Good afternoon, ladies and gentlemen, and welcome to the Pacific Biosciences of California, Inc. Third Quarter 2020 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Ms. Trevin Rard. Please go ahead.

Thank you, Alexander. Good afternoon, and welcome to the Pacific Biosciences Third Quarter 2020 Conference Call. We hope that you are keeping well during this time. 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 8-K available on the Securities and Exchange Commission website at www.sec.gov. With me today are Christian Henry, our Chief Executive Officer; Susan Kim, our Chief Financial Officer; and Ben Gong, our Vice President of Finance and Treasurer. Similar to last quarter, we are hosting our conference call from a number of different locations, so please bear with us if there are any technical issues or pauses. Before we begin, I would 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, research and development efforts, products, sales, plans of our collaboration partners, plans to grow and the potential impact of growing our commercial team and other future events such as the impact of the COVID-19 pandemic on our business, partners, customers and employees and the use of our products in COVID-19 research. 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. In particular, the extent of COVID-19's continued impact on our business will depend on several factors, including the severity, duration and extent of the pandemic as well as actions taken by governments, businesses and consumers in response to the pandemic, all of which continue to evolve and remain uncertain at this time. These risks and uncertainties are more fully described in our Securities and Exchange Commission filings, including our most recently filed reports on Forms 8-K, 10-K and 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 would now like to turn the call over to Christian.

Good afternoon, and thank you for joining us today. I am pleased to be hosting my first earnings call for Pacific Biosciences as the Chief Executive Officer, and I'm excited to share some of the progress we've made in my first 7 weeks. For my prepared remarks, I will briefly review our Q3 financial and business highlights, provide an update on how the COVID-19 pandemic is impacting our business, and finally, give some early impressions as CEO and share our view of the opportunity we have to grow the business. But before I begin, I do want to thank all of the employees of PacBio for their extraordinary effort during the pandemic. During the quarter, we were able to successfully maintain production and continue with our research and development activities without significant disruption from the pandemic. I'll start with an overview of our Q3 2020 financial. Consumables revenue for the quarter was $8 million, up 66% sequentially from Q2. Most of our customers who had shut down due to the pandemic in the second quarter have reopened. We are pleased to report that system utilization on installed Sequel II systems had returned to levels similar to or even higher than where they were before the pandemic. Instrument revenue for the quarter was $7.7 million or down 14% sequentially from Q2. As I mentioned in our previous earnings call, we have seen significant headwinds in instrument sales due to the pandemic. Many of our instrument sales opportunities have been delayed as some capital budgets were put on hold in Q2. This impacted new bookings and of course, instrument revenue in Q3. We believe these delayed system purchases continue to be opportunities, and we've recently seen instrument bookings improving. Additionally, we have a healthy system sales pipeline. However, due to the pandemic,…

Thank you, Christian. And good afternoon, everyone. I am excited to be on Board at participating in my first earnings call as the CFO of Pacific Biosciences. I will be providing an overview of our Q3 2020 financial results with comparison sequentially and year-over-year. In addition, I will provide commentary on our outlook for the fourth quarter of 2020. Starting with revenue. Total third quarter revenue was $19.1 million, an increase of 12% from $15.6 million in Q2 of this year but a decrease of 13% from $21.9 million in Q3 of last year. Let me provide some additional detail on the revenue for the quarter. Consumable revenue for the third quarter of 2020 was $8 million growing sequentially 66% from $4.8 million sold in Q2 of 2020 and up 16% from $6.9 million sold in Q3 of 2019. The sequential growth in consumable revenue reflects the increased utilization of our installed base, which, as we indicated, has returned to levels prior to the pandemic. Sequel II consumables represented approximately 70% of our total consumable shipments in the third quarter, and roughly 25% of our consumable shipments were purchased for the older Sequel systems. It is encouraging that customers have been able to take advantage of the benefits that come with our Sequel II systems. We expect the proportion of consumable sales from Sequel II systems to continue to grow as the installed base for Sequel II continues to expand. Instrument revenue recognized in Q3 was $7.7 million, down from $8.9 million recognized in Q2 and down from $11.6 million recognized in Q3 of last year. Instrument revenue this past quarter reflected the pandemic headwinds on our instrument sales, largely due to customer uncertainty associated with COVID-19 and the funding environment for capital spend. Instrument bookings in Q2 had hit…

Thank you, Susan. As many of you may know, one of my first objectives upon joining the company is to define the core strategies that will drive our execution and growth over the next several years. Although I've only been at the company for several weeks, that strategic planning process is well underway, and I look forward to sharing more detail with you in the coming months. Today, however, I'd like to share 3 core objectives that will drive us in 2021. Our first core objective for 2021 will be focused on expanding our commercial reach. With the launch of the Sequel II and IIe systems and the emergence of highly accurate long reads or HiFi reads, PacBio is now being recognized as not only the leader in long-read sequencing, but also as the leader in accuracy and completeness among all sequencing companies. These advances make our products desirable to more customers than ever before. As a result, we need to expand our commercial team to take advantage of new opportunities and to meet the needs of these new customers. Today, we have a modest global sales force of approximately 20 sales personnel. We plan to dramatically increase the size of that sales force over the next year. In fact, recruiting is already underway for more than a dozen new sales positions. We believe these new positions will enable us to reach more potential customers than ever before, which will help us grow. Of course, hiring and training takes time, and I would expect that it would take at least a few quarters once a new salesperson is hired to get up to speed and start contributing in a meaningful way. As we expand our sales force, we will also need to expand our ability to execute within the commercial…

[Operator Instructions] We have your first question from Doug Schenkel from Cowen.

So first, just on some of your commentary on systems. Could you just unpack whether or not there have been any notable differences by geography in terms of delay and pipeline progression? And I guess kind of the same question on applications. There's been areas where the ability to accept instruments to place orders has been a little more durable versus others.

Yes, Doug, it's good to talk to you. The -- what we're seeing geographically is the challenges are really mostly focused in AMR and EMEA and probably even more strongly than EMEA than AMR, AMR meaning Americas. But what we're seeing is that an instrument order may be somewhat delayed due to kind of funding changes or really timing of when people are getting back to work, and we saw some of that in Q2 impacted us in Q3. And if you kind of look out in the future here, as we said in the prepared remarks, we see the pipeline improving across -- pretty much across the board. And it's just -- what we'll be concerned about is thinking through if we do have significant closures like what we see in France, for example, right now, how that will impact us in the very near term. If that answers your question. The second part on applications. I think there's a lot of excitement around whole-genome sequencing right now with HiFi reads, and we're getting a lot of traction and a lot of good collaborations as we've outlined. And so I'm actually pretty excited about that.

Okay. That's super helpful, Christian. And maybe kind of building off of that. Well, maybe -- maybe the placements would have been higher if it hadn't been for the pandemic. I think we're -- there was definitely some encouraging progress was on the Sequel II consumable utilization numbers. You talked about utilization normalizing to levels at least as high as prepandemic levels. I'm just wondering if you'd comment on, first, was there any stocking dynamic in the quarter. And then second, maybe it's a little bit early to ask this question again. But if we look back at Sequel I, I believe pull-through kind of got to about $200,000 annualized. I think it was 8 quarters into launch. Do you think at this point you can get there or beyond with Sequel II over the coming quarters?

Yes. I think that -- I'll let Ben address the question on the pull-through because he's got more history than I do still. But on the stocking, there wasn't a lot of stocking per se during the quarter. I think it was -- people were getting back to work. And we -- one thing at PacBio that we have is we have an excellent way of tracking the runs. It's our SMRT Link software, and we're able to see what many of our customers, not all, but a significant majority of our customers are actually running. And we were quite encouraged that people were running their systems pretty consistently all through the quarter. And so we don't think it was a stocking phenomenon, particularly in the third quarter. With respect to pull-through, maybe Ben, you could address that.

Yes, I'd be happy to. Yes, Doug, you're right that the pull-through revenue has gotten back up to, let's say, $160,000, let's say, for Sequel IIs, which is kind of where we were right before the pandemic hit. Kind of hard to predict where it's going to be going in the future. We are driving toward increasing that by having some of these high volume or larger projects like the All of Us project and the Darwin Tree of Life project hopefully kicking off or ramping up, I should say, next year. But at the same time, that's going to be a contest between new system placements. So I'd say this time, we're -- it's a bit early for us to predict where that's going to settle out. We're just happy that it's kind of recovered back to where we had gotten into before the pandemic hit.

Okay. Yes, I think that's helpful. Sorry, Christian.

Yes. I think -- No, that's fine. I'd just say the last point on that is that I think that as we drive our commercial organization, and we believe that will drive accelerated placements in the market, it will be interested -- as Ben said, it will be interesting to see how fast we can empower those customers to ramp to get to the throughput levels that we would be hoping on the consumables. And we can't predict that now. But obviously, our objective would be to at least maintain or even grow from those pull-through numbers.

Okay. That makes sense, guys. And maybe just a last one, specifically on the clinical side. As you noted in your prepared remarks, you had a couple of new announcements over the last quarter. And then I guess Invitae was actually in October. Is the role of PacBio in these agreements largely to elucidate the link between structural variation and genetic disorders? I asked because I'm just trying to understand if these agreements serve largely as ways for PacBio to get in there and really serve as a complementary tool to short-read solutions. Or whether or not you view these types of agreements as really being positive leading indicators for PacBio increasingly being viewed as competitive or even replacing short-read solutions.

Yes. I think that's a great question, Doug. Thank you. I think that right now, we are clearly a complementary technology given the fact that our costs are higher than short-read approaches. However, there are customers and partnerships that are looking to figure out can they create a PacBio workflow that as we increase our technology and capability, increase our throughput, can they do more and more and get more benefit from the long-read sequencing. And so I think today, we all have to look at it as it's a complementary technology, but there are a lot of cases where customers are interested in could this be a technology that we could bring more into high throughput practice. And we have some work to do on our side on driving the cost and throughput of our machines to cost down and throughput up, but I'm really excited about the prospect of being to do that over the next few years.

We have your next question from Tejas Savant from Morgan Stanley.

Just a couple of quick ones here. Christian, can you talk about just early customer feedback to the IIe announcement? And specifically, should we expect to see customers perform more long-read sequencing given the time data storage and compute saves -- cost saves that you've spoken about? And also, over time, what traction of the user base do you expect will upgrade here to the IIe? Is it sort of essentially 100% of your existing Sequel user base?

Yes. Tejas, thank you for the questions. I think the early customer feedback has been -- thank you. This is a great -- this is a great advancement. Being able to do the secondary analysis on the instrument really simplifies our life. And I think what you're going to see is customers that have significant compute infrastructure already in place may not upgrade, but they still may upgrade just because the fact that they can save money on the storage side. What I think is the most exciting aspect of the IIe launch is it's an instrument now that you can take into a core lab, maybe not necessarily the first-tier core lab, but a second-tier core lab can actually create an accessible workable solution for them. Because if you have to buy the instrument and then buy another $100,000 of compute on top of it, that's a pretty significant budget. Now we've just eliminated that other piece of compute. And so it gives us an opportunity to get into places where we probably haven't been able to penetrate before because the overall cost is too much. On how many customers are going to actually upgrade? I think -- I think there'll probably be a reasonable percentage. And I do think new customers and new machines, I would believe that we're going to have predominantly people buying the IIe. It's just a great value for just a little bit more money.

Got it. And then just following up on Doug's question earlier on the clinical side, Christian, your work in Children's Mercy and the Invitae program. How do you expect sort of pediatric samples to kind of like ramp over time? And what do the economics look like for PACB? I mean are you initially, given that these are sort of research efforts, discounting these samples to like enable clinical adoption down the road? Or is it a full price sample for PACB as it otherwise would be?

Well, in general, I think the pricing is kind of consistent with our discounting methodologies that we use for these customers. We may be more aggressive in certain situations, particularly where we are trying to get maybe some really collaboration in terms of workflow benefits or the ability to try new things with the customers that we could then standardize throughout the market. And so I think that in the short term, it will -- the pricing is kind of discounted, I would say, but not so heavily discounted that it's not kind of consistent with what we do. In the long run, I think our -- I think it will be -- the opportunity for us is as we drive our throughput up, we share the benefit of those gains or share the economics associated with the benefit between us and the customer. And we've seen this kind of story work in the past, and it will just be dependent on market conditions and what the customers' needs are on how much of the sharing that we, in fact, do. But I think given what we have in our R&D pipeline, we're going to be able to create a business where overall gross margins will improve because we have products that are priced better for the company.

Got it. And then a 2-parter on the sales force expansion here, Christian. I know you spoke about sort of a dozen open positions. How large do you envision the sales force being in steady state down the road? And have you had sort of early conversations with some of the core labs and the large genome centers, perhaps in the U.S., where you don't essentially have them as your marquee customers but they could become marquee customers over the next 12 months or so? And then secondly, just a little bit of a fuzzy question, if you will, on culture I mean. Regarding your push to a more aggressive customer-centric culture here, what are you doing internally to ensure that the core DNA of the company around sort of R&D and innovation stays intact?

Yes. That's such a great question. Let me see if I can unpack all of these. So with respect to sales force expansion, I do think over the long run, you're going to see us dramatically increase from here. I probably not ready to tell you, well, we're at 20 now, we should be 120 at some point. But I think what you're going to see is we're going to unpack this in phases, particularly while we still have the headwind of the pandemic, it does -- I want to make sure that we aggressively build, but we do it in such a way that we can be responsible on the P&L side of the -- on the expense side of the equation, but -- and -- but also prepare ourselves as we launch new products, the sales force is in place and ready to go and train. So that's the balance that we're playing. I also think there's -- the balancing act there, too, is we want to grow quickly, but I want to make sure that we hire the highest quality people we can. We get them trained appropriately. And so we have some infrastructure to build around that, particularly in our commercial operations organization. And so that organization doesn't really exist very much yet today. And so I need to build -- we need to build some of that. Once we get that in place, then we could actually accelerate our hiring probably faster. But I think in 2021, you should be thinking that we will hopefully more -- hopefully double our sales force if not more, but it really does depend on how the pandemic plays out, I think, at some level. With respect to the conversations with customers, that's actually been one of the best…

We have your next question from Tycho Peterson from JPMorgan.

Christian, good to have you back. I know one of the things you're committed to is narrowing the cost curve with short-read. And I didn't hear a lot about that. You talked about kind of product development is 1 of the 3 core objectives. But it might be helpful to just kind of level set how you're thinking about the path to a $1,000 platinum-grade genome? And are there things you could do to accelerate that, that you've maybe identified at this point?

Yes. Tycho, it's great to hear from you. No, I'm sorry about that, Tycho. The -- yes, we are accelerating this. This is actually the central aspect of R&D, right? We have to drive the throughput up of our systems, which drives cost down. And we also, as we develop new platforms, we have to fundamentally think through how do we drive the platform cost down, too, so that when you're looking all in on a sequencing project, you're getting to those competitive prices where we need to be at population scale. And there's a couple of different things that were -- in the short term that we're going to be focused on. We still have lots of opportunity on the chemistry itself, even on the Sequel II platform. And so you'll see us working really hard on making chemistry improvements, which increased throughput, which then lowers the cost of sequencing. You'll also see us start to really work hard on -- more on the front end so that as we -- our systems become higher throughput, we lower the input requirements of DNA, so that we can access more samples than ever before. We'll also look at how do we fully automate the sample prep process so that when you're in a high throughput situation, you're not going to lose a deal because your system is not automated. And I think those are some things that we're working on now. And you'll see progress on those fronts in 2021. And of course, one of the beautiful aspects of the technology is that we are leveraging the semiconductor industry and we have the opportunity to kind of continually advance the state of the art or the number of VMDs -- VMWs on a chip. And in due course, you'll see advancements on that front as well. So we're pushing on a lot of different balls at the same time here and with the goal that we believe is achievable of being very competitive with short-read sequencing at the whole genome large population scale.

And then following up on some of the discussion on the clinical opportunities earlier. I think this is something investors have always struggled with a little bit, what are the right opportunities for long-read and you've obviously been entrenched in transplant diagnostics. You mentioned epilepsy with Invitae and [ rugged ]. Are there other opportunities you've identified early on? You've only been there a few weeks, but from your perspective that you think are particularly underappreciated from the clinical side for you guys?

Well, I think those are probably in the sweet spot right now. And I think opportunities will -- applications will emerge even more as people understand that we really can drive the cost down on long-read. I think the only applications, in my mind, that probably aren't very accessible are liquid biopsy-type applications where you're looking at cell free -- small pieces of cell-free DNA. It probably doesn't make sense to be using the PacBio technology there. But -- but you can imagine a day when every sequence is effectively a high-quality de novo human sequence because the cost is reasonable. And you can use that in a clinical setting. And I do think we definitely have that vision, and I do think some of our clinical partners have that vision as well. So we'll see -- we'll see how we go down the road there. But out of the gate, I think we've got a lot on our plate and a lot of opportunity there.

Okay. And then 1 or 2, hopefully, quick ones on the model before I hop off. But on the Children's Mercy, $100,000 -- 100,000 genomes over 7 years at, call it, 3,000 of genome now could be a pretty meaningful opportunity. Can you help us think about how that volume ramps over the next couple of years?

Yes, you know what, I think that's -- I'm not sure -- I don't believe that they're using all 100,000 on PacBio sequences, at least out of the gate. So that probably wouldn't be a fair way to model it. We're working with them, and they're -- you should be thinking now they're in the -- they're much lower than that. And in fact, Ben, you might know the exact number that they're doing right now. I don't know if you know that number, but I don't, to be honest. We could follow-up with Tycho on that.

Yes, Tycho, I would just add, they have 2 Sequel II systems right now, which is a pretty good start. It is, as you mentioned, is a 7-year program. And so I don't think they actually have all the samples. Even if you had the running capability to actually run through those, I think the idea here is to do that over a period of time. And our goal here is to continue to increase the throughput of the system so that we can help them do more and more of those genomes over the course of those years.

Okay. And then just lastly, on the launch of the IIe, you mentioned kind of the dynamic and upgrading some of the Sequel IIs that are out there. I know you still have some RS IIs out in the field. Do you think this is enough to kind of convert some of those older platforms that never upgraded to Sequel II?

I think about -- I mean, this is a pretty compelling opportunity. And to the extent there are RS instruments out there, I'll challenge our field force to make sure we get the Sequel to be in front of those customers and make sure they have a significant opportunity to upgrade because the reality is that it's good for us, too, if we can move everyone forward into the Sequel II, IIe platform.

We have your next question from Kyle Mikson from Cantor Fitzgerald.

Welcome, Christian and Susan. So I appreciate the color on the new bookings and the government orders being overpressured recently, but just was wondering if you had any kind of expectation that the loss opportunity of revenue could be recaptured maybe the next year or so. Just kind of wanted to gauge your thoughts there, maybe these customers, these opportunities were kind of a little bit more concrete than what you might have heard?

Yes, that's a great question. And my belief, based on talking to the sales force and spending some time with the sales management is that yes, those opportunities -- some of those opportunities may be lost because budgets were allocated to maybe a COVID project instead of where they originally allocated. But the vast majority, I really would call them delays, and I would expect us to be aggressively pursuing those opportunities to get them converted into either new customers or additional sales as expeditiously as possible. The good news is that we are -- sales execution processes are -- have improved over the course of the last year. And now with this significant focus in commercial that the team is feeling, I think that we are going to have opportunities to convert those potential sales into actual sales likely in '21.

So just unlike the, I guess, sales force expansion is kind of all systems go. But just was wondering if any of these, you have more recent international lockdowns or the increases in COVID cases really domestically and internationally are going to really potentially pressure that sales force expansion as it relates to maybe countries outside of the U.S., if at all?

Yes. I -- look, we started recruiting. We've opened up for acquisitions. We're starting the recruiting process. There's no question that lockdowns have an impact on how fast you can recruit, interview, hire. So I would be -- it would be silly to say that doesn't have some impact. The good news is that everyone is on Zoom, and everyone is able to interview. And so I think that -- I think it won't -- it's not as bad as it would have been in the "old days", but I think it will have some impact. However, over the course of the year, I think we should be able to get moving. We've had a lot of -- there's been a lot of interest in PacBio with this transition, and I'm hopeful that we can leverage that into some hiring. So that would be good.

Turning to the Sequel IIe rollout. I know it's early, there's a lot of uncertainty, but are you expecting any substantial cannibalization of Sequel II consumable revenue earlier in 2021? And then also, I was wondering if you could comment on the feedback you've received on this new trade up program. I'm curious because it's the first time, I think your offering credit customers looking to switch their instrument from a competitor rather than just a PacBio instrument. And from what I understand, it's just for North America in this program. And so are you going to be rolling out similar programs in -- or promotions in other like regions?

Yes. So I don't think we're going to see significant cannibalization of consumable revenue because basically the consumables work on both systems. And so it's -- the IIe, the real drive is the on compute, the compute that's been improved. And so you're not going to see cannibalization in that sort of way as we saw from Sequel II to Sequel I. With respect to the new promos, these are new ideas that the PacBio team is coming up with. And there's been some early interest, and we'll see how it goes. I think it's too early to tell whether -- how well it's going to work. One reason why you start in Americas and some of the other regions have much longer sales cycles. And so we'd like to try to get some quick wins as opposed to -- as opposed to kind of having it out there in really long sales cycles. So we'll see how that goes. But one thing you can be assured of is that we are going to be -- as we grow our commercial footprint, we will be focusing on the nuances of each geography and doing promotions or doing activities in each of those regions that really drive sales for that particular region. And that's something that's really important to me because there's no question that there's differences between Asia Pacific and Europe and Americas. And to date, the company has had a very small sales footprint, so they haven't really had the capability to operate globally in the same way that maybe will help us down the road.

We have your next question from Steven Mah from Piper Sandler.

Just mostly follow-up questions because we've covered a lot of ground. But as your long-read costs go down, and there's more of a focus on clinical applications. Is there going to be internal clinical development at PacBio where you kind of own your own clinical development programs? Or will it be strictly partnerships going forward?

Yes. I think the core strategy today is to really focus on partnerships. That said, there may be opportunities that make more sense for us to develop internally. And I do think we have to be thinking through whether we should have the FDA-cleared instruments and how that would help us in the market. As I said at the beginning of my prepared remarks, we're working on a strategic planning process right now. And this is front and center in the plan is trying to work through that, what makes the most sense. One thing I would say is that common strategies like building panels, may or may not make sense because I believe that we are moving to a world of whole-genome sequencing in the clinic. And I really want to make sure that, that we're moving to where the puck is going as opposed to where it's been. And -- but there may be -- that said, there still may be opportunities on panels that might make sense. I would just stay tuned there. And as we kind of unpack our strategy in more detail to the community, we'll definitely address that issue.

Okay. Great. And then one more quick one before we hop. On -- you talked about FDA-cleared instruments on the potential path forward. But can you give us any updates on Sequel II and the China regulatory process with the -- that you have with Berry Genomics?

Yes. So Berry, I don't really have a real update today other than they've been -- I talked to the folks at Berry and they're working hard on getting the system through the process. And hopefully, I'll have more information for you at another time. But I don't have a significant update on that today.

There are no further questions at this time. Presenters, please continue.

Okay. Well, we'd like to thank everyone for attending today's call, and we look forward to speaking with everyone after our next quarterly earnings call. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.