Pacific Biosciences of California Inc (PACB) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen,, and welcome to the Pacific Biosciences of California, Inc.

Fourth Quarter 2017 Earnings Conference Call.

(Operator Instructions)

I'd now like to introduce your host for today's conference Ms. Trevin Rard.

Ma'am, you may begin.

Thank you.

Good afternoon, and welcome to the Pacific Biosciences Fourth Quarter and Year Ending 2017 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 8-K, 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 reports on Form 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 our live call.

I'll now turn the call over to Mike.

Thanks, Trevin.

Good afternoon, and thank you for joining us today.

We are pleased with our fourth quarter results and our progress in driving growth in our business.

Highlights of our Q4 and full year 2017 financial results are as follows.

We generated $24.9 million in product and service revenue for the fourth quarter, up 2% from Q4, 2016.

For the year, our product and service revenue grew 19% from $78.6 million in 2016 to $93.5 million in 2017.

Consumable revenue for the fourth quarter was $12.7 million, up 70% from the $7.5 million recorded in Q4, 2016.

For the year, our consumable revenue increased by 75%.

The dramatic growth in consumable revenue was driven by increased utilization on our growing installed base of Sequel systems.

Consumable revenue generated from Sequel Systems grew more than 8x year-over-year, and represented approximately 80% of the Q4 total.

The average annualized pull through revenue on Sequel instruments during the fourth quarter was over $180,000 and is approaching $200,000.

Instrument revenue for the quarter was $9.2 million, compared with $13.1 million in Q4 of 2016.

For the year, instrument revenue totaled $38.6 million compared with $41 million in 2016.

The decrease in instrument revenue year-over-year stems from higher shipments of instruments in the latter part of 2016 and early 2017.

As we work down the initial backlog of Sequel orders that had built up while we were limiting shipments until we had moved to our high volumes SMRT Cell supplier in 2016.

Most of that backlog was depleted after Q1, 2017.

We ended the year with an installed base of over 370 Pack Biosystems.

Gross margin for the fourth quarter was 38%, representing a recovery from the dip in gross margin that we saw in third quarter.

We mentioned in our previous call that our gross margins have been hindered this past year by higher service-related costs.

While margins on our service business are still not where we'd like them to be, we expect gradual improvement in our service margins, as we continue to work through upgrades, apart from the shorter-than-expected lifetime, which we discussed in our Q3 conference call.

Turning now to recent sales highlights.

We continue to see significant growth of our business in China.

For the year, our sales into China exceeded 30% of our total sales, compared with about 10% of our sales in 2016.

Our sales momentum in this region continues, as we recently received an order for 10 Sequel systems, from BGI in China.

BGI had previously purchased one RS II instrument in 2015 and 2 Sequel instruments in 2017.

As one of their premier sequencing service providers in the world, they are seeing significant growth in demand for PacBio sequencing services.

We are particularly pleased that BGI chose a significant additional investment in our long-read sequencing technology, even after careful evaluation of alternatives.

They intend to use this additional capacity to satisfy their demand for plant, animal and bacterial sequencing and to embark on new projects in areas such as conservation biology.

We expect to receive an order of similar size from another Chinese service provider in the next couple of months.

Other sales highlights for the quarter apart from our business in China, include repeat orders at several sites in the U.S. and Europe that previously had been holding off on these orders until system reliability and performance were at the level they expected.

We've also started to see a pickup in system utilization across numerous sites such as these, as our customers have been achieving consistent results with their Sequel systems.

A few weeks ago, we attended the Annual Plant and Animal Genome Conference, or PAG, in San Diego, which brings together over 3,000 researchers in the space each year.

The first PAG conference report of a plant genome assembly based on SMRT Sequencing occurred in 2014.

Fast forward to 2018, and PacBio is now a leading player in plant and animal sequencing.

There were 66 program presentations and 50 poster presentations at this year's PAG conference featuring PacBio.

Our the past few years, PacBio has enabled researchers in the egg bio space to produce over 350 high-quality reference genomes for a wide range of important plant crops and animals.

Interestingly, the genetic variation in plants and animals is significantly higher than humans.

And therefore, in order to effectively study this variation, it often requires more than just a single reference genome for each species.

Leading up the conference, multiple customers recently cited that they are embarking on generating many more reference genomes with PacBio.

For example, Rod Wing from the University of Arizona stated that he is aiming to build high-quality reference genomes for 23 additional species of rice using SMRT Sequencing.

At DuPont Pioneer, researchers have started creating high-quality reference genomes for several of their elite reading lines, as well as select wild streams.

Kevin Fengler from the Data Science and Informatics Group at the Pioneer, stated that having multiple genome assemblies of the same high standard for several genotypes being increasingly important as researchers try to achieve a greater understanding of the impacts of structural variation on plant genomes.

He went on to say, "We want to focus on true structural variation and have confidence in the new discoveries we find in these genomes.

Until now, focusing on one reference genome has limited our view.

We're just beginning to explore what we've been missing all along."

Shortly after the conference, researchers at the Max Planck Institute in Dresden, published in Nature the assemblies of axolotl and planaria, 2 of the major model organisms for studying tissue regeneration.

The axolotl genome is 10x the size of the human genome and is now the largest assembled genome.

Referring to MPI Dresden's axolotl study, one recent tweet stated, "A study in complex repeats this large and important genome assembly, down with @PacBio long-read technology, will unlock mechanisms of genome regulation, limb regeneration and species evolution."

I don't usually cite tweets in these conference calls, but this one simply states the importance of this study, importance also illustrated by the axolotl assembly report, making the cover of the journal Nature this week.

Turning now to our product development activities, we are currently performing field beta testing on a new enzyme and software for the Sequel systems, which we expect to provide significant performance improvements across all of our customer applications.

Early results show the experiments using large libraries can yield up to twice as much data for SMRT Cell compared to a year ago.

In experiments with shorter amplicon-based libraries can yield up to 4x as much data compared to a year ago.

In addition, new software provides further capabilities and streamlining for applications such as structural variation analysis and Iso-Seq, which is becoming a popular PacBio solution for taking RNA sequencing beyond gene expression to characterizing isoforms.

We are planning to start the full commercial release of these improvements in a couple of weeks.

Later this year, we are planning to release a new chemistry that will again increase read links and throughput on the Sequel system.

Our target is to at least double the throughput through chemistry sample prep and software improvements again this year.

We are continuing to work also on the new version of the 8 million ZMW SMRT Cell.

This program is progressing well, and we continue to target completing the development of the chip by the end of this year.

Our ongoing goal is to enable our customers to generate high-quality, human-sized de novo genomes that cover the full range of genetic diversity, from single nuclear-type variance to structural variance to haplotype phasing at a cost comparable to short-read based analysis of single nuclear-type variance alone.

On the publications front, a very interesting article made the cover of Nature Biotechnology this month, entitled Metagenomic binning and Association of Plasmids with bacterial host genomes using DNA methylation.

In this study, researchers from Mount Sinai used PacBio to generate metagenome sequences from human microbiome samples.

The biggest challenge in interpreting these sequencing has been developing binning methods to identify the various genomes present in each sample, especially where they are multiply closely related species or strains present.

The researchers in this study took advantage of PacBio's unique capability to recognize DNA methylation signatures in bacteria, to resolve individual reads and contigs into species in strain level bins.

In addition to binning, the researchers were able to link plasmids and other mobile genetic elements to their host bacterial species.

These genetic elements are frequently the source of changes to these organism's bacterial virulence and resistance to antibodies -- antibiotics.

That concludes my initial remarks.

I'll now turn it over to Susan to provide more details on our financial results.

Thank you, Mike, and good afternoon, everyone.

I will begin my remarks today with a financial overview of our fourth quarter that ended December 31, 2017.

I will then provide details on our operating results for the quarter and the year, with a comparison to Q4 of 2016 and the full year of 2016, respectively.

I will conclude my remarks with a brief discussion of the 2017 end of year balance sheet.

Starting with our fourth quarter of 2017 and 2017 full year financial highlights.

During the quarter, we recognized revenue of $24.9 million and incurred a net loss of $20.8 million.

For the full year of 2017, we recognized revenue of $93.5 million and incurred a net loss of $92.2 million.

We ended the year with $62.9 million in cash and investments.

Turning to revenue.

The $24.9 million of product, service and other revenue in Q4 of 2017 was $500,000 higher than the $24.4 million of product, service and other revenue in Q4 of 2016.

In Q4 of 2016, we also recognized $1.2 million of Roche contractual revenue.

Including this contractual revenue, total revenue was $25.7 million in Q4 of 2016.

For the year, products and service and other revenue in 2017 was $93.5 million, up 19% compared to $78.6 million recognized during 2016.

Total revenue in 2016 was $90.7 million, which includes $12.1 million of Roche contractual revenue.

Breaking down the revenue.

Instrument revenue recognized in Q4, 2017, was $9.2 million, down $3.9 million from the $13.1 million recognized in Q4 of 2016.

Full year instrument revenue was $38.6 million in 2017, $2.4 million lower than the $41 million recognized during 2016.

Consumable revenue continues to be strong, increasing 70% to $12.7 million for the quarter, up $5.2 million from the $7.5 million reported during the fourth quarter of 2016.

This substantial year-over-year revenue increase highlights the continued consumable sales momentum that has now resulted in 8 consecutive quarters of consumable revenue growth.

For the year, consumable revenue increased 75% to $41.4 million in 2017, compared to $23.7 million in 2016.

Service and other revenue was $3.1 million in the quarter, down from $3.8 million in Q4 of 2016.

For the year, service and other revenue was $13.4 million, down from $14 million in 2016, with regards to gross profit and margins.

In Q4 of 2017, we generated a gross profit of $9.5 million, resulting in a gross margin of 38%.

This compares to a gross profit of $11.4 million in Q4 of 2016.

Excluding the $1.3 million of Roche contractual revenue, the adjusted gross profit was $10.1 million and 41% gross margin in Q4 of 2016.

For the year, gross profit in 2017 was $34.7 million and gross margin was 37%.

This compares to a gross profit of $44.2 million in 2016.

Excluding the $12.1 million of Roche contractual revenue recognized in 2016, the adjusted gross profit in 2016 was $32.1 million with a gross margin of 41%.

Our regional and product mix contribute to quarterly gross margin variances.

In 2017, a consistent contributor to our total gross margin decrease has been the decrease in service margins.

2017 service margins have been affected negatively due to the transition from the RS II to the Sequel product line.

Year-over-year our service revenue has been slightly down, as the higher-priced RS service contracts are being replaced with lower-priced Sequel contracts.

This has occurred while our service costs have increased, in part, due to an early buildup of our field personnel to ensure that our early Sequel customers are successful.

Also, as we have stated in previous calls, we incurred $1.6 million in charges related to the change in useful life of RS II lease instruments earlier this year.

The leased RS II instruments helped a number of our customers experience a smooth transaction to their Sequel instruments.

And as we have previously mentioned, our proactive replacement of certain parts in the Sequel installed base has added to the service costs 2017.

Moving to operating expenses, operating expenses in the fourth quarter of 2017 totaled $30 million compared to $29.2 million in Q4 of 2016.

For the full year, operating expenses in 2017 were $124.4 million, $9 million higher than the $115.4 million incurred in 2016.

Noncash stock-based compensation included in the operating expenses was $4.8 million in Q4 of 2017, verses $4.3 million in Q4 of 2016.

Breaking down our operating expenses.

R&D expenses in the quarter were $15.6 million, down from $16.2 million incurred in Q4 of 2016.

R&D expenses were $65.3 million in 2017, down $2.3 million from the $67.6 million incurred in 2016.

Most of this decrease year-over-year was related to the higher chip development cost incurred in 2016.

R&D expenses in the quarter included $2.4 million of noncash, stock-based compensation expense, slightly higher than the $2.1 million of expense in Q4 of 2016.

Sales, general and administrative expenses in the quarter were $14.4 million compared to $13 million in Q4 of 2016.

For the full year 2017 SG&A expenses were $59.1 million compared to $47.8 million incurred in 2016.

As we mentioned throughout last year, the move to our new facility in Menlo Park in Q1 2017, impacted expenses and SG&A.

Additionally, SG&A expenses were higher year-over-year, as a result of increased legal and compensation costs.

Compensation costs rose primarily due to the hiring in our sales and field support organizations.

SG&A expenses in the fourth quarter of 2017 included $2.4 million of noncash stock-based compensation expense, relatively flat compared to the $2.2 million of noncash stock-based compensation expense recognized in Q4 of 2016.

Finally, in Q4 of 2017, we recorded $200,000 of net interest and other expense compared to $1.1 million recorded in Q4 of 2016.

The primary reason for the reduction was $700,000 in more favorable foreign exchange movement in Q4 of 2017 in contrast to less favorable foreign exchange movement in Q4 of 2016.

While our interest expense in 2017 a consequence of our pay down of $4.5 million in debt in June of 2017, also contributed to the reduction of other income and expense in 2017.

For the year, we recorded $2.4 million in net interest and other expense, compared to $3.2 million in 2016.

Turning to our balance sheet.

As I mentioned to begin my comments, our balance of cash investments was $62.9 million at the end of the fourth quarter, $21.1 million lower than the $84 million at the end of third quarter.

While cash flow can always fluctuate as a result of balance sheet changes, in Q4 of 2017, we experienced particularly large changes in the balances of both inventory and accounts receivable that contributed to the increase in cash burn in the quarter.

Our inventory balance was substantially higher at the end of the quarter, $23.1 million in Q4, up from $18.2 million at the end of Q3.

This was primarily the result of our stocking up of chip inventory, to ensure we can meet the high growth we are experiencing in consumables revenue.

Accounts receivable balance can also increase substantially in Q4 to $13.4 million from $8.9 million at the end of Q3.

This was a result of a higher proportion of (inaudible) shipments occurring during the latter part of Q4.

Specifically, between the 2 aforementioned accounts, we increased our working capital by $9.4 million and consequentially, increased our cash usage above normal rates in the quarter.

Going forward, we expect to reduce our capital -- working capital requirements and bring our cash usage levels below our historic numbers.

This concludes my remarks on the financial results for the quarter.

I'd like to turn the call over to Ben.

Thank you, Susan.

I'll be providing a forecast of our 2018 financial performance.

Starting with revenue, we were pleased with our fourth quarter revenues, which came in above our previous forecast.

Building on this momentum, we expect our 2018 revenues to grow 20% over our 2017 revenues, which translates to approximately $112 million in total revenue.

A significant driver of our revenue growth continues to be consumables, as our annualized average pull-through revenue per Sequel instrument grew to over $180,000 this past quarter.

In the near term, we expect our Q1, 2018 revenue to be a little lower than our Q4, 2017 revenue due to seasonality.

As Mike mentioned earlier, our revenue in China represented over 30% of our total revenue last year.

During Chinese New Year, which occurs in the middle of Q1, we expect many large sites in Asia to stop running their systems for 1 to 2 weeks.

As a result, our consumable revenues for Q1 are likely to be slightly down compared with Q4.

We expect significant sequential growth in consumables after Q1.

Moving on to gross margin.

We are focused on improving gross margins this year by driving topline growth, while keeping our fixed cost flat and by gradually reducing our service costs.

We will likely start off the year with gross margin that is relatively flat compared with Q4, which is a little less than 40%.

If our revenue increases during the year as anticipated, we expect our gross margin percentage to gradually increase and get to the mid-40s by the fourth quarter of this year.

Moving onto operating expenses, we're targeting to keep our operating expenses relatively flat year-over-year at approximately $125 million.

We expect our quarterly operating expense pattern to be similar to what we saw in 2017, with Q1 and Q2 operating expenses higher than Q3 and Q4.

Adding up our revenue, gross margin and operating expense estimates for the year, we are forecasting a net loss of approximately $81 million for the year.

However, our net loss estimate includes approximately $27 million of noncash stock compensation and depreciation expense.

And we expect to bring significantly less cash in 2018 compared with 2017.

We ended the year with about $63 million in unrestricted cash and investments on hand, and while we expect to consume less than that amount this year, we plan to raise additional capital this year.

That concludes our prepared remarks, and we will now open the call up to questions.

(Operator Instructions) I have a question from Amanda Murphy from William Blair.

So I guess just a quick one on the consumables side.

Obviously, you've had good success there in ramping.

Can you just remind us where -- what -- maybe even just that the highest use customers kind of where they sit or what the theoretical max is on the Sequel per -- kind of on an annualized basis?

And then, to the extent that you can give us some sense of how you're thinking about that $180,000 going to $200,000, et cetera, through '18?

Should we sort of expect it to continue to ramp or are we kind of running into sort of an average max at this point?

This is Mike, Amanda.

Well, you -- the really high-end customers are some of the big service labs, particularly in China, can run north of $400,000 per year.

And a couple of them are.

We don't expect to be able to get anywhere close to that as an average to the system I think right now.

On the other hand, what we're trying to do is push the overall average up by moving up the people who are at the lower end of the spectrum usage near to the high one.

And we think we haven't reached the average maximum yet.

But what happens once you get beyond a certain point is people have to ramp-up their throughput by buying more instruments.

And that's what we've seen in China.

And we're starting to see now in the U.S. and Europe, which keeps the average from going up too high, but it gives your total a big boost, because you get more instruments, upon which to apply that average usage per instrument per year.

So that the consumables kind of drive, particularly with high usage, drive instrument purchases and instrument purchases drive more absolute consumable dollars.

Yes.

That makes sense.

And then I know you're trying to get away from the idea of giving specific platform numbers and all that, but then -- I guess just thinking about next -- this year as it is now '17, '18.

And instrument revenue, it seems like you've been kind of bumping up on that $10 million number for a couple of quarters, and you've obviously got a couple of pretty large orders that have been closed.

So I guess how do we think about that through the year, especially if you come into the potential for a new chip?

Do you think that might drive an acceleration or just trying to get a sense of the year progression on the instrument side.

Well, yes, this is Ben.

Quarter-to-quarter, instrument revenue forecasting is just a challenging thing to do.

So we are seeing a lot of interest.

And as you've mentioned, we have a good start here with this 10-unit order from BGI.

But know that since it is a little bit choppy, we would probably refrain from giving you some quarterly forecast on what the instrument revenue are going to be.

We try to incorporate what things average out to be in the overall guidance for the year.

Okay.

And then in terms of the 8 million, well, chip, so can you just kind of walk through as to when we might -- obviously you're -- you've been working on that for a while now.

I guess like when can we kind of expect to see some even internal generated data?

Is that something that would be closer to the end of the year or maybe -- might be something midyear?

Well, I think we'll stick with what we said is we expect to finish the development of it by the end of the year.

We've kind of consistently said that for the last year plus.

And obviously, in the course of that development, you're generating data internally.

When we choose to release that depends on how fast we get that done, and it -- as I said before, one of the frustrating things about this technology is how long it takes to get things through chip fabs.

There about chemistry you can make something and do the experiment really fast, but this chip development processes because -- well, the lithography can be really slow, take a while.

So we're trying not to get too far ahead of that.

We feel that we're on track with where we thought we were going to be for the last 1.5 years and still are very confident about the time line that we've announced.

And obviously as when we get data that's appropriate, we will make that available.

Okay.

Yes.

I guess was just trying to get a sense if you've seen -- I mean, that's a pretty meaningful increase in throughput, and you've obviously delivered throughput increases already that are quite meaningful.

So is that translating into new -- and obviously you've had repeat orders that you've talked about, but is that translating into new orders at this point?

Or are you sort of running -- go ahead.

You have to remember we're (inaudible) chip developed.

We don't even have a chip developed, so...

Well, I guess I'm just referring to...

Let me see if I can answer the question.

So -- well, the answer is yes.

Although we did a major release of software and some aspects of our chemistry back in mid-summer last year, and it's at that point that we began to see a fairly dramatic increase in the overall utilization of the Sequel Systems.

It was a pretty hefty improvement in reliability which helped, so people got more consistent results.

And that drove up the usage.

And we would expect, as people start to get the release that we're a couple of weeks away from now, that we've been in beta for a while, where they will see similar levels of performance increase.

And every time in the past, even on the old RS, when we increased performance on the system, that makes the system more amenable to use by a larger number of people on larger projects.

And so we think that's unique to us.

If you look at other suppliers of sequencing systems, going back 25 or 30 years, increased performance, reduced cost to do projects, drive new applications and new use and increased use on the technology.

So we fully expect, as we can continue to do what we've been doing, to see that happening.

And our next question comes from Tycho Peterson from JPMorgan.

Mike, wanted to ask on your visibility and trying to be on kind of some of these bigger multisystem orders that are coming through.

Are you starting to get interest from smaller labs and customers?

Yes.

We've always had interest in smaller labs and customers, and we don't obviously announce every single unit order that we get.

Unless they want to.

Unless the customer wants to do that.

Because individually, they're not material to us from a reporting perspective.

But we've continued to see smaller purchase, not just in China, but in several countries in Asia.

And then if we think about the legacy installed base, you still have about 150 RS IIs out there.

Can you maybe just talk on how you think about potentially upgrading those over time in the U.S. and Europe?

Yes, Tycho.

This is Ben.

I think, naturally, some of those have been upgraded as some people have purchased Sequel Systems and sort of wean themselves off of the RS IIs, if you will.

So it continues to be a source for us in terms of targeting certain customers.

And now that there's more and more good data coming out on the Sequel System, we expect that to continue.

Again, people who sort of on the tail end of their lives with the RS II are looking at Sequel in terms of their next capital purchase.

And then I guess on the clinical front, just curious as to your latest thoughts on partnering up there.

And yes, I mean, are you having active discussions with other potential partners at this point?

We are.

And Kathy Ordoñez is both on our board and Chief Commercial Officer is spearheading that.

We have active negotiations with more than one potential partner there.

As we said before, we're trying to be very careful this time about matching up the needs and expectations and opportunities from these more closely with both our capabilities and what we need to be providing into that space than maybe we did in our past experience there.

But we still feel very encouraged about the place for a technology in that space and the ability to work with the right partner there.

And our next question comes from Bill Quirk from Piper Jaffray.

Great.

So just to follow-up, Mike, with Amanda's question.

Do you have a timetable at this point for when the 8 million features or more waveguides would be released to your users?

Well, what we've said pretty consistently, I think, is that we expect to get the development done this year so that we can produce them and then begin in 2019 to roll that out to the field.

And the only reason we've not given an exact date on it at this point is that it does depend how fast we can ramp up the production facility.

This is a less of an issue from an unknown than it was with the first Sequel chip because the fundamental elements of it are pretty much the same, but you are somewhat dependent upon schedules at the fabs and so forth that we use.

And we don't see any glitches at this point.

They're likely to delay what we're doing, but we're still a year away from being able to roll that out to a significant number of places.

So we want to be a little cautious about that.

That said, we've been on track from our schedules from day 1 so far, which is helpful, because it is consistent with the fact that we're not making nearly as dramatic changes in the chip as we did going from the RS-type SMRT Cell to the Sequel-type SMRT Cell.

Okay.

That's good to hear.

I appreciate the color.

And then on the potentially additional large order coming in from China, it sounded like, based on your comments there, Mike, that, that sounds -- it sounds like it's kind of in the final stages here.

So is that something that we could expect to see from an announcement standpoint here, presumably some time in the first quarter, certainly in the first half of the year?

The answer is yes.

I mean, that's what we're expecting.

The thing that you find in negotiating these deals, bigger deals in China, as we mentioned before, a lot of these are driven by the regional provincial governments in helping these companies set up or expand their operations dramatically.

And so you're negotiating not just with the company who can make a decision pretty quickly once they go through the formal tender process.

But you're also in the end, negotiating with the source of the cash, which is the local government.

And particularly, in the case where we've got Chinese New Year coming up in a couple of weeks, the exact timing on how soon you get through those, that latter level of negotiations is not something we feel predicting down to the week.

That said, and I suspect most of you have seen some of the early announcement by the company of their intentions to expand SMRT technology that was made even back in December, we feel pretty comfortable with where the process is and its various stages right now without knowing exactly the date in which we will not only sign on the dotted line with the government but go through the process where we could call it a full order and begin to ship the systems over there.

But the best guidance we've given you is in the next couple of months.

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

So I just wanted to talk about -- or wanted to ask about placements to new versus existing customers and what that ratio looks like.

Yes.

This is Ben.

It's -- yes, quarter-to-quarter, tougher to sort of pin down because, again, it does fluctuate.

But we're still getting, generally speaking, more orders from new customers than existing customers.

But you get some of these large orders like the 10-unit order from BGI that kind of skews that calculation a little bit.

But I do think, this is Susan, one thing Mike mentioned that was important to point out in the call, especially in this last quarter.

We do see the -- with the reliability and the -- of the Sequel System and release of the software that we released in the center that this customer is coming back now, so there were some nice repeat orders in the base.

I mean, you can even think of the BGI order as a repeat order, right?

Yes, yes.

Got 2 initially.

And having seen the performance over the last 6 months, they now ordered another 10 instruments.

And I -- we're just now starting to really see that in the U.S. and Europe.

This really was the first quarter where we had a significant number of those sites that came back, and I think it will be a while before some of those get up to the size of some of these big sites in China, these big service providers.

But the encouragement is they're starting that process now, and they weren't before, which was holding back both our overall sales.

But it also means that these are people who are at the higher end of the usage spectrum because otherwise they don't need to buy more instruments.

And so that encourages us from the perspective of the consumables growth.

Got you.

And I don't know necessarily how to look at this.

So I mean, I guess the reason why I'm asking is you saw it on a go-forward basis.

Should I be -- I know it's a chicken-and-egg kind of question.

But should I be looking at consumables driving instrument base?

Or should I be looking at the instrument base being the one that's driving consumables?

Yes, yes.

Yes.

It is both.

Well, it certainly is both.

In the long term, we firmly believe that utilization is going to drive instrument sales and that's because you -- unless you have good references out there.

And it is still largely a reference-based sale.

You're not going to get those unless you have a good customer base that's having successes with their systems.

And then for these repeat orders that we've been talking about, these are people that are getting up to the capacity on their systems because of the utilization rate, and that's going to lead to further system purchases.

So the way we like to think about it is ultimately you got to have high utilization, which translates into successful customers in order to have ongoing instrument sale.

Got you.

I don't mean to keep...

Let me just add a little bit to that.

That high usage in those -- in your existing base drives new sales to new customers as much as it does drive new sales as repeat sales to those existing customers because you really need both.

You really need that sort of spur of customers doing marketing for you, in a sense, to their colleagues to get new people committed to doing it, who are the first-time users of the system.

And so it really plays both, on the repeats and the new ones.

Got it.

That's very helpful.

And then not to dwell on the exact same concept over and over again in different ways, but what about the placement mix in the U.S. of service providers versus -- basically versus those that are running the Sequel in-house?

Well, I would say the service provider structure in the U.S. is different from China by a lot.

In the U.S., you have a lot of "service providers" who are academic core facilities and who are what I would call small-scale almost by necessity, service providers mostly for their local institute colleagues.

There are some reasonable-sized commercial -- fully commercial service labs in the U.S. They're not nearly at the scale of some of the big labs in China which rival the output from a total sequencing prospective of the big NIH-funded or Sanger-funded genome centers.

They just don't exist here.

And part of that is because of this proliferation of these smaller academic, nonprofit ones.

We are starting to see and we did in some of the repeat orders in the U.S. last quarter the -- ramp up a little bit of some of those places.

That if you take, for example, the -- a lot of the business that we do in China to these core labs or to these commercial sequencing sites are in the plant and animal genome space.

In the U.S. and Europe, most of the time, we have a lot of that going on as well.

But it tends to be the big agricultural bio business companies that do their own sequencing, and they're our customers as opposed to a large Novogene or BGI or (inaudible) level service provider who's servicing China or their region.

And so it's a little different in terms of the nature of service sequencing companies in the U.S. and Europe versus Asia.

And our next question comes from Joe Munda from First Analysis.

Mike, I was just curious.

As far as the guidance is concerned for 2018, should we see China as a percentage of the mix be higher off of the 2017 number?

Or do you expect it to build over that 30% to be a bigger percentage of the mix?

Well, it's fluctuated a little bit through 2017.

It certainly went up particularly in the second half of the year once this second big order from Novogene came in.

And the usage rate is higher there, on average, somewhat given the nature of the customers.

But I would expect that it won't change a lot overall this year because we've begun to see finally the same kind of increase in average usage in some of the big sites that we expected to be big users in the U.S. and Europe that lagged behind the increase that we saw in the Chinese sites.

And so we would hope that we get a faster growth rate, particularly on the utilization, than we have over there.

In a lot of those spaces, in China, it would be driven by the fact that we sell more instruments because they're pretty much at capacity utilization anyway.

Whereas in the U.S. and Europe, we have a lot of room to grow in terms just of utilization per instrument and as well as in placing new instruments.

So we have sort of 2 series of growth drivers there.

And, Mike, following up on that comment, in regards to the U.S. I know we talked in the past about the budget, but are you seeing any -- are you seeing that loosen up?

Are you seeing more -- I don't know what the word is.

But are you seeing the budgets in the U.S. loosen up here and open to purchasing more products?

Well, we did see a fair number of orders from U.S. government research labs in Q4.

Some of which were repeat purchases, which was good.

We take that on a quarter-by-quarter basis because, remember, the government was shut down for 3 days, not that long ago.

And we have another deadline coming up in a week.

But I would say it's, at least right now, less of a concern than it was at this time last year where it became a serious issue.

And -- but we'll see.

I mean, it's -- I think the other thing that we're seeing, the U.S. expand and even Europe, even beyond the government labs that were high users of our systems before, we're seeing a little more uptick from the commercial sites in the U.S. as well, which kind of balances out that.

But like I said, so far, Q4 for us and government institution-type purchases was reasonably on track, and NIH academic purchases were okay as well.

But we still don't have a budget.

So who knows?

In terms of expenses, and I was just wondering what steps are you guys taking to keep the expenses flat?

And then a follow-on to that is Kathy Ordoñez, I know she came on last quarter.

I guess what impact does she had, thus far, on the business, if measurable?

I'm just curious.

Yes.

I'll take the first one.

In terms of expenses, I think you actually even saw in 2017 that our -- at least our R&D expenses moderated because as you got past some of that bump in the Sequel development, we didn't need to spend as much in R&D.

But you did see that we invested in the SG&A side in order to drive some of the revenue growth.

So 2018, maybe some of the same sort of pattern you'll see is that -- again, we're planning to keep total operating expenses relatively flat, yet still make sure that we invest in the right areas that can drive the top line growth.

And in lot of those areas, and Kathy has helped drive this, we've moved some of the responsibility for product marketing into the individuals field districts in Asia, where we had some already to assist our distributors.

But we did not have field marketing in Europe, and we didn't have it in the U.S. And we've -- Kathy has put that in place, along with our sales management teams.

We've kind of, as we've pointed out in the last call, unified our field support organizations, which were 3 in number, each having responsibility for somewhat different aspects of customer support into one organization and charged them with not only keeping the customers happy but helping them increase their usage.

Because as we pointed out already, that helps drive satisfaction of the customer and leads to new sales, either from the colleagues or from themselves.

And having put that in place, particularly in Europe and the U.S., where we were lagging behind in usage, we would expect that to be part of the continuing drive in increasing consumable sales in those areas in particular.

Yes.

And one thing I would add to that, Joe, is that we're in the process of adding a couple of distributors in Europe to increase our sales force power in countries where we don't have any direct representation.

(Operator Instructions) The next question comes from Drew Jones from Stephens Inc.

This is James Rutherford on for Drew.

I want to start off with Europe, just to follow up that last comment.

I was curious if you have worked through some of those technology and sales hiccups there and what changes the new Head of Sales is making besides adding distributors in those locations?

Well, again, I think -- this is Susan.

So what she's done is start to work with Kathy on -- she came onboard in the summer to really look at areas where she could focus the strategic selling to get involved in the kind of large studies that would result in multisite sales as well as look at areas where she could bring field marketing into play.

Yes.

I think that one of the lessons that we've learned from a positive sense in our China sales, in particular, is that helping foster the success of these larger sites leads to bigger transactions, both in the short term in terms of instruments and in the long term in terms of consumable usage.

And the thing that Susan mentioned is that we were more focused, I think, in Europe, in particular on one-off sales, as opposed to how do we get in and participate in a larger way with some of the larger projects.

One of the ones that we've mentioned briefly has been in the structural variant analysis, programs that are being kicked off in Europe, led by several groups, but -- in particular, ones coming out of the Radboud institute and hospital in the Netherlands.

But there are a whole host of other country-specific population genetic programs going on in Europe, and we weren't really driving much success in those.

And part of those was because we were -- our sales organization was more focused on real tactical one-off sales at smaller sites.

And between Kathy and [Dominic] and [Dominic's] team over there, we're really pushing to get more involved with some of those bigger projects.

And then just raising awareness of the power of our technology, the cover of Nature this week is coming from a European institution.

Yes.

So maybe asked differently, are you seeing utilization growth on the consumable side outside of China, which obviously is seeing very strong growth?

I guess that question would apply to Europe and to the U.S.

Yes.

Well, the answer is yes.

It didn't get there as fast as it did in China, and it helps in China that they're driven by these big commercial entities that have -- they have more visibility into their project backlog, which encourages them to buy more machines when they kind of run up against a delivery schedule that they have to deal with.

And part of the process is helping some of the smaller service providers where we do sell systems into get out and market their capabilities.

Part of it is helping the other customers in a broad sense do it.

And we've seen a pickup, as I said, particularly in Europe, which really had lagged behind the usage per machine elsewhere in the latter part of last year as we began, not just to get the reliability of the systems up, but to focus our support teams on helping these people get projects, both acquired, to sequence on our systems and successfully implemented.

And then the reason we were able to get preorders in the U.S. and Europe that Mike talked about earlier was because they were getting the volume up at their sites with the reliability release that we did and the software enhancements this summer.

And they start to use it in the fall and get their usage up and therefore taken to and now that demand for another system in both U.S. and Europe.

Yes.

The middle of last year, I don't think any of our -- well, with one exception in the HLA space.

Any of our U.S. and Europe customers would have ranked into the top 15 or 20 usage sites, and that's changed in the last quarter.

We got a lot of work to do to make it more broad based in that sense compared to these -- some of these big sites in Asia, but it's definitely progress.

Yes.

Okay.

The last question I'll ask is just whether you all have been able to quantify the additional market opportunity that you expect to be able to address when these throughput improvements are kind of done and you get that 30x bump all-in a few years?

I mean, what will that additional market be?

And then what's your confidence that you can actually turn those into incremental dollars?

Are your customers asking for these things is kind of the question I'm getting at.

Well, customers are always asking for more for less.

There's no doubt about that.

It's -- you can do this market analysis all over the place.

I think the way that I've tried to put it before is that if I look at what short-read sequencing can do today, what long-read sequencing can do today and extrapolate as the performance changes over time, where can you rationally get to?

Because we're not going to take over the entire sequencing market.

There's too many things you can do with short-read technologies, in particular, that you don't need long reads for.

They're just -- it's not appropriate for it.

And things like looking for large studies of cell-free DNA, the small pieces, anyway.

They're 150 base pairs long.

Our technology doesn't do much for that, particularly when you're either looking for a needle in a haystack and it's a really big haystack.

Are you just trying to count through 25 or 30 base pair reads, which pieces of DNA are coming from which chromosome in the IPT space?

And you also have some RNA quantitation-type experiments where you need to look at millions to billions of pieces of DNA in a single experiment.

And our technology is not amenable to that.

On the other hand, as the technology throughput goes up and the cost per genome comes down and we get to a comparable cost to what you do with short reads at the whole genome level, situation is a little different.

And we would say overall that, that is certainly likely to be half of the overall sequencing market which, in itself, is growing.

And our goal long term is to get to the point where if the comparable cost to do a sequencing experiment at the whole genome level gives you all the structural variation, the single nucleotide variation, a haplotype phasing and so on in one experiment for that amount of money that you get with the short-read sequencing experiment, which gives you effectively with any kind of completeness at all just a single nucleotide-variant picture.

If we do that, then we're a major player in that space, and that's kind of what we're shooting for.

The other things that we think is a growing opportunity for us are in some of the targeted -- in particularly, human sequencing applications, where you just can't get the answer in certain gene families or even certain genes that are both research important and clinically relevant.

And again, there's a lot of those areas where short reads are really good, and there's areas where they're not.

And we see long term, a split of about 50-50 in those cases as well.

Thank you.

And I see no further questions in the queue, so I'd like to turn it back to the speakers for any closing remarks.

Okay.

So in closing, we remain steadfast in our commitment to bringing the unique advantages of our SMRT technology and products to our customers and the scientific community in general.

We believe that SMRT Sequencing provides the industry's most complete and accurate picture of genomes due to its superior performance in sequencing accuracy, uniformity of coverage, extremely long-read lengths and ability to characterize DNA-based modifications.

Furthermore, we're providing scientists with an ability to obtain a comprehensive set of sequence information with a single experiment.

SMRT Sequencing is often the lowest cost and only research tool available to meet their needs.

Thank you for joining us, and we look forward to talking again in 3 months' time.

Ladies and gentlemen, this does conclude your program, and you may all disconnect.

Everyone, have a great day.