacturing capabilities, thus dramatically speeding up the development process. I believe we have a lot to offer. I've established a strong rapport with John, who is also integrating well as part of the acquisition. We are truly excited about where we are today. Given that the Omniome and Onso products are rolling out, we have the resources to develop this product without significantly increasing our expenses, which is indeed promising.

The next question comes from Jack Meehan with Nephron Research. Please go ahead.

Thank you. Good afternoon. First is on consumables, is it possible to share sort of a range of SMRT cell utilization you're seeing for Revio in the field? I understand the consumables can be lumpy, but thought the data generation could be a good early proxy for that. And then second, just maybe more broadly Christian, is it possible to call out like where you think you might be gaining share with Revio versus areas that, or legacy short-read, how does that compare to your expectations a few months ago?

Sure, thanks Jack for the questions. With respect to consumables, we're not going to break those things out right now. As you can imagine, we're still really early in our launch. What I can tell you is that the utilization metrics have been at what we expected or even a little bit above what we expected. So we're seeing our customers get off to a good start, which means they understand how to use the system. They've got projects and their goal is for it. As I said, or in my prepared remarks, we've been seeing more and more standing orders come in. This is huge for us because as we scale as a company, it allows us to optimize our manufacturing so that we know when we're going to need to be shipping consumables and we know those projects are out there. And so I know the whole world wants to know, is the consumable throughput, pull through what is that number going to look like and how fast are we going to get to kind of our steady-state? And I would say we're on the upward slope of that curve right now. But we're not really prepared to make remarks on where that curve is going to end up, other than to say that we're off to a good start, probably a little bit better than what we expected. With respect to Revio gaining on the short-read space or market share in general, the one thing I'll just re-point to in our prepared remarks, we did have one significant win in the quarter that I highlighted where there was another long-read technology entrenched in the account and they are converting basically the vast majority of their business to Revio because they see the utility of the product versus other approaches. With respect to short-reads, I think what we're seeing is that in population-scale programs in particular, you're seeing us start to take share in the sense of a project that was once going to be completely a short-read project, is now scientific design, experimental design has been thinking through how do we integrate long-reads into that and taking a portion of those. We've seen several examples of those already, just in the first little bit here of the Revio story. We're seeing in our funnels actually major opportunities to take tens of thousands of samples in these kinds of programs. We'll see how that goes over the course of the year. But I think what you're seeing is that the comprehensiveness of HiFi coupled with the performance of Revio and the simplicity and the ease of use and the informatics burden is really putting us in a position to make significant gains here. And that's really been the strategy all along and here we are starting to really execute on it. Hopefully that helps.

The next question comes from Daniel Brennan with TD Cowen. Please go ahead.

Great, thanks. Thanks for the questions. Congrats on the quarter. Maybe just a multi-parter, just Christian, you talked several times throughout about the very strong backlog. Sounds like book-to-bill could have been notably above one. So first question would be any color there? Secondly, I know Susan talked about Revio placements up modestly quarter-to-quarter. Just wondering any color on what drives the pacing? Is it manufacturing capacity? Is it customer readiness? Is it the size of your funnel? And could you accelerate it further? And then the final one would just be on implied in the revenue outlook. While you're not going to give a pull-through number, could you just help us think through the mix between instruments and consumables?

Sure, thanks Dan for the questions. So, one thing, we are talking about orders, and I've been making a point of this since JP Morgan actually that we're not going to talk about orders. We did have orders come in on our expectations for the quarter. We are in a healthy backlog situation, as we talked about. Now, backlog is both, it's a blessing of course, because it gives us some predictability of on our revenue but also, every instrument that sits in backlog does not generate consumable revenue and does not propel us forward in terms of long-term growth. Our strategy is to try to whittle that backlog down over time, which you'll see us start to do. We've got manufacturing now basically to a steady state where we can deliver on what we expect to deliver for the remainder of the year, and we'll see at the end of the year or basically as we go forth when we need to increase capacity, if we need to increase capacity, etc. Revio pacing itself, Susan did say modest increase sequentially kind of moving forward. I think we're just taking a very straightforward approach to kind of continuing to build the business, continuing to serve our customers well. We've been doing some hiring with the field support teams to make sure that we can address issues in the field. When you look at how we push this business forward, we really are trying to think in totality of how do we create amazing customer experiences so that repeat customers get great data, which creates a flywheel for more leads for instruments for more pull-through down the road. So, when we think about how we deliver for the rest of the year, we try to think through those things. As far as manufacturing goes specifically, I do think we have capability right now to do pretty well over the course of the year and we always can increase capacity down the road if we need to. Finally, with respect to product mix, the product mix is going to be really important in 2024. 2023, as we've been saying all along is going to be a very instrument-heavy year, and we'll start to see customers ramping their Revios. We still have some questions about how fast Sequel II ramps down and Revio ramps up, so that's an area where we're watching and we're trying to understand. Q2 though, we saw the Revio is growing quite a bit and the Sequel II starting to ramp down. So basically in line with our expectations, maybe Revio is a little bit higher than we expected in the quarter. I suspect we'll probably see some of those trends continue through the rest of the year. So it's a very instrument-heavy year going to continue to be, but Revio consumables are starting to really shine.

Scotiabank: Sung Ji Nam: Hi, thanks for taking the question and congrats on the quarter and the acquisition. Just on the sequencing coverage for Revio, I don't know if it's too early to tell, or I realize it also depends on the application, but I was wondering if you might be seeing more of your customers, especially maybe for the population scale projects taking advantage of lower coverage given that could provide more attractive economics. Just kind of curious, what trends you might be seeing there. Thank you.

Thank you, Sung Ji. That's actually a great question, and I appreciate it. With traditional short-read sequencing, 30x coverage is kind of the benchmark. The truth is that customers always are making their own coverage decisions based on the application. But if you compare 30x short-read sequencing with PacBio sequencing, I do think more and more every single week customers are seeing that less than 15x coverage can get you very significant performance relative to 30x coverage. As a result, you're right, the economics get even better and if we just use 15x, and you use $995 list price, which is what our list price is for a genome on Revio, that list, it's basically a $500 genome. So, the economic gap between long and short-reads is really shrinking quickly when you look at it on coverage metrics and thinking about your experiment. There’s no question that the population-scale customers are thinking through that and leveraging that ability to get great low coverage and very high accuracy comparable with 30x. Now in other applications, customers are still going to want to do 30x or perhaps even more, perhaps in some oncology, some rare disease, where you're looking, where you're trying to make a decision about a patient or trying to understand a translational research situation and so in those cases, I suspect they might be doing different coverage models other than that. But it was important for us to start really helping the world understand that you don't need 30x coverage. 30x coverage in long-reads is very different than 30x coverage in short-reads. I'm actually really thrilled that the world's seeing that, and some of our best customers are actually promoting that. So that's a great reason for you to be getting into long-reads.

The next question is from Luke Sergott with Barclays. Please go ahead.

Great, thanks guys. So I guess the first one, I just kind of want to get a sense of the timing and the strategy there from Apton. I understand how it fits in the portfolio, etc., but I just, you guys are in the midst of the biggest launch of the company's history between two instruments, is there a risk there that you could be biting off more than you could chew from an organization. I know that Christian, you'll drive them hard enough. But just kind of thinking there from a timing perspective, why not build up some cash, get a successful launch out there and then do the deal? Because it was still an early-stage seed round, I guess. And then my second one is, as you think, I know you're not going to give any orders or placements, but it sounds like the orders were less than the shipments and you guys burned down some backlog. Is there something from the April timeframe where you were kind of going, not full bore there just any color on the pacing of the orders that have been coming in?

Thank you for your questions, Luke. Regarding Apton, we have a strategy to develop a multi-product portfolio in short-reads, which we believe is essential to fully address the market and maximize the value of SBB chemistry. Our team is well-equipped to execute this plan, and while we're still refining the platform after its launch, the Apton technology is sufficiently advanced. They have been working on it for years, so we already have operational systems ready, and the deal will close soon. We'll set up systems in San Diego and Menlo Park to begin optimizing the chemistry immediately. This is crucial as we aim to build momentum with Onso and SBB chemistry, particularly in routine usage, which may include liquid biopsy applications. Achieving routine usage necessitates high throughput. We believe there is a market opportunity that allows us to introduce a competitive high throughput product. Hence, timing is critical. While we are pushing our team hard, it feels like everyone is equally driven, which is a positive change for the company. Now is an ideal moment to advance. The acquisition of Apton provides us with an excellent opportunity to expedite development, launch a high throughput product, and offer a complete portfolio. This will help us drive revenue, improve gross margins, and present a comprehensive offering to our customers. We are excited to finalize this acquisition today, as it is essential for achieving our long-term goals. Concerning the backlog, as I mentioned earlier, our orders for the quarter aligned with our expectations. We are on track for the year regarding orders and aim to reduce the backlog throughout the year to enable quicker consumable revenue. Generating consumable revenue sooner enhances gross margins, which in turn supports our goal of achieving positive cash flow—a key focus for the company right now. I prioritize cash flow discussions in every strategic planning meeting. It's vital for ensuring sustainability amidst growing demand, and I believe we can improve even further.

The next question comes from Rachel Vatnsdal with JP Morgan. Please go ahead.

Great. Thank you for taking the questions and congrats on the strength this quarter. So I wanted to dig into some of your comments on the gross margin line. Guidance now assumes non-GAAP gross margins of 32% to 34% for the year. We also mentioned that that gross margin line could fluctuate based on Revio ASP and consumables on Sequel II and Sequel IIe. So can you just walk us through what's actually contemplated in that gross margin guidance for the year? And then how should we think about the levers impacting that gross margin progression into 2024? Thank you.

So Susan, would you like to discuss what's happening in 2023 while I address 2024?

Yes. So, I'm happy to. So this year we have baked in for gross margins the ASP trends for Revio and then also in addition, manufacturing efficiencies with manufacturing the Revio instrument. So if I start on the ASP side, you see that just in terms of calculation, the ASP has improved in Q2 relative to Q1, and given the backlog and the funnel we have ahead of us in terms of orders and instruments we expect to shift, we do expect that the ASP for the Revio instrument will be consistent with where we were in Q2 or slightly better than Q2. So that was baked into how we estimated our gross margins. And then also with respect to manufacturing the instrument, our manufacturing team has done a great job of improving efficiencies with building that instrument. One measurement we have is touch time on building that instrument and that touch time has been coming down; it's come down in Q2 relative to Q1. We are baking in incremental improvements in those efficiencies to build the Revio instrument, which is helping our gross margins. In our gross margins for the year too are the Revio consumables, and we are improving in terms of yields and how we're doing there, which incrementally reduce the cost to manufacture consumables. So all of that has been factored in when we guide our year.

Yes, and so that's helpful, Susan. When you think about it, anytime you have a launch year, you certainly have lower gross margins, but we also had, the complexity of a pretty fundamental product transition with Sequel II to Revio and also kind of the lingering effects of COVID. We did have, unfortunately, we have had higher write-offs in the first quarter in particular which impacted our gross margin expectations for the year. Susan's right; as we continue to drive costs out of the system, that's going to help our gross margins, particularly in 2024. ASPs will likely kind of achieve a steady state by the end of this year and into 2024. I think those are really positive signs and positive signals that are going to help drive gross margins up. Finally, perhaps most importantly of all is the fact that the Revio instrument can drive much higher consumable pull through; therefore, the product mix will start to change. I would imagine later this year and into 2024 and probably into 2025 too, that you start to see more of a traditional mix of consumables to instrumentation, which will also very significantly help our gross margin over the next few years here. We are managing aggressively; I think the team's doing a good job, but we have a lot of work to do.

The next question is from Tejas Savant with Morgan Stanley. Please go ahead.

Hey guys. Good evening. Thanks for the time. Christian I know you don't want to comment on, on Revio orders and backlog, so maybe I'll take a different tack on that question because I think it's an important one. Can you help us sort of frame, historically at what point in a product sort of launch cycle would it be normal to see the backlog start to come down and any color on what kind of backlog are you looking at? In terms of where you'll be at year-end heading into 2024. And then my second question really is on the Onso side of things. I know you've excluded it sort of prudently from the 2023 guide here, but as we think about that Onso ramp in 2024 any sort of like thoughts on how you see that inflecting based upon your feedback from early customers? Thank you.

Thanks, Tejas. So starting with, kind of the backlog and kind of traditionally what happens when you have a new product cycle, oftentimes you first go to your existing customers and drive, drive heavy orders in that way, and then you work to new customers. The order book would look like a bit of a yes, kind of an increasing curve and then a plateau and then another increasing curve. Right now, I would say we're kind of in the, we're still at the tail end of the increase and starting to be in that plateau phase. What that means is that new customers are starting, are really taking notice. They want to see how the data is from the best customers. They want to make sure the system is working as intended. If you look at our sales funnels, our sales funnels continue to grow and be strong globally. Our objective is to whittle the backlog down some. Incredible opportunities for demand to and as a result, we've raised our guidance significantly this year. We're off on a whole new trajectory as a company and I think that's really what we're seeing right now. Very excited about the order book, excited about the health backlog that continues to propel us forward. We've got to start whittling that backlog down so that we can make sure we get the consumable pull through and the consumable revenue, which will drive our gross margins as I said before. Now, the Onso ramp, what's amazing about Onso is that it's an instrument that we can reach with the sale, same sales team and the same call point. Since we have a global organization, we can, we've seen a lot of opportunity and I think the majority of the early orders actually are coming out of Asia, for example. We're seeing strong demand in Asia, strong demand in Europe, and this is where the emerging companies just don't have the capability that we have and the scale. I'd expect us to go through the ramp in 2023 of manufacturing and making sure the product's robust in the market and providing our world-class service and support so that we get great data sets out there. We've seen a lot of momentum building in the sales funnel and that's why it was so important for us to get across the goal line. As I said, back in June, we had some validation and verification challenges that we were working through. We've largely worked through those now and we're scaling manufacturing. We're very happy the runs that happened over the weekend for the first shipments here were fantastic. We're just really excited about where that product is going. When we look at 2024, we're going to leverage our scale and really press our advantages with a product that I think has excited a lot of customers. And so we'll see how we do.

The next question comes from Ross Osborn with Cantor Fitzgerald. Please go ahead.

Congrats on the quarter and thanks for taking our questions. So maybe just one for us on the long-read market broadly. Historically, I believe the company's views that you and Oxford did not overlap as much as people think. Was this still the case in the quarter? And in terms of new customers to PacBio, were they new users to long-read, or did you perhaps see more conversion from Oxford this quarter?

Ross, those are good questions. It is difficult to, I would say customers use multiple technologies. When you start to say conversions, it is not; it's a little more nuanced than that. I do think when you look at scaled users, the example we pointed out in our opening remarks was really a scaled user moving from Nanopore to Revio because they see the utility of the product versus other approaches. In the past, we just never had the throughput or the economics to be truly competitive even though we had higher accuracy, easier to use workflows, etc. But the reality is we just, scientists couldn't do the experiments they wanted to do. Now with Revio, we're actually penetrating all over the market with a product that meets our customer's needs. I would say that broadly speaking, we – for high throughput scale users, it's competitive. We are seriously making inroads. And then there's a part of the long-read market that Nanopore technologies serve that we don't serve. That's the kind of single-use $1000 low throughput part of the market which we're not really that engaged with because that's not where our focus is. I would say in the areas where we are focused, we are highly competitive. I think we already lead that part of the market, but we're gaining traction as well.

Today's final question comes from John Sourbeer with UBS. Please go ahead.

Hi, thanks for taking my question here at the end. So I guess now that you're, two quarters into the Revio launch, just how are you thinking about the upgrade cycle from here, from the Sequel II, is it three to two, two to one, one-to-one, any color there? And then I ask to follow up on the Onso, just any color on the backlog mix on what are standalone Onso orders versus Revio Onso combo packages?

Yes. So John, that's a good question. I still believe that in the long run, it’s more likely to be closer to one-to-one Revio to the Sequel II install base than say anything else. I think in the early days, we have seen probably more in the three to two or even two to one kind of range. But that's because the system's 15 times more capable than the Sequel II. People are scaling into the platform. I'm leveraging a lot of gray hair and a lot of experience with launching platforms that are significantly more powerful than their predecessors. So far, it seems like in my experience, almost every single case, you've seen a dramatic, ultimately say a couple of years post-launch that old install base largely does turn over to the new products on close to a one-to-one basis. It's still too early to see, but I don't think our view has changed any since our last quarter, last our last call last quarter. Lastly, with respect to the Onso platform, I don't have the numbers right in front of me, but it's about, it probably is about half, right? A little, maybe a little bit less than half are bundled deals of the orders we have so far. I don't have the numbers right in front of me. My expectation is, I think it's a really powerful, unique offering that PacBio has, no other company has the ability to have highly accurate short reads and highly capable long reads, in a bundled arrangement where you can, you don't, your technology doesn't drive your experiments; what kinds of applications and what kinds of answers you're looking for drives what your decisions are. Given our ability to work very closely with our customers, perhaps in a different way than others, I think it can give our customers a lot of confidence that when they come to PacBio, we are going to serve them and really focus on meeting their needs with great technology. So, thank you for the question.

The only one thing I was going to add, John, is with respect to the, so we gave the statistic that there are 100 customers that have ordered a Revio system, and if you compare that even to the install base of Sequel II, that's about a third of the customers who have a Sequel II. The vision that Revio will access more and more of the market and more new customers, even by the fact that the number of orders coming from new customers is 40%. We expect that to be the case going forward for the next couple quarters; we are accessing more of the market, and so the install base of Revio, we expect it to be much larger than the Sequel II.

Sure. Well, perhaps that's a great place for us to wrap up for today.

Yes, sounds good. Yes, thank you all for joining us today. This will conclude our call and replay of today's call is available on our investor section and we look forward to updating you throughout the quarter and the rest of the year on our progress.

Thank you. The call has now concluded. Thank you for attending today’s presentation. You may now disconnect.