Pacific Biosciences of California's (PACB) CEO Mike Hunkapiller on Q1 2016 Results - Earnings Call Transcript

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Pacific Biosciences of California, Inc. (NASDAQ:PACB) Q1 2016 Earnings Conference Call August 4, 2016 4:30 PM ET

Executives

Trevin Rard - IR

Mike Hunkapiller - CEO

Susan Barnes - CFO

Ben Gong - VP, Finance and Treasurer

Analysts

Amanda Murphy - William Blair

Bryan Brokmeier - Cantor Fitzgerald

Tycho Peterson - JP Morgan

Bill Quirk - Piper Jaffray

Joe Munda - Frist Analysis

David Westenberg - CL King

Jonathan Abodeely - XLCR Capital

Operator

Good day, ladies and gentlemen, and welcome to the Pacific Biosciences of California Incorporated Second Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time [Operator Instructions]. As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Trevin Rard. Please go ahead.

Trevin Rard

Good afternoon and welcome to the Pacific Biosciences second quarter 2016 conference call. Earlier today, we issued a press release outlining the financial results we'll be discussing on today's call, a copy of which is available on the Investors section of our website at www.pacb.com or alternatively as furnished on Form 10-Q available on the Securities and Exchange Commission website at www.sec.gov.

With me today are Mike Hunkapiller, our Chief Executive Officer; Susan Barnes, our Chief Financial Officer; and Ben Gong, our Vice President of Finance and Treasurer.

Before we begin, I'd like to remind you that on today's call, we may be making forward-looking statements, including plans and expectations relating to our financial projections, products and other future events. You should not place undue reliance on forward-looking statements because they are subject to assumptions, risks and uncertainties, and may differ materially from actual results. These risks and uncertainties are more fully described in our Securities and Exchange Commission filings including our most recently filed report on Form 10-Q. Pacific Biosciences undertakes no obligation to update forward-looking statements.

In addition, please note that today's call is being recorded and will be available for audio replay on the Investors section of our website shortly after the call. Investors electing to use the audio replay are cautioned that forward-looking statements made on today's call may differ or change materially after the completion of the live call.

I'd now like to turn the call over to Mike.

Mike Hunkapiller

Thanks Trevin. Good afternoon and thank you for joining us today. We are pleased with our second quarter results and our continued progress in driving growth in our business. Highlights of our Q2 financial results are as follows: We received orders for 25 PacBio instruments during the second quarter.

The instrument orders came from a broad range of customers and were well distributed across the US, Europe and Asia. We shipped 26 instruments during the second quarter. Our backlog of systems remains at more than 50.

Total revenue for the second quarter was $20.7 million, excluding contractual revenue related to our Roche agreement; this represents growth of 51% over Q2 2015. We are on target with a revenue forecast of at least $93 million for this year and with a significant backlog, we are well positioned to continue delivering sequential revenue growth throughout the year.

Consumable revenue for the second quarter was $5 million, up 11% from Q2 2015. Consumable revenue for the quarter primarily reflected usage of the RS II systems as we continued to be supply constrained on Sequel chips throughout the second quarter. System utilization among RS II users has remained steady.

Instrument revenue for the second quarter was $8.6 million, up 100% compared with Q2 2015 and reflects an increasing ramp of Sequel instrument shipments. Our gross margin for the quarter was 51%, representing a significant improvement in product margin over last year’s margins. Last year, we recorded a $10 million revenue milestone from Roche at 100% margin. Excluding that milestone, our gross margin in Q2 2015 would have been 30%.

A significant increase in product margin this year reflects the higher profit margin that we generate from selling Sequel systems compared to RS II systems. We are pleased to see that we’re tracking closer towards profitability with this improved product margins.

Now I’ll provide an update on our Sequel product launch. During Q2, we continued with our planned controlled ramp up of instrument system shipments. Due to our limited supply of Sequel SMRT cells from our prototype product supplier, we have restricted cell shipments to existing customers and kept new instrument shipments relatively low.

We appreciate the patience our customers have shown with this situation, and we recognize that it hasn’t had an impact on their ability to use the full capabilities of the Sequel system. Today, we announced that as soon as customers have transitioned to our latest software release and sample prep protocols, they will no longer be on restrictive smart cell allocation.

The chip performance from our prototype supplier has become more consistent, resulting in an increased supply from them. Moreover we continue with their program to phase in production from our high volume supplier and recently have begun shipping samples of these chips from early pilot runs to select customers. While we will receive chips from both suppliers for some time, we expect to be fully transitioned over to the high volume supplier before the end of the year.

Demand for the Sequel system continues to be robust, both from new and existing RS II customers. While we had fewer orders in Q2 than the previous quarter, the pipeline for new orders is strong across all three geographic regions, and we expect to see an increase in bookings in the coming quarters. Some perspective customers have waited to place order until they can be assured that they will not be limited by the chip supply issue that has limited the amount of reference that it generated by our early customers.

We are also continuing to make progress and improving the overall performance for the Sequel system. The software upgrades we have recently released contain a number of improvements. These include a fix for data transfer issues that have been causing problems for a number of our earlier customers, support for additional sequencing applications and increased consensus sequencing accuracy.

Our improved sample protocol increases both sequencing read lengths, sequencing yield and raw single-pass accuracy. We expect to enable all of our existing Sequel customers to take advantage of these upgrades by the end of the current quarter. We also expect to release a new chemistry designed to further increase read length and throughput by the end of the year, as part of our continuing program or performance improvement.

Now turning to other highlights, we made an announcement earlier this week that HistoGenetics, a worldwide leader in HLA typing has recently won a large contract to process samples specifically with their PacBio systems. As background, we started working HistoGenetics about two years ago, when they purchased two of our RS II instruments. The recognize the benefits of smart sequencing early, but it took them a little time to incorporate it in to their production pipeline and to optimize methods to achieve higher throughput of samples on the PacBio machines.

They have increased through system capacity and utilization overtime and more recently they have bid for and won a very large HLA typing project to run on PacBio systems. To prepare for this project, HistoGenetics have already ramped up their RS II production capacity to process thousands of samples per week and they are now our largest single RS II install site.

In addition to HLA typing, they are interested in using PacBio technology to further their research of other immunology related genes. We are pleased to see our technology being adopted for high volume sequencing applications such as the HistoGenetics HLA typing program.

On the publications front, we continue to see an accelerating pace of new publications featuring SMRT sequencing. One paper recently appeared online in bio archive entitled; SMRT Genome assembly corrects reference errors resolving the genetic basis of virulence in Mycobacterium tuberculosis.

The authors noted that their correction to existing sequence is based on a shorter read technologies “ undermine and in some cases invalidated the conclusions of several previous studies”. They concluded that, “our results changed the picture of virulence continuation” in this important pathogen.

Given the continued re-emergence of tuberculosis as an international health problem, we are pleased that use of our technology is contributing to a better understanding of the pathogen responsible for this disease. Another recent paper appeared in Nature Communications at the end of June entitled, Long Reach Sequencing and De Novo Assembly of a Chinese Genome. The authors of the paper from Jinan University in China and the University of Southern California described how they used SMRT sequencing of genomic DNA and IsoSeq transcriptome analysis to create a Chinese reference genome.

The results were impressive, they were able to assemble the genome with a Contig N50 of 8.3 mega basis. As a reminder, previous assemblies of human genome for the use of short read technologies plus rigorous add-on efforts have only yielded Contig N50 in the range of 100 to 200 kilobases.

Importantly the team found approximately 20,000 structural variance compared with the GRCh38 reference at NCBI. Using PacBio’s IsoSeq method the scientist also analyzed the transcriptome of the individual and detected more than 58,000 isoforms. The authorized author summarized their findings stating, ‘for short read based alignment and variant calling based on reference genome remain a common practice to SA personal genomes de novo assembly by long read sequencing may reveal novel and complimentary biological insights. Furthermore, long read RNA sequencing may identify novel transcripts that can be missed by short read RNA sequencing’.

This paper is an indicator of the growing interest among scientists worldwide to generate high quality reference genomes that are specific to particular ethnic populations. The Chinese government has committed to spend approximately $10 billion over the next several years on its precision medicine program, and we believe smart sequencing can play a significant role in contributing to this effort. Our business in China has been robust and we expect this trend to continue.

I’ll conclude my opening remarks with a brief update on our Roche partnership. We and Roche continue to prepare for the Sequel based product launch. While Roche has targeted their launch for the latter part of this year, they may choose to delay their launch by a few additional months as they work to incorporate and validate some of the software features and assays they require for a clinical system. We are also working to enhance our manufacturing training and service processes to assist Roche with their launch. As part of this effort, we’ve recently passed the first surveillance audit, where ISO 9001 and ISO 13485 certifications.

That concludes my initial remarks, I will turn it over to Susan to provide you with more details on our financial results.

Susan Barnes

Thank you Mike and good afternoon everyone. I will begin my remarks today with a financial over view of our second quarter that ended June 30, 2016. I will then provide details on our operating results for the quarter and year-to-date with a comparison to the second quarter and first half of 2015 respectively. I will conclude my remarks with a brief discussion of our balance sheet.

Starting with our second quarter and year-to-date financial highlights; during the second quarter, we recognized revenue of $20.7 million and incurred a net loss of $18.5 million. This brings our year-to-date total revenue to $39.9 million and our net loss to $37.9 million. We ended the quarter with $102.5 million in cash and investments.

Turning to revenue; total revenue from the quarter was $20.7 million before it turned $2 million less than the $24.9 million recognized in Q2 of 2015, which included the recognition of $10 million of revenue associated with the achievement of a development milestone. Year-to-date, total revenue in 2016 was $39.9 million slightly below the $42.6 million recognized in the first half of 2015.

Excluding the $10 million Roche milestone revenue in Q2 of 2015, total revenue in Q2 of 2016 was higher than Q2 of 2015 by $5.8 million or 39%, and year-to-date [2000] revenue was higher than a similar period in 2015 by $7.3 million or 22%.

Breaking down our revenue; instrument revenue quarter-over-quarter doubled to $8.6 million recognized in Q2 2016 compared to $4.3 million recognized in Q2 of 2015. Year-to-date instrument revenue was $16.3 million, a 44% increase over the $11.3 million recognized during the same period last year.

Consumable revenue continues to be strong increasing 11% to $5 million for the current quarter, up from $4.5 million reported during the second quarter of 2015. Year-to-date consumable revenue has increased 9% to $9.7 million in 2016, compared to $8.8 million in the first half of 2015. Service and other revenue increased 42% to $3.5 million in the quarter, compared to $2.5 million in Q2 of 2015. Year-to-date service revenue was up 28% to $6.7 million from $5.3 million in 2015.

And finally this quarter, we recognized $3.6 million of contractual revenue associated with amortization of the $35 million upfront payment that we received from Roche in Q3 2013. This was $10 million lower than at $13.6 million we recognized in Q2 of 2015, which included the $10 million Roche development milestone previously mentioned. We generated a gross profit of $10.6 million in Q2 of 2016, representing a gross margin of 51%. This was down from the $14.5 million of gross profit and 58% gross margin recognized in Q2 of 2015. The lower profit and margin this year were a result of the $10 million Roche development milestone recognized in Q2 of 2015 with 100% margins.

Year-to-date gross profit was $20.1 million, representing gross margin of 51% compared with a 2015 year-to-date gross profit of $20.4 million and a gross margin of 48%. Excluding the $10 million Roche milestone revenue in the first half of 2015, gross profit and margin in 2016 increased.

In Q2 2016, the gross profit increased to $10.1 million from $4.5 million, and margins increased to 51% from 30% year-over-year. Year-to-date profit increased to $21.1 million from $10.4 million and margins increased to 51% up from 32% in 2015. These achieved increases are primarily a result of higher revenue and margins recognized from sales of a Sequel system as Mike mentioned.

Moving to operating expenses; operating expenses in the second quarter of 2016 totaled $28.7 million, $2.8 million higher than the $25.9 million incurred in Q2 of 2015. Year-to-date operating expenses increased 11% to $56.8 million from $51.1 million in 2015. The increase in 2016 expenses is largely been the result of higher compensation expenses related to an increase of headcount, an increase non-cash stock based compensation expense and higher R&D chip development expenses in 2016 versus 2015.

Non-cash stock based compensation increased $1.4 million quarter-over-quarter and $2.6 million year-to-date 2016 over 2015. Breaking down our operating expense; R&D expenses in the quarter were $17.5 million, $2.5 million higher than the $15 million of expenses incurred in Q2 of 2015. Year-to-date R&D expenses were $33.9 million, a 4.4 million increase over the $29.5 million of expenses in 2015.

R&D expenses this quarter included $2.1 million of non-cash stock based compensation expense, a $900,000 increase over the $1.2 million expense in Q2 of 2015. Year-to-date, our operating R&D non-cash stock based compensation expense was $4 million in 2016, a $1.5 million increase over the 2.5 million expense incurred in 2015.

Sales, general and administrative expenses in this quarter were $11.2 million compared to $10.9 million in Q2 of 2015. Year-to-date, SG&A expenses increased $1.3 million to $22.9 million in 2016, up from $21.6 million in the first half of 2015. SG&A expenses in the second quarter of 2016 included $2.3 million of non-cash stock based compensation expense, up $500,000 from the $1.8 million recognized in Q2 of 2015. Year-to-date, 2016 SG&A non-cash stock based compensation expense was $4.5 million, up $1 million from the 3.5 recognized in 2015.

And finally in the area of other income and expense; in Q2 we recorded $400,000 of net other expense including the normal $700,000 of interest expense associated with the debt we took on in Q1 of 2013 partially offset by an adjustment to the value of the derivatives associated with the debt we took on in Q1 of 2013. Year-to-date, our net other expenses have totaled $1.2 million. Ben will provide further guidance on our ongoing expense rate later in the call.

Now turning to our balance sheet; as I mentioned in the beginning of my comments, our balance of cash and investments was $102.5 million at the end of second quarter. This is a $11 million increase during the quarter. Our cash increase reflects $31.5 million of proceeds from APM facility partially offset by our Q2 net loss of $18.5 million.

Inventory balances increased $2.1 million in the quarter to $14.2 million from $12.1 million at the end of Q1. Accounts receivable increased in Q2 to $10.4 million from $8.1 million at the end of Q2. This concludes my remarks on the financial results for the quarter.

I would like to now turn the call over to Ben.

Ben Gong

Thank you Susan. I will be providing an updated forecast of our 2016 financial performance. First of all as Mike mentioned earlier, we booked orders for 25 systems this past quarter. Our shipments were about the same as our bookings for Q2, which left us with a backlog of over 50 systems at the end of the quarter. We are not providing a specific forecast for future booking, however based on our existing pipeline, we expect our booking rate to increase in the second half of the year compared with the first half.

Now moving on to revenue, our Q2 revenue of 20.7 million was in line with our previous forecast and therefore we continue expects our total revenue for the year to be at least $93 million. Excluding Roche contractual revenue, this represents a 70% increase in product and service revenue year-over-year.

In the near term, we expect Q3 revenues to grow sequentially compared with Q2. As we mentioned in last quarter’s earnings call, we do not have milestone revenue to recognize this year. So quarterly comparisons of revenue from last year will vary.

In Q2 of last year we recognized a $10 million revenue milestone, and in Q4 of last year, we recognized a $20 million revenue milestone. In addition the quarterly amortization of the Roche contractual revenue is scheduled to change later this year.

For Q3 the quarterly amortization should remain the same as Q2 at roughly $3.6 million. For Q4 and going forward, the quarterly amortization is scheduled to drop to less than $100,000. Despite a year-over-year reduction of over $33 million in contractual revenue, we continue to forecast total revenue this year to be greater than last year, based on our growth estimates for product and service revenues.

Moving on to gross margin, we were pleased to again see the improvement in gross margins up to 51% this past quarter compared with gross margin excluding milestone revenue of 30% in Q2 of last year. The margin improvement we have seen this year is driven by sales of our new Sequel system

We expect to see similar gross margins in Q3, however, as a reminder, the $3.6 million in quarterly contractual revenue will just about go away after Q3 of this year, and since this is recorded at a 100% gross margin, our overall gross margin percentage will likely decrease somewhat in Q4 this year.

Our operating expense in Q2 increased by 11%, compared with Q2 of last year, fueled primarily continued development cost for Sequel SMRT cells and increased non-cash stock compensation expense. Stock compensation expense this past quarter increased by approximately 48% over the last year, and for the rest of this year, we expect to continue to record stock compensation expense at this level.

We expect our total operating expense to grow by roughly 12% for the year, which is a little higher than our previous estimate of 10% growth. This comparison excludes a one-time and $23 million gain we recognized in Q3 last year associated with the amendment to our property leases. We estimate our combined non-cash stock compensation expense and depreciation expense to be between $6 million and $7 million per quarter for the remainder of the year. Regarding our interest expense, we continue to expect to record approximately $3 million for the year.

To sum up our forecast update, we expect to record a net loss of approximately $74 million for the year, which includes over $23 million of non-cash expense. And with that we’ll open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] our first question comes from Amanda Murphy with William Blair. Your line is now open.

Amanda Murphy

I just had a question on Roche. Obviously there’s a lot of discussion around the timing of their launch and what not. So to the extent that you can help us understand the mechanics there for you guys. So obviously you maintain your guidance, I guess if there is delay in to ’17 desired affect you remember it’s this year and then how do we think about that going forward just in terms of modeling and the risk around the launch plus as it relates to your numbers.

Ben Gong

I’ll take a first shot at that Amanda. So, we have not changed our forecast for the year for revenues, as its still at least $93 million. So we continue to sell smaller number of systems to Roche as we have in the past quarters, after they’ve launched we do expect to sell more to them. But with the significant backlog that we have and as I said before of 50 systems and then backlog, we feel pretty secured about the forecast we gave for this year.

Amanda Murphy

Got it. And then in terms of the order that you have in the pipeline that you mentioned, it sounds like they are pretty broad based. But you also brought up the Chinese PMI effort. Is there any (inaudible) like you can give around kind of - if you have any orders from that initiative at this point or is that something that could should explode through at some point over the next three month here. And then just in terms of the Roche, you just made - I guess same question in terms of the orders, is it - do you expect to kind of a similar number of shipments to them to the rest of the year as you did in the first half.

Mike Hunkapiller

I’ll take a crack at that. So the Chinese genome project or the personal medicine initiative is kind of like the US one. It’s a long term process, it’s not a short term thing. So what we have seen broadly as we try to mention is that we do pretty well in China already in various sundry, government, academic and commercial sites. And we expect that to continue, and as they get more business from bigger initiatives, we would expect to be able to share in that.

Relative to Roche as Ben tried to point out, we’ve been shipping for actually the last three quarters a limited number of systems to Roche or their assay development program and some of their training operations for the subsidiary sites. We continue to do that independent per say of their broader customer launch, and we weren’t planning on that customer launch to be done other than sometimes later in the year.

Anyway so it wasn’t a significant part of the revenue forecast that we’ve given you other than the ones that we’ve been shipping in sort of early development systems to and we plan to do that. Obviously once they launch, we would expect to ramp up pretty quickly.

Amanda Murphy

Got it. And then I just had one more, the chemistry upgrades or update that you rolled out. So there’s also been a decent amount of discussion to think around the performance of the platform as its evolved here at the Sequel. As you’ve introduced updates for the (inaudible) chemistry. So can you just kind of refresh us at this point, where we stand in terms of obviously there’s variability surrounding the customer side, but kind of what people are generally getting in terms of performance with the new chemistry update relative to the fact and you’ve also laid out a roadmap overtime. Do you feel comfortable that the target you laid out over the longer term are achievable?

Mike Hunkapiller

Well announced the upgrade, and we have quotes from two of the - they are actually two of our original test sites, beta sites and the system who’ve kind of watched the development of the technology over six months plus period now. And I’ll let what they said speak for themselves in a sense, we feel pretty comfortable. This is really the first sort of chemistry/ sample prep upgrade really that we’ve done of importance, and continues a series of software both for instrument operation as well as data processing.

And we think we are in a pretty good shape from that perspective. But it’s an ongoing process, we’ve continue as we’ve done for the last five years or so on the RS to continue to plan the rollout a series of upgrades both in application support as well as sequencing performance, and we’ve announced today that and in my presentation that we would expect to have a relatively substantial sequencing chemistry release around the end of the year.

The system has consistently performed, the issue that we’ve had from day one and we have tried to make this clear going back to the end of September early October last year that we would be operating in the first half of this year with prototype cells manufactured during a development process by our Belgium supplier, and would expect to have relative low yields that we would have available to ship to customers and we’d try to make that fair to customers as well. But the performance of those cells would be, given that they in the development process still relatively erratic.

We feel pretty comfortable now that the development process has ironed itself out, and certainly in terms of the yield of the cells, we feel comfortable enough to take off of restricted allocation as soon as they have upgraded to the related software which is key those cells. So we would expect to see much more use of the system just because we’re allowing them more use with more cells, but also the performance that’s substantially improved versus what it was with the early versions of the cell. So we will see, but we’ve had a relatively limited field experience of that since we’ve just rolled that upgrade out really to beta sites in the last two to three weeks.

Operator

Our next question comes from Bryan Brokmeier with Cantor Fitzgerald. Your line is now open.

Bryan Brokmeier

Have you made any updates to the RS II over the last quarter or so?

Mike Hunkapiller

I would say no substantial ones. We are working with some of the customers in terms of beginning to give them access to what’s called Super Poisson Loading, which allows them to get more useable ZMWs per run. We’re also working on that internally to put it on to the Sequel system as well. That’s the major thing that we focused on for the RS this year in terms of increasing throughput.

Bryan Brokmeier

And have you received any request from customers to upgrade their RS II to the Sequel and how are you managing those requests?

Mike Hunkapiller

Well as we’ve pointed out, we’ve received orders from a fairly substantial number of existing RS II customers for Sequels. Have we received request for upgrades? Yes we have not offered any specific upgrade program for trading in RS II for Sequels, despite what you may have read from comment from an individual.

Bryan Brokmeier

And bookings were ahead of what many people were expecting. I apologize if I missed this, but where do you believe that the source of the greatest outperformance was? Did you receive orders from any types of accounts quicker than expected or if from any regions such as Asia, did those start to come in that maybe people weren’t factoring in to their outlook.

Ben Gong

So you’re asking about the existing pipeline Bryan?

Bryan Brokmeier

Right. The bookings in the quarter were better than a lot of people anticipated, and it’s now a couple of quarters in a row and when you’re bookings says exceeded expectations. So where do you believe that you’re seeing the most upside versus expectations.

Ben Gong

Well I don’t know that they necessarily exceeded our expectations. I mean it’s pretty much in line with what we’ve been expecting. As Mike mentioned the demand is coming from or brought to the customers and pretty well distributed across the US, Europe and Asia. And then we did mention on the call that the pipeline is pretty strong and so we actually think the bookings that we’re going to have in the second half of the year is going to exceed what we had in the first half.

Bryan Brokmeier

Okay. And that’s regardless of whether Roche launches this year or next year?

Ben Gong

Yes.

Operator

Your next question comes from Tycho Peterson with JP Morgan. Your line is now open.

Tycho Peterson

Hey Mike can you comment of HistoGenetics, what the new contract means potentially in terms of both new instruments and consumables.

Mike Hunkapiller

Well as I pointed out, they’ve been ramping up their RS II capacity for some time in anticipation of this because they had to be able to validate that they could start on a pretty short timeframe once they began to get samples under the contract assuming that they were on the contract. And I think what we would say is that we would expect it once they ramped up to generate in excess of $1 million a year in consumable spending to us.

Tycho Peterson

And then there is a potential upsell to Sequel to them at some point?

Mike Hunkapiller

There’s a potential upsell to Sequel that test, although if you remember, that falls under the purview of Roche to sell Sequel systems in to blood bank typing operations. So what Roche is launched and is in a position to supply that particular assay should they decide to do it, then they’ll have the right to see Sequel systems in to that space.

Susan Barnes

It’s Susan, if you remember from the press release, they said they’re also doing research in other areas and that research would be something that we could work with them on a Sequel system line.

Tycho Peterson

And then can you maybe just give us a sense of what Sequel times are for new orders in terms of installation, I’m just trying to tickle a bit about backlog and as you get better at installing and validating systems, can the conversion pickup there.

Ben Gong

Yeah, we’ll let - you just do some back of the envelope. If we have something like a little more than 50 systems in the backlog, we should be able to ship at least that many systems in the balance of the year. So, it - a lot depends, but if you got an order in quickly you could probably get it in Q4 in terms of install or if not Q4 then Q1.

Tycho Peterson

And then last one from me on R&D --.

Mike Hunkapiller

Can I add to that? Doing the installs has not been the problem, the problem has been if we didn’t think we had enough SMRT cells to support these guys which we clearly did it. We were holding back and some of the customers knowing that were comfortable with the process. So we expect them to be a little more anxious to get their installs done now that we’ve loosened the reigns a little bit.

Susan Barnes

And the other piece I think we mentioned earlier is that we were having trouble getting in to sometimes their secondary server analysis. Again this software upgrade has some solutions that make that easier as well.

Tycho Peterson

And the last one on R&D, understand you had both stock based comp and chip development in this quarter. How should we think about it for the back half of the year? Did the chip development cost burn off and is it going to come down?

Mike Hunkapiller

Well I’m trying to incorporate that in to our guidance for the year. The stock comp is going to continue on which is probably going to make tell to make their (inaudible) why we increased it from the 10% to the 12% growth quite frankly. The chip development cost, there will be some ongoing chip development cost, not just for the stuff we’ve been talking about, but we have mentioned that we are working on more I’d say dense chips as well. So there’s going to be some ongoing R&D expense and we try to incorporate all that in to that expense forecast of 12%.

Operator

Our next question comes from Bill Quirk with Piper Jaffray. Your line is now open.

Bill Quirk

This first question is, recognizing that obviously you’re going to be rolling out a new software and a sample prep which is going to help Sequel performance and Mike you talked about a significant chemistry improvement later this year. How are you talking to customers about expected specs and throughput and such on the instrument, there does appear to be a bit of a debate in the community about kind of where performance is, kind of where it’s going etcetera.

Mike Hunkapiller

Well I don’t know that it necessarily changed our message to customers. What we have been trying to tell them all along is that they will be operating even at a restricted level with really prototype level chips and our experience with those until we got to get through the whole development process was that that was going to be somewhat erratic, and so we were guiding people to using applications for which, let’s say the applications were more forgiving of the variation that we were seeing in the chips and in that case they were doing pretty well.

It wasn’t quite suited yet for all the applications that people would like to do, and partly because as a performance, but partly because those kinds of applications just required more chips than we could commit to individual customers. So I think that we fully expect to see a pretty sharp uptick in both utilization and breadth of application that people were able to do successfully on the system. Our feedback is consistent with that.

Bill Quirk

Got it. I appreciate the color Mike. Secondly, now that the supply constraint is up, obviously upon adoption of the upgraded software, is it safe to assume Mike that you would expect to see a number of kind of the earlier customers start to move in to production mode here over the balance of the year and our sense is we obviously see your associated Sequel consumables start to climb as well.

Mike Hunkapiller

Yes. If not we would be pretty worried.

Operator

And our next question comes from Joe Munda with Frist Analysis. Your line is now open.

Joe Munda

Mike just real quick with everything going on in Europe, we were hearing ancillary talk from Brexit from certain customers. You know you have talked about strength in all regions. I guess I’m interested particularly in Europe and the demand and the strength you’re seeing there, as well as to a certain competitor are you coming up against the same customer debating whether purchasing one of your units versus one of their units.

Mike Hunkapiller

Well I’m not aware of any impact that we see it even theoretically from the Brexit ruling. Not that there may be one, but I’m not aware of any. Europe has actually been an increasing source of strength for us, with the Sequel in terms of the sales that we’ve already made and the orders we’ve gotten as well as the pipeline that we have. And it’s open up just because of the price of the instrument, customers that really wanted to have access to long read technology like ours but simply didn’t have the budget capabilities for almost a million dollar instrument investment, which kind of what they faced with the RS II.

So I think that’s from my perspective, not too much of a surprise, but it’s been pleasant that Europe has really come out fairly strongly for us. Anyone in the sequencing space is going to be looking at some mix right now on long read and short read technologies. And whether you count that as competition between the two or the fact that people are rightly looking to the fact that they need both kinds of technologies for a diverse set of applications and sequencing, I’m not sure I would call that competition per say, but it is a factor in terms of how much they spend with one technology versus another, as opposed to an either or scenario.

I don’t think that we’re seeing competition in that sense even from anyone other than the obviously market leader.

Susan Barnes

Can I take that one, we know Sequel up to right price point, at the same time we’ve really brought the scientific communities understanding of smart read technology what it does not only in its length and ability to assemble, but all the other pieces it brings with it in one experiment. That’s got more and more momentum for us. So I think that is also very much what the European community is endorsing as well.

Mike Hunkapiller

I think we announced at the beginning of the year that we had kind of passed the 1,000 publication level late last year and we’re fully on track to more than double that by the end of this year. And that’s a test to the uptake and understanding of the value of the technology inherent in long reads. And we’re seeing rapidly five publications per day on a relatively small installed base of RS II. And that kind of validates to a potential customer base the value of the long read technology.

Joe Munda

That’s helpful Mike. As far as RS II goes, the shipment, I might have missed this, it was strictly Sequels this quarter, were there any RS II shipped?

Ben Gong

Small number. Yeah it’s a very small number of RS II as well.

Joe Munda

Okay. And that’s included in that total number?

Ben Gong

Yeah. It was included in the total number of 26 shipments.

Joe Munda

And Mike, the breakout for Sequels to new customers, it was strictly through existing customers, correct?

Mike Hunkapiller

No, it was a mix. Actually I think for the first time in terms of orders it was slightly weighted towards new customers. We said before, it started off about 60-40 and then 50-50 and now it’s about 40-60, old versus new.

Joe Munda

And then my last question Mike a number of lads we spoke to on clinical side, really want to get their hands on Sequel. Any concerns on your part that a potential delay, I know you said a couple of months that that could cause them to alter their purchasing decisions or really not a big concern.

Mike Hunkapiller

Well, no, if it’s a short period of time, I don’t know that, because Roche hasn’t announced an official time on their schedule yet anyway. So I’m sure they have had discussions and are continuing to have discussions with a lot of their early target customers, many of which are not in the United States. We’ve mentioned that before that it’s easier for Roche to get through regulatory hurdles with assay specific test in places outside the US than it is here. And so you’d have to ask them what concerns they have about potential losses.

I mean Roche knows how to deal with product launches pretty well. And it’s not a typical that things get delayed a little bit from what you would hope to get them done, but I’m sure that they have built in a reasonable amount of buffer in that with their discussions with their early customers.

Operator

And our next question comes from David Westenberg with CL King.

David Westenberg

Do you have any more visibility on what the decommissioned for RS II might look like in the coming years? I mean with new Sequel customers?

Mike Hunkapiller

Well I’m sure overtime they will switch over. I mean up to now as we pointed out, our usage on the RS’s has been fairly steady measured this quarter versus this quarter last year. Partly that’s because they’ve been somewhat constrained as to how much work they can get done on the Sequel systems with the chip supply. But once you’ve already bought and paid for the RS, it’s a really good instrument. So I don’t know whether they’re going to junk them right away.

David Westenberg

Are there any new type’s projects on the Sequel that might have surprised you that new customers are doing. I know that there’s still been a chip supply issue, but have you seen anything that surprised you in terms of projects.

Mike Hunkapiller

Not really. I mean we’ve developed a wide range of applications that people can successfully do with the RS and the Sequel is just a swooped up version of the RS in that respect that it has more throughput capacity than RS does. But it doesn’t qualitatively do things that couldn’t do on the RS. So I don’t know we’ve had any surprise there.

A lot of the applications that people have done on the RS and we suspect we’ll do on the Sequel as well are ones that have been customer developed applications, and we sometimes follow in terms of providing visits to work for it and our (inaudible) software. But again the Sequel is smart sequencing, just like the RS is smart sequencing. It’s just that it can be done at a lower cost both from an upfront perspective and on a per project basis.

So our feeling is that we’ve established the broad range of applications and now it’s up to us to make sure that we can exploit the fact that an increasing number of those applications and an increasing number of projects for each one of those can rationally be done on our technology.

David Westenberg

Got it. And then I’ve got to heard from excitement from new customers of Sequel is its potential in doing whole plant genomes. Can you talk about some of the size of that Ag market and its potential to you.

Mike Hunkapiller

Well it’s not just plants, it’s also animals in a broad sense. Well I think we’ve said for a reasonable period of time, plant and animal meaning non-human, non-microbial samples accounted for roughly half to slightly over half of total usage on the RS. So it’s been a big source of opportunity for us for quite a while and we would expect that the Sequel continues that trend making it minimal to larger and larger projects. And I think people, just as the groups that I mentioned working with a microorganism that’s been studies a long time in tuberculosis. If you build all of your studies based on incomplete or even incorrect sequences, you can really go down the garden path and get yourself in trouble.

And people actually woke up to that in the plant space more than they did even in the human or earlier than they did, because the short read technologies even the old (inaudible) methods were just not very good with dealing with a particularly first time sequence of an organism and one that you didn’t really have the resources when those were done to back and do all the add-ons that helped fill in at least some of the gaps. And so they were more quick to recognize the value of doing it right the first time and its opened up the possibilities in a broadening array of particularly agriculturally important plants and animals. And we certainly see that trend continuing.

Susan Barnes

Right. And it’s very hard to get a market source on that, because what we think is happening is people who did sequencing for, because the answers were so incomplete and that data was so useless for the projects that we’re seeing new time people first in the core labs and the service providers are now in some cases directly with the Sequel at its center point coming in to the market that really didn’t exist before any sequencing.

Operator

And the final question comes from Jonathan Abodeely with XLCR Capital. Your line is open.

Jonathan Abodeely

Mike this one’s for you, Roche recently commented earlier this week at their analyst day that they were very pleased with some of the early customer reaction to some of the data sets in Europe, and specifically that the commentary about the launch in Spain. There was some public commentary about some of the indications that they were targeting specifically in hereditary and non-hereditary cancer, and infectious disease. And I was wondering if you could give some feedback based on what they commented about publicly, what you see the clinical potential of their sequence to be.

Mike Hunkapiller

But we’ve been pretty clear about, we’re going to let Roche do their announcements of the applications that they are going to support. For a couple of reasons; one, it is their business and two, they’re going to make the valuation, the evaluation of what they are going to support as an assay and when they’re going to support it. And we just don’t want to get in the way of that process, and cause any confusion with their affiliates or their customers in that regard. So we really would respectfully ask you to direct those questions to Roche. It really is their prerogative to make that.

Now that said, but they have said in a broad senses they are interested in infectious disease testing, they are interested in things like HLA, they are interested in other genetic type diseases, I think some of those were mentioned in that report that they gave versus their program in Spain. But specific test and when they might be available, I would really ask you to inquire of them.

Jonathan Abodeely

And secondarily just on the active loading initiative, I’m under the assumption it’s a pretty big driver for you in the near term to enhance the cost competitiveness of the system and just wondering if you could share comments about the progress you’re making on the active loading initiative, thanks.

Mike Hunkapiller

Well I mentioned that we’ve initiated a trial with one large customer, and so we maybe even mention who that was in other circumstances, who has a very large applications. It’s specifically really very good in targeted applications, where you’re going after specific gene sets because it increases the multiplexing that you can get in terms of number of samples you can run in a single cell whether on the RS or Sequel and that’s been the primary focus of that.

But it increases the number of ZMWs that you can load with a single DNA molecule and the reason that’s important is that you can only get by [person] statistics. Around 37% single molecule loading in any random number of ZMW. And the more you try to load, you just start loading more holes with more than one piece of DNA which will give you confounding results to until one of those happens to die.

And so you wind up on average getting longer reads and you get more reads. And so the throughput can go up pretty substantially. And the longer reads, strictly if you’re in a CCS type mode or you’re trying to get very high accuracy on individual molecule becomes really important because you get more turns around an individual molecule.

So the (inaudible) go up, the number of reads go up, both of which can be very important.

Operator

And at this time I’m showing no further question. I would now like to turn the call back over to Mike Hunkapiller for any further closing remarks.

Mike Hunkapiller

We’d like to thank you for tuning in to the conference call today, and we look forward to speaking to you again in three months.

Operator

Ladies and gentlemen, thank you for your participation in todays’ conference call. This does conclude today’s program. You may all disconnect. Everyone have a great day.

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