Pacific Biosciences of California, Inc.

Good day and welcome to the PACBIO Second Quarter 2024 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Todd Friedman, Senior Director of Investor Relations. Please go ahead.

Good afternoon and welcome to PACBIO Second Quarter 2024 earnings 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 investor section of our website at .pacb.com or as furnished on form 8K available on the Securities and Exchange Commission website at .scc.gov. A copy of our earnings presentation is also available on the investor section of our website. With me today are Christian Henry, President and Chief Executive Officer and Susan Kim, Chief Financial Officer. On today's call, we will make forward-looking statements, including among other statements regarding predictions, estimates, expectations, and guidance. You should not place undue reliance on forward-looking statements because they are subject to assumptions, risks, and uncertainties that could cause our actual results to differ materially from those projected or discussed. Please review our SEC filings, including our most recent forms, 10Q and 10K, and our press releases to better understand the risks and uncertainties that could cause results to differ. You disclaim any obligation to update or revise these forward-looking statements except as required by law. We will also present certain financial information on a non-GAAP basis, which is not prepared under a comprehensive set of accounting rules and should only be used to supplement an understanding of the company's operating results as reported under US GAAP. Reconciliation between historical US GAAP and non-GAAP results are presented in our earnings release, which is available on the investor section of our website. For future periods, we're unable to reconcile non-GAAP gross margin and non-GAAP operating expenses without unreasonable effort due to the uncertainty regarding, among other matters, certain acquisition-related items that may arise during the year. A recording of today's call will be available shortly after the live call in the investor section of our website. Those electing to use the replay are cautioned that forward-looking statements may differ or change materially after the completion of the live call. I'll now hand it over to Christian.

Thank you, Todd, and thank you for joining us today. The first half of 2024 has been challenging for Pacfile. However, early in Q2, we successfully initiated a significant restructuring, which we expect will reduce our non-GAAP operating expenses by more than $75 million on an annualized basis and significantly reduce our quarterly cash burn. Even with this restructuring, we are making significant progress in our product development pipeline and serving our customers with -in-class support. There were several bright spots in many areas of our business in the quarter, including several customers adopting Revio in a clinical setting, and we are now seeing signs that lead us to believe that we will see sequential growth throughout the remainder of the year. I want to thank all of our employees for their dedication and support as we pursue our mission of enabling the promise of genomics to better human health. On our last call, I outlined the following four strategic priorities for the remainder of the year. Number one, improving our commercial execution to drive adoption of both Revio and Onsla. Number two, continuing the development of new platforms that are expected to broaden our product offering and drive revenue growth. Number three, improving our gross margin and driving manufacturing efficiencies. And number four, reducing annualized non-GAAP run rate operating expenses. In my remarks today, I will comment on the progress we are making against the top two priorities, specifically focusing on our end markets and related commercial execution. Susan will then spend some time focused on our third and fourth priorities and outlining our financial results. But first, let's do a quick overview of our second quarter results and our updated guidance. Total revenue in Q2 was $36 million, which was below our expectations. Our revenue reflects a shortfall in instrument placements, which we believe is due to the ongoing impact of the difficult macro backdrop and elongated customer purchasing cycles. Second quarter revenue included 24 Revio systems, representing four systems below our expectations. Although we shipped fewer Revios than anticipated, the average selling price of Revio increased during the quarter. We continue to see elongated instrument purchasing cycles in each of our regions during the quarter, which we believe is due to a number of factors. Number one, several companies and organizations are awaiting funding for their systems, and we're seeing that funding is increasingly delayed. Number two, we continue to experience an unanticipated delay in the procurement process, which include tenders in Europe and APAC, but they're taking longer than expected. And number three, sample volumes are not materializing as fast as we expected for some potential new Revio customers, causing them to delay their purchases. On the consumable side of our business, we delivered revenue of $17 million, growing 24% year over year and 7% sequentially, as customers continue to ramp up their Revio usage. We saw strength in EMEA, with consumable revenue growing 42% year over year and 50% quarter over quarter, hitting an all-time high. The growth in consumable revenue in EMEA was driven by new customers scaling long read sequencing during the second quarter. Notable customers include the University of Tartu, sequencing for the Estonian Biobank, and BioSentia, a leading global provider of clinical laboratory testing services in Germany, which is scaling its testing offerings. We are further encouraged by the growing excitement for long reads in the region. Novigene, for instance, has implemented Revio in its brand new lab in Munich, Germany, to serve customers across the European scientific community. Despite the total growth in consumables, revenue was slightly below our expectations, which we believe was primarily due to a large research project in the United States losing funding and weakness in the Asia-Pacific region, notably in China. Looking ahead for the full year, we now believe revenue will be around the low end of our previously guided range of 170 to 200 million, which we believe is primarily due to the continuation of the headwinds we experienced in the first half of the year, and the expectation that organizations will continue to operate in a capital constrained environment for the rest of 2024. Indeed, external challenges are affecting Pacfile and others in the industry, particularly with respect to capital equipment purchases. In order to drive instrument placements, we have implemented a number of programs to make high-file long read sequencing more accessible than ever before. Including promotions designed to ease customers' upfront capital expenditure requirements, while maintaining Pacfile's overall economic value. In the second quarter, we shipped several instruments to customers utilizing some of these promotions, and are actively working to close several more deals in the second half of this year. Additionally, we announced last week that our leasing partner, Mitsubishi Capital, is offering one of the most attractive deals on a Revio instrument through a two-year rental agreement for eligible customers in the United States. With this offer, Mitsubishi will purchase the Revio directly from Pacfile, and then rent the system to customers with an option for the customer to buy the Revio at the end of the lease term. This program does not require a consumable purchase commitment, which is appealing to research customers that are primarily project-based. We expect this new promotion to make high-file sequencing even more accessible to a broader range of customers. As for Anso, we launched a promotion for the system in late May to make it what we believe is the most attractive mid-throughput short read instrument on the market. As a result, customers can trade in any NGS system and acquire an Anso for $99,000. The sequencing costs as low as $4 per gigabit. This promotion has already garnered customer interest and increased the order opportunities in our sales pipeline. Consequently, we anticipate a substantial ramp-up for the platform in the second half of the year. In order to continue building our sales funnel, we held several major marketing events throughout the world during this order. These prism marketing events were an overwhelming success. The six events attracted approximately 800 attendees and helped drive dozens of new Revio opportunities, some of which have already closed and others that were actively working on closing in the second half of this year. On the consumable side, we are seeing indications that give us confidence that consumables will continue growing in the second half of the year. For example, we are now seeing several large projects such as the University of Khartoum sequencing for the Estonian Biobank, the Singapore Precise Project, and the Greger Consortium Project all scaling up. In addition, we continue to see positive -to-bill ratios for consumables as customers are placing longer-term purchase orders for their smart cells and reagents, a potential leading indicator for quarterly growth. While we remain cautious about the outlook in China for the remainder of the year, customer utilization trends have started to improve in the past couple of months, and July marks the highest utilization month for the region this year. On our last call last quarter, we introduced a histogram chart of our Revio install base by utilization rate. As a reminder, we can monitor the utilization of the majority of our Revio fleet. As one might expect, newer customers take longer to ramp utilization levels, and we continue to see this in Q2. However, what was encouraging is that compared to last quarter, we saw more instruments move from the low utilization bucket into the medium or high utilization buckets, and we saw increased pull-through from both medium and high utilization customers. Our focus will be to continue simplifying our workflows and helping our customers get up to their planned utilization rate as fast as possible in order to maximize our consumable revenue opportunity. Now, let's take a look at a few of the other commercial highlights during the quarter. We continue to be encouraged by the growth in sequencing data as data produced from the Revio platform grew quarter over quarter, and total data output from PacBio sequencers grew 2.2 times from the second quarter of last year. Revio continues to be the fastest growing instrument in our history, in part through its ability to gain market share via new customers. In the first half of 2024, new customers accounted for nearly half of total shipments, highlighting the growing value proposition of Hi-Fi sequencing and the expanding range of applications that Revio addresses. At the same time, we see significant opportunities to drive adoption among the remaining 180 plus SQL2 customers who have not yet ordered a Revio. Further encouraging are the results from our annual customer survey, which shows an NPS score of 56 among those surveyed. In addition, nine out of 10 respondents reported being satisfied or very satisfied with their Revio system. We are pleased by the diversity of customer types that are adopting Revio. In the second quarter, we delivered multiple Revios to a range of customers, including research institutes, core labs, service providers, diagnostics and LBT labs, children's hospitals, human genetic research organizations, and pharmaceutical companies. This customer diversity is expected to lead to more application and greater penetration into our end markets. Additionally, we expect adoption by diagnostic and LBT labs can potentially establish a long-term revenue stream as these companies expand their testing menus. Notably, we delivered multiple Revios to Quest Diagnostics to support the company's development of tests for neurological disorders, leveraging the advantages of our recently launched PureTarget Repeat Expansion Panel. Chululongkorn University Faculty of Medicine in Thailand has adopted its second Revio system to scale its Hi-Fi sequencing capability. The organization plans to sequence 1,000 human genomes annually over the next five years to improve health outcomes. HealthEncode, a leading company in genetic diagnostics, is bringing the first Revio system to Spain, becoming PacFile's first service provider in Southern Europe. This system is expected to enable large-scale Hi-Fi long reads to improve the detection of variants in complex regions for customers throughout the region. We're continuing to see the adoption of transcriptomics and single cell RNA sequencing with our Kinects kit, which launched last December. In Q2, Kinects already surpassed one million in quarterly revenue and helped drive Revio placements, including a Revio system at a prominent cancer research center in Texas. In Q2, we also started to see some early customers ramp up their use of Onsa. The Hospital de Estelar de Dades in Ecuador, for example, has sequenced 700 patient samples as part of a 2,000 sample oncology project and is looking to expand into other projects. In Q2, we also made significant progress in research and development. For example, we are in the late stages of developing a new Revio consumables, which we expect will meaningfully increase the system's throughput without the need for additional capital investment. The new consumables are also expected to significantly decrease DNA input requirements and add additional methylation calling capabilities. We believe these improvements will unlock more samples and increase Revio's capacity, providing our customers with more value than ever before. We look forward to sharing more about this consumable upgrade later this year. Additionally, we're continuing to make progress in our work to develop a low-throughput long read platform and a high-throughput short read system. Finally, we're supporting our customers and R&D pipeline while reducing our costs and cash flow. As we discussed last quarter, we initiated a restructuring plan to reduce our non-GAAP operating expenses and expect to exit this year with annualized run rate savings exceeding our previous non-GAAP target of 50 to 75 million. As a result of this restructuring, we believe our cash burn will continue to decline sequentially in the third quarter and the fourth quarter of this year. With that, I'll hand the call to Susan to discuss the financials in some more detail. Susan?

Thank you, Christian. I will be discussing non-GAAP results, which include non-cash stock-based compensation expense. I encourage you to review a reconciliation of GAAP to non-GAAP financial measures in our earnings trust release. As discussed, we reported 36.0 million in product, service, and other revenue in the second quarter of 2024 compared to 47.6 million in the second quarter of 2023. Intro revenue in the second quarter was 14.7 million, a 51% decrease from 29.9 million in the second quarter of 2023 due to lower Revio unit shipment. We ended the quarter with an install base of 225 Revio systems. According to consumables, revenue of 17.0 million in the second quarter increased 24% from 13.7 million in the second quarter of last year. Approximately 74% of consumable revenue came from Revio systems, which reflected an annualized pull-through of the Revio system of approximately 251,000, with the remainder coming from a mix of other systems. Finally, service and other revenue was 4.3 million in the second quarter compared to 3.9 million in the second quarter of 2023. We expect to see modest sequential increases in service and other revenue as the commencement of Revio service contract is expected to more than offset the decrease in service contract revenue resulting from SQL 2 and 2ED commissions. From a regional perspective, the Americas revenue of 20.8 million exceeded our internal expectations due to greater Revio placements, but represents a decrease of 13% compared to the second quarter of 2023. Growth in consumables was offset by lower Revio placements compared to last year. For Asia Pacific, revenue of 8.2 million decreased 36% over the prior year, driven mainly by lower revenue in China, which continues to face challenges with funding in a weaker macroeconomic environment. We expect many of our customers to benefit from the government-announced stimulus program, but we don't expect any impact from such programs until 2025 at the earliest. Finally, EMEA revenue of 7.0 million decreased 35% over the prior year. As we discussed, the region saw record consumables as customers ramped up their Revio usage, which was offset by lower Revio placements. Moving down the P&L, second quarter 2024 non-GAAP gross profit of 13.2 million represented a non-GAAP gross margin of 37%, compared to a non-GAAP gross profit of 15.7 million, or 33%, in the second quarter of last year. The second quarter's non-GAAP gross margin improved approximately 400 basis points from the first quarter of 2024, as Revio ASPs improved, and in particular, as we continue to realize production cost savings on the Revio instrument build. Non-GAAP operating expenses were 71.0 million in the second quarter of 2024, representing an 18% decrease from 86.7 million in the second quarter of 2023. Non-GAAP operating expenses also declined 19% sequentially compared to the first quarter of 2024, as we began to realize cost savings related to our restructuring plan initiated last quarter, and represented our lowest non-GAAP operating expenses quarter since Q3 of 2021. Regarding headcount, we ended the quarter with 581 employees compared to 796 at the end of 2023, and 818 at the end of the second quarter of 2023. Our restructuring reduced our non-GAAP operating expenses, some of which was a result of a 25% reduction in total headcount. Operating expenses in the second quarter included non-cash share-based compensation of 16.1 million compared to 16.7 million in the second quarter of last year. Non-GAAP net loss was 55.2 million, representing 20 cents per share in the second quarter of 2024, compared to a non-GAAP net loss of 65.6 million, representing 26 cents per share in the second quarter of 2023. Non-GAAP net loss excluded 93.2 million in non-cash goodwill impairment charge due to the decline in stock price, among other factors, 18.0 million of restructuring expenses, and 6.9 million related to the amortization of acquired intangible assets. Turning to our balance sheet items, we ended the second quarter with 509.8 million in unrestricted cash and investments, compared with 631.4 million at December 31, 2023. Inventory increased slightly in the second quarter to 68.6 million, representing 1.6 inventory turns, compared with 67.3 million at March 31, 2024, representing 1.7 inventory turns. Accounts receivable increased in the second quarter to 32.4 million, compared to 30.3 million at March 31, 2024. Turning to guidance, as Christian mentioned earlier, we expect full year 2024 revenue to be around the low end of the previously guided range of 170 million and 200 million. The low end of the full year guidance range assumes 80 million of insurance revenue, which includes 115 revue shipments. We expect 72 million in consumable revenue, which assumes an annual pull through of 260,000 for the revue platform. With revenues at the low end of our range, we also expect non-GAAP gross margin to be around the low end of our previously guided 35% to 38% range. As we discussed, we have made significant progress on improving the per unit production cost of both revue instruments and revue consumables, and expect both to end the year approximately 20% lower than when we launched the platform. We anticipate that these costs and operational improvements will continue beyond 2024 and are expected to drive quarterly gross margin expansion this year and going forward. However, our total gross margins in the second half may fluctuate quarter to quarter based off on product mix, customer product mix, and ASPs. Moving to operating expenses, we remain diligent in our efforts to lower cash burn and spend profile and expect non-GAAP operating expenses to be around the lower end of our 300 to 310 million range. The low end of the operating expense guidance range assumes 140 million in non-GAAP research and development expenses and 160 million in non-GAAP selling, general and administrative expenses. We continue to expect full year non-GAAP operating expenses to decline in 2025 compared to 2024 and expect to exit the year at a full year run rate that reflects savings significantly above the high end 75 million non-GAAP reduction target. We expect interest in other income to be around the high end of our 5 million to 10 million range. Our operating expense and cash management discipline is allowing us to maintain our ending cash equivalence and investments guidance in the range of 435 million to 450 million representing a cash burn of 189 million at the midpoint. But more importantly, our expected quarterly cash burn exiting this year will be reduced materially helping to set up 2025 with a much lower cash burn than 2024. We still expect 273 million in weighted average shares outstanding for the full year 2024. Finally, we remain committed to turning the business cash flow positive by the end of 2026. We intend to do this by executing on our strategic priorities which are anticipated to result in revenue growth in 2025 and beyond with new products and consumables expansion from the increasing Revio install base. Expanding growth margins with lower per unit production costs and continued mixed shift to consumables and lower non-GAAP operating expenses in 2025 with minimal growth thereafter. We will provide more details on our assumptions and updated long-term guidance at a later date. I'll hand it back to Christian for some final remarks. Christian?

Thank you, Susan. While the first half of 2024 has certainly been challenging, I'm encouraged that we're taking the difficult but necessary steps to streamline our business by reducing non-GAAP operating expenses and driving costs out of our manufacturing. I'm also encouraged by the incredible progress that we continue to make in our product development pipeline. We continue to improve the performance of the Revio platform which will provide more value to our customers than ever before and we have made substantial progress in our low throughput long read platform which will enable us to reach a broader customer base. Commercially, we are seeing increased adoption of Revio in more clinically focused accounts as these customers are leveraging the platform in applications that are extremely difficult for short read sequencing technologies. We're also seeing signs that we will return to growth in the second half of the year as we've seen several customers choose to expand their Revio fleet and we continue to see a large number of our Revio purchases from new customers. We remain optimistic about our business and the prospects for both our long and short read sequencing technologies. I firmly believe that we are on the path to building a packed bio into a leader in life science tools and that we are on track to becoming cash flow positive by the end of 2026. And with that, I'd like to open up the call to Q&A. Operator?

We will now begin the question and answer session. To ask a question, you may press star then one on a touch tone phone. If you're using a speaker phone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then two. Also, please limit yourself to one question and one follow up, re-queue to ask additional questions. The first question comes from Dan Benin with TD Cowan. Please go ahead.

Hi, this is Tom for Dan. Thanks for taking the question today. I want to focus on your consumables for the back half of the year. It looks like you're taking a more measured look at that. I want to understand maybe given the install base is a bit more mature and a lot of the new installs will be in instruments that are new to pack or clusters that are new to pack bio. Kind of what gives you confidence coming into 2025 that you do get that utilization up and maybe talk through a bit about sample comment you made on the preferred marks? Thanks very much.

Sure. Thanks for the question. So, you know, I think what we saw in the second quarter was we did have a reasonably good consumable result and we saw some pretty exciting pockets such as what's happening in Europe right now. And what gives me some confidence that we're seeing those trends and we expect those trends to continue is really a couple of different things. You know, first, we're seeing customers that have been in low utilization, the low utilization bucket, which are traditionally the new customers, are actually moving into kind of the mid utilization bucket. And then in some even into the higher utilization bucket. And what we're seeing is in the mid and high utilization in the second quarter is we actually saw higher consumable pull through. That higher consumable pull through is really related to larger projects that are starting to get up to speed, which we announced a number of those. And then some kinds of customers are starting to be, you know, those clinical type customers that run very consistent and have that consistent revenue stream. As we move into 2025, I fully expect us to see even more of that, more clinical customers adopting our long read technology because it can do things that short read technologies just can't do. And we're starting to see, you know, more of the big projects. Now, in the second quarter and for 2024, there is a mitigating factor. One of the large projects in the United States lost a lot of its funding or most of its funding, which will impact our back up of 2020 for some. But on balance, we're seeing more consumable utilization and more consumable usage, which I think bodes well for future instrument pull through and, you know, improving, significant improvement from where we are today.

Thanks. And if I could just follow up on that kind of on that kind of POP-seq topic. You know, some experts we've spoken to are excited about the ability to run larger scale studies on lower coverage, but that they've run into some sentiment in the community that people are still focused on doing a 30X steps genome. I guess what do you think changes that and over what time frame do you think that changes?

Well, it's interesting. You know, this has been one of the big questions that we've had to address over the last few years. If you know, for those of you that have been following this space for a long time, you know, 30X has been around and was really somewhat of an arbitrary, you know, level of coverage. And as we know in the real world, customers do experiments at a whole range of coverages, some much higher than 30X and some much lower than 30X. But what we've done is pretty extensive titration experiments comparing PacBio HiFi sequencing to other technologies at 30X and lower. And what we consistently see is that customers are very comfortable, you know, below 20X even comparing a HiFi genome to an alternative genome. And so I think I think the community has more papers continue to get published with those lower coverage levels. That will build more more confidence. But, you know, even if the coverage stays at 30X, we continue to improve the Revio system. I talked about, you know, really for the first time today, talked about new consumables that we will be shipping, you know, shipping at the end of this year, roughly, that will significantly improve the which will drive the cost per gigabase down even further and also significantly lower the DNA input amounts. I'm not going to give too many of the specifics today because we want we want to save that for when we get in front of customers. But but it is quite exciting. And so we have that, you know, we are continuing to increase the throughput, which will drive the cost per gigabase down, which will give customers even more flexibility, whether they want to sequence it. 10X, 20X, 30X, 50X, whatever they decide. Thanks,

Kristen.

Appreciate

that. And the next question comes from Tejas Souvante with Morgan Stanley. Please go ahead.

Hello, this is Yuko on the call for Tejas. Thank you for taking our questions. Could you provide early feedback on the new PacBio Capital program announced and and provide indicators that make you believe that access to capital is the key hurdle for Revio placements rather than the excess capacity enabled by substantially higher throughput with Revio?

Yeah, so we you know, several several of the of the 24 systems that we closed in Q2 were under our various promotional programs. Some of those are through the PacBio Capital. You know, we announced a new program last week with Mitsubishi Capital, where there's no reagent commitment and it's just a straight rental, which is great for some research, some research organizations. And, you know, the the reason why we feel it's it's still more capital driven than excess capacity in the is that, you know, when we go through the instruments that didn't close in the quarter that we were hoping to close, almost all of them or the vast majority were due to funding constraints or timing around the funding and not not the decision to purchase because they have too much capacity. Now, in some cases with some service providers, that's certainly the case where, you know, they've they've and it's so much more powerful than the sequel to that it takes them time to order their second Revio. But but we still see, you know, we still see quite frankly in the in the deals that didn't close in the second quarter, the vast majority were funding related and timing of receiving that funding.

And then separately, last quarter, you talked about improvements in manufacturing, providing you the flexibility to lower this price on on so flow cells. Have you passed on any of the cost saving from manufacturing improvements to customers to catalyze greater adoption?

We certainly have, you know, with respect to on so in particular, we've done a couple of things. We've we've, you know, introduced promotional pricing in late May with respect to the capital. And now, you know, right now you can trade in any other NGS system and get a 99 K on so. But we've also lowered the cost per gigabase to now as low as four dollars. And when we launched the product, we launched it at fifteen dollars a gig. So, so, yes, we've taken some of that benefit by frankly, the majority of that benefit and passed it on to customers to drive adoption with respect to on so. And, you know, to kind of go back to the long report folio, we certainly are doing the some of the same things. You know, our yields have been improving on consumables, which are helping to drive our ability in bigger projects to give very nice pricing, but also drive better margins over time. And, you know, as Susan pointed out, and probably one of the things that the operations group is especially proud of is they've significantly taken the cost of Revio out, production costs of Revio down. And that's, you know, that's resulting in a lot more price flexibility. Turns out in the second quarter, we really didn't we really didn't need that. We, you know, we, we, the ASPs were up a bit, but it is part of our whole plan to get the cash flow break even, drive our gross margins up. And I think you're seeing early indications, you know, with the 400 basis point improvement this quarter that we're on a path to make that happen.

Thank you. Thank you,

Bill. Yeah. And the next question comes from Sudhi Nambi with Guggenheim. Please go ahead.

I apologize.

I apologize, Sudhi. Can you please repeat your question there?

Sure. This is Ricky on Fursubu at Guggenheim. Thanks for taking our question. You mentioned that you're expecting a 20 percent reduction in the Revio instrument and consumable costs by the end of the year, and you're expecting that to continue beyond 2024. So how much more room is there to reduce the costs from there? And then with respect to the source of the cost reductions, how much of this is due to scaling up production volume and how much of it is from more production based actions that you could carry across to other products as you launch them?

Yeah, that's a great question. And Ricky, to be clear, we talked about a 20 percent drop in Revio production costs, not the consumables per se. The consumables are going down as well. So we're going to see significant improvements. Those are both durable improvements that will persist. And they were not due to not really due to increases in manufacturing volumes. They on the Revio instrument side, the reductions are due to innovation that we've been able to do to take, you know, move the bomb and make the bomb less expensive. So that's improved algorithms which drive less the requirements for less compute or less cheaper GPUs, which drive cost down. They also include manufacturing changes in how we manufacture, you know, the relationship between our contract manufacturer and ourselves. We're insourcing more of the production. And as a result, we're able to eliminate the margin that our contract manufacturer would receive, which is substantial and still have a very high quality product and meet the production. On the consumer, Revio consumable side, you know, the benefits we're seeing, we're seeing increased yields. And so yields have been improving, which are a direct impact on the level of cost. And then we have, you know, we're tightening up our supply chain, which is also giving us benefits. So you're seeing durable impacts that will persist into 2024 and beyond.

I think the one thing that I'll add to that as well is that our restructuring, it also entails a restructuring of our service organization, which enabled us to take out some costs, which is again, structural going forward in terms of us being able to support more service revenue on a lower cost base, which is going to help improve our gross margin.

Yeah, that's a good point, Susan.

Great. Thank you. And just as a follow up, can you confirm how much of those cost reductions are baked into your guidance?

Well, we certainly are anticipating them and they're very real. So they're generally in our guidance, right Susan?

That's right. And so Christian had talked about enforcing a key component, which we initiated in Q2. There are other ideas that our manufacturing team has that we're more confident that we're going to enforce more. A lot of that is not baked into our guidance. It could be upside for this year, but if not, it'll come into 2025. We still have improvements in reducing the bond that is embedded in our guidance that is reflected in the graph that you see in the earnings presentation.

Yeah.

Thanks for the next

question.

Next question comes from Jack Meehan with Nefron Research. Please go ahead. Hi, thanks. Good afternoon.

I wanted to ask Christian just about your confidence around growing sales sequentially into year end. Even if you land at the low end of 170 million, I think that implies something like 45, 50 million per quarter in the back half. So I was just curious, did you build any backlog in the quarter or is this just really like timing, you can see the orders and they're going to start coming in in the second half?

Yeah, it's a good question, Jack. We did actually, our book to bill ratio was over one in the quarter, so we did build a little bit of backlog. But really, we see the sales funnels and we have building confidence that our consumables are going to grow and that instruments are expected to improve from where we are right now. I would expect the third quarter to be lower than the fourth quarter and also in the third quarter, we may see some government year end spending as well as in the fourth quarter, kind of general year end spending. So that might help us. And actually, if you look at the mix of revenue for the year versus most other years, it's not really that far out of line. Typically, you see 45, 55 in terms of percentages of the year. We're not that far off from those kinds of metrics. So if you look at the past, it's not unreasonable to kind of think of how this is going to play out. And if you look at the detailed sales funnels, we see radio instrument placements improving. We see the on-so funnel is significantly bigger than it's been, which should help. And then also the consumables, we're getting more, we have nice bookings in Q2. A lot of those will ship in Q3 and all through, for the next 12 months as more customers are getting on standing purchase agreements, which allows us to really have so much better visibility into the consumer numbers. So we have building confidence. The economic environment is still tough. I think most of our peers have been talking about a tough capital environment on their calls this quarter. We think it's going to be difficult the rest of the year. When we considered our guidance, we considered it was still going to be tough.

Great. And just one follow-up. Is the build of revenue into your end, is this predominantly coming from Revio? I know you talked about the new program as it relates to on-so for trade-ins. Is there any color you can share on what's embedded for on-so in terms of second half versus first half? Thank you.

Yeah, I think, I mean, on-so, we haven't, we don't break out on-so revenue, but on-so revenue is forecast to be significantly better than it was in the first half. So that will, you know, when you look at growth, that will be one of our fastest growth areas if our forecasts hold. But most, you know, on a relative basis, right, the Revio instruments, a lot more revenue per unit. And so I would expect Revio instrumentation as well as the scale-up in growth and consumers. Those will be the predominant drivers of growth in the backup.

Thanks, Jack.

And the next question comes from Doug Schneekel with Wolf Research. Please go ahead.

Hi, this is Madeline Moulman on for Doug. Growth margin improvement is one of the keys to financial viability of PacBio. Just wondering, how are you thinking about the exit rate for growth margin, given that you now expect to be at the low end of the guide?

Susan, you want to answer that?

Yeah. So you're right that we had guided the year's growth margins to be at the low end of the 35 to 38 percent growth margin. And our growth margins, we are structurally reducing the cost base of manufacturing our instruments and our consumables. And it's very much front and center when we think about the new products we're developing and how we, what components we include and how we think about the pricing and margin at launch. And so overall, our growth margins will expand as our revenue grows. That 35 percent, of course, if you look at how we've done in the first half, does assume that there's some fluctuation quarter to quarter. And as my prepared remarks describe, sometimes you do have some fluctuations in growth margins related to AFP mix, customer project mix, revenue mix. That can change some of the quarter to quarter margins. But I think the important takeaway is that structurally our cost base is coming down, such that when you look at 25 and 26 as our revenue continues to grow, our growth margins will expand and we'll get nice leverage on our growth margin as our revenues continue to grow. I think

that one thing I would add to that is, is, you know, revenue mix is essential here. You know, PacBio for its entire existence has been so dependent on instruments which carry lower gross margins than consumables. And, you know, Revio for the first time truly gives us the ability to have, you know, to generate consumable revenues that are high enough that really positively contribute to the gross margin. So although we may exit 20, you know, the year 24, you know, kind of at the lower end of the guidance, you know, when you look at the whole year, as consumables continue to grow, that will provide a natural uplift. Also, you know, we fully expect the new products that we're developing to carry higher gross margins than our existing products. And so those will all be contributing to, as we start to look at, you know, 2025 and 2026. It's a front and center issue for us, no question about it.

Great. Thank you.

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

Hi, this is John-Anne for Dave. Thanks for taking the question. First, I'd just like to ask about your headcount reduction. Could you give any thoughts on how confident you are that the reduction won't impact sales growth? Thank you.

Well, you know, I think you asked the question for sales growth in the headcount reduction specifically, and so I'll address that first. But, you know, we did make cuts across the organization, and surely the sales organization was impacted some, but it was less impacted than some of the other groups. And so, you know, we spent a lot of time building out a commercial infrastructure to support the long run of the company. And what we've done is, in this last restructuring, we reorganized the commercial organization a bit so that we can have fewer spans and layers and have much more executive touch, so to speak, with the customers directly. And so I feel pretty confident that that's helping and that's driving conversations. Of course, Q2 is when we executed all this, so we'll see over the next few quarters how we do. But the early signs are pointing to that we are maintaining those customer relationships, we're building new relationships, and we are acting faster, which is encouraging. If you look at the rest of the business, you know, we also cut very significantly across R&D, but we were very focused on focusing, making sure that we invested appropriately in the near-term revenue driving projects like the new platforms. And those new platforms, you know, are fully staffed and we're making great progress. And, you know, quite frankly, when you look at Q2, the revenue result was not what we expected, but the R&D result was was actually ahead of what I was expecting. And so I'm very excited about the progress we're making, even though we had to make some very painful decisions with respect to the restructuring.

Great, thank you. And if you could give any thoughts that you have on what the pipeline that looks like for population sequencing projects globally and what the appetite is for long read sequencing generally, that'd be great. Thank you.

I missed the second part of that question. Yeah, top 10 was the first part. What was the second part? Oh, appetite for long read sequencing in general. So, you know, with respect to top 10, we're still tracking many, you know, many, many 10,000 plus sample projects that are working their way through the system. We are very happy to see some of the bigger projects get off the ground in Q2. So the Estonia Biobank project started sequencing, the Gregor Consortium project started sequencing precise, started sequencing. So those are all, those are all strong projects that are going to, that are really starting to scale. We see lots of opportunities around the world. And it really comes down to these projects take a long time to get the sample cohorts in place, as well as all the funding and all the infrastructure required to execute on them. But with respect to, you know, seeing more of those later this year, I wouldn't be surprised to see us announce some other projects this year. Certainly over the next, you know, certainly over the next 18 months, there are lots of projects and lots of fleet expansions that we are seeing that I think are real, you know, opportunities for the company. One thing I would say that is really encouraging and probably the brightest spot in the quarter is just the amount of clinical adoption we're starting to see is really fantastic. And it was really driven off of, we launched a new product called Pure Target, which is a panel, which a lot of the clinical diagnostic companies are leveraging that panel and creating their own versions of the panel to do everything from carrier testing to neurology and other kinds of clinical testing. These are going to be, you know, very large customers over time for us. That's our expectation. And they will be running thousands and thousands of samples, which will create a durable source of revenue. And I think that's happening on a timeline quite frankly faster than I would have expected. So encouraged by the population sequencing, also very encouraged by sequencing uptake in general. I do think that we are still absorbing some capacity, you know, with particularly with service providers and kind of the classic academic core labs. And so, you know, we're working hard with them to help them get projects so that they can fill their instruments up. And eventually we'll have the low throughput long read instrument, which will be a great complement to Revio. And we'll see, I wouldn't be surprised to see many customers have Revio and the low throughput instrument in their labs. And other customers allowing a more distributed long read sequencing capability using Hi-Fi with the low throughput instrument. So looking forward to getting that product out the door too. Thanks, John. Thank you very

much. And the next question comes from Eve Bernstein with Bernstein.

Hi, this is Alberto on for Eve. I remember having a discussion with you on customers in China generally having very high utilization rates. Yesterday, one of your competitors said that stimulus in China would not affect NGS while you mentioned that it could be actually a tailwind. So how are the conversation going with these customers and potentially other customers in the region? And what do you guys expect for 2025, especially after a rough year in China for everyone?

Yeah, that's a good question. I don't think any stimulus funding wouldn't necessarily be a tailwind. I think it's maybe perhaps a bit of a more return to normalcy. Our business is very different than some of our competitors in China in particular in that we have several large service providers as our primary customers and then they market out into the Chinese market and it's mostly a service business for us. The implications of that are that we perhaps get more aggregated revenue into a concentrated customer base. Those service providers have been having a tough year this year, but we do think the stimulus will add more projects which will help those service providers and as we get the low throughput instrument into the market as well, give other Chinese customers the opportunity for that low throughput instrument. If you look at the rest of Asia Pacific, there are a few bright spots, but actually Asia Pacific as a whole has been pretty tough. Korea is not in very good standing. Japan is doing okay. The rest of Southeast Asia, at least for us, is doing maybe just a bit below expectations but not radically strong either. Asia is really a tough market for us overall this year, mainly driven by the China challenge. I think 2025 will be better than 2024. I do think the stimulus will help. Some new products will help and we'll go from there.

Okay, thank you. Another question I had, I saw from your graph and also from your comments that actually the Quest partnership is going very well. How would you speculate your strategy around the clinical market and partnership? We've seen your main competitor having large partnerships with equity investments in there. How would you articulate your strategy in the clinical market? Aside from neurological applications, what are the main areas in which you're seeing the most interest that could actually really scale to the next level?

Yeah, so in the clinical market, our strategy is to develop products and kits and technologies that really compete and do things that short-re sequencing can't do very well first and foremost and use that as a beachhead to get into those accounts and then demonstrate that the power of Hi-Fi can supplant even short-read sequencing. This is evident, for example, at Biosentia in Germany where they're converting many tests into one Hi-Fi whole genome test. For them, economically, it makes incredible sense because they're eliminating all of these other tests and using a long-read whole genome to get the results. Our strategy is to penetrate with applications that are difficult for short-reads to accomplish, if not impossible, and then spread by demonstrating our value proposition and our competitive costs and economics across the entire workflow. That's the fundamental strategy. The early applications where we're seeing the most traction are, of course, in rare and undiagnosed disease where we're seeing institutes like Kildes-Mercy continue expanding their fleet and they're now using a Hi-Fi whole genome as the first-line diagnostic for these kids coming in with rare disease, which is just quite frankly very gratifying and quite remarkable. We're also seeing customers interested in various long-read panels, particularly in carrier testing, where long-read sequencing can be much more effective at many different disorders or potential diagnostic problems when thinking about having a baby than what short-read sequencing can do. Then the third is this whole genome approach where you do a whole genome and you replace a battery of other tests. The combination of those is where we're seeing a lot of traction. Really, we saw that was certainly one of the biggest bright spots for us in Q2. Over time, we think we're going to see more oncology testing, particularly in the blood cancers using long reads. As we drive our sample input requirements down with the new radio consumables, that will enable us to do more than we ever have before as well. We see the clinical opportunity as fundamentally really important. We're very focused on it right now by providing technologies that no one else really has and we can do things that others can't.

Thank you. The next question comes from Sung Jinam with Scotiabank. Please go ahead.

Hi, thanks for taking the questions. A lot of my questions have been answered, but just wondering about your existing SQL customers. I might not be doing the maps fast enough, but the ones that have not converted yet to Revio that are waiting for funding or whatnot, are they still utilizing consumables at a pretty steady rate? Do you expect them to continue to do or has there been any slowdown in terms of consumable pull through for that segment of your customers?

The customers that are still SQL users are generally using their instruments. The pull through of the install base has gone down some. They are using them less, but the reality is they're still using consumables. They're still regularly using them. I would expect over time they will move on to Revio or they'll move on to the low-throughput system when that's available. I would suspect some of those SQL customers are also outsourcing maybe perhaps their bigger projects to Revio core labs, which is okay, but it's another indication that we need to keep pushing long read samples into the market so that we can really take advantage of the throughput and the capability of the Revio system.

Gotcha. Then just on the low-throughput long read, just as a clarification, that's what you used to say, is that correct? Sorry if I missed it, but what's the timing in terms of the launch there? Is that a platform where you expect to do some sort of an early access program to get a sense of the customer feedback or is that something that you can just launch and plug and play?

The low-throughput system is certainly the bench-top system. We should have used that terminology. With respect to an early access program, the reality is that the bench-top system uses the exact same consumables as the Revio. It uses the 25M smart cell as the principal tool there. We expect it to basically work with all applications straight out of the box. I don't think we'll have a very extensive early access program. I think we'll go pretty much straight to market. We're deep in our development right now. We haven't announced the launch date, so I'm not going to use an earnings call to do that, but I do think it is a mission-critical platform for us. We've made a lot of progress and we're not that far away.

Super helpful.

Thank you.

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

Good afternoon. Thanks for taking my questions. Just an interest of time. I think it's got two quick ones. I'll ask them both up front. The first one is just Christian on ASPs. You've made a couple of mentions of higher ASPs in the quarter. One, what's driving that higher ASP? What are your expectations of ASPs going to the back half? Just given the mix of programs you have to onboard customers, is there any particular program that's driving that? Secondly, just on the demand and your comments on reacceleration of back half, you outlined a couple of points for Q2 that are hurting demand, two of which are the delays in procurement and the sample volumes. Do you expect those to improve or do you expect more to persevere through those issues that could last throughout the course of the year?

Thanks. Good questions, Matt. First of all, ASPs were higher. ASPs are going to vary from quarter to quarter. The reason why I highlighted that on the call was I just wanted to point out that ASPs, although we didn't have a great unit quarter relative to our internal expectations, we also didn't give away the farm to get to the numbers that we got to. That was important. I think that ASPs will probably stick around the same range we're in right now, give or take for the rest of the year. The promotional programs, you know what's important about those? Usually what happens is you get some deals on those promotional programs, but the most important part of these promotions is it gives us opportunities to market the products and get, it funnels, drives interest. Some customers can take advantage of the promos, like we have a promo now where you don't pay any money down for the instrument, but you have to take a certain amount of consumables every month, so to speak, and basically the price of the instrument is baked into the price of the consumables. Some customers can do that because they have a steady stream and they know where they're going. Other customers can't because they run from project to project and they worry that they may not have a use for the consumables in the off month, so to speak. That's why I'm so excited about this Mitsubishi program where it's a straight rental. I haven't seen that done very much in our field in the past, and so that'll be interesting to see how research customers take that up, but either way, it's a really good way for people to, for us to get out there and be in front of our customers, demonstrating flexibility and driving sales. With respect to kind of the challenges with accelerating demand, procurement and numbers of samples, I think procurement is an area where you just have to persevere. I think the rest, I think the capital market is, the market for capital equipment is still going to be tough. It's probably going to be tough all next year and perhaps even into next year. So we just have to be very much in tune with our customers and understand everything it takes to get a sale done and through the pyramid process so that we can, number one, forecast accurately, but number two, accelerate the deals as fast as we practically can. With respect to samples, I think samples are continuing to increase. One of the metrics Todd kept talking to me about was the fact that we sequenced over 2.2 fold more sequence in the last year when you compare on a year over year basis. That's dramatic, and it shows that long reads, it demonstrates that long reads really are taking hold in the market and becoming a very important part of the market. What we, I do think more and more samples are coming into the market, and so that one, I think, can be, you know, will be rectified probably much faster. And also, as we continue to develop new applications, those new applications drive even more samples. When we talked about with the new Revio consumables that are coming, the DNA input requirements are going to go down very, very significantly, and that is also going to drive more samples into the Revio platform. So I'm much more bullish on samples coming into the market than solving the procurement challenge, to be honest.

Got it. Very helpful. Thanks, Christian. Yep. Thank you,

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

Sure.

Thanks, Dave, and thanks, everybody, for the questions and the time today. We look forward to connecting with many of you later this quarter at the various conferences, and we'll talk soon. Take care.

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