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Pacific Biosciences of California (NASDAQ:PACB)

Q3 2012 Earnings Call

October 25, 2012 4:30 pm ET

Executives

Trevin Rard

Michael W. Hunkapiller - Executive Chairman, Chief Executive Officer and President

Susan K. Barnes - Chief Financial Officer and Executive Vice President

Ben Gong

Analysts

Daniel Brennan - Morgan Stanley, Research Division

William R. Quirk - Piper Jaffray Companies, Research Division

Bryan Brokmeier - Maxim Group LLC, Research Division

Sylvia Chao

Operator

Good day, ladies and gentlemen, and welcome to the Pacific Biosciences of California, Inc. Third Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Trevin Rard. Ma'am, you may begin.

Trevin Rard

Thank you. Good afternoon, and welcome to the Pacific Biosciences third quarter 2012 conference call. With me today are Mike Hunkapiller, our Chairman and CEO; Susan Barnes, our Chief Financial Officer; and Ben Gong, our Vice President of Finance and Treasurer.

Before we begin, I'd like to inform you that comments made on today's call may be deemed to contain forward-looking statements. Forward-looking statements may contain words such as believe, may, estimate, anticipate, continue, intend, expect, plan, the negative of these terms or other similar expressions and include the assumptions that underlie such statements.

Such statements may include, but are not limited to, revenue, margin, cost and earnings forecast, future revenue implied by the company's backlog, expectations of future cash usage and other statements regarding future events and results.

Actual results may differ materially from those expressed or implied as a result of certain risks and uncertainties.

These risks and uncertainties are described in detail in the company's Securities and Exchange Commission filings, including the company's most recently filed quarterly report on Form 10-Q. The company undertakes no obligation to update, and prospective investors are cautioned not to place undue reliance on such forward-looking statements. Please note that today's press release announcing our financial results for the third quarter of 2012 is available on the Investors section on the company's website at www.pacb.com and have been included on the Form 8-K, which is available on the Securities and Exchange Commission's website at www.sec.gov.

In addition, please note that today's call is being recorded and will be available for audio replay on the Investors' Section of the company's 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 and that Pacific Biosciences undertakes no obligation to update such forward-looking statements.

At this time, I'd like to turn the call over to Mike.

Michael W. Hunkapiller

Thanks, Trevin. Good afternoon and thank you for joining us today. We are continuing to make progress against the plans we laid out earlier this year. Highlights of our third quarter achievements are as follows: We booked orders for 4 new PacBio RS systems, up 3 from the 1 order we booked during the second quarter; our recurring revenue grew sequentially despite the effects of typical season summer seasonality; we launched our automated mag bead station for the PacBio RS during the third quarter as we had planned and we have upgraded nearly all the systems in the field; finally, we continue to see numerous scientific papers published highlighting the advantages of the PacBio RS. In just the past few months, there have been 11 papers published in journals such as Nature, Nucleic Acids Research, Genome Research and the International Journal of Cancer.

Now, I'd like to take this time to review the priorities we established at the beginning of the year and then highlight the progress we've made on those priorities.

Those priorities are: one, improving system reliability and performance; two, delivering a series of product enhancements; three, providing full customer solutions including front-end sample prep and back-end bioinformatics; and four, focusing on the key applications where we add significant value, which are de novo assembly, targeted sequencing and base modification analysis.

We are very pleased with the progress we have made over the course of the year on these priorities. In terms of system reliability, we've come a long way in just a few quarters. Beginning of the year, our customers were having issues that stem from hardware and software bugs as well as training. In many cases, this resulted in low system availability and low utilization. Since then, we upgraded the installed base with a comprehensive release called C2, which included a host of reliability improvements and we have continued to provide focused training and support through our field and technical support organizations. While we will always continue to work to improve reliability, our system uptime is now very good and comparable to that of some of the more mature life science tools.

We are pleased that system reliability is not the pressing issue it was at the beginning of the year. We've also made excellent progress throughout the year on improving system performance to product enhancements.

In the first quarter, we launched our C2 release, which doubled the read lengths to approximately 3,000 bases on average, with 5% of those reads above 8,000 bases. Our C2 release also significantly increased throughput and improved accuracy.

During the second quarter, we launched new software which provided customers with the ability to detect base modifications using the kinetic information captured by the PacBio RS system. This was the first step in enabling our customers to study base modifications with the PacBio RS.

I will elaborate on this in just a minute when I describe the follow-up software which we just announced earlier this week. The third quarter, we introduced the automated mag bead station, which has already made a big impact. Customers who have had trouble with difficult sample preparations in the past have been telling us that the mag bead station does a wonderful job cleaning up samples so they can generate more useful sequence data from them.

This can make a big difference as customers hesitate to start projects when they only have a small amount of input sample to work with and they want to make sure they can generate good data from that sample. One customer summed up their feedback on the new upgrade in a recent e-mail to us which read: Mag bead equals awesome.

Right on the heels of releasing the mag bead station, we just announced our latest secondary analysis software release, which further enables the study of base modifications. This software release includes automated tools for detecting and characterizing methylated bases and bacteria. As a background, the most common modified bases found in bacteria are 6-methyladenosine, 4-methylcytosine, and 5-methylcytosine.

These methylated bases can have a significant effect on the pathogenicity and viability of certain strains of bacteria. Up to now, the study of these methylated bases has been limited due to lack of available tools to study them.

Now with the PacBio RS, and these new secondary analysis informatics tools, the methylomes of bacteria can be studied on a large scale. As an example, a paper entitled The Methylomes of 6 Bacteria was published in the Journal Nucleic Acid Research earlier this month, which illustrates how researchers have used the PacBio RS for discovering a series of new methylation patterns in bacteria that were previously unknown. This is a very exciting area and we have likely just seen the tip of the iceberg.

We have recently seen a significant increase in base modification studies by our customers and we expect to continue to see growth going forward.

We also continue to push the capabilities of the PacBio RS and later this quarter, we plan on releasing new chemistry and software that we expect to increase the current read length achieved by our customers to approximately 5,000 bases on average. With 5% of those reads above 13,000 bases, long read lengths are especially valuable for de novo assembly applications and targeted sequencing of large repeat regions, regions with complex structural variations. These types of projects are not easily addressable with short read technologies and the PacBio RS is proving to be the only way to completely sequence certain complex genomes.

We've been working with some customers to test an early access version of this chemistry and the feedback has been very positive. One customer used the chemistry to sequence the rice genome, they commented that the results they have achieved with 9x coverage, so far, were 7x better than they could achieve with Illumina technology at 60x coverage.

The rice genome, like that of most plants, is replete, with repetitive genetic elements and chromosomal duplications that make analysis for short read sequencing technologies very challenging, over which the PacBio RS long reads are particularly helpful. I just gone through an impressive list of product enhancements that we've released or plan to release this year. I'd like to acknowledge our product development and product rollout teams for doing a remarkable job in getting these enhancements in the hands of our customers so quickly.

Now circling back to our efforts in delivering full customer solutions. We've made significant progress on sample preparation and bioinformatics tools. With regard to sample preparation since the beginning of the year, we've made method improvements that have cut the sample input required to sequence with the PacBio RS by approximately 90%. Our customers want to take full advantage of the fact that our platform does not require amplification and therefore, it's important to be able to generate sequence data from a small amount of sample input. For base modification analysis, it's also necessary to be able to study samples without amplification, because the amplification process would render the sample useless for this purpose.

In addition, we are continuing to work with vendors on sharing in sample capture products, which further simplify the sample preparation process for the PacBio RS.

Equally important to improvements in sample preparation for us, is development of bioinformatics tools and we've made tremendous progress in this area. We have seen that even the best sequencing data generated does not help customers solve problems without the right software tools to take advantage of the data. The additional of software tools we released for studying base modifications, we released a series of software tools for enhancing the assembly of genomes with PacBio data. Our latest software release, for example, includes a version of Celera Assembler that has been tuned specifically for the PacBio RS long reads.

A recent publication in the journal Nature Biotechnology highlighted how researchers at Cold Spring Harbor and the National Bio Defense Analysis and Countermeasures Center use this version of Celera Assembler to improve assemblies for a range of genomes from microbes to higher new carry outs.

This highlights a very important point that's worth repeating. For new sequencing technologies, it typically takes time for software and bioinformatics tools to develop, which takes full advantage of the data being generated. A lot of people in the industry are used to working with short read data and the assembly tools they use have been tuned for that kind of data. We commercialized the PacBio RS about 18 months ago, and now, we're seeing a series of bioinformatics tools coming out that take full advantage of the long reads and random error profile of our data.

As a preview of bioinformatics tools to come, we have recently made available a set of new software tools on our DevNet site, which is where we and our customers share the latest developments in secondary analysis tools. With these latest software tools, we've been able to demonstrate an ability to generate high quality, high accuracy assemblies, while using only PacBio long reads. We are cautiously optimistic about where this will take us as this could dramatically simplify the process of assembling the most complex genomes. Instead of using a combination of different platforms, multiple libraries and hybrid assembly techniques, users can create a single library for a sample, make one run with the PacBio RS and end up with an answer in front of a complete assembly and epigenetic profile of a bacteria. It's still early and our customers need some time to work with these new tools to see how they can incorporate them into their workflows, but we believe this will be instrumental in driving broader adoption.

Switching now to customer successes in our key applications. A number of good examples were customers' progress represented last week at the user group meeting we hosted at our headquarters in Menlo Park. We had 78 attendees from 25 different customer sites. There were numerous presentations from a wide range of customers covering applications at all of our key target areas: de novo assembly, targeted sequencing and base modification analysis. While all of the presentations were well received, I will highlight just 2: the first comes from a customer who has only had their PacBio RS for a little less than a year. Garth Ehrlich and Joshua Earl from the Center for Genomic Sciences at Allegheny-Singer Research Institute discussed how they were using the PacBio RS system in production mode to sequence and assemble high-quality genomes of multiple bacterial strains from both human and plant pathogens. Their optimized strategy is a cost-effective approach using solely PacBio data with the Celera Assembler. This produces much better assembly results than assemblies that they have generated using the Roche 454 Titanium system.

In one recent project, they sequenced and assembled 20 strains of Xylella fastidiosa, a plant pathogen responsible for causing disease in over 100 species, many of which are important agriculturally.

They received 20 strains from the U.S. Department of Agriculture and used just 4 SMRT cells per strain. The USDA gave them 6 weeks to deliver the results but they were able to upload assembly results for all the strains a week before the deadline. The team at Allegheny also shared some preliminary results for a pilot project which has just received NIH funding to sequence 1,700 Haemophilus influenzae strains as part of a program to understand pathogen evolution of C2 but they were able to show highly improved assemblies using just 3 SMRT cells per genome. This work at Allegheny demonstrates how the PacBio RS is becoming the gold standard for bacterial sequencing.

The second presentation I will highlight comes from Jeff Rogers, Adam English, Kim Worley, Stephen Richards and the group from the Human Genome Sequencing Center or HGSC at Baylor College of Medicine.

At the HGSC, they are using PacBio to improve their assembly of primate genomes. As background, the study of primate genomes is important because of their close similarity to the human genome. As a result, the primates are often used as animal models for human diseases. Researchers have created what they call draft genomes for a number of primates using Sanger sequencing or Illumina short read sequencing. One problem with these draft genomes is the large number of gaps that researchers have not been able to close and relatively short continuous pieces that they have assembled due to the limitations of these methods.

For example, the sooty mangabey genome was sequenced using Illumina technology to more than 100x coverage but assembly resulted in a draft genome with an estimated number of 186,000 gaps. And the contigs are continuous pieces of sizes such as half of the genome falls in contigs less than 35,000 bases long.

The HGSC team has embarked on upgrading and improving the genome with PacBio reads and so far, they have reduced the gap count by 65%, and they have more than tripled the length of the contigs.

The software used to improve this assembly work will soon be published on the Journal PLoS ONE. Doctors Rogers and English explained the importance of this improvement the following way: The sooty mangabey is an important genome because this species is an important model for the study of AIDS. The HGSC group is collaborating with Dr. Guido Silvestri at Emory University to develop mangabey into a better model for characterizing its genome. This primate has a natural resistance to AIDS, whether it's been infected with relevant virus in the wild or in a lab environment.

In contrast, the Rhesus macaque, a closely related primate, develops the disease readily when exposed to the same virus to which the mangabey is resistant. In order to understand how the sooty mangabey is able to control the virus, researchers want to study the relevant genetic pathways that direct the response of its immune system to infection.

Therefore, the investigators must have a long continuous assembly of the important coding and regulatory regions of its genome. What they have already accomplished with the PacBio RS is taking us significantly forward in our knowledge of this genome and they believe this will significantly impact the value of the species in AIDS research.

One of our customers, the University of Oslo in Norway, was not in attendance at our U.S. user group meeting but we recently received a highlight from them. They've just announced a large grant from their Norwegian Research Council to study the genomes of Atlantic Salmon and Cod. They plan to sequence 1,000 salmon genomes and 1,000 Cod genomes from a variety of locations to provide a deep catalog of genetic variation in each species.

Their goal is to understand the impact of this variation on the breeding and production of upper culture grown salmon and cod. We're excited as the University of Oslo plans to use their PacBio RS as an integral part of the study.

Now turning to our sales activities. As a reminder, at the beginning of the year, we cautioned listeners on our conference calls not to expect many bookings in the first part of the year, but that we were targeting higher bookings in the second half of the year. We made progress on this goal in the third quarter with bookings for 4 new systems. We attribute this improvement in bookings to all the progress we've been making this year in improving system reliability and performance and focusing on making our customers successful.

In addition, we are continuing to expand the addressable applications of the PacBio RS with performance enhancements and new products which will continue to drive growth in consumable revenue.

We measure our sales by the results we deliver and our goals is to make progress every quarter. Finally, I am proud that we announced Dr. Lucy Shapiro has joined the PacBio Board of Directors. Dr. Shapiro holds the Virginia and D.K. Ludwig Chair in Cancer Research at the department of Developmental Biology at Stanford University School of Medicine where she's also the Director of the Beckman Center for Molecular and Genetic Medicine. She previously served as chair of the Department of Microbiology and Immunology in the College of Physicians and Surgeons, Columbia University. Dr. Shapiro received a Bachelor of Arts from Brooklyn College and a Ph.D. in Molecular Biology in the Albert Einstein College of Medicine. She is also a Co-founder and Director of the anti-infective discovery company, Anacor Pharmaceuticals. Dr. Shapiro has received numerous awards, most recently, the 2012 Louisa Gross Horwitz prize for her work on the dynamic 3-dimensional organization of bacterial cells. She has been elected to the National Academy of Sciences, the American Academy of Microbiology, the American Academy of Arts and Sciences, and the Institute of Medicine of the National Academy of Sciences for her work in the fields of molecular biology and microbiology.

We are fortunate and honored that Lucy has joined our board. As a reminder, last quarter, we announced the addition of Dr. David Botstein to our Board who is held in high regard for his many accomplishments in genetics. With the recent additions of David and Lucy Shapiro, we have a wealth of scientific expertise on our board. They are active in the scientific communities of genetics and microbiology, which are highly synergistic with the strengths of our products. I'm excited to work with them both on maximizing the value we bring to the scientific community.

With that, I'll turn the call over to Susan.

Susan K. Barnes

Thank you, Mike, and good afternoon, everyone. I will begin my remarks today with the financial overview of our third quarter that ended September 30, 2012. I will then provide details on our operating results for the quarter with a comparison to the second quarter of 2012, as well as a comparison to the third quarter of 2011. Finally, I will conclude my remarks with a brief discussion of our balance sheet.

Starting with our third quarter financial highlights. Consistent with the outlook we made earlier in the year, our bookings began to pick up in the second half of 2012 as we booked 4 instrument orders, bringing our instrument backlog from 1 at the end of Q2, to the current backlog of 5 instruments.

During the third quarter, we recognized revenue of $2.8 million, and incurred a net loss of $22.7 million, while cash used during the quarter totaled $17.7 million.

Breaking down our revenue. Total revenue for the quarter was $2.8 million, a decrease of $4.5 million from the $7.3 million of revenue realized in Q2 and a decrease of $7.7 million from the $10.5 million recognized in Q3 of 2011.

We did not recognize instrument revenue in Q3, as the 1 instrument we had in backlog at the beginning of the quarter was still in the process of being installed at the end of the quarter. No instrument revenue in Q3 compares to $4.6 million realized on 7 instruments in Q2.

With regard to our recurring revenue. Although the summer months are typically slower, our consumer revenue still increased to $1.3 million in Q3, up from $1.2 million in Q2. Our customers are continuing to increase system utilization as the number and size of projects they are working on expand. Service revenue remained relatively flat with Q2 at $1.3 million, as our installed base in both quarters was approximately 66 systems. Gross profit in the quarter was $200,000, representing a gross margin of 7%. This is relatively flat from the $300,000 or 4% growth margin recognized in Q2.

Year-over-year gross margin was down 32% from the 32% margin realized in Q3 of 2011. The gross margin decrease compared to last year reflects the margin benefit that we had in Q3 2011, as a result of product inventory that was expensed in accordance with GAAP accounting into R&D during periods prior to our commercial launch.

Moving to operating expenses. Operating expenses in the third quarter totaled $22.8 million, including $2.3 million of non-cash, stock-based compensation expense. This spending was consistent with our second quarter operating expenses of $22.8 million.

R&D expenses increased $1.4 million during the quarter to $12.6 million. This increase can be explained by the recording of an additional $1.2 million of manufacturing overhead into R&D during Q3 in accordance with GAAP if manufacturing resources were used to contribute to ongoing R&D endeavors during times of reduced manufacturing activity.

R&D expense for the quarter included $1.2 million of non-cash stock compensation expense.

Sales, general administrative expenses for the quarter decreased $1.4 million to $10.1 million from $11.5 million in Q2. This reduction largely represents continued focus on controlling expenses with the largest single contributor to this decrease being a $600,000 reduction in legal professional services as a result of higher expenses incurred in Q2 to wrap up 2 patent receipts [ph] that were settled earlier this year. SG&A expense for the third quarter includes $1.1 million of non-cash stock-based compensation expense.

Year-over-year, operating expenses decreased $10 million from $32.8 million in Q3 2011. R&D expenses over this time decreased $7.4 million and SG&A expenses were $2.6 million lower as a result of the company restructuring at the end of Q3 2011 and the subsequent reduction in payroll and other expenses.

Now turning to our balance sheet. Cash and investments totaled $119.4 million at the end of the third quarter, down $17.7 million from the previous quarter and down approximately $58 million from the end of last year. Cash used during the quarter reflects our third quarter net loss of $22.8 million, less $4.3 million in non-cash expenses, primarily composed of $2.4 million of stock compensation expense and $1.7 million in depreciation.

Cash used also reflects reduction in working capital of $800,000, stemming primarily from a $2.8 million reduction in accounts receivable, offset in part by a $1.1 million reduction in accounts payable.

Earlier this month, we filed a perspective supplement to our existing SEC shelf registration that would allow us to raise up to $30 million by issuing new shares of common stock at market price using an at-the-market, at-the-money or ATM offering. We have not yet issued any shares under this program and should we choose to utilize this facility going forward, we will disclose such activity in future SEC filings.

Accounts receivable decreased from $3.4 million at the end of Q2 to $500,000 at the end of Q3. Average day sales outstanding remains well below the industry average of approximately 90 days. And lastly, inventory balances remained relatively flat this quarter, down $100,000 sequentially, to $10.2 million at the end of September 30, 2012. This concludes my remarks on the financial results for the quarter. I'd like to turn the call over to Ben.

Ben Gong

Thank you, Susan. As in previous calls, I will be providing guidance on our near-term financial performance. In brief review of our previous guidance on revenue, as we had expected our third quarter revenue was primarily comprised of recurring service and consumable revenue. When an instrument is booked in a quarter, we typically convert it to revenue in either the subsequent quarter, or the second quarter afterwards, depending on customer readiness.

For example, for each of the 5 systems that were in backlog at the end of the third quarter, we expect to convert them into revenue in either the fourth quarter or the first quarter. With some of the systems likely to be recognized in the fourth quarter, we expect our fourth quarter revenues to increase sequentially from the third quarter.

With regard to gross margin, at our current revenue level, we are a little above breakeven and we expect our fourth quarter gross margin from a dollars perspective to be similar to last quarter.

Our operating expenses have been fairly stable at roughly $23 million per quarter and we expect this to remain relatively the same for the fourth quarter.

Please note that our operating expenses have included non-cash stock compensation expense and depreciation expense that together amounts to approximately $4 million per quarter.

Finally, with regard to cash usage, we are targeting less than $20 million with cash usage per quarter, and less than $80 million with cash used for this year, which would translate to approximately $100 million in cash and investments at the end of the year. This does not take into account any additional cash that we may raise, pursuant to our recently filed perspective supplement. As Susan mentioned earlier, we have not yet raised any cash with the aftermarket equity offering vehicle and we have not yet made any specific plans for doing so.

And with that, we will open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Dan Brennan with Morgan Stanley.

Daniel Brennan - Morgan Stanley, Research Division

So Mike, you laid out just a kind of a litany of kind of improvements both on some existing improvements and some future improvements. Maybe, can you help maybe narrow in on kind of what you have in place today with adding [ph] the fruits of benefits like how do you think the current technology and improvements you've already made kind of positions you to kind of grow say, as you look out from here? I mean, do you need to have some of the additional pieces in place or do you think that what you've already made thus far, with the C2 and their performance enhancements, kind of positioned you guys to grow from here?

Michael W. Hunkapiller

Well, I think it's a series of incremental improvements and I think our customers in this regard expect that kind of continual improvement no matter what state they are. As we expand the read length, as we expand the throughput of the system, as we make it addressable to more and more samples, more sampled types, then we just continue to open up opportunities, both for expanding the use by existing customers, as well as by getting to the point where other customers with different kinds of applications can now see their way towards the capital outlay for purchasing a new system. So we've made a lot of progress, that's why I think we're getting to see that and from an order perspective, as well as the utilization perspective, but we're certainly not going to stop there. I think in this business, if you kind of rest on your laurels, you run into problems pretty quickly and we clearly need to continue, maybe even to increase the pace with which we improve the system in order to take full advantage of the capabilities that we see inherent in the technology. So we've done a lot, we're seeing the results of that, we've got certainly more and more papers being published on the technology, particularly since C2 came along, which reminds people, we only released beginning in the middle of February this year. So most customers didn't get it until this spring and yet, we're beginning to see people produce good, strong, novel science out of that technology and important areas who are ready.

Ben Gong

Dan, the only other thing I might add is a lot of the papers and talks that you've seen people make as in doing work on bacterial genomes, and maybe to your point with all of the products that we've released so far, it's been really useful and impactful on bacterial genomes, and we are starting to see people do things on much larger genomes such as the primate genome that Mike talked about earlier. And with the further enhancements that we have in plan, you might see more activity in these larger genomes.

Michael W. Hunkapiller

Yes. We've had people who've done a little bit in those up to now. This kind of proved that this long, reasonable [ph] loan made a big difference. I think that the issue in the bigger genomes is just total throughput. And with some of enhancements that we've just recently come out with or about to come out with on the chemistry side, the early access customers have already started applying those into what traditionally have been very tough genomes to sequence in the plant field. And everybody's done a lot of work on them because they're important but they're just so complicated, the genomic structures, because they've been resulting quickly to agriculture. The important ones from fusions of different species, genomes together, that they get a very piecemeal look at them with existing technologies. And they're, I think, extremely excited about being able to tackle these things now in a way that would really give them insights as to how these plants function and what you might want to do to them to make them more productive from an agriculturally useful perspective.

Daniel Brennan - Morgan Stanley, Research Division

Great. And then maybe just as a follow-up. So from what you seemed to convert the 4 orders in the backlog, I mean, are you willing to discuss at all any kind of visibility towards whether 2, 3, 4, 5 minutes? When do you think you'll be in a position to give us any sense of -- again, it's going to be lumpy, we get that, but maybe as you look out, do you feel confident yet given the improvements in the funnel to discuss any kind of forward visibility on kind of trends, on order trends?

Michael W. Hunkapiller

In general, we're optimistic that we are in positive momentum from where we were at the beginning part of the year. That's clear. In terms of calling it exactly, we don't have a specific forecast for you for Q4 and forward. But we are feeling confident that you're going to see us delivering results that are better than what we're delivering in the first half of this year.

Operator

And our next question comes from the line of Bill Quirk with Piper Jaffrey.

William R. Quirk - Piper Jaffray Companies, Research Division

So first question is, I guess, perhaps, working off of Dan's last one. Recognizing that you don't necessarily want to talk specifically to the deal funnel, can you talk a little bit, guys, perhaps about just the amount of prospects? And just thinking about it from more of a broad brush stroke, has the new chemistry led to via more prospects that hopefully will turn into deals, 1, 2, 3 quarters down the road?

Michael W. Hunkapiller

Well, I think that's our expectation. I think we had more prospects now than for -- new system orders than clearly we had in the first half of the year. And it's not that there weren't people who are interested at that point, but the technology in their mind wasn't quite at the point of them really pulling the trigger and finalizing -- getting the funding in place and getting ready to place the order, and we've seen that. It's also, it is still a tough environment out there for our customers in a lot of cases if they've been funded by government agencies. It's still a little up in the air as to exactly what their budgets are going to be over the next year. But that aside, we're seeing a renewed interest by a wider range of customers in acquiring the technology. So that's why we feel a little more confident now about where we're going from an order perspective than certainly we were earlier in the year, where we really decided we needed to buckle down and focus on getting the proof statements out there from our existing customers and the kind of work we're doing that justified people's willingness to go out and come up with the money.

William R. Quirk - Piper Jaffray Companies, Research Division

And then following up on some of your earlier comments about some additional chemistries being released and the fact that you have, let's call it for lack of a better term, C3 in the hands of some of your beta users right now. Is it reasonable to assume that we might see this 5,000 average base, 13,000 base of 5%, call it, February or early 2013, essentially kind of the year after you officially released the C2 chemistry?

Michael W. Hunkapiller

I think you might expect to see it a lot sooner than that, actually.

Ben Gong

Yes, we suggest that we're going to be releasing that this quarter and -- but maybe what's to your point is will people be sharing results with it? And I think, what Mike gave you an example of is with an early access version of it, some people already had some pretty good results.

Michael W. Hunkapiller

And actually, you had presented that at a meeting or 2. So yes, I would be very disappointed if you didn't see it about earlier than February. But you should definitely begin to see presentations at meetings such as AGBT in February from a variety of customers using the chemistry. So stay tuned.

Operator

Our next question comes from the line of Bryan Brokmeier with Maxim Group.

Bryan Brokmeier - Maxim Group LLC, Research Division

Of the 3 key applications, where are you seeing the most customer interest in research paper publications? And also, after introducing the new chemistry, do you expect that to change at all?

Michael W. Hunkapiller

Well, I think the change has come in a sense in the last 3 or 4 months since we really began to give easily usable software for doing base modifications. Before that, we had a few people who were doing some really early proof of principle studies with their own informatics expertise. But now that they've got decent software tools that process the data as part of the normal sequencing operation of the machine, we've seen a big uptick in customers starting to use the technology for base mods. I think for the sort of targeted sequencing applications, that's continuing to expand as the sample prep technologies got better. I think on the de novo thing, I wouldn't necessarily say that there's been any -- sort of hasn't been any lack of people interested in that already. I think what's happened as the read links get longer, the throughput gets longer, it's moving from the smaller genomes to the mid-sized genomes and now a little bit for the very large genomes because throughput is more compatible with that. And so it's not so much a change in people want to do de novo assembly, which they wanted to do all along. It's just the kinds of genomes that they can apply the RS technology to. And we're clearly seeing a trend towards people using it for larger and larger genomes.

Ben Gong

Bryan, the only other thing I'd add is the sheer volume of the publications have increased. And so, you probably still have at least as much volume and activity in de novo assembly and targeted sequencing. And then on top of that, you're probably going to see even more publications on base modifications.

Bryan Brokmeier - Maxim Group LLC, Research Division

Okay. And given the expected seasonality in the third quarter over the summer months, was consumer pull through in line with your expectations? Or do you see any weakness there that was more than the planned seasonality?

Michael W. Hunkapiller

Well, I think if you remember the last call, we expected it actually to be flat to slightly down, which is more typical for the summertime on a sequential Q2 to Q3 basis. So we were certainly glad to see that and in fact we got a modest uptick in the quarter.

Operator

[Operator Instructions] Our next question comes from the line of Amanda Murphy with William Blair.

Sylvia Chao

This is actually Sylvia here today for Amanda. I just had a follow-up on the consumable utilization. So is this the level that you see to be a more stable level in terms of per machine utilization like, yes, just in general, it's just like the -- on the annualized basis, this range, sort of the range that your customers are using?

Ben Gong

Well, I'll take a shot at that. So this is Ben. So honestly, it was relatively level Q3 and Q2 at, let's call it, $75,000 of consumables annualized over each system. On a go-forward basis, we're certainly working toward driving that upward. And in the long term, we absolutely expect that to be higher than where it is today. The pace at which that goes is the harder thing to say, but there's a lot of promising things that are happening out there with various customer projects. We highlighted a couple of them on this call, and when more of those kinds of projects kick in, that should contribute, we think, to in general, larger or higher utilization across the board.

Michael W. Hunkapiller

We've got -- we have users that are kind of maxing out their system in a sense in terms of usage. So it's much higher than the average $75,000. In our number, we have users quoted that are below that number. And one of the things that we've been working really hard to do is to get the performance across a wider variety of projects for people, up to enable those so that a broader group of customers can come up to a more reasonable or higher number of projects that they're carrying out on the RS, it has increased the utilization. So that was one of our main goals, been one for this year and certainly will be a main goal for next year to really kind of ramp up the consumables usage.

Sylvia Chao

Okay. Then I have another follow-up on the product enhancement side. I guess I'm just curious at this point, what are the other enhancements or key characteristics your customers are looking for in addition to what you have thrown out?

Michael W. Hunkapiller

Well, it's one of the things that we shared with the users who were are at the meeting last week and that we've begun to share with some of our other customers. And that it's basically to -- sort of a lot of variety of fronts, you can't just improve one parameter in this space and get the full benefits of it. So you really have to work sort of soup to nuts on the sample prep up front, for one thing, certainly on the bioinformatics tools at the back end. On the core instrument performance and the chemistry associated with it, it essentially is to increase -- continue to increase the read links and the percentage of the reads that are very long because those are the most useful ones. And to -- at the same time increase the total throughput in terms of number of basis per experiment that people get out of the system. Because that's what drives it being applicable to more and more choices. And so we've laid out a series of incremental steps over the next 1 to 12 months that were incremental increases by a factor of 2, say, each time, relative to say, total throughput. And a couple of rounds potentially with the chemistry of continuing to increase the read link in about the same rate that we've been doing over the last 12 to 18 months. So once you get to do that, you kind of change pretty dramatically, I think, the kinds of projects that they're going to see the PacBio RS is suitable for. And particularly, as you get into larger and larger genomes, you got -- you can't just get the results with 1 or 2 cells right now, you need a very large number. We need to get that down to a reasonable enough number that they're going to do it a lot. And that's sort of what we rolled out.

Ben Gong

Yes, so one more thing I'd add. It's kind of subtle that Mike mentioned this, some of our latest secondary analysis software that we made available on our DevNet site, typically what we do when we stuff is brand new and we want to get it out there available to the people is we put it in the DevNet site, and some the really advanced users start getting access to it. And then we follow on it some months later and incorporate that in sort of a production mode into the Software as a System. And as Mike mentioned, we're cautiously very optimistic with some of the latest developments in the secondary analysis software. And what we think is this could be a pretty significant driver or broader adoption because it just simplifies the ability for people to do projects in terms of using one type of library, one type of run and then getting an answer at the end of the experiment.

Sylvia Chao

Okay then. Have you guys talked about the potential throughput after the next region upgrade?

Michael W. Hunkapiller

Well, as I said, we actually gave them kind of a roadmap somewhat to define way of exactly what the next chemistry beyond the one that they're getting ready to introduce is. And that was part of that sort of stepwise group of 2x improvements that we showed them. So yes, we have laid that out.

Ben Gong

And the way it kind of makes its way to our something tangible to customers, I'd just point out a couple of examples that Mike pointed out, is the one customer, Allegheny, that was doing a genome with 4 SMRT cells or different genome with 3 SMRT cells, the idea is that you can actually do a discrete project with a pretty small number of SMRT cells, and that's where the throughput is really meaningful.

Operator

And I'm not showing any further questions at this time. I'd like to turn the call back to management for closing remarks.

Michael W. Hunkapiller

Thank you. So in closing, we remain steadfast in our commitment to bring the unique advantages of our SMRT technology and products to our customers and scientific community in general. Our customers are taking increasing advantage of our recent product releases to expand their use of the system. We're starting to see some momentum building in both system utilization and system bookings. With further products and software releases on the horizon, it will be exciting to see how this will impact both our consumable sales and new system bookings in the coming quarters. Thank you for listening in, and we will talk again in 3 months time.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.

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Source: Pacific Biosciences of California Management Discusses Q3 2012 Results - Earnings Call Transcript
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