Pacific Biosciences of California Inc (PACB) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pacific Biosciences of California First Quarter 2018 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Trevin Rard.

Ma'am, you may begin.

Thank you.

Good afternoon, and welcome to the Pacific Biosciences First Quarter 2018 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're 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 Forms 8-K, 10-K and Form 10-Q.

Pacific Biosciences undertakes no obligation to update forward-looking statements.

In addition, please note that today's call is being recorded and will be available for audio replay on the Investors section of our website shortly after the call.

Investors electing to use the audio replay are cautioned that forward-looking statements made on today's call may differ or change materially after the completion of the live call.

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

Thanks, Trevin.

Good afternoon, and thank you for joining us today.

We are pleased with the progress we've made in our business during the first quarter.

However, our financial results were mixed.

We had strong Sequel instrument bookings in the quarter, with the largest number of instruments ordered in a quarter since Q4 of 2015, when we first announced the Sequel System and converted pipeline RS II orders to Sequel.

The orders were highlighted by 10-unit instrument orders from both BGI and Annoroad in China.

These orders allowed us to build up our backlog of instruments.

However, we were not able to ship a majority of those 20 systems in Q1 while customers facilities were being prepared.

As a result, instrument revenues for Q1 came in at $7.2 million compared with $12.6 million in Q1 of last year.

As we previously noted, in Q1 of last year, we had a spike in Sequel System shipments as we rapidly worked down the backlog of Sequel instruments that we built up in 2016 when constrained by limited supply of SMRT Cells.

Quarterly comparisons for instrument revenue can be challenging because of lumpiness and the timing of instrument orders and installs.

The disproportionate impact of large, multi-unit orders enhances this challenge since the timing of customers' facility readiness is difficult to predict.

To date, most of our large multi-unit Sequel orders have come from China, driven by plant and animal sequencing projects.

We expect such order activity to expand to other geographies, such as the U.S. and Europe, as the cost of SMRT Sequencing reaches levels that enable it to be used more widely in large human population genetic studies.

Our overall consumables revenue for the quarter came in at $9.1 million, which was up modestly from $8.7 million in Q1 of last year.

Sequel SMRT Cell usage was up threefold, but RS II SMRT Cell usage declined significantly, which offset the gains from Sequel consumable sales.

RS II consumable sales represented approximately 20% of our total consumables for Q1 this year compared to over half of our total consumable revenues in Q1 2017.

This decline is a result of customers switching their projects over from the RS II platform to Sequel, a switch that is accelerated due to the Sequel performance enhancements we've introduced over the last several months.

While RS II revenue is likely to decline further, it is now a much smaller portion of our total revenues, so we expect the impact of further declines to be less significant.

As we had previously noted, we'd expected Q1 2018 consumable revenue to be lower than the $12.7 million we recorded in Q4 of last year.

One of the factors we noted was that we expected an impact from reduced consumable usage in Asia during the Lunar New Year, but we somewhat underestimated this effect.

In fact, a significant number of our large users in Asia stopped running their instruments for an extended period of time during February of this year.

Additionally, our largest customer made a large consumable purchase in late Q4 2017 and experienced facility issues that reduced their Q1 usage independent of the Lunar New Year shutdown.

They are, for the most part, back to normal operation.

However, they did not place new Sequel consumable orders in Q1 as they had not sufficiently worked down their consumable stocks.

The RS II consumable decline also affected the Q4 to Q1 comparison.

Total revenue for the quarter was $19.4 million, down 22% compared with $24.9 million recorded in Q1 last year.

As previously mentioned, Q1 revenues last year spiked up as we worked down instrument backlog.

And in Q4 of last year, we exceeded our previous forecast due to the timing of strong product shipments at the end of the year.

With this in mind, we forewarned investors during our last earnings call to expect a relative decline in revenue for Q1 of this year.

That said, Q1 revenue came in somewhat below our target for the reasons I mentioned earlier.

Looking forward, we're expecting to get back on track as we install the instruments that we'd added to the backlog in Q1 and as customers begin operating those systems.

Now turning to business updates.

We're seeing significant progress in applying SMRT Sequencing to key applications by our customers.

HudsonAlpha, which has been using PacBio in their agricultural biology work, is now expanding the use of our products into human clinical research.

They purchased another Sequel System this past quarter to add capacity to their Sequel -- their first Sequel and their RS II instruments.

A project they're working on is to improve the diagnosis of intellectual and developmental disabilities in children.

Already, they have more than 500 children their parents enrolled in the study.

They will be applying whole-genome sequencing with PacBio to identify diverse types of genetic variance underlying disease in children, for which other analyses have failed to identify the cause.

In reference to the project, a faculty investigator at HudsonAlpha stated, "PacBio sequencing has made it possible for us to generate high-quality reference genomes for most plants, and we now want to apply the benefits of this technology in the human disease space."

In addition to HudsonAlpha, we've engaged with numerous other customers who've begun applying PacBio sequencing toward clinical research.

Radboud University Medical Center in the Netherlands, which also acquired a second Sequel instrument this year past quarter, is using PacBio sequencing to detect structural variance in rare disease as the leading participant in the SOLVE-RD European consortium that is tasked with solving unsolved rare diseases.

We're also working with multiple large clinical testing centers that are interested in developing test for diseases characterized by large structural variance.

At the recent American Association for Cancer Research, multiple researchers presented results of studies featuring the use of our Iso-Seq method for full-length RNA transcript sequencing in cancer research.

A recent review article in Nucleic Acids Research titled Single molecule real-time SMRT sequencing comes of age: applications and utilities for medical diagnostics, written by researchers at KU Leuven and Uppsala University in Europe, offers a great overview of how SMRT Sequencing is already being used in clinically relevant applications, ranging from cancer to reproductive medicine and more.

The paper notes that SMRT Sequencing offers tremendous benefits because it resolves many problems with short-read platforms.

The author stated, "limitations such as GC bias, difficulties mapping to repetitive elements, trouble discriminating paralogous sequences and difficulties in phasing alleles."

In addition, SMRT Sequencing has "higher consensus accuracies and can detect epigenetic modifications from native DNA", the authors noted.

We're continuing discussions with potential clinical diagnostic partners, and we're working to decide among several choices in China, in particular, who have expressed strong interest in SMRT Sequencing for clinical applications.

In the plant and animal area, we're continuing to work with various consortia engaged in large-scale sequencing programs to understand the genetic diversity in earth's biome.

Over the past year, the G10K/B10K consortium has started sequencing a relatively small number of samples across multiple sites, and they generated high-quality reference genomes for a number of animals using PacBio's SMRT Sequencing.

We expect the volume of sequencing at these sites to increase significantly in the coming months as they expand the number and diversity of species they are studying.

We've also seen an increase in the adoption of SMRT Sequencing by AgBio firms interested in commercial breeding programs.

Turning now to our product development activities.

In Q1, we released our latest sequencing enzyme and software for the Sequel System.

As to this week, we've already successfully rolled it out to most of our customers.

We're extremely pleased with the performance that our customers have been achieving with these latest reagents and tools.

Some of our customers have achieved average read lengths above 20,000 base pairs and throughput above 12 gigabases per SMRT Cell sequencing, sheared genomic libraries for de novo assembly.

Others have achieved average read lengths above 40,000 base pairs and throughput above 20 gigabases of data per SMRT Cell sequencing amplicon-based libraries for applications such as transcriptome isoform analysis using our Iso-Seq protocol.

Furthermore, system reliability and consistently -- consistency has continued to improve, which are key parameters for customers who want to conduct large projects that drive system utilization.

As we mentioned in our previous call, we are planning another software chemistry release later this year, with the goal of increasing throughput per SMRT Cell by another factor of 2, along with further enhancements to our sequence analysis programs.

Our work on the new version of the Sequel SMRT Cell has 8 times as many reaction wells as our current SMRT Cell is progressing well.

We continued to talk at completing the development of the chip by the end of this year.

Our ongoing goal is to enable our customers to generate up to 150 gigabases of data from a single SMRT Cell, which would enable us to provide high-quality human-sized de novo genomes for approximately $1,000, and low coverage genomes for structural variant analysis were substantially less.

That concludes my initial remarks.

I'll now turn it over to Susan to provide more details on the financials.

Thank you, Mike, and good afternoon, everyone.

I will begin my remarks today with financial overview of our first quarter that ended March 31, 2018.

I will then provide details on our operating results for the quarter with a comparison to Q1 of 2017.

I will conclude my remarks with a brief discussion of the March 31, 2018, balance sheet.

Starting with our first quarter 2018 financial highlights.

During the quarter, we recognized revenue of $19.4 million and incurred a net loss of $24.2 million.

We ended the quarter with $79.3 million in unrestricted cash and investments.

Turning to revenues.

The $19.4 million of revenue recognized in Q1 2018 was $5.5 million lower than the $24.9 million of revenue in Q1 of 2017, primarily as a result of lower instrument revenue in the quarter.

Instrument revenue recognized in Q1 2018 was $7.2 million, down $5.4 million from $12.6 million recognized in Q1 of 2017.

As a reminder, in the first half of 2016, we were installing a low number of instruments while we worked out our Sequel chip production challenges.

This staggered instrument rollout created a large backlog that was worked out during the second half of 2016 and into early 2017.

It consequently led to higher numbers of instruments recognized into revenue during that time frame.

Consumable revenue in Q1 2018 increased to $9.1 million, up $400,000 over the $8.7 million reported during the first quarter of 2017.

Service and other revenue was $3.1 million in the quarter, down from $3.6 million in Q1 of 2017.

While Sequel service revenue from a growing installed base continues to increase.

The decrease in the higher price RS II service revenue has outstripped the Sequel revenue on a year-over-year basis.

With regards to gross profit and margins, in Q1 2018, we generated gross profit of $7.3 million, resulting in a gross margin of 38% compared with the gross profit of $8.9 million and a gross margin of 36% recognized in Q1 of 2017.

In Q1 2017, we recorded a $1.3 million charge to cost of revenue to write down the value of certain leased RS II instruments, which negatively affected our gross margin by approximately 5%.

Moving to operating expenses.

Operating expenses in the first quarter 2018 totaled $31.2 million, down slightly from $32.2 million in Q1 of 2017.

Noncash stock-based compensation included in the operating expenses was $4.6 million in Q1 of 2018 versus $4.5 million in Q1 of 2017.

Breaking down our operating expenses.

R&D expenses in the quarter were $16.3 million, $700,000 less than the $17 million incurred in Q1 of 2017.

R&D expenses in the quarter included $2.2 million of noncash stock-based compensation expense, slightly higher than the $2 million of expense in Q1 2017.

Sales, general and administrative expenses during the quarter were $14.9 million, slightly lower than the $15.2 million in Q1 of 2017.

SG&A expenses for the first quarter of 2018 included $2.4 million of noncash stock-based compensation expense, slightly lower than the $2.5 million of noncash stock-based compensation expense recognized in Q1 of 2017.

Turning to our balance sheet.

As I mentioned at the beginning of my comments, our balance of unrestricted cash and investments was $79.3 million at the end of the first quarter, $16.4 million higher than the $62.9 million at the end of the fourth quarter of 2017.

In February, we issued 14.4 million new shares of common stock at a market price of $2.40 per share, generating net proceeds of $33.1 million.

Excluding proceeds and the related costs from the follow-on offering, we used $16.5 million in cash during the quarter.

Additionally, in line with our lower revenue in Q1, our accounts receivable balance decreased $5 million to $8.4 million in Q1, and we increased our inventory balance by $2.8 million to $25.9 million in Q1.

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

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

Thank you, Susan.

I'll be providing an update to our forecast for 2018 based on our results in Q1.

As Mike mentioned earlier, we shipped fewer instruments and consumables, resulting in lower revenues than we previously expected for the first quarter.

We believe this is a short-term issue.

However, the timing of customer site readiness for installing new systems, particularly for multi-unit orders and variable customer ordering patterns for consumables has made it difficult for us to predict revenue timing.

As a result, we are not providing a revenue forecast for the year.

However, we will provide other information about the business to assist you in evaluating our performance.

While customer ordering patterns can cause consumable revenues to vary in the short term, revenues in the long term are ultimately driven by system utilization.

Despite the impact of the Lunar New Year celebrated in Asia in February, Sequel System utilization in Q1 was very strong.

Compared with Q1 of last year, usage of Sequel chips by our customers tripled.

We expect consumable revenues to increase year-over-year, but we may experience some variation from quarter to quarter.

With regard to instrument sales, we ended the second quarter with a larger backlog than we had at the beginning of the first quarter.

We also have a healthy pipeline for new instrument orders, and we generally expect to record higher instrument revenues for each of the subsequent quarters this year.

Moving on to gross margin.

Our Q1 gross margin was in line with our previous forecast.

We're focused on improving gross margins this year by driving top line growth while keeping our fixed costs flat and by gradually reducing our service costs.

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

Now moving to operating expenses.

We are managing our expenses closely, and we expect our total operating expense for the year to come in a little lower than last year's operating expense total of $124 million.

Our net loss for Q1 included $7.1 million of noncash stock compensation and depreciation expense, and we expect to continue to record a similar amount of noncash expenses for each quarter this year.

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.

We ended the quarter with $79 million in unrestricted cash and investments on hand after raising $33 million in net proceeds from our follow-on offering and burning $16.5 million in cash during the quarter.

We expect to reduce our cash burn significantly this year, primarily through increasing sales and gross profit and by controlling expenses.

That concludes our prepared remarks, and we'll now open the call up for questions.

(Operator Instructions) Our first question comes from Amanda Murphy with William Blair.

This is actually Max on for Amanda.

Just had a quick question.

I know that you aren't providing specific platform numbers, but just wanted to get a sense and maybe some general commentary about how we should think about the progression of the instrument sales throughout the year, maybe some commentary around placements to new versus existing customers and some trends that you're seeing from an average order size perspective.

Max, this is Ben.

So one thing I would like to again repeat, which I just said is, the backlog at the beginning of the second quarter here is certainly bigger than we had at the beginning of Q1, driven by -- largely driven by anyway some of these large 10-unit orders.

As Mike mentioned, we did not install majority of those last quarter, so we will expect those to be installed this year certainly and already started installing some of those in the quarter.

So Q1 was probably, in our opinion, a pretty low point in terms of instrument shipments.

So we're expecting, as I mentioned, higher instrument shipments in each of the quarters throughout this year.

The timing, though, is certainly going to be subject to, as I mentioned and Mike mentioned, these larger orders tending to add more sort of fluctuation in the installs because if you have a 10-unit order that doesn't get installed in one quarter and does get installed the next, it can cause quite a bit of fluctuation quarter-to-quarter.

Got it.

Yes, certainly appreciate the commentary there.

And then I know you also talked about the legacy installed base as well, and in the prior quarter you discussed the transition for some customers in the U.S. and Europe specifically from the legacy installed base.

And just was wondering if we could get an update there as to how the progress -- how that's progressing and what we can expect moving through the rest of the year.

Yes, I think, well, we are definitely seeing, I would say, fairly rapid transition for some of our customers who have both RS II and Sequel Systems to be doing more sequencing on their Sequel Systems and, therefore, spending less on their RS IIs.

And that's one of the reasons why we saw a pretty healthy decline in RS II consumable revenues year-over-year.

Again, I'll quote that the percentage of the consumable revenues in Q1 was about 20% RS II consumables, whereas in Q1 of last year, it was over 50%.

So we definitely have that transition going on.

And it's going to continue, in our opinion.

The percentage change might not be as big just because you're working with a smaller number now.

But the good news is they are transitioning over to Sequel.

Sequel, by its nature, generates more revenues for us than RS II, and so we expect to see benefits from that transition.

Our next question comes from David Westenberg with CL King.

This is a little bit of a continuation of Max's question here.

Can you just talk about -- sorry, the previous question.

Can you talk about the -- you talked about the instrument backlog.

So then should we expect an instrument catch-up then in Q2?

I just want to know a little bit more about the cadence of what our expectation should be there.

Yes, I mean, we wish we could give you specifics quarter-by-quarter, but I think what we're learning at least from the experience we had in Q1, so recent, that these things can vary.

Certainly, it's going to even out over time, and having a bigger backlog going into the quarter's certainly going to be a benefit for future quarters.

Calling the specifics of which quarter you're going to see significant installs versus other ones where you're going to have fewer, I think, is going to be tough.

So one thing that we are pointing out, since Q1 was a pretty low quarter in terms of installs compared to even the last few, it's probably a low point.

So in subsequent quarters this year, we expect to do better than we did in Q1.

Can I -- thought I'd add a little bit.

So one of the things that we are seeing is, as the system output has gone up, as the reliability has gone up, as the number of applications for which the system matches well.

A lot more interest in a variety of sites expanding their capacity on the Sequel by a lot, and that's leading to more of these large multi-unit orders.

And we try to point out that, that's certainly been true in China, primarily driven by the plant and animal work that they're doing.

But even there, they're starting to apply it in a bigger way towards human-derived samples, and we're seeing the same sort of impetus coming both from Europe and the U.S. And as we get more and more large unit orders, that makes the ability that we have to predict shipments in an individual quarter worse than it was when we had a lot of 1-unit instruments where 1 being delayed for facility's preparation didn't matter so much, but when it's 10 in a whack it makes a big difference.

The good news in that is that we're starting to get a lot more activity at the higher end of unit purchases, which says people have faith in the technology, they're now deploying it where they're really thinking about using it in a big way as opposed to the occasional way, which is what most of the users in the U.S. and Europe have done.

In the short term, it makes quarter-to-quarter predictions a lot more erratic.

No problem.

So in terms of just the behavior of your customers that have both RS II and Sequel, are they -- are you seeing -- project types, are you seeing a preference still for small projects on RS II and then big projects on your Sequel?

Or are they even maybe transitioning even some of those smaller projects to Sequel?

And just kind of help us think about that.

So the main driver -- there are a couple of exceptions.

In the RS world, I've met people who are focused on sequencing individual bacterial samples, where they've got 1 bacterium to sequence at a time.

And the Sequel is way overkill for that.

The RS is perfectly placed for it.

And one of the things that will drive -- continue to drive the RS down is that we're now in the process of rolling out a protocol that allows more easily multiplex bacterial samples to be run on the Sequel, which allows the cost per bacterium on the Sequel to be equal to or actually even less than what it would cost on RS, and that will, in the end, drive most of the RS customers over to the Sequel platform.

Now some people take time to get the money to be able to make the switch, but our goal over the next couple of years would be to move almost everybody over, if not everybody, to the Sequel System.

Got it.

That's really helpful.

And you are -- your new chip, your eightfold increase in throughput, that's going to be coming in 7 month-ish.

Are you starting to have that conversation with customers about maybe it's time to look into the system because we're about to get a whole different level of throughput and whole different system capabilities.

Is that -- are you selling on that feature now?

Or is that something maybe back half of the year you'd start to talk to your customers about that?

Well, we've given that -- we've given kind of a 2-year road map to our customers since the beginning of last year.

And so it's not that they haven't known about that before.

What we try to do is keep them a little more focused on the shorter term in that regard and make sure that they understand that we make commitments about sort of a twofold increase over the last year, which we did slightly more than that, and then another twofold increase just from a perspective of chemistry and software, and then early next year have available a bigger jump in the context of having a eightfold increase in the multiplex on the chip on top of those chemistry and software changes.

And so it's a continual progression and some people look to make decisions because they have short term needs to get sequencing done, others have a longer term, larger projects that they plan and so they want to know at some level what's your road map is all the time, and they make their decision on whether they're dealing with short-term or long-term issues.

A lot of the cases, if people are applying for research grants, that process can take a year.

So they need to know ahead of time how to plan their project scope and expenses and so forth relative to what's going to be available when they actually start projects and so it's a mix.

Got it.

And I'll just ask one more.

It's interesting to hear the undiagnosed projects at the university in the Netherlands.

So can you talk about that potential as an application?

And are you seeing -- are you having a conversation with some of your customers or different sites on trying to apply that in places across America?

Or what is the potential for your system in rare diseases?

Well, the HudsonAlpha example was very similar.

And so one of the strengths of our system, which certainly adds to what you can do with short-read sequencing, is to look at structural variation.

And if you take -- take the undiagnosed or difficult to diagnose things that you suspect have a genetic basis, the short-read technologies are very good at getting at single nucleotide changes or really tiny INDELs.

They're not good at longer structural variance.

And so typically, people find that they get hits using short-read sequencing alone on, say, 30% to 40% of those cases.

And the belief is, now that people understand how much structural variant diversity there is, is that you'll pick up at least that much of the remainder using structural variant analysis.

And because we have a much higher hit rate and much lower false positive rate, that's why our SMRT Sequencing technology is attractive to the people who are starting these large programs on there, where they know they don't get all the answers by any stretch of the imagination just with short-reads alone.

And so we're seeing that not just in those 2 sites, those are the ones that we've mentioned because they did public releases on what they're going to do with the systems, but we are definitely seeing that in a variety of sites, both in the U.S. and Europe, and we announced one last year in China as well.

(Operator Instructions) Our next question comes from Joe Munda from First Analysis.

Mike, real quick, can you give some sort of semblance of what the geographic breakdown would look like in sales?

I know China had been leading the way for the last couple of quarters.

But if you could give us some sense of what it looks like geographically, that would be great.

Well, again, let me talk about orders versus sales.

I mean, China is still very strong market for us, and it's got a lot of consumables as well as a lot of instrument sales.

And so we've said that it represents over 30% of our total worldwide sales.

And there are other areas in Asia that also add to that.

And I don't -- we haven't seen that change yet.

I think the opportunity for enhanced growth in Europe and the U.S. is dependent upon our penetration into the large human population genetic-type studies because, disproportionately, China has spent more money in the plant and animal space than the U.S. and Europe, but less in the human side, at least for us, probably not true necessarily for other technologies.

And as we make more progress just because that's where there is more money in making our system cost-effective for some of the human large studies, particularly as we fold into those studies a lot more structural variant analysis then I would expect the balance to tip more towards the U.S. and Europe in terms of the growth.

Okay.

In terms of installed base, could you give us some idea of what the total installed base is?

I'm not asking for breakout of RS II and Sequel, just a total number or even perhaps a backlog number.

Yes, Joe.

So total installed base is around 400 systems worldwide.

And if round numbers, think of it as around 250 Sequels and around 150 RS IIs.

We've gotten to 160-ish RS IIs, but over the past couple of years, some of those have been retired.

So at least the ones that we're tracking it's probably down a bit from there.

But the Sequel installed base continues to grow.

We're not giving the exact backlog number, but it certainly is bigger now than it was 3 months ago.

Okay.

I appreciate it.

That's helpful.

And then I guess, in terms of -- I guess, I must have missed it, there was a write-down of a couple of RS IIs in the quarter.

Can you remind me what that was?

I'm sorry, Joe, that was last year.

So what we're trying to explain is, if you look at the gross margin year-over-year, last year's gross margin, even though it had higher sales numbers, had a lower gross margin because it was also taking that 5% gross margin hit.

Okay.

I get it.

Yes.

And then I guess, my final question.

Cash runway, you have $79.3 million on the balance sheet, I mean, I know you guys have talked about expense -- holding expenses tight.

If we annualize the number in the first quarter of the decrease in cash, the use, you get to $64 million for the year.

I mean, how much of a runway do you think you have based on the current cash on the balance sheet?

I'll take a shot, then maybe Mike or Susan can chime in.

Q1 is typically our biggest cash-burn quarter.

It's just a quarter in which you have certain payouts of things like commissions and bonuses and then there's higher payroll taxes.

So we don't expect to burn as much in the rest of the quarter this year as we did in Q1.

And we're going to try to couple that with growing top line revenue.

So you put those together and then, hopefully, you have significantly less cash burn going forward.

So you're going to burn significantly less than that $60-plus million number that you talked about.

So again, there's different ways for us to add funding to the company, and our preferred way, certainly, is to have top line growth and to control expenses.

But there are other things that we've talked about in the past where we continue to explore, that would be, let's say, less dilutive and, let's say, the follow-on offering that we just did last quarter.

Our next question comes from Drew Jones with Stephens Inc.

This is James on for Drew, James Rutherford.

My first question is a follow-up to the U.S. conversation.

It's really what gives you confidence that you can get into those large population studies?

Are these conversations that you're having with customers or potential customers in the U.S.?

Or is that a little bit further off at this point?

No, we're having discussions.

What gives us confidence, particularly in the human space, is that the recognition of need to include structural variant analysis in those studies is becoming more and more clear, number one.

Number two, all these sites have tried the other technologies, other long-read approaches, other synthetic long-read approaches, various manipulations they can do on the short-read technologies alone and have just not gotten the answer that they want.

They either have far too low sensitivity, meaning they miss a lot of structural variance or they have way too high false-positive hits.

So their specificity and their sensitivity are not where you want them to be in the big studies.

They've done enough with our technology now to realize that we satisfy those requirements quite well.

And they also know what the cost of doing it with our system is.

And they can afford to do relatively small projects at the current cost, and they will expand that, in what they've told us, as the cost continues to go down.

So we've put a lot of emphasis, a, on continuing to have them have faith that we're on track relative to the kind of promises that we've made over a long period of time of gradual improvement in the throughput, which cuts the cost down; and we kind of know where we get to that matches up to their ability to do really large numbers of samples.

And so that's why we have within a reasonable scope of figuring out what the opportunities are, pretty good confidence that we're right on track to be able to do that.

Okay.

That makes sense.

And is that 8 million [welled] ship that we expect probably sometime in 2019 the real catalyst to getting that -- those orders actually coming through?

Well, it certainly is a catalyst in terms of getting the installs done, let me put it that way.

Building up to that, you have to get their commitments so that they knew -- know what to expect, those customers, and they can plan their projects accordingly.

But yes, I mean, each bit of increase in throughput makes it easier to use it for larger and larger sample sizes.

And that alone is, obviously, a big jump.

But if you go back to where we were, say, in the middle of last year, to just the end of this year, just on chemistry changes alone, that's a factor of 4. And so the 8 is important on top of that, but at that point, it's part of a progression that gets you to the larger and larger studies that can use our technology.

Okay.

Understood.

Now flipping over to gross margins.

The service and other kind of gross margin was a little better than we had expected.

Looks like some costs came out perhaps there.

Just trying to understand what's going on and how we should model that going forward?

This is Ben.

So we said before that we are working on improving the gross margins, in particular in the service area.

So part of that improvements stem from us reducing some costs there.

Our ASPs on instruments has remained pretty constant, so we're not necessarily seeing any sort of pressure on that.

So our goal here is to continue to drive the top line growth.

And if we're able to do that, then we should even improve on the gross margins that we've delivered in Q1.

Okay.

That's helpful.

And in terms of China and the utilization there, I'm just -- understanding that there was an impact from the Chinese New Year.

Just kind of curious, did you see a similar impact last year?

Was there anything that happened in this quarter that we had that outsized impact to cause the year-over-year kind of growth hit?

Well, the answer is, yes, we saw the impact.

But it wasn't significant at that point because we had not installed very many instruments in China in Q1 of last year.

We purposely had held Chinese shipments or actually Asian shipments down during 2016 while we were really getting the initial bugs of Sequel introduction out, but more importantly because of the constraint we had SMRT Cell supply.

And so it wasn't until Q1 last year that we really started to release shipments into Asia.

And so relatively speaking, it didn't have as much of an impact.

And it isn't that we didn't see it, we did on the instruments that were there.

They just weren't nearly as big a percentage of our installed base.

It's more like less than 10% versus more than 30%.

The miss that we made in a sense was that, given the size that a lot of these guys were operating at, they shut down a little bit before the Lunar New Year started because they had to get all the stuff that was running into their computing system.

And then it took them a little longer, since most of these guys are service companies, to get back up and running.

They had to restart the process of prepping their samples, generating the sequence libraries from their DNA samples and so forth.

And so it was a little longer on the front-end and fair amount longer on the back-end than just a normal 10 to 12 days that you would have expected them to be on vacation somewhere.

And we didn't do as good a job at predicting that as we should have.

Okay.

That makes sense.

And my last question on the balance sheet.

The inventory kind of keeps marching higher.

Would you just talk about what's happening there and how we should think about that going forward?

Yes, I'll say something and then maybe Susan can chime in, too.

Timing has a lot to do with that.

We had mentioned that we didn't install very many of the systems that we had these large multi-unit orders for.

And if we had done so, then that inventory would not have been as high.

So if you kind of mute the timing out, then I think over, let's say, multiple number of quarters, you're going to see sort of a more normal average inventory level.

We have said in the past that our manufacturing cycle for chips is actually quite long.

And so would, by its nature, causes a certain amount of inventory buildup is just the fact that we have to ramp up the production of chips.

And when we do that, we start wafers months ahead of time, and that adds inventory to the balance sheet.

And I'm showing, currently, no further questions at this time.

I'd like to turn the call back over to Mike Hunkapiller for closing remarks.

Thanks.

In closing, we're excited about the prospects for our business as our customers are gaining momentum with the use of their Sequel Systems.

Our Q1 financial results were somewhat mixed, but the fundamentals of the business are healthy and robust as evidenced by growing system utilization and the multiple large instrument orders we've received during the quarter.

We have a great team of people in place who are committed to delivering successful results this year and beyond.

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

Ladies and gentlemen, this concludes today's conference.

Thank you for your participation.

Have a wonderful day.