Pacific Biosciences of California - Q4 2022

Transcript

Operator (participant)

Hello, welcome to the PacBio fourth quarter 2022 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Todd Friedman, Director of Investor Relations. Todd, please go ahead.

Todd Friedman (Senior Director of FP&A and Investor Relations)

Good afternoon, welcome to PacBio's fourth quarter 2022 earnings conference call. Earlier today, we issued a press release outlining this natural results we will be discussing on today's call. A copy of which is on the investor section of our website, www.pacd.com, or it's furnished on Form 8-K, available on the Securities and Exchange Commission website at www.sec.gov. With me today are Christian Henry, President and Chief Executive Officer, and Susan Kim, Chief Financial Officer. Before we begin, I'd like to remind you that on today's call, we will be making forward-looking statements, including statements regarding predictions, progress, estimates, plans, intentions, guidance, and others, including expectations regarding our Revio and Onso systems and their commercialization timeframes, the future availability, uses, accuracy, coverage, advantages, quality or performance of, or benefits or expected benefits of using PacBio products or technologies, including our Revio and Onso systems.

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 these products. We refer you to the documents that we file 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 effort due to the items indicated in our earnings release. Please note that today's call is being recorded and will be available for audio replay on the investor 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. We will be hosting a question and answer session after our prepared remarks.

We ask that analysts please limit themselves to one question so that we could accommodate everybody in the queue. With that, I'll turn the call over to Christian.

Christian Henry (President and CEO)

Thank you, Todd. Good afternoon, welcome to our fourth quarter results and business highlights call. Thanks for joining us today. We have a lot of exciting news to share, I'll kick things off with an update on our performance in the fourth quarter and 2022. I'll delve into some exciting developments we've seen in the past few months and wrap up with an update on our market segmentation. Susan will provide a more in-depth look at our financial results and our guidance. First, a quick recap on Revio, our most transformative long-read sequencer to date. We are just a few weeks away from broad commercial availability of Revio, which is scheduled for next month. Currently, we have dozens of instruments on the manufacturing floor in our Menlo Park facility, at this point, we don't see any serious supply chain constraints.

I expect that we'll ship at least 25 Revio systems to customers prior to the end of the quarter. We will continue our manufacturing scale up through the second quarter. I believe we will be at our planned production rate for 2023 by the end of Q2. This is good news as the Revio platform enables our customers to take on projects in the thousands to tens of thousands of samples. With this scale, we believe Revio will be a game changer for scientists and clinical researchers. What would have taken years or even decades with long read sequencing in the past, can now be completed in a fraction of the time and cost with the Revio platform. For years, the scientific community has relied on short read genomes and exomes, yielding valuable insights into the human genome.

Despite millions of short-read genomes being sequenced, much of the genome remains unactionable today, and our understanding of our 20,000 plus genes and their role in driving disease is still quite limited. We now know that phenotype is not solely determined by genes, as mutations in non-coding regions can cause certain cancers. Our understanding of the impact of methylation on genetic disease is in its earliest stages, we also recognize that the importance of both sequence length and accuracy in understanding disorders caused by tandem repeat expansion. It's clear that to better understand the human genome, researchers must be able to interrogate its full complexity with high accuracy. We expect that sequencing with the Revio platform will provide researchers with the most complete and accurate view of the genome in a single assay.

With Revio, researchers will be able to interrogate the genome from telomere-to-telomere, obtain phasing information, structural variation, epigenetic profiles, and of course, single nucleotide variants, all at the scale and affordability required for large projects. The early excitement around Revio and the immense possibility for genomics support our belief that we can grow our revenue towards our goal of a compound annual growth rate of 40% to 50% through 2026. As we work to achieve our revenue growth targets, we see 2023 as a year of product transition. We expect many Sequel II and IIe users will migrate over to Revio over the course of the year. These transitions are difficult to precisely predict, and as a result, we may see some temporary variability with respect to consumable revenue.

On the instrument side of our business, we expect to see continued strength for Revio throughout the year. Additionally, we do expect to place a modest number of Sequel IIe systems, and of course, Onso, our short read sequencer, remains on track for commercial shipment in Q2 of 2023. As a result, our initial guidance for 2023 is that we expect to achieve between $165 million-$180 million in revenue, which represents growth from 29%-40%. Turning to our results. In the fourth quarter, PacBio achieved revenue of $27.4 million, a 24% decrease compared to the previous year's quarter. The decline in revenue was primarily driven by the announcement of the launch of Revio in the fourth quarter, which impacted orders and shipments for Sequel IIe.

We delivered 18 Sequel IIe systems during the fourth quarter, bringing our total install base to 512 Sequel II and IIe systems as of December 31. However, what truly sets this past quarter apart is that we received orders for 76 Revio systems, a record-breaking start for a PacBio launch, and far surpassing our expectations. We have seen a growing excitement around the potential of Revio, as indicated by the positive feedback we have received from our customers. At the recent AGBT conference, many customers told us how Revio could help them scale their research and interrogate the genome at unprecedented levels. At the Plant and Animal Genome conference in January, we saw a deep appreciation for the importance of HiFi sequencing and the enthusiasm for higher output long-read sequencing in the community.

We hosted a packed workshop where researchers from Corteva, UCLA, and HudsonAlpha discussed how PacBio sequencing advances their work in agrigenomics, biodiversity, and plant evolution. We are thrilled to announce that the first early access Revio is en route to researchers at the Broad Institute. Over the next few weeks, the team at the Broad Institute will perform their first internal sequencing runs on the platform, and in March, we expect to begin full commercial shipments. The Broad has already ordered 10 Revio systems to scale long-read sequencing for programs like the NIH's All of Us program. To put that in perspective, 10 Revio systems has the equivalent sequencing power of 150 Sequel IIes. We look forward to supporting this project and more population scale research initiatives to come.

While on the topic of All of Us, I wanted to discuss a recent preprint from researchers involved in the program, which highlights the utility of long-read sequencing. The authors noted that HiFi reads produced the most accurate results for both small and large variants, and concluded that, quote, "Long reads have widespread value for generating complete and accurate variant calls," end quote. The study showed that PacBio is best in class for calling variants even at lower coverage than other technologies. This supports our belief that even a PacBio genome at tenfold coverage can be more than sufficient for many research projects. At tenfold coverage, a Revio can sequence 12 human genomes in 24 hours or almost 4,000 genomes per year at a list price of approximately $330 per genome, with methylation included.

The demand for highly accurate long reads is increasing as evidenced by the recognition of long read sequencing as Nature Method's Method of the Year. With innovative studies utilizing PacBio's long reads from the Vertebrate Genomes Project, Telomere-to-Telomere Consortium, and the Human Pangenome Reference Consortium, we believe Revio can drive further discovery with its enhanced throughput and cost effectiveness. Our existing customers have also recognized the potential of Revio to accelerate their research.

For example, Mohammed Bin Rashid University of Medicine and Health Sciences, or MBRU, purchased Sequel IIes last year and ordered multiple Revios in the fourth quarter to sequence for a very large-scale research project in Dubai. The Wellcome Sanger Institute, a long time user of PacBio for plant and animal research, now plans to increase its use of long reads in human applications such as single-cell transcriptomics and variant detection with the added power of Revio. Moving on to Onso, our beta program is in full swing at the Broad Institute, Corteva Agriscience and Weill Cornell, each evaluating how Onso's extraordinary accuracy can benefit their various genomic applications. Feedback so far has been excellent, with one partner sharing that they've been extremely impressed by Onso's levels of accuracy, and another saying how highly accurate reads will be transformative for many genomic applications, including oncology.

We're pleased to announce that we're on schedule to begin commercialization of Onso in the second quarter with a launch specification of 400 million-500 million reads and 200 cycle and 300 cycle kits. The expected specification for accuracy of over 90% of the bases at Q40 plus, and the potential to reach Q50 plus through improved library preparation, we believe Onso will set a new standard in the industry. The system has a competitive list price of $259,000, with the 300 cycle kit listed at $1,995. We're collaborating with workflow partners across the short read ecosystem and will provide library prep conversion kits so that any current short read assay can move directly onto the Onso platform.

Regarding its capabilities, we have validated Onso's performance through various testing methods, including the Seraseq cell-free DNA control with Agilent library prep and capture, and our conversion kit. Internal results demonstrate that Onso is 2 times more sensitive in detecting Variant Allele Frequency of 0.05%, and is 1.4 times higher sensitivity even when applying duplex UMIs at 4 times the coverage with other short read sequencing technologies. These performance metrics highlight the exceptional value that Onso can bring to the market, offering high accuracy and sensitivity to meet the demands of various genomic applications, including cell-free DNA research. In addition to cell-free DNA, in collaboration with TenX Genomics, Onso achieved 99.8% of the bases at Q30 or better for single-cell RNA reads, showing the potential use of ultra-high accuracy in single-cell workflows.

We are dedicated to providing our customers with comprehensive and streamlined solutions for their sequencing workflows. This includes offering a range of tools and workflows that are designed to support their success, from automation to sample preparation and informatics. Our recent initiatives include expanding our MAS-Seq program to support new assays on the Sequel II and IIe, and Revio sequencing systems. These kits, which build on the success of last year's MAS-Seq concatenation technology for single cell isoform sequencing, includes 16S and bulk Iso-Seq and will be available later this year. Our bioinformatics team is continuously improving interpretation tools such as the recently launched Paraphase tool that helps characterize the dark regions of the genome linked to spinal muscular atrophy. On top of our internally developed products and tools, we're partnering throughout the ecosystem to make it more plug and play.

As such, we recently introduced the PacBio Compatible program, designed to make PacBio sequencing more accessible, which includes partners across all ends of the sequencing workflow, from automation and sample and library prep to secondary and tertiary analysis tools. Moving on, I want to share an update on our internal market segmentation from the previous year. In 2022, human genomics was the largest portion of our business, accounting for nearly 40% of our revenue. Customers in this segment include GeneDx, who recently ordered a Revio to target difficult to sequence genes and sequence human whole genomes for rare diseases with previously inconclusive results. Radboud University has leveraged PacBio technology to make numerous genetic discoveries, and plans to ramp up from hundreds to thousands of genomes using Revio.

Beyond human applications, we expect Revio to be utilized in applied markets like plant and animal genomics, which made up about 25% of our revenue in 2022. In this market, customers like Corteva Agriscience are utilizing PacBio to study plant genomes and identify microbial infectious diseases that affect these plants. They can improve crop yields and drive agricultural sustainability. Plant and animal genomics also include research programs like the Darwin Tree of Life project, which recently celebrated sequencing its 500th HiFi genome. The program aims to sequence 70,000 species of eukaryotic organisms in Britain and Ireland. We expect Revio to enable the researchers to progress towards this goal.

Infectious disease and microbiology, which represented 20% of our revenue in 2022, includes customers like Bioengineering Lab, who plans to use Revio for metagenomics to discover and characterize communities of microbes for industrial and biomedical applications. About 10% of our 2022 revenue was from oncology applications, with PacBio's highly accurate long reads, allowing researchers to uncover novel isoforms, fusions, and structural variants with exceptional accuracy. Looking ahead, we expect to address more of this large market with Onso's potential for extraordinary sensitivity in liquid biopsy applications. The remaining portion of our revenue comes from other and emerging applications. This includes gene editing and gene therapy applications. We are pleased with the support and interest from investors in our equity raise last month.

In an upsized offering, we raised $201 million in gross proceeds, which will further bolster our ability to grow our business and drive towards our goal of positive cash flows during 2026. With that, I'd like to turn the call over to Susan to discuss our financials and guidance in more detail. Susan?

Susan Kim (CFO)

Thank you, Christian. As discussed, we reported $27.4 million in product, service, and other revenue in the fourth quarter of 2022, which represented a decrease of 24% from $36 million in the fourth quarter of 2021. Inter-revenue in the fourth quarter was $6.1 million, a decrease of 62% from $16.2 million in the fourth quarter of 2021. The decline in revenue was primarily driven by the announcement of the launch of Revio in the fourth quarter, which impacted orders and shipments for Sequel IIe. We delivered 18 Sequel IIe systems during Q4, growing the install base to 512 Sequel II and IIe systems as of December 31, 2022.

Turning to consumables, revenue of $16.7 million in the fourth quarter grew 11% from $15.0 million in the fourth quarter of last year and was a record for PacBio. Sequel II and IIe consumables represented approximately 94% of our total consumable revenue in the fourth quarter, with the rest from older systems and other consumables. Annualized pull-through per system on the Sequel II and IIe install base in the fourth quarter was approximately $127,000. We expect Sequel II and IIe pull-through to decline throughout 2023 as we begin shipping Revio and customers transition to the new system. Finally, service and other revenue was $4.6 million in the fourth quarter compared to $4.8 million in the fourth quarter of 2021.

From a regional perspective, America's revenue of $12.0 million declined 36% compared to the fourth quarter of 2021, primarily driven by lower Sequel IIe placements with the recent announcement of the Revio launch. Asia Pacific revenue of $10.2 million grew 23% over the prior year. The region continued to recover with growth from both consumables and Sequel IIe system sales compared to the prior year period. With the launch of Revio, several customers also purchased the Revio Sequel IIe bundle to progress their HiFi sequencing volume with plans to further expand upon the receipt of their first Revio. EMEIA revenue of $5.2 million was 43% lower than the prior year period, also primarily driven by lower Sequel IIe placements.

Currency fluctuations in the pound sterling and euro drove a 7% headwind. The region posted another record consumables quarter. Moving down the P&L, GAAP gross profit of $5.1 million in the fourth quarter of 2022 represented a gross margin of 19% compared to a GAAP gross profit of $16.8 million in the fourth quarter of 2021, which represented a gross margin of 47%. Fourth quarter 2022 non-GAAP gross profit of $5.3 million represented a non-GAAP gross margin of 19% compared to a non-GAAP gross profit of $16.9 million or 47% in the fourth quarter of last year.

GAAP and non-GAAP gross profit in the fourth quarter reflects loss on purchase commitments and adjustments for excess inventory, totaling approximately $7.1 million, primarily related to a faster than expected ramp in Revio demand, which resulted in a faster than expected decline in Sequel IIe demand upon the launch of Revio. GAAP operating expenses were $92.2 million in the fourth quarter of 2022, compared to $81.4 million in the fourth quarter of 2021. Non-GAAP operating expenses were $87.6 million in the fourth quarter of 2022, representing a 10% increase from non-GAAP operating expenses of $79.9 million in the fourth quarter of 2021. Increased GAAP and non-GAAP operating expenses primarily reflect higher sales and marketing related expenses.

In terms of headcount, we ended the quarter with 769 employees, compared to 771 at the end of Q3 2022, and 728 at the end of last year's fourth quarter. Operating expenses in the fourth quarter included total non-cash share-based compensation of $16.8 million, compared to $17.5 million in the fourth quarter of last year.

GAAP net loss in the fourth quarter of 2022 was $84.4 million or $0.37 per share, compared to GAAP net loss of $69.3 million in the fourth quarter of 2021 or $0.31 per share. Non-GAAP net loss was $79.6 million, representing $0.35 per share in the fourth quarter of 2022, compared to a non-GAAP net loss of $66.4 million, representing $0.30 per share in the fourth quarter of 2021. Turning to our balance sheet. We ended the fourth quarter with $772 million in unrestricted cash and investments, compared with $834 million at the end of the third quarter of 2022.

Our ending cash and investments exclude gross proceeds of approximately $201 million, resulting from the sale of shares of our common stock in a follow-on public offering in January 2023. Inventory balances increased in the fourth quarter to $50.4 million, representing 1.6 inventory turns, compared with $43.5 million at the end of the third quarter of 2022, representing 1.9 inventory turns. The increase in inventory primarily reflects purchases of Revio and Onso instrument and consumables inventory. Accounts receivable decreased in the fourth quarter to $18.8 million, reflecting a DSO of 70 days, compared with $22.8 million at the end of the third quarter of 2022, reflecting a DSO of 71 days. Moving to guidance.

For the full year 2023, we expect revenue in the range of $165 million-$180 million, representing a growth rate of approximately 29%-40% compared to 2022. The lower end of the range assumes that a reduction in Sequel II, IIe consumables from a faster than expected ramp down more than offsets a ramp in Revio consumable revenue later in the year. The high end assumes consumable revenue is flat to slightly higher compared to 2022 and greater Revio shipments in the year. In both high and low ends of the range, we expect service revenue to decline compared to 2022 as customers decommission their Sequel II and IIe. For the first quarter of 2023, we expect to ship at least 25 Revio instruments as we build and ramp manufacturing capacity.

We expect manufacturing capacity scale through the second quarter, reaching our planned production rate for 2023 by the end of Q2. Please note that with the annual guidance in place, we do not expect to share instrument backlog or order numbers on a regular basis going forward. Moving down the P&L, we expect 2023 non-GAAP gross margin to be between 36% and 40%, which will exclude the amortization of intangible assets. Lower margins result from a higher concentration of revenue weighted towards instruments, with the early shipments of Revio at lower margins due to the combination of lower ASPs from customer loyalty discounts, coupled with higher costs during a new platform launch. We expect margin expansion beyond 2023 and maintain our long-term guidance of 55%-60% plus in 2026.

We expect operating expenses to be in line with long-term guidance, and therefore, non-GAAP operating expenses will grow less than 5% in 2023 compared to 2022. We expect the weighted average share count for EPS for the full year to be approximately 255 million shares, reflecting the recent sale of common shares and shares expected to be issued as part of the Omnium milestone later this year. With that, I will turn the call back to Christian. Christian?

Christian Henry (President and CEO)

Thank you, Susan. During last month's JPMorgan Healthcare Conference, I outlined our strategic goals for this year, focusing on delivering results to our stakeholders. Our first priority is to drive widespread adoption of our Revio sequencer by converting existing Sequel II and IIe customers and attracting new PacBio customers. We're off to a strong start with 76 systems in our backlog as of year-end, and approximately 30% of our sales pipeline consisting of new customers as of year-end. Second, we aim to demonstrate the unparalleled accuracy of Onso in customers' hands and show its ability to transform research in several genomic applications. As discussed, our internal data shows that Onso's accuracy can detect variants at far greater depth than SBS, and beta partners are sharing that they're having an excellent user experience.

Third, we're committed to continuing to develop our long-read sequencing technology, including ultra-high throughput and benchtop systems, and a next-generation SBB sequencer. This year marks the first step in our journey for offering multiple systems across the sequencing spectrum, with Revio and Onso leading the way. We will leverage the current infrastructure to drive towards positive cash flow. As Susan shared with our OpEx guidance, we're going to prioritize and focus on spending on the areas that matter the most. We plan to expand our partnerships across the ecosystem and workflow to increase customer adoption of SBB and HiFi. With the launch of the PacBio Compatible Program, we have a framework in place to onboard the best partners in the sequencing workflow.

Our long-term goal is to exceed $500 million in revenue in 2026. We believe that 2023 is the start of a multi-year growth story towards achieving this. I look forward to keeping you all updated on our progress throughout the year. With that, operator, would you please start the Q&A portion of our call?

Operator (participant)

Yes, of course. We will now begin the question and answer session. To ask a question, you may press Star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the queue, please press Star then two. As a reminder, in the interest of time, we ask that you please limit yourself to one question. At this time, we will pause momentarily to assemble our roster. The first question this evening comes from Kyle Mikson with Canaccord. Please go ahead.

Kyle Mikson (Director and Senior Equity Research Analyst of the Life Science Tools and Diagnostics)

Hey, Christian and Susan, thanks for taking the questions.

Christian Henry (President and CEO)

Yeah, hi.

Kyle Mikson (Director and Senior Equity Research Analyst of the Life Science Tools and Diagnostics)

Hope you're feeling better. Yeah. Hey, I guess on the guidance, this is kind of the range a lot we're expecting. Two questions about this, I guess, within my one here. On instruments, does this kind of assume you're just straight lining the 25 Revios in the first quarter? Just curious if you could kind of talk about like the cadence of the orders and the shipments and the rev rec going forward? Maybe like within that like, you know, beyond the shipment bullish in March and the recommencement of the shipments and maybe like May or June, there's gonna be probably like an assumption for inventory instrument terms in the second half. I'm just curious about that. That's for instruments. On consumables, maybe just pull through dynamics for Sequel IIe.

$127K, I think in four Q. I mean, how quick could that decline? Could that be like $80K-$90K by the end of the year? I think you mentioned Susan Revio pull-through could be, you know, you're assuming some consumables there. What are you like thinking about there? Curious about that. Thanks, guys.

Christian Henry (President and CEO)

All right. A lot to unpack there, Kyle. Thanks. I am back in the saddle. So, I'm sorry I missed everyone at AGBT last week. Let's talk about the guidance a little bit, and how we thought about it. You know, the, we do expect, that, you know, on a quarter by quarter basis, revenues will improve throughout the year. You know, we don't give quarterly guidance on revenue, so I'm not other than to say that I do think that you're gonna see us grow over the course of the year and probably gonna stop there. With respect to Revio shipments, you know, 25 is really just the start, and we're prepared to, you know, produce and ship more than that per quarter.

We're starting at 25 because we wanna make sure we have an incredible customer experience with these early shipments as we scale up. I wouldn't, I wouldn't assume that it's a linear, you know, a linear kind of outlay quarter after quarter after quarter. I would say that 25 is a good starting point for us to, you know, really get the system out in the field and start to see how it impacts both consumables with Sequel IIe, but also, you know, the utilization of Revio itself. With respect to the pull-through dynamics, you know, as I've said a couple of times, we aren't gonna know really what the pull-through dynamics look like for several quarters, the truth is we're not gonna try to speculate or guess.

What we do know is that some of our largest customers are early adopters of Revio, and so that will have, you know, our assumption is that they will use Revio, and they will start to slow down the usage of Sequel IIe. It may not go totally to zero with those customers, but it will certainly decline as they move to the, you know, scale and cost effectiveness of Revio. You know, that could have an impact on, and it's likely that it will have an impact on Sequel IIe pull-through, probably over the next couple of quarters. Where that ultimately settles out, you know, I think you quoted 80-90K. You know, we don't know, and we're not gonna make a, we're not gonna try to guess at that today.

We're gonna see how this unfolds over the course of the year. I do think that Revio utilization will likely grow over the course of the year, and particularly as we start to ship to the larger scale customers first. What we will see is we will start to see some sort of normalization of that. I suspect, you know, based on past experiences, it's probably gonna take us three or four quarters to really see where that settles out. Hopefully, Kyle, that answers your questions and gives you a sense of how we're, you know, thinking about the guidance with respect to the instruments and consumables.

Kyle Mikson (Director and Senior Equity Research Analyst of the Life Science Tools and Diagnostics)

Yeah, that was great, Christian. I'll hop back in the queue.

Christian Henry (President and CEO)

Cool.

Operator (participant)

The next question is from Julia Qin with JPMorgan. Please go ahead.

Julia Qin (VP of Global Real Estate)

Hi, good afternoon. In terms of the manufacturing capacity for Revio, you said, 25 shipping in 1Q and then, fully ramped up by 2Q. Where do you think the supply will stand, at run rate, in the second half of the year? And then, in terms of the Revio pull-through ramp, I believe you previously mentioned that you expect a barbell distribution in terms of the customer kind of in a volume. Is it fair to expect that, you know, the lower throughput customers will onboard later this year, or do you think that's more of a 2024 and beyond dynamic?

Christian Henry (President and CEO)

You know, Julia, thank you for the questions. It's good to talk to you. You know, first of all, thinking about the run rate on manufacturing, you know, the good news is that we have enough production capacity today to satisfy a very wide range of outcomes with respect to demand. You know, we are gonna we're gonna scale our production and get to kind of our steady state by the end of Q2. That doesn't mean we couldn't scale further in Q3 or Q4 and beyond. What we're trying to do is not put us in a situation where we produce a lot of instruments at one time and then reduce the steady state.

We'd much rather be a little bit more, you know, kind of consistent over time because that's how we'll get the best efficiency out of the plant, and that's how we'll get the lowest COGS and improved gross margin. You know, part of Revio is not only the enablement of this new technology for our customers, but it's also for us to drive our gross margin improvement, both through the instrument itself over time, but also and especially because it can be a much higher pull-through instrument which will drive product mix.

When we think about that, barbell distribution, as you were talking about with respect to consumables, you're right that, you know, typically in these markets, you end up with a kind of maybe a bimodal distribution of, very high throughput customers with very high utilization and then lower throughput customers. You know, our expectation is with Revio that sure, the earliest shipments will probably be to the higher throughput and highest throughputs, and that'll probably be, mostly through Q1 and even a lot of Q2. We're gonna... You know, it's really important that we provide this technology to all of our customers.

We're gonna try really hard to be, to, you know, to get some of our lower throughput customers, which we think will be the high throughput customers of tomorrow, the system as soon as we can. Of course, we're gonna serve our very large, you know, customers and large projects because they really enable, you know, the, the next sets of large projects to come through to build the business. I would expect to see a pretty broad, distribution of customers over the course of this, 2023, and it'll continue on in 2024.

Julia Qin (VP of Global Real Estate)

Gotcha. That's very helpful. Just one follow-up on the Sequel pull-through, if I may. I think you mentioned that, you know, there might be some near-term volatilities in the Sequel utilization 'cause there's an initial wave of, you know, inventory destocking. If customers' early orders aren't fulfilled, they might kind of, you know, have a rebound in utilization. I'm just curious, you know, has the your expected or reasonable expectation of Revio supply constraint in that, you know, initial year been communicated to these customers in an attempt to kind of maybe smooth out their inventory management of Legacy Sequel II? How does that kind of, you know, tie to the best case and worst case scenario of Sequel pull-through that's embedded in your guidance?

Christian Henry (President and CEO)

We have been very clear with our customers, and we are. You know, one of the things we are trying to do is we are laser-focused on our customers. It's one of our core values, and helping them understand, you know, timing of when they're gonna receive Revio, when they, you know, utilization of Sequel IIe consumable and II and IIe consumables. You know, we're really trying to work at the grassroots level, each customer, so that they can optimize, you know, their experience. Some customers that have ordered, you know, say recently, it's likely that they're not gonna get their Revio for a while, so they're gonna continue to run their projects on Sequel IIe. We're gonna wanna make sure we help them manage, you know, manage that transition. It could have...

Like I said in my prepared marks, there could be some variability or volatility around the consumable revenue as we go through this transition. The good news is that by the, you know, really by the end of the year, this volatility is likely behind us and we're, you know, we're scaling our utilization on Revio, and you're starting to see the consumable pull-through from Revio. We're starting to understand what those numbers look like and have more sense. You know, the next few quarters, it is gonna be transition, and we're just managing that the best we can. The other piece of good news is that we have done a really good job on producing 25M SMRT Cells, and we're in an excellent inventory position already.

If most of you recall, we actually completed the 25M SMRT Cell over a year ago at this point. We've got a lot of experience with it. Yields are already coming up in the manufacturing plant. You know, our ability to supply the market at really any level of demand that we're kind of seeing, is already in place effectively, which is super exciting.

Operator (participant)

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

Tejas Savant (Healthcare Equity Analyst of Life Science and Diagnostic Tools)

Hey, guys. Good evening. Christian, it's good to hear your voice. We missed you at AGBT, especially after the sun went down, as a lot of people told you, I'm sure. On the Revio first to kick things off, you know, you've got 76 orders in backlog. You're shipping 25 here in essentially a month here. You've got the April pause as well, which you know, Mark talked about at AGBT is not particularly impactful from a numbers standpoint. Could we actually see you ship all of the current orders in backlog by the end of the second quarter? Do you see that as more of a third quarter or a mid-third quarter situation? My second question here is on Onso.

First, easy one for Susan, what exactly are you know, baking into the guide for Onso, perhaps, you know, any color on the number of shipments here in the back half? I think you showed really good data at AGBT. I think it was, you know, something like 600 million to 730 million reads, you know, higher than your 400 to 500 target range. What exactly remains to be done there over the next few months, other than just incorporating, you know, some of the learnings from your beta users?

Christian Henry (President and CEO)

Yeah. Okay. A lot to unpack there, Tejas. Thank you for the questions. First of all, you're right, we had 76 orders in backlog at the end of December, but the truth is we have more orders in backlog than we did at the end of December today. The reason why I start by that is that the reality is that we expect, you know, we expect to continue getting more and more orders over the course of the year. It's, you know, shipping the 76 by a certain amount of time, you know, I would expect us to carry backlog for quite a while actually, because I do think the order, you know, the demand for the product is quite substantial.

You know, what we're doing is we're working to ship at least 25 units, is what I said specifically, this quarter to get started. You're right, in April, we're still gonna be manufacturing systems all through April, so it's not like it's. You know, when we say pause, all we're doing is making sure the field is, you know, that we're very satisfied with how customers are ramping up on Revio. It has nothing to do with anything other than that. It has exactly zero impact on our ability to deliver revenue in Q2. I just wanna make that crystal clear, 'cause it does seem like some analysts have really kinda drilled into that, and I don't...

You know, what we're focused on is having an incredible launch, that's part of how you plan these things out to do it exceptionally well. You know, we're not, you know, I'm not really gonna say when the 76 gets all shipped, but what I am gonna say is that, you know, I do expect us to run in backlog for several quarters this year, and that's partially because I think the order book is gonna be very strong all year. That's how we think about that. Let's see. Talked about the pause. You know, with respect to what... I'll pass the guidance to Susan in a second, but just to comment on the Onso, what do we have left to do?

You are right, we've seen some great results from our beta customers with respect to the density. What we have to do now we're really in the phase of, you know, making sure that the instrument, we can produce the instrument at scale, making sure that we can, you know, make sure the chemistry is hardened so that it can get to a very broad diversity of customers, working on making sure we get production of flow cells right so that we can deliver to our customers consistently and at scale. It's, it really is, you know, there's still some software work to do as there always is. There is a lot of work to do still to get to full commercialization.

The good news is that you're seeing the chemistry starting to perform, you're seeing the densities improve in getting to commercial, getting to commercial specifications. You're seeing, you know, you're seeing the incredible accuracy even in the hands of our beta customers. Out in the field on customer samples, you're seeing that. All of those signs are really encouraging for us. It'll just be about the ramp, scale, finalizing the development, taking feedback from those beta customers and integrating it into the product. You know, part of this also is making sure that the Onso launch doesn't interfere with the Revio launch too.

We wanna make sure that we do both launches exceptionally well because we think both products are, you know, critical to pushing the state of the community forward and allow us to really, you know, really grow and take a leadership position in this, in this community. Susan, do you wanna comment on Onso into the guidance?

Susan Kim (CFO)

Sure. I think with that backdrop, we are super excited by the positive customer feedback on Onso, customer interest in terms of the Revio-Onso bundle. In terms of the year, this is a Revio year in terms of our guidance. I guess to provide some perspective in terms of Onso, what is baked into our guidance is basically a modest number of Onso shipments in the year, but it's not a material contribution to the overall revenue number, as this year, again, is mostly driven by Revio.

Christian Henry (President and CEO)

Yeah, particularly most of the growth.

Susan Kim (CFO)

Most of the growth, exactly.

Christian Henry (President and CEO)

Yeah.

Operator (participant)

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

Dan Brennan (Managing Director and Healthcare of Life Science and Diagnostic Tools Research Analyst)

Great. Thanks for taking the questions. I guess maybe I'll stick with one, but I guess a multi-parter, so that's easier. In terms of consumables, that was really helpful to hear some color in the total guide about how to think about consumables at the high end of the guide?

While I appreciate the Sequel IIe roll off is a hard thing to predict, like can you give us any more color within that guidance range? Like, you know, what are the barriers on Sequel IIe consumables? Then B, Christian certainly can appreciate that the orders didn't stop at year-end. You know, you discussed 76 orders from 43 countries and 30% of those from new customers. That was as of the end of the fourth quarter. Can you just give us some color maybe about how the order book has evolved since early January? I'll leave it there. Thanks.

Christian Henry (President and CEO)

Yeah, I mean, I think, you know, realistically, we're gonna try to stay out of, you know, looking at backlogs and order books and this and that. To color, you know, what's happened since year-end, we've had two very successful conferences, the Plant and Animal Genome Conference, AGBT. If anything, the funnels are strengthening, the perspective, you know, lots of customers or many customers have actually run samples inside of our labs now in our applications lab. The, you know, customers are getting more confidence around it really is what we say it is. I think that's really exciting. The, you know, the funnel continues to strengthen.

It is a global funnel. There are a lot of new customers. I think that's really important to me is not only do we wanna, you know, get all of our existing customers to scale up with Revio, but it is really important for us to show, new customers and see these new customers get engaged with the technology. So far, I think we've seen a lot of that internally, you know, with our customers. Perhaps maybe most interestingly is the scale people are starting to talk about is different than ever before in the history of PacBio.

People are contemplating, you know, 10,000 sample projects, 20,000 sample project, larger scale, large scale transcriptomics projects, large scale whole genome projects. I think that's gonna be... that's extremely encouraging to, you know, kind of prove out the thesis that we needed to get to higher throughput, and we needed to get to economics that enable that enabled scale. We already, and we continue to do it with the best accuracy. As that All of Us preprint showed, you know, quite frankly, the HiFi sequencing right now is the most accurate and most complete sequencer you can get. So that's all been really well.

I know that doesn't help you kind of build your model per se, but anecdotally, it makes us feel a lot better. I didn't understand, Dan, your question really on guidance barriers on Sequel II. Maybe could you ask that question again?

Dan Brennan (Managing Director and Healthcare of Life Science and Diagnostic Tools Research Analyst)

Sure. I think Susan talked about consumables at the high end of the guide would be flat to up. That, I presume you were referring to total consumables, so Revio plus Sequel, and I just wanted to clarify that. If it was, I was just trying to think through on Sequel itself, you know, within the guidance, any color on, you know, how we're thinking about Sequel IIe consumables at the high end and the low end of the guide?

Christian Henry (President and CEO)

Susan was talking about the total consumable number, which the total number is actually the hard number to predict, right? Because you don't know how fast Sequel II is gonna decline. You do know that Revio is gonna accelerate, and it'll continue to accelerate, you know, throughout the year. But we don't really know yet how that will transpire exactly. That's why, you know, when we think about our guidance, we have contemplated that volatility in the range of different outcomes. I think that's probably the easiest way to put it.

Operator (participant)

The next question comes from David Westenberg with Piper Sandler. Please go ahead.

David Westenberg (Managing Director and Senior Research Analyst)

Hi. thank you for taking the question. I echo everybody's sentiment when I said we really missed you at AGBT.

Christian Henry (President and CEO)

Thank you.

David Westenberg (Managing Director and Senior Research Analyst)

Let's start with the... I think you've got the number 30% new to PacBio. Would you be willing to discuss whether they might be existing long-read customers using maybe ONT that are looking for maybe accuracy at a lower cost, or if this would be short-read customers that really are looking for long reads because for all that it offers and then the kind of projects that they're looking at? Is there any way to describe that 30% of customers?

Christian Henry (President and CEO)

Yeah. You know, I can't... I don't have the breakout in front of me, so I can't give you kind of specifics. The reality is that, you know, there has been a lot of conversations and, you know, I'm getting the second half 'cause I wasn't at AGBT, unfortunately. At AGBT, there were lots of conversations where customers were, you know, kind of expressing their need to move to Revio from their existing long-read sequencing paradigm because they see the accuracy, because they see the completeness. The other thing is they believe in the robustness of the platform that we bring to bear, given their market experience with Sequel IIe.

We've seen that. But the predominant portion will still be short read customers moving to long reads. You know, what everyone has to realize is that virtually every lab that's doing sequencing has a short read sequencer today, or is, you know, that's the predominant phenotype in the world. What's happening is that they will bring a Revio machine into their lab, and they'll start to move projects away from short reads to long reads for exactly what you said, the benefits of completeness, structural variation, you know, being able to see phasing straight out of the gate without any tricks, epigenetics. You know, it's just become so apparent that there's so much advantage to looking at long reads over short reads in most applications.

That, you know, you're starting to see a lot of people, you know, start to make that switch and move forward. I think you're gonna see, you know, Revio machines sitting right alongside existing short read sequencers, and the Revio machines are going to be capturing more and more of the dollars, in many different applications where, you know, we clearly have significant competitive advantage. Now we have the scale and the economics to, you know, to enable our customers.

Operator (participant)

The next question comes from Sung Ji Nam with Scotiabank. Please go ahead.

Sung Ji Nam (Managing Director and Senior Equity Research Analyst of Life Science Tools and Diagnostics)

Hi. Thanks for taking my question. I can totally appreciate that this is the year for Revio. But given the really positive feedback on Onso, and also the really attractive bundle that you're offering, we're just kind of curious what your thoughts are in terms of the attachment rate, if you will, in the outer years? What do you think might be kind of the biggest barrier in terms of customers, you know, really adopting Onso at this point? Are they looking for more data, in, you know, comparing Onso to other short read platforms? If you could talk about those.

Christian Henry (President and CEO)

I think you're right. There's a lot of excitement about Onso because, you know, really for the first time in a very long time, there's significant differentiation in the short read space with Onso, and customers see that. They see the bundle pricing and offering that we have as something unique. No one else can, you know, provide that. You know, it's exactly why our strategy of becoming, you know, the only company with highly accurate long and short read technologies gives us the ability to talk to every customer in the space and really ask them what questions are they trying to answer and provide them solutions that answer their questions.

That's, that's gonna be really powerful, not only as we get out of the gate here, but over the next several years in particular. What I think customers are going to be excited about is getting Onso into the lab to see what it can do, and then watching our ability to increase the power of the technology through increases in density, driving more, you know, driving more reads per run, which would create more value than ever before. It's really that differentiation. You know, I think the barriers today are probably the biggest barriers we have to get the product to market, to be maybe a little tongue in cheek, but that's really what it is. I think that there's a lot of excitement around the product.

We need to finalize the development, make it a highly robust, and have an amazing launch. That's really what we're gonna do here over the next, you know, as we get Revio out the door and prepare for Onso. You're gonna see us continue to focus over the second half of the year and into next year on how you integrate with bundles, how you increase the performance of both Revio and Onso, quite frankly. You know, increase our value to the customers. That's really the plan of attack here. I'm very enthusiastic about it. I mean, we are From a guidance perspective, we are taking a modest view because, you know, we wanna make sure we get this right.

We know that there's a lot of choice in the market. We believe we have a highly differentiated offering, but we also wanna be, you know, practical and responsible about how we give our financial guidance.

Operator (participant)

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

John Sourbeer (Executive Director)

Hi. Thanks for taking the question here. Maybe just a question for Susan. You know, on the greater than 25 shipments in the first quarter, do you think you can recognize those in revenue, or could you remind us how the revenue recognition is on the shipment? A follow-up. You know, it sounds like the Broad for the Revio has been shipped out the door. Have they actually received it and up and running? If so, any early feedback on the installation there and software? Thanks.

Susan Kim (CFO)

Yeah. John, at least 25, those will be recognized as revenue because the predominance of our shipments are the predominance of the instruments we deliver to customers is recognized upon delivery. That is, that is meant for revenue recognition in the quarter.

Christian Henry (President and CEO)

On the Revio going to the Broad, it was, you know, we sent it via truck, so the truck's arriving-

Susan Kim (CFO)

Yes.

Christian Henry (President and CEO)

No, I think it's arriving actually in the next couple days.

Susan Kim (CFO)

Yeah.

Christian Henry (President and CEO)

The truck will arrive, and they'll install it next week. They'll, you know, They're very, very capable, so I wouldn't be surprised if before the end of the month, we're starting to see runs come off of the machine, assuming the installation goes well.

Operator (participant)

The final question this evening comes from Ross Osborn with Cantor Fitzgerald. Please go ahead.

Ross Osborn (Director and lead Research Analyst of MedTech & Diagnostics)

Hi, thanks for squeezing me in. I know it's been a long call, so I'll be quick. Just curious to hear your view on China. You said the border is opening, but cases increasing, really strong instrument demand, but any insight into overall activity would be appreciated?

Christian Henry (President and CEO)

Yeah, I'll right now, overall activity has been pretty good. We had very strong demand for Revio in China and I think that's gonna, you know, that will help us with our Chinese revenue in the quarter. You're right. When I give guidance, one of the things I do worry about is, you know, how does China play itself out this year? None of us really know how that will completely play itself out. What buoys my confidence is the fact that we have a new product cycle and a lot of enthusiasm and a lot of orders already for Revio, that will help. You're right. You know, potential closures, COVID, those kinds of things. There's still headwinds that we face in the market.

You know, when we were thinking about our guidance, we are trying to think through, you know, through that there still are headwinds sitting out there that, you know, that we're concerned with and watching. So far, our view on China right now is that, you know, we expect it to be operations as normal. We will be shipping some Revios to China this quarter. You know, that will help and get those customers started. Right now, there's nothing extraordinary to report. We are watching, as is I'm sure all of our competitors and peers, how that will unfold over the next several quarters.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Todd Friedman for any closing remarks.

Todd Friedman (Senior Director of FP&A and Investor Relations)

All right. Thank you all for joining us today. We look forward to connecting with many of you later this quarter at our several investor events and updating you on our progress this year. As a reminder, a replay will be available on our website. This now concludes our call. Thank you.

Operator (participant)

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