Pacific Biosciences Of California, Inc. Q4 FY2023 Earnings Call

Hello and welcome to the PacBio Fourth Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. I would now like to hand the call to Todd Friedman, Senior Director, Investor Relations. Please go ahead.

Good afternoon and welcome to PacBio’s fourth 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. With me today are Christian Henry, President and Chief Executive Officer and Susan Kim, Chief Financial Officer. On today's call, we will make forward-looking statements, including statements regarding predictions, progress, estimates, plans, intentions, guidance, and others, including expectations with respect to our growth potential, instrument and consumable sales, and GAAP and non-GAAP growth guidance. 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. We refer you to our documents that we 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. 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 in 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're unable to reconcile the non-GAAP gross margin and non-GAAP operating expenses without unreasonable efforts due to the uncertainty regarding various matters, including certain acquisition-related items that may arise during the year. 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 that forward-looking statements made on today's call may differ or change materially after the completion of the live call. A question-and-answer session will follow our prepared remarks. I will now turn the call over to Christian.

Thank you. Thanks, everyone, for joining our call today. I'll start by recapping our results for the year and the quarter. Then I'll discuss our commercial activity around Revio and Onso. Finally, I'll discuss our latest product launches that we believe will further create value and differentiation around PacBio sequencing. I'll then pass it to Susan to discuss financials and guidance in more detail. 2023 marked PacBio's most transformative and successful year in our history. Our team executed aggressive goals to ramp Revio manufacturing and scale the installed base, which enabled PacBio to grow revenue 56% in 2023 to $200.5 million, which was ahead of our expectations. For the quarter, revenue grew 113% year-over-year to $58.4 million, and we shipped 44 Revio instruments in the fourth quarter, bringing our installed base as of December 31, 2023, to 173 Revio systems. We also grew consumable revenue in the fourth quarter to $18.9 million, which included Revio consumables of approximately $12.4 million and represented an annualized consumable pull-through of around $385,000. The demand for long-read data continues to grow, as total gigabase output on PacBio sequencers grew 68% in 2023 compared to 2022. We believe this momentum sets us up for another year of growth as we continue to see growing interest in HiFi for larger-scale human genomics and see it becoming more mainstream in genomic testing. The market clearly demonstrates a shift towards long-read sequencing in a growing number of major applications, and I will share some of the specific examples showing this shift today. With that, our initial view on 2024 is that revenue will be between $230 million and $250 million, representing a 15% to 25% growth compared to 2023. At the midpoint of this range, we expect Revio system shipments to be roughly flat to slightly up year-over-year. As we have previously communicated, customers have lengthened their capital purchasing timelines, which impacts the timing of instrument orders and the pace of Revio adoption. We do not anticipate these current macro trends to fundamentally impact customers' desire to sequence with HiFi long reads. Susan will touch more on our guidance later. Now turning back to 2023, Revio, our flagship long-read sequencer, launched early last year, is making significant progress in transforming how researchers look at the genome and we're still in the early adoption curve. We've been especially pleased with the number of new customers adopting Revio, as nearly 30% of Revio systems ordered in the fourth quarter were from new PacBio customers, and almost 40% of Revio systems ordered in 2023 were from new PacBio customers. New customers in the fourth quarter included Karolinska University Hospital in Sweden, a HiFi Solves consortium member planning to use Revio to address the limitations of short-reads on structural variation, tandem repeats, and phasing to find more answers for genetic disease. The HiFi Solves consortium was just announced last quarter. And by creating this collaboration of 15 leading genomics research institutions across 10 countries, we expect best practices sharing to accelerate the impact HiFi can have on human health. We're also making solid progress on converting existing PacBio customers over to Revio, as about one-third of our Sequel II and IIe customers have now ordered Revio. We are still in the early product transition cycle and expect most Sequel II or IIe users to migrate over to Revio over time. Additionally, we expect customers who have adopted Revio in 2023 to continue to expand their fleets as they fill their Revios to capacity. We're already starting to see this with some customers ordering their second or third Revios in the fourth quarter, like Radboud University, which took its second Revio expanding its fleet to ramp up its efforts in rare disease research. Additionally, Children's Mercy Hospital of Kansas City ordered its third Revio to continue its effort to consolidate tests for genetics and epigenetics, increase efficiency, and improve solve rates, while accelerating turnaround time. These fleet expansions demonstrate the elasticity and the demand to move samples over to HiFi long reads. 2023 was also a landmark year for PacBio as we launched Onso, our second major sequencing platform just months after we started shipping Revio, enabling us to address a multibillion-dollar short-read sequencing market. With Onso, we've gradually ramped up manufacturing capacity and grew shipments sequentially in the fourth quarter. We have now received orders from a wide range of customers who plan to use it in applications ranging from oncology, including research into fragmentomics and targeted cell-free DNA panels to exome sequencing and metagenomics. One Onso customer is TGen, which is taking advantage of the platform's accuracy to detect rare populations associated with disease in a high background of non-disease material for applications like early cancer detection and infectious disease research. Last month, researchers from the Institute presented data that shows Onso is achieving well beyond its Q4 specification on customer liquid biopsy samples with the majority of bases over Q50 or one error in 100,000 bases of sequencing. Since Onso's launch, peers in the industry have been increasingly discussing the value of accuracy, which we believe underscores accuracy as an unmet need that PacBio is differentially positioned to address with our sequencing by binding chemistry. Moving on, as we do every year, I wanted to share an update on our internal market segmentation from the previous year. Our customers use our products across a diverse set of sequencing applications. In 2023, human genomics was the largest portion of our business, accounting for approximately 40% of our revenue. This includes a wide range of customers like UC Irvine and the GREGoR Consortium looking to run a multi-thousand sample project in rare disease or Biosensia, who is now using HiFi for routine testing for certain sensory disorders. Plant, animal, and agrigenomics, again, was the second largest part of our customer base, making up approximately 25% of our revenue as long reads have been well positioned to interrogate these often large and complex genomes. This includes agricultural companies that are adopting Revio to incorporate low-pass genome sequencing to improve their workflows and get better insights into crop development and production. Microbiology and infectious disease make up about 20% of our business and include a wide array of customers across public health labs, research institutes, and academic labs across a dynamic range of applications from pathogen surveillance to the biology of host-pathogen dynamics, drug resistance, and more. Cancer genomics was roughly 10%, and this is really an application that we believe can be further addressed with Onso's accuracy. For example, McGill University researchers used Onso, and preliminary results presented at the early detection of cancer conference in October indicate that Onso's ability to accurately sequence through homopolymer regions has the potential to increase the detection of microsatellite instability. The remaining approximately 5% of our revenue is from other and emerging markets, including biopharma, and in the fourth quarter, it included a new gene editing customer planning to implement Revio as part of its cardiovascular disease therapeutic development. Turning to product launches. Last week at AGBT, we announced new library prep kits that eliminate bottlenecks in the HiFi workflow and make PacBio long-read library prep on par with that of short-read sequencing, making it easier for our customers to make the most of their Revio systems. Our HiFi Prep Kit and HiFi Plex Prep Kit 96 offer customers the potential for up to a 60% decrease in workflow time and up to a 40% reduction in costs and further lowers the DNA input requirements. It also allows customers to automate the sometimes tedious library prep process by integrating with the Hamilton NGS Star system and with other automation platform partners to be announced in the future. In the fourth quarter, we launched our Kinect kits for scalable, cost-effective RNA sequencing. We've been extremely pleased with our customer enthusiasm and uptake for these kits, and we now have orders from over 115 different customers. An early adopter at UCSD's Sanford consortium commented on how demand for the full-length RNA sequencing is outpacing genomic DNA sequencing, and the customer shared that the Kinect kit enables competitive pricing, high throughput, ease of use, and automation and has provided for consistent sequencing yields across various samples. Kinect can also help researchers glean more insights into RNA across various applications. For example, another early user from a leading pediatric hospital in Columbus, Ohio used Kinect to study somatic mosaic diseases like cancer and epilepsy and with Kinect was able to pinpoint specific cell types harboring disease-causing genomic variants from single-cell data. The customer explained that Kinect can help identify cell types harboring the mutation and then understand the mutation's influence on the transcriptome, which could lead to a better basic biological understanding of how the disease occurs, but can also give clues into the timing of disease occurrence and the onset in children. These are just a couple of examples, and we believe Kinect will continue to accelerate long-read sequencing as the preferred method in several RNA-Seq applications. Lastly, we rolled out our V13 software for Revio last quarter and 93% of our Revio runs are using the new V13 software. As a result, customers are getting a better user experience. We've seen over a four-fold decline in overloading and customers are starting to realize increased yields on their smart cells. Finally, to wrap it up, last week was the annual Advances in Genome Biology and Technology Conference, or AGBT, and it was encouraging to see the impact that HiFi long-read sequencing had on the research community and the desire for researchers to look deeper and assemble more information from the genome than ever before. Our team walked away from the conference feeling like an inflection point for HiFi sequencing has truly just begun. With that, I'll pass the call to Susan to discuss our financials. Susan?

Thank you, Christian. As discussed, we reported $58.4 million in product, service, and other revenue in the fourth quarter of 2023, which represented an increase of 113% from $27.4 million in the fourth quarter of 2022. Instrument revenue in the fourth quarter was $35.1 million, an increase of 475% from $6.1 million in the fourth quarter of 2022, driven by continued adoption of the Revio platform. We ended the quarter with an installed base of 173 Revio systems. Turning to consumables, revenue of $18.9 million in the fourth quarter increased 13% from $16.7 million in the fourth quarter of last year and was a record for PacBio with approximately $12.4 million of consumable revenue coming from Revio Systems, reflecting an annualized pull-through for the Revio System of $385,000 and the remainder from other systems and other consumables. Finally, service and other revenue was $4.4 million in the fourth quarter compared to $4.6 million in the fourth quarter of 2022. From a regional perspective, Americas revenue of $33.9 million grew 182% compared to the fourth quarter of 2022. The region's record quarter was driven by continued growth in instruments and consumables from both new and existing customers. For Asia-Pacific, revenue of $13.4 million grew 31% over the prior year, with consumables in the region growing nearly $2 million quarter-over-quarter, which was in part due to stocking orders and year-end budget spend. Finally, EMEA revenue of $11.1 million grew 114% over the prior year period. Moving down the P&L, a GAAP gross profit of $9.6 million in the fourth quarter of 2023 represented a gross margin of 16% compared to a GAAP gross profit of $5.1 million in the fourth quarter of 2022, which represented a gross margin of 19%. The GAAP gross profit in the fourth quarter of 2023 includes the amortization of acquired intangibles from the acquisition of Omniome as we allocate some of the amortization expense to the cost of goods sold now that we are generating revenue from the Onso product. Fourth quarter 2023 non-GAAP gross profit of $11.1 million represented a non-GAAP gross margin of 19% compared to a non-GAAP gross profit of $5.3 million or 19% in the fourth quarter of last year. Gross profit in the fourth quarter of 2023 and the fourth quarter of 2022 included inventory reserves and loss on purchase commitments totaling approximately $9.3 million and $7.1 million, respectively, primarily due to the continued decline in Sequel II/IIe consumable demand in the transition to the Revio platform as well as the decline in Sequel II instrument demand from predominantly one customer in China. GAAP operating expenses were $97.1 million in the fourth quarter of 2023 compared to $92.2 million in the fourth quarter of 2022. Excluding changes in fair value of contingent consideration, amortization of acquired intangible assets, merger-related expenses, and restructuring costs, Non-GAAP operating expenses were $88.4 million in the fourth quarter of 2023 compared to $87.6 million in the fourth quarter of 2022. Regarding headcount, we ended the quarter with 796 employees compared to 844 at the end of Q3 2023 and 769 at the end of the fourth quarter of 2022. Headcount declined following Q3 2023 due to a reorganization, primarily within our R&D organization, which resulted in a reduction of approximately 55 positions in the fourth quarter. Operating expenses in the fourth quarter included non-cash share-based compensation of $15.4 million compared to $16.8 million in the fourth quarter of last year. GAAP net loss in the fourth quarter of 2023 was $82.0 million or $0.31 per share compared to a GAAP net loss of $84.4 million in the fourth quarter of 2022 or $0.37 per share. Non-GAAP net loss was $72.5 million, representing $0.27 per share in the fourth quarter of 2023 compared to a non-GAAP net loss of $79.6 million, representing $0.35 per share in the fourth quarter of 2022. Turning to our balance sheet items. We ended the fourth quarter with $631.4 million in unrestricted cash and investments compared with $767.8 million at the end of the third quarter of 2023. The decline reflects approximately $95.8 million in cash paid to the former Omniome shareholders in connection with the milestone achievement. Inventory balances decreased in the fourth quarter to $56.7 million, representing 2.9 inventory turns compared with $68.3 million at the end of the third quarter of 2023, representing 2.2 inventory turns. Accounts receivable increased in the fourth quarter to $36.6 million compared with $30.5 million at the end of the third quarter of 2023. As of December 31, 2023, our total product backlog was approximately $18.7 million compared to $51.5 million as of December 31, 2022. The decline was primarily related to our record starting backlog in 2023 and the ramp-up of manufacturing to deliver Revio to customers throughout 2023. As we've communicated before, we expect to share this backlog figure on an annual basis in our Form 10-K. Now to expand a bit on financial guidance. As Christian indicated, we continue to expect Revio to drive growth in 2024 and expect full-year revenue to be between $230 million to $250 million. Compared to 2023, this represents a growth rate of approximately 15% to 25%, which we believe will be well above the sequencing market growth rate. At the midpoint of our guidance range, we expect Revio system shipments to be flat to slightly higher compared to the 173 units shipped in 2023. Our growth expectations consider several macro factors that are impacting purchases of capital equipment. For example, the funding environment in China is impacting our ability to further expand our Revio installed base in the country, specifically with smaller volume academic labs. Additionally, persistent inflation and high interest rates are lengthening sales cycles globally. In terms of linearity, we expect approximately 45% of revenue in the first half and 55% in the second half. Based off what we've seen quarter-to-date, we expect the first quarter revenue to be lower compared to the fourth quarter of 2023, with Revio system shipments flat to slightly down sequentially, with lower average selling prices and total consumable revenue approximately flat. As we continue to expect revenue, instruments, and consumables to make up the majority of revenue, we do not expect to share SQL IIe or Onso placements or pull through on a quarterly basis for these platforms this year. Moving down the P&L, we expect the 2024 non-GAAP gross margin to be in the range of 36% to 39%, and we do believe that gross margins will improve over the course of the year. As a reminder, inventory reserve charges associated with the decline in SQL II demand in place of higher Revio demand represented a headwind of approximately 700 basis points in 2023. Additionally, compared to the 2023 non-GAAP gross margin, we expect improvement driven by a mix shift toward higher-margin consumables and higher consumable manufacturing volumes as well as instant manufacturing optimization, helping to drive lower manufacturing unit costs. We expect non-GAAP operating expenses to grow less than 5% compared to 2023, which is consistent with our long-term guidance. We expect interest and other income to be between $5 million and $10 million in 2024, and the weighted average share count for EPS for the full year to be approximately 273 million. I'll hand it back to Christian for some final remarks.

Thanks, Susan. As we move forward in 2024, I want to reiterate our strategic priorities that I laid out last month. Our top priority is increasing the adoption of our technology by driving more Revio placements at new customers, converting existing Sequel II and IIe accounts, and expanding Revio fleets at current customers. Additionally, as we expect to complete our scaling of Onso manufacturing this quarter, we will aggressively drive placements of the Onso platform so that our leading SPB chemistry can get into the hands of more customers globally. Another important priority is continuing to build the momentum for sales into the clinical and translational market. Earlier in the call, we discussed a few of our customers who are starting to use their Revios in this setting, including Bioscientia and Children's Mercy Kansas City, and we aim to expand our support in this market in 2024. Additionally, we are progressing the development of our groundbreaking technologies. We launched two transformative platforms in 2023, but our work is far from complete. I previewed three other instruments we're working on that we plan to launch over the coming years, and we expect to make meaningful progress on all of these this year. I look forward to sharing more about these instruments when they near their completion. Finally, we intend to continue building our business with the goal of becoming cash flow positive during 2026. On top of our long-term revenue target of reaching at least $500 million in 2026, we have several gross margin initiatives that are expected to lower production costs, better utilize manufacturing overhead, and improve our supply chain efficiency. These programs, along with the product mix shift towards consumables, are expected to improve our gross margins. Further, we expect to continue to be disciplined in how we deploy our operating expenses and make investments in the future of our business. I continue to be encouraged by our customers' enthusiasm for our products and look forward to updating everyone on our progress as we continue to drive adoption of our technologies this year. So with that, let's start the Q&A.

Thank you very much. We will now begin the question-and-answer session. Today's first question comes from Dan Brennan with TD Cowen. Please go ahead.

Great. Thanks. Thanks for taking the questions, guys. And Susan, maybe just on the headwind that you talked about, implicit in the guidance, you talked about China and kind of close rates again. Can you give some more color on China? What did it kind of do in the quarter? What are you kind of baking in for China on the funding side? Is that worsening? Is it stable in terms of these close rates? Have you seen any change there?

Yes, Dan, thank you for that. We won't talk about the Q4 China's break that out separately. We actually had a decent Q4 in China. We had some of our large service providers go with new multi-system orders, some of which were delivered in Q4. Some will be delivered over the course of the first half of the year. But what we see in China is we do see funding challenges in China that are making it difficult for the smaller labs to drive into Revio. And as a result, they're sending out their samples to the large service providers and driving the business that way. And so although the consumables will be strong, the instruments are not as strong in China as perhaps we would be hoping for. And as a result, in our guidance, we significantly took down our forecast for China for the year. It's actually one of the biggest areas of challenge for us as we look into 2024.

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

Yes. Hey, guys. Thanks for the question. Congrats on the year. Maybe just, Susan, could you talk about the gross margin cadence in 2024 as you reduce production costs for the Revio and increase Revio consumables revenue as well given the expanding installed base? And how does this kind of funnel into cash burn this year as well, just given you have that 2026 target? Thanks.

Yes. Thank you for the question, Kyle. So you're right. What's implied in our guidance is that our gross margins will improve this year. And our gross margins this year will come from a combination of activities, some of which we've actually already initiated, which is going to help to reduce not only the instrument cost but also the consumable costs. These initiatives include consolidating manufacturing facilities so that we have better overhead allocation across more products, which helps to lower the unit cost, initiatives such as better balancing of insourcing and outsourcing, which will help to lower the cost on the instrument. And of course, improving manufacturing yields and value engineering to drive down the bill of materials further for especially on the instrument side, but also on the consumables side. We're going to start to see some of these cost reductions as early as Q2, and then we'll continue to improve even in the subsequent quarters such that in the second half, our gross margins continue to improve relative to the first half. And this is a key part of our path to getting to cash flow positive, as you had alluded to, Kyle, improving gross margins and also being very disciplined with respect to our OpEx.

The next question is from John Sourbeer with UBS. Please go ahead.

Hi, good evening and thanks for taking the questions. Maybe just digging in a little bit further on maybe some of the assumptions that changed on Revio placements being up versus the midpoint being roughly flat here. Beyond China, any other color you can provide on that and insight that gives you confidence into getting that flat placement for the year? Thanks.

Thank you for the question, John. We're observing a significant number of opportunities, especially for larger projects, which will not only boost consumable demand but also lead to more unit placements. As these projects commence, we anticipate they will indeed contribute positively, enhancing Revio placements compared to what we've seen previously. Regarding China, we are facing some challenges that we've been discussing for several quarters, and the situation seems to have worsened slightly. Looking ahead to 2024, I am confident that we can achieve placement rates similar to what we experienced in 2023. Currently, our focus is on driving adoption and maintaining a balanced view, especially given the tough macroeconomic conditions.

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

Thank you. Good afternoon. Christian or Susan, could you share the assumptions for consumables in 2024? Additionally, what is your visibility on this as you evaluate the various ongoing projects? Thanks.

Yes. When considering consumables, we anticipate significant growth this year. This is primarily due to the substantial number of systems we shipped in 2023, which will impact consumable usage as they reach their planned utilization. Additionally, the new systems being shipped in 2024 will contribute as they become operational. By the end of this quarter, we will have been shipping the Revio system for a year, which is when you will start to see this growth reflected. We are also introducing new consumable kits, which have already generated strong interest, particularly the Kinect kit that over 115 customers have ordered. Furthermore, larger projects, such as the Singapore population project, are expected to increase consumable demand as they begin their sequencing. There are multiple factors contributing to the anticipated growth in consumables for 2024.

The next question is from Doug Schenkel with Wolfe Research. Please go ahead.

Good afternoon and thank you for the question. I have a few points I’d like to cover. First, I want to follow up on the earlier discussion regarding gross margins. It appears you are projecting an exit rate in the mid-40s for gross margins, which is crucial for building confidence in your long-term targets. Additionally, regarding the placement numbers you provided for Revio, it’s not clear to me if your guidance includes an assumption for a significant increase in consumable revenue per box. I want to ensure that is the case because typically, there is a relationship between the number of instruments placed and the types of customers. If you are placing significantly more instruments and targeting lower-tier customers, those customers may initially spend less. Conversely, if you are placing fewer boxes year-over-year, I would expect the consumable revenue per box to increase. I would appreciate your insight on this to confirm whether we should view this as a potential source of upside for the year. Thank you.

Thank you, Doug. Regarding gross margins, I anticipate that we'll see improvement throughout the year, moving towards exit rates. Our guidance is set at 36% to 39%, which indicates we are aiming for the 40s. Whether we achieve that this year remains to be seen, but we certainly see room for growth in gross margins for various reasons outlined by Susan. She mentioned innovation, which is significantly helping to reduce costs, especially by lowering compute expenses associated with Revio. This presents a substantial opportunity for gross margin enhancement, potentially tens of thousands of dollars per system. By combining these factors with factory consolidation and changes in product consumable mix, we are working towards reaching the 40s and beyond. Our goal is to achieve 55% to 60% by 2026, and I believe there is still a viable path to reach that target. Concerning placement numbers and their relation to consumable pull-through, it is quite complex with numerous variables at play. As more systems are placed, they tend to serve lower utilization customers. However, we are still in the early stages of Revio's adoption, particularly for larger projects ranging from 1,000 to 10,000 samples. Notably, we've observed unprecedented interest in large-scale projects recently, as highlighted at ASHG and AGBT. These projects take time to secure funding and begin, but once they do, we expect high utilization rates since they are typically managed by large laboratories accustomed to operating with high sample volumes. While both factors may compete against each other, we still believe the consumable pull-through will likely fall within the $300,000 to $400,000 range, although this remains uncertain for several more quarters. There are various competing influences here, making it a complex issue similar to what you are trying to decipher. However, what is clear is that the number of samples being submitted to the system is rising, reaching historic levels for the company, which bodes well for revenue growth, enhanced adoption, improved gross margins, and increasing market presence. This aligns with our core objective of driving adoption, establishing confidence in our data type, and demonstrating the advantages of HiFi in Germline Genomics.

The next question is from Sung Ji Nam with Scotia Bank. Please go ahead.

Hi. Thanks for taking my question. So Christian, you mentioned your outlook for this year, obviously, is much higher than kind of the overall sequencing market growth. Just kind of curious, I don't know if it's too early to tell, but just how much of that growth do you think for you guys this year is coming from potentially taking share from the short-read sequencing market versus kind of expanding into new territories with long-read sequencing, given the new library prep launch recently, the HiFi consortium you talked about in all these large-scale studies that you are saying that there is more interest than ever? So I'm just kind of curious, do you have a sense at a high level, kind of how much carry might be taking from the short read versus creating new markets?

Certainly! Most of our new customers are already utilizing short-read sequencing. Typically, they’re allocating funds from short-read sequencing to long-read sequencing. Although short-read approaches have shown some success in rare diseases, long-read sequencing provides significantly greater information, improves solid rates, and reduces costs. The question becomes whether we are creating a new market or simply supplementing short reads. I believe it is a combination of both. We are winning projects that were initially intended for short reads. Initially, we were winning portions of projects where long reads handled one part and short reads managed the rest. However, we are now seeing customers who recognize that it is feasible to conduct entire large-scale projects using Revio. They are indicating that, if it fits their budget, they are willing to switch their entire projects to long reads. This is very exciting, and I look forward to sharing updates as we progress with these projects throughout the year.

The next question is from Eve Burstein with Bernstein Research. Please go ahead.

Hi there. Thanks a lot for the question. We talked about gross margins in 2024, but one clarifying question on the gross margin for this quarter. If I'm doing the math right, even if we account for the charges on inventory reserve and loss on purchase commitments and amortization, we still get to about 35%, and we know that ASP was unusually high for Revio. So if you normalize for that, it looks like a normalized gross margin this quarter of about 32%. So why is this flat versus last quarter if the consumables went up as a percent of revenue? And then is there any color you can give on gross margin for consumables versus instruments or for Revio versus Sequel?

To clarify your question, I'm trusting your calculations without going over them again. In the fourth quarter, we faced some yield challenges with consumables that affected us slightly, which may not be included in your figures. Despite the increase in consumables, the yield challenges we experienced in the fourth quarter were not extremely significant, but they did have an impact. Most of those issues have now been resolved, and I expect that moving into the first quarter and beyond, we will begin to see gross margins improve on a quarterly basis.

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

Hi. Thanks for taking the questions. So on the call, you mentioned consumables stocking in APAC. Did stocking occur in other geographies? And is this a normal phenomenon? And if not, could you provide some more color here.

In the fourth quarter, we didn't see significant consumable stocking, although there is usually a slight increase during this period. In the APAC region, for instance, customers might order their consumables earlier due to holidays in Q1, giving them a good lead time before the holidays. However, nothing major occurred in terms of stocking. Some of our larger customers placed substantial blanket purchase orders that will be fulfilled throughout 2024, and a portion of these orders was taken in Q4 as well. Overall, it wasn't an exceptionally heavy stocking quarter for the company. Ready for the next question.

Thank you. The next question comes from Matt Sykes with Goldman Sachs. Please go ahead.

Hi. This is Avi on for Matt. Thanks for taking my question. So I know you said your sales cycles are extended with general weakness in the funding environment. But is there a recovery baked into your guide for 2024? And are you expecting a continuation of the current trends throughout the year?

I believe we have a fairly moderate perspective on sales cycles. We hope that by the end of the year, sales cycles will return to more typical levels. However, we are prepared to navigate longer sales cycles throughout 2024. Our guidance reflects considerations of factors beyond our control. If conditions worsen, our outlook may change. Conversely, if circumstances improve, we could exceed our guidance range. Currently, we have aimed for a balanced guidance given the challenging funding environment. For instance, in the United States, we are still operating under continuing resolutions without a finalized budget, creating uncertainty regarding NIH funding, which is crucial for our business. This situation likely adds some difficulty in the sales process. We have also discussed the challenges in international markets, particularly in China and Europe, where interest rates and funding conditions remain tough. Despite these challenges, Europe performed well for us last year, and we anticipate continued growth there, though some friction remains. On a positive note, there is significant interest in Revio and HiFi sequencing, as indicated by our 2.3 million social media impressions at AGBT last week, far surpassing our competitors. This interest is beneficial for building our sales funnels and presents opportunities we plan to focus on this year.

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

Good evening, Christian. I want to revisit that question from a different angle. Considering the lower end of the guidance, it seems to be around 60 million in revenue. Could you walk us through what you observe? You've mentioned before that backlog isn't the best leading indicator, but could you discuss the qualified lead pipeline or other metrics that contribute to your confidence at that lower end? Additionally, regarding the Onso, my question pertains to the value proposition and product market fit, especially with some emerging sequencing vendors improving their Fred scores on the benchtops and the upcoming [indiscernible] for the NextSeq. Is the benchtop market essentially in a bit of a standstill right now?

Thank you for the question. When we established our guidance of $230 to $250 million, we took into account the quality and strength of our sales funnel for Revio, Onso, and our consumables across all products. Both ends of the range are supported by our sales funnels, and the different possible outcomes are primarily influenced by the timing of orders and project funding. We also need to consider our sales execution, manufacturing capabilities, and timely delivery to customers. This guidance reflects careful consideration of those factors, with the possibility of exceeding expectations if our excitement and sales funnels prove sufficient. However, there are risks that could push us toward the lower end of the range. Our pipeline looks promising, leading us to develop this range. Regarding Onso, I’d like to highlight that most bases coming off the sequencer are actually over Q50, with expectations that 90% will exceed Q40. Competitors haven't formally specified these metrics, but data from customers like TGen shows substantial quality over Q50, which enables them to observe genomic details that others cannot. This highlights our value proposition. The mid-throughput sequencer market remains substantial, with many units sold each year. We aim to capture our share by positioning Onso for specific niche applications rather than trying to serve every need. We believe the opportunity is strong.

The next question is from Subbu Nambi with Guggenheim. Please go ahead.

Hi. Thank you for taking my question. Following up on Doug's question on consumable revenue per Revio. Your guidance seems to imply that you're assuming $300,000 per box in full year guidance. Is that right? And if so, keeping in mind what you described on this call and in AGBT last week, are you expecting this will build momentum in the second half of the year and heading into 2025? And then I have more follow-up.

Okay. Regarding the pull-through, there are many ways to reach our guidance, and we won’t specify whether our model suggests 300, 350, or 400. We do not know where our pull-through will ultimately land, but I mentioned last week at AGBT that I believe it will fall within the $300,000 to $400,000 range. Many factors will influence this, which I have already discussed during this call. However, I won’t directly comment on whether our model for guidance was based on $300,000 per box. Generally speaking about the business, we anticipate more revenue coming in the second half of the year than in the first half. This trend is not unusual, and as Susan mentioned, the split is expected to be 45-55, which is typical in the life sciences sector. We expect the business to strengthen throughout the year due to large projects, increased consumables, and the opportunities we see for Revio and Onso over the year. We are optimistic about our ability to grow faster than the market, and we believe our competitive position is very strong right now. We just need to execute.

That makes perfect sense. Christian, as you mentioned, there was a lot of enthusiasm in our discussions at AGBT last week. However, there was also a clear need expressed for lower costs and more streamlined solutions related to sequencing costs and the sequencing process itself. You recently launched the HiFi kit to tackle this specific issue. What additional developments should we anticipate in the pipeline to further address this concern? How significant is the opportunity to reduce friction in terms of lowering activation energy and increasing revenue?

Yeah, that's a great question. Thank you for it. You're right. The new kits we've been really focusing on automation and reducing the friction and cost of the upfront workflow. We continue to lower the DNA input requirements, which gives you more access to more kinds of samples, more samples; all those things are critical. Other things that we're doing to decrease friction and enable revenue growth is on the bioinformatics side. And so we continue to build out more applications that really highlight the benefits of HiFi sequencing and using long-reads. And the more of those applications that are out there, the more we can reach more and more customers. We're also doing things on the market development side. So we created the HiFi Solves consortium so that customers can work together to solve rare diseases to show how they can benefit from seeing some particular variant in a particular sample because by definition, rare disease, each single one of them is rare. And so enabling the community is an important thing. And then finally, of course, we have a bench-top sequencer, a long-read sequencer, in development now. And once that product comes to market, that will change the capital barriers, of course, of the system and enable us to even broaden our customer base further. And we haven't given specific timing on that, but we will certainly share updates as they are warranted. So thank you for the question.

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

Perfect. Good afternoon and thanks for squeezing me in. So I wanted to ask, at AGBT, you talked about some of this cautious capital spending that you're seeing at customers. And so you noted that you're starting to explore giving discounts to customers on Revio, but then requiring higher minimum spend on consumables to kind of alleviate some of that capital purchasing dollars. It's almost more of a reagent rental model. So can you spend a minute talking about that for us? Have you started to use that go-to-market strategy this year? And then if so, how should we think about that impacting ASP as we model Revio for this year as well? Thank you.

Rachel, it's a great question. Thank you. Yes, we are exploring alternative business models or economic arrangements that still get us to the same place with respect to Revio, but as perhaps a customer pays more for consumables and less for their instrument. We last year implemented a new leasing partner. That new leasing partner gives us the ability to do more creative financing arrangements where the leasing partner takes some of the financial exposure, but we obviously get the benefit to our customers, and we still get healthy revenue from that. And so we’re managing through this period by starting to think about how we experiment with different models to see how we can continue to grow the market. The vast majority of our sales are still going to be traditional sales as we've historically done. And so I don't think anyone should be thinking that we're fundamentally altering how we think about generating revenue and the geography of revenue on the P&L. But I do think at the margin, some customers might benefit from more reagent rental type programs. And the implication of that would be that would be, you would likely have higher consumable revenues. And effectively, what the Street would see is lower instrument ASP maybe a little bit. But I think that when you think about 2024, the real impact to ASPs and consumable revenue probably isn't that significant really. I think at the end of the day, it ends up being much more of a marketing tool and a way to get into customers, and then they will decide how to deploy whatever opportunity that we provide them. So we'll see how it goes, and we'll keep you guys posted.

The next question is from Mason Carrico with Stephens. Please go ahead.

Hi, guys. Sorry if this has been asked already, I hopped on a little bit late here, but you guys have talked about these larger sequencing projects coming online in the back half of the year. Is there any way to frame up the magnitude of these projects in terms of the growth implied in the guide? I mean, ultimately, I think the question is how derisked is the revenue baked into the guide related to these projects? How much visibility do you have into the timing and ramp of these customers scaling them up in the back half?

Thank you for the question, Mason. It's a relevant one. Large projects tend to have a lot of variability in their start dates. Once they begin, however, they usually progress quickly. We are doing everything we can to expedite these starts. Some projects already have samples prepared, which means they'll likely commence sooner than others, particularly those that involve prospective studies. To gauge the scale of a project, you could consider the cost per genome and multiply it by the number of samples involved. For instance, if you have a project with 5,000 samples at $750 per genome, that gives you a rough estimate of the project's size. Additionally, remember that capital investments are necessary to operate these projects. When it comes to our guidance, we have adopted a conservative approach due to the unpredictability of when these projects will start. We aim to provide responsible guidance and not rely too heavily on any single project. However, I believe that in 2024, you'll start to see significant progress as several of these projects initiate. We are already witnessing some movement, including the GREGoR Consortium project and Singapore's kickoff later this year. Every conference we attend adds more samples to our pipeline, which is exciting. Now it’s about timing and execution, and we are prepared to move forward.

Thank you. This concludes our question-and-answer session. I'd like to turn back to management for any closing remarks.

All right. Well, we want to thank everyone for hanging in with us. I know we're a few minutes over time today. We expect 2024 to be an exciting year for the company, and we appreciate everyone's support. We look forward to seeing you at the various conferences over the course of the quarter and on our next earnings call. With that, we will end this call. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.