Pacific Biosciences of California Inc (PACB) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Pacific Biosciences Incorporated 2011 year-end financial results conference call. My name is Erin and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will be facilitating a question-and-answer session toward the end of today's conference. (Operator Instructions)

I would now turn the presentation over to your host for today's conference, Ms. Trevin Rard. Please proceed.

Good afternoon, and welcome to the Pacific Biosciences fourth quarter and fiscal year 2011 conference call. With me today are Mike Hunkapiller, our Chairman and CEO, Susan Barnes, our Chief Financial Officer; and Ben Gong, our Vice President of Finance and Treasurer.

Before we begin, I would like to inform you that comments mentioned on today's call may be deemed to contain forward-looking statements. Forward-looking statements may contain words such as believe, may, estimate, anticipate, continue, intend, expect, plan, the negative of these terms or other similar expressions, and include the assumptions that underlie such statements. Such statements may include, but are not limited to, revenue, margin, cost and earnings forecasts, future revenue implied by the Company's backlog, expectations of future cash usage, and other statements regarding future events and results. Actual results may differ materially from those expressed or implied, as a result of certain risks and uncertainties. These risks and uncertainties are described in detail in the Company's Securities and Exchange Commission filings, including the company's most recently filed quarterly report on Form 10-Q. The Company undertakes no obligation to update, and prospective investors are cautioned not to place undue reliance on such forward-looking statements.

Please note that today's press release announcing our financial results for the fourth quarter and fiscal year 2011 is available on the Investor section of the Company's website, at www.pacb.com, and have been included on a Form 8-K, which is available on the Securities and Exchange Commission's website, at www.sec.gov. In addition, please note that today's call is being recorded and will be available for audio replay on the Investors section of the Company's 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 and that Pacific Biosciences undertakes no obligation to update such forward-looking statements.

At this time, I would like to turn the call over to Mike.

Thanks, Trevin, and good afternoon.

It's been an exciting and eventful year for PacBio, as we launched our initial products, including the PacBio RS in April, 2011, and have since been selling and supporting our products for about nine months. Highlights of our fourth quarter results are as follows. We installed 17 new PacBio RS systems, bringing our install base up to 48 systems in total. We booked six new system orders. We recorded $12.4 million in revenue. And we recently completed the development of our C2 product release, which I will describe in more detail later in the call. For the full year of 2011, we installed 48 PacBio RS systems, at end of the year with a backlog of 16. We generated $34 million in revenue, and high-value applications using SMRT technology have begun to emerge, as evidenced by numerous customer presentations at scientific meetings and by peer-reviewed publications in prestigious journals, such as Nature Methods and the New England Journal of Medicine.

As we look back on our first year of commercialization, I believe it is important to put into perspective where PacBio is in its life cycle. In general, when companies first introduce a new technology to the marketplace, they often think they know where it will add value. They are usually only partially right. It's the customers who have had access to and time with the new technology that determine where it adds the most value to them. Our customers have only had a short amount of time with their products, but already a few high-value applications have emerged, including de novo whole genome assembly and targeted sequencing for variant validation and analysis of difficult to sequence DNA regions. We're beginning to put more emphasis on these applications to drive adoption across a broader number of customers by providing more focused sample prep protocols and data analysis tools. We are still early in this process, and we expect that it will take time, as most new disruptive technologies take some time to become broadly adopted. We are also expanding our development of the base modification analysis methods enabled by the unique preliminary schematic measurements from our SMRT technology. Base modifications are key components in biological processes, such as gene expression, post pathogen interactions, DNA damage and DNA repair.

Turning now to some recent business highlights. We recently attended the Plant and Animal Genome, or PAG, conference in San Diego. PAG is a growing conference that was attended by over 2,700 people this year. Several presentations highlighting PacBio's products were made. Dr. Michael Schatz from Cold Spring Harbor presented data on using the PacBio RS for de novo assembly of complex genomes. In his talk, he described the difficulty of assembling complex genomes with short read technologies alone, due to limitations of their ability to handle regions of highly repetitive sequence of those containing very high GC or AP content. Using PacBio technology with its long read technology and random error profile, he is able to span repeats and resolve complex regions of genomes. In just one example, using hybrid assembly techniques with PacBio, he was able to more than double the size of previous contigs assembled on the parrot genome from approximately 47,000 bases to over 99,000 bases. He concluded that PacBio has capabilities not found in any other technology and that enables the highest quality de novo assembly.

Dr. Timothy Smith, from the US Department of Agriculture, presented on applications of SMRT technology to animal health and food safety. During his talk, Dr. Smith described his groups use of the PacBio RS for bacterial sequencing, which is important in studying diseases that affect livestock and which can be passed on to humans in food supplies. From one of his experiments, he was excited to report that for the first time, he was able to generate one contig for a single chromosome with no gaps and with minimal human intervention to complete the assembly. What this means is that they are able to create simple, timesaving protocols for sequencing bacterial genomes at higher quality than they could achieve previously. As a result, they are interested in incorporating the use of their PacBio RS into numerous sequencing projects. They've only had their system for a few months, and we are encouraged that they are already seeing the value of their PacBio RS system -- that their RS system can bring to their important research.

Finally, Dr. Simon Chan with the Department of Plant Biology at the University of California Davis, present on the use of PacBio long arrays to study centromere evolution. The centromere is the region of a chromosome that allows chromosomes to be accurately partitioned during cell division. It is a fast evolving region of genomes and is difficult to sequence due to the number of tandem repeats that are present. In his talk, Dr. Chan showed that PacBio sequences reveal higher order structure in centromere repeater rays, due to the very long reads that it generates. He and his team are early in their studies, but they are excited about the new information that is being revealed.

In summary, it is presentations like these at the PAG that show the progress we are making in driving the adoption of our SMRT technology. In the near term, customer presentations highlighting their successes with our products are the best leading indicator we have that we are on the right path for growing the business. What is even more exciting in terms of customer validation is the scheduled lineup of PacBio focused presentations and posters at the upcoming Advances in Genome Biology and Technology, or AGBT, conference next week. There are roughly 390 total posters and presentations that are being featured at AGBT this year. 50 of them highlight PacBio's technology and products, a threefold increase over the 16 presented at last year's meeting. 35 of the 50 PacBio related posters and presentations are being made by our customers, compared to 8 last year, while 15 of them are being made by PacBio scientists. It is encouraging to see such a significant amount of customer led presentations after just nine months of having the product released. We look forward to gathering the feedback from this conference and providing an update in our next conference call.

Finally, I would like to give you an update on our latest product enhancement release that we refer to as C2. This release encompasses a number of elements that provide our customers with higher performance, such as longer read lengths, better accuracy and higher throughput. And it also includes a number of product quality improvements designed to improve the reliability and consistency experienced by our customers. For some perspective, our C2 product release is expect to deliver the following improvements over our initial product release nine months ago. A twofold increase in average read length, a three to fourfold improvement in mapable data for smart cell, a 50% to 80% reduction in DNA sample amount requirements, consistency accuracy of 99.999%, or Q50, at substantially lower sequence coverage. In addition, significant improvements in our SMRT cell design manufacturing processes, instrument firmware and analysis software to drive reliability improvements. All of this leading to better enablement of key applications, such as de novo whole genome assembly and targeted sequencing. We've just begun the process of upgrading our install base with the C2 hardware, software and consumables, and all shipments of new instruments going forward will include the features of C2. We expect the upgrade process to take several weeks. Ben will provide some additional color on this later in the call.

And with that, I will turn the call over to Susan.

Thank you, Mike, and good afternoon, everyone. Please forgive my voice, I am recovering from a cold.

I will begin my remarks today with the financial overview for the fourth quarter ended December 31, 2011, and then provide details on our operating results for the quarter, along with comparisons to the third quarter. After discussing the quarterly results, I will touch on the full year 2011 financial highlights and operating results. I will not be providing extensive full year comparisons to our 2010 results, as 2011 marked Pacific Biosciences transition from a development organization to a commercial operating company. Given the difference in how we are operating year-over-year, detailed financial comparisons generally provide few, if any, additional insights into the progress of our operations. Finally, I will conclude with a brief discussion of highlights from our balance sheet.

Starting with our fourth quarter financial highlights. During the fourth quarter, we recognized revenue of $12.4 million, and incurred a net loss of $22.8 million, while using $16.3 million of cash. It should be noted that we are continuing to recognize revenue on the instrument backlog that we built in 2010. We are entering the first quarter of 2012 with a backlog of 16 instruments, reflecting the 27 instrument orders in backlog at the end of the third quarter, 6 new orders received in the fourth quarter, and less the 17 instruments recognized in the fourth quarter.

Going into detail. Total revenue for the quarter was $12.4 million, an increase of $1.9 million from the $10.5 million of revenue realized in Q3 2011. Our revenue breaks down as follows. During Q4, we recognized $10.8 million of instrument revenue, reflecting the installation of 17 PacBio RS instruments, compared to $9.4 million realized on 15 RS instrument installations in Q3. Consistent with quarter-over-quarter growth in our RS install base, which now totals 48 installed instruments, our consumable revenue grew 58%, to $700,000 in Q4, up from $400,000 in Q3. And service revenue increased 42%, to $800,000 in Q4, up from $500,000 in Q3. Finally, research grant income in the quarter was $200,000, flat as compared to revenue recognized in the third quarter.

Gross profit in the quarter was $1.5 million, representing a gross margin of 12%, down from the $3.3 million gross margin of 32% realized in Q3. The reduction in gross margin quarter-over-quarter reflects the accounting treatment that we have discussed on previous calls. Our margin reported on a GAAP basis reflects the benefit of lower current product costs due to the fact that a significant portion of these product costs were expensed into R&D during 2010, as required under accounting rules. The reduction in gross margin from Q3 to Q4 reflects the fact that the instruments installed in Q4 had lower previously expensed manufacturing costs than those sold in Q3. It should be noted that in Q4, all remaining margin benefits associated with the product cost expensed in 2010 have been exhausted.

Moving to operating expenses. During September of this year, we made a significant reduction in our PacBio team. This action resulted in a third quarter period charges totaling $4.9 million. These costs were primarily related to employee severance and benefits packages, with $3.5 million being charged to R&D and manufacturing departments, and $1.4 million into SG&A. To provide a meaningful comparison between third and fourth quarters, I would exclude the reorganization charges recognized in Q3 from the quarterly comparison discussions of operating expenses. Operating expenses for the fourth quarter totaled $24.2 million, including $3.3 million of stock-based expense. This is a $3.6 million, or 13%, decrease from the restructured adjusted $27.9 million of expense recorded in Q3.

R&D expenses decreased 24% in the quarter, to $12.4 million, compared to $16.5 million in Q3. The $4 million reduction in expenses was due to reduced compensation expenses as a result of the headcount reduction realized in late Q3, and lower internal lab and consumable expenses. R&D expenses included $1.7 million and $1.6 million of non-cash stock-based expensed during the fourth and third quarters, respectively. Sales, general and administration expenses were relatively flat from the previous quarter, increasing a modest 4% during the quarter, to $11.8 million, as compared to $11.4 million spent in Q3. SG&A expenses included $1.6 million and $1.4 million of non-cash stock-based expense during the fourth and third quarters, respectively.

Moving to our full year 2011 financial results. We began realizing revenue on instruments during the Q2 2011, and for the year we recognized revenue of $33.9 million and incurred a net loss of $109.4 million, while using $106.2 million of cash. Going into further income statement detail. In the year, we recognized $30.2 million of instrument revenue, a result of the installation of 48 RS system instruments between Q2 and Q4 of 2011. From this install base, we realized $1.3 million from sales of our SMRTbell and reagent consumables, and recognized $1.5 million of service revenue in the year. Rounding out our 2011 revenue, we also realized $900,000 in the year from research grants. Gross profit in 2011 on product and service revenue totaled $12.1 million, representing a gross margin of 37%, which as previously mentioned, reflects the accounting benefit of expensing product costs in prior years when incurred, and according with accounting rules.

Operating expenses in 2011 were $122.8 million, including $12.4 million of stock compensation expense. This can be broken down further as follows. R&D expense. Those were $76.1 million, including $66.4 million of stock compensation expense. SG&A expenses were $46.7 million, including $6 million in stock compensation expense.

And now for our balance sheet. Our year-end cash and investments balance was $177.4 million, down $16.3 million for the quarter and $106.2 million for the year. Cash used during the quarter reflects our fourth quarter net loss of $22.8 million, less $4.8 million in non-cash expenses, composed of $3.3 million of stock compensation expense and $1.5 million for depreciation. Notable additions to sources of cash include $4.7 million associated with inventory reduction, and $1.5 million of advanced payments by our customers. Notable uses of cash include capital expenditures of $2.5 million, and a $3.4 million decrease in accounts payable. Accounts receivable increased $100,000 to $4.6 million in Q4.

From the inception of our commercial operations, we have experienced strong collections as evidenced by the fact that we have already collected payments on most of our Q3 installations and many of our Q4 installations. And finally, as mentioned previously, inventory balances declined this quarter by $4.7 million, or 23%, to $15.5 million at December 31, 2011, compared to $20.3 million at the end of the third quarter. The decrease reflects continued improvements in our efforts to match our manufacturing activity to our projected demand.

This concludes my remarks on the financial results for the quarter, and I would like to turn the call over to Ben.

Thank you, Susan.

By providing forecasts on these calls, our intent is to provide transparency on what financial results we can recently expect in the near term. To the extent that we have visibility, we provide guidance. We avoid providing forecasts for results that are subject to high variability or that are simply unknown. With that in mind, I will be providing forecast information primarily on results for the first half of 2012.

Starting with revenue, I would first like to put into context what we recorded in revenue over the past three quarters. The majority of the system revenue we recorded was derived from the backlog we had built up during the 18 month period prior to our product launch in Q2 of last year. At the end of Q1 last year, we had a backlog of 44 units and we ended up recognizing revenue on 48 units for the year. Out of the 20 units we booked between Q2 and Q4 last year, 16 remain in backlog. Generally speaking, we have just worked down the backlog that we built up in 2010 and early 2011. Going forward, our system revenue should more closely track our bookings, with a lag period to account for scheduling, delivery and installing systems after they are booked.

With this in mind, I will provide our revenue forecast for the first two quarters of 2012. Our system revenue backlog at the end of Q4 was approximately $11 million, comprised of 16 units. We're planning to install these systems ratably over the next two quarters. While at the same time, we are planning on upgrading our installed base of 48 systems with the C2 product release. Comparatively speaking, this will represent a significantly smaller amount of system revenue in each of the next two in each of the next two quarters than we saw in this past fourth quarter. Our consumable revenue will likely be impacted in the short-term by the transition from our C1 consumables to our C2 consumables, and therefore, we may not see growth in consumable revenue during Q1. After that transition is complete, we expect our consumable revenue to increase, as our install base increases and more of our customers integrate the PacBio RS into their product pipelines. We expect our service revenues to increase sequentially each quarter, but since this is currently a smaller portion of our total revenue, we expect our total revenues to decrease sequentially from Q4. Assuming that roughly half of the units in backlog are installed in each of Q1 and Q2, and further assuming that any system orders we receive in Q1 and Q2 are not installed until after Q2, we would expect our total revenue to be between $7 million and $8 million for each of the next two quarters.

Moving now to gross margin. Most of the positive gross margin we recorded in 2011 represented a carryover benefit from purchasing and expensing material in 2010. At the end of this past quarter, those carryover benefits have been exhausted. For the first half of 2012, we expect to be at or slightly above break even gross margin. In the longer term, when our revenue levels increase, we expect our gross margins to improve.

Our operating expenses in the fourth quarter of $24.2 million represents the floor that we established with our workforce reduction September of last year. We expect our operating expenses to increase modestly, primarily in SG&A, as we are investing more in our commercial organization to support our growing install base of customers. We expect our quarterly operating expense to increase to approximately $26 million in the near-term. A significant portion of that will be non-cash expense. We are estimating our non-cash stock compensation expense to remain at approximately $3 million to $4 million per quarter.

Finally, with regard to cash usage, as Susan mentioned, we consumed approximately $16 million during the fourth quarter, compared with a net loss of $23 million. Accommodation of strong cash collections last quarter and managing down our inventory levels resulted in relatively low cash usage, compared to our expectation of consuming roughly $20 million per quarter. In the near term, we continue to target using approximately $20 million in cash per quarter; however, we expect that our actual cash usage each quarter will likely continue to fluctuate. And, quarters with lower cash usage, such as our previous quarter, may be followed by quarters with higher cash usage, simply due to the timing of AR collections.

And with that, we will open the call to your questions.

(Operator Instructions) Ross Muken, Deutsche Bank.

Good afternoon. So in terms of, Mike, coming in and now sort of getting your hands on the business and on the commercial organization and trying to figure out the best direction to take the instrument in terms of getting greater traction with the customer base, what's your sort of early feeling where you kind of have not exploited potential either application areas or potential other uses or other types of customers, where you feel like just with the existing box you could do a better job of sort of penetrating that group? And then, where have you spent time, from a technology perspective, thinking you need to get to in order to achieve other sort of milestones you think will be maybe tipping points for more broad-based purchasing?

Well, the first part of that, I think, was an analysis of how our customers that have been in the early adoption phase have chosen to use the system. And that's kind of the thing I mentioned before. It's usually the customers that figure out where it is most of value to them, and that gives you the opportunity to say well, okay are there enough customers beyond the early adopters with those kind of needs in order to move forward with. And our conclusion was yes. And there actually was more than one area there that met that.

And, so the next step in that process is to help the customers be successful enough that they are in a position to publish and present the results of their use of the technology and why it was important in getting the scientific results that they wanted. Because it's that message to potential other customers that aren't necessarily technology early adopters that drives those other people, which usually are larger in number, to want to get into the technology. In order to do that, the third thing you have to do is make sure that you've got the system enveloped enough around the total solution to enable people who are not technology adopters, but just want to use it in their research, to be able to do so successfully. So, we've focused a lot in the last couple of months on what do we need to do to provide the sort of workflow and experimental planning, sample prep methodologies tailored to these specific applications that we've identified to focus on. At the same time working on the backend of the data analysis issues in order to enable people who clearly are not bio informatics specialists in a lot of these broader market areas, but who just want to get results and be able to interpret them quickly.

And so it is putting that sort of whole solution, sort of soup to nuts set of capabilities, along with the PacBio RS itself, in order to enable these people. At the same time, you're continuing to work on what it takes to improve the sort of generic capabilities of the system in terms of throughput and accuracy, and read length and so forth.

Great. And maybe, Ben, sort of digging into bit on the guidance. Just trying to understand it terms of on the revenue side, what are the assumptions for kind of first-half bookings, or is that not necessarily built into kind of the revenue forecast? And on the expense side, excluding the charges this quarter, I was getting to an operating number closer to $20 million. I think you said in the remarks that the go forward quarterly rate is going to be closer to $26 million. What is sort of the crosswalk delta there between those two figures on kind of a run rate number?

Sure. The first part of your question, our guidance is not really meant to try to give you a sense for how many bookings we're going to be getting. It was literally to tell you that with the backlog we have and the schedule to upgrade all of the install base to C2, we're going to be pretty busy basically delivering on tate backlog over the next couple of quarters and upgrading those 48 customers. So, the revenue for the first half is basically kind of what we se e in the backlog plus whatever service and consumable revenues are going to be in it. So not a big surprise there.

In regards to the spending, you have to realize that we had $24.2 million in operating expenses in Q4 and we burned $16 million in cash. And so, you realize that there's quite a bit of non-cash expenses that we record and report. Somewhere between $3 million and $4 million of stock compensation expense, and then something like $1.5 million in depreciation. So you have, at least in Q4, something like $5 million of non-cash expense. So, if you combine that with operating expenses of around $26 million and you have either a breakeven or a little bit more contribution on gross margin, then you can see that's our sort of steady, not steady state, but near-term cash burn might be something like $20 million a quarter.

Okay. And, just the number that you quoted for the quarter, did that include the sort of one-time expenses for the restructuring? Or was that sort of, I guess, a run rate number?

So the good news is all of the one-time expenses were actually recorded in Q3 of last year. The $4.9 million of expense was all incurred and recognized in Q3 of last year.

Okay. So there was no other run rate expenses in the quarter. Okay, great. Thank you very much.

Sure.

Bill Quirk, Piper Jaffray.

Great. Thanks. Good afternoon, everybody. Ben, just a quick clarifying question. In terms of the logistics involved with upgrading customers to C2, did I hear you correctly that you're not anticipating generating new order flow in the first two months there?

Let's be really clear about that. That's not the case at all. We're absolutely going to be generating orders in Q1 and Q2 and we're just not giving you a specific forecast on what those are going to be. And, I certainly did caveat the forecast saying, assuming that all we get completely installed by the end of Q2 is the backlog, then you would get $7 million to $8 million of revenue per quarter. If we're able to get through all of that stuff in a more efficient manner and we can start installing some of the ones that we get both in Q1 and Q2, then perhaps there will be a little bit more. So, the attempt was not to give you any sort of forecast on our Q1 or Q2 bookings.

Okay, no, that's -- appreciate the quarter. Is it reasonable to assume, then, that assuming a successful upgrade cycle with C2, is it -- are you seeing customers that are sitting out and effectively kind of waiting to see, to make sure that indeed the new performance metrics are delivered as billed? Anything like that then we might look at and say that this is a bit of a springboard to say a higher order rate in the back half of the year?

Well, we would certainly hope that. I think that we've had elements of the C2 chemistry out in some early test site hands for a couple of months. But, no one has had the full array of things that are involved in C2 out there. We certainly expect to see in the results we present at AGBT next week, and some of the customer presentations who have come from those early release sites, sort of their views of what the capabilities of the system are likely to be. And we'll present more ourselves in our own presentations at a couple of workshops. So, we would expect that reception to be positive, based on the results and the feedback we've gotten from our early release sites.

Very good. Thanks a lot, Mike. Appreciate it.

Amanda Murphy, William Blair.

Hello. Good afternoon. It's actually Sylvia here for Amanda today. Just curious on the operational expense level, maybe just a follow-up. So I am curious on your thoughts on the strategy for leveraging the existing R&D, or maybe your existing infrastructure to support the future technology development. And, I wonder if you can give us more color on how you prioritize those projects? And meeting the appropriate level of your technical goals, et cetera?

Well, we think that we did that effectively through the force reduction that we instituted in Q3. It was looked at pretty carefully as to what it would take going forward to continue to develop the RS system, continue to make improvements in reliability and robustness, and to provide the kind of applications level support that open up broader markets for us. So, what we know now, we are well-positioned for that.

Okay. And maybe in terms of the consumable usage, so just curious on the capacity for your install base. Are they running at the full capacity? Or just generally, how long does it take for a new customer to run through the full capacity after instrument is installed?

This is Ben.

So certainly, our customers could run more of our consumables through the system. So we only have a few data points, $700,000 in consumables, up from $400,000 in the prior quarter. Part of that is just having a larger install base, part of it is some customers finding value, like Mike was highlighting with the USDA. You find these projects that they can start devoting usage of their PacBio toward and that's going to drive more consumables. So we're certainly pretty early with the majority of our customers, in them setting up a series of projects. And so it's tough to come up with an estimated run rate that you're going to see, but certainly our goal is to drive our utilization across the board.

But part of the normal startup phase is that they're sort of getting used to how to use the instrument, period. Then there's one of the projects that it goes best with. And you wind up doing, as a customer, a series of relatively small pilot projects to figure that out. So most of our customers over the last nine months have been in that phase. There are a few exceptions who have already moved it into what I would call more of a production mode. But most of the customers up to now have been in sort of the pilot project mode, and so their usage is relatively lower than what we would hope them to be long-term, in a full-out production mode.

Okay, got it. And maybe last one from me. Just for your six new customers or six backlog this quarter, can you give us a high level of details of who are they? Are they mostly academic users? And just in terms of international, what is your outlook there? Have you seen a lot of interest from those markets?

Yes, Sylvia. So we try not to be too specific, to maintain some confidentiality for them. We can say there was certain international mix in there. And this is going to be a generalization. We are continuing to sell to early adopters. And that doesn't mean the early adopters can't be high users of the system, but the stage that we are at, we are selling to folks who are anxious to get their hands on a new technology, knowing that it is still relatively young in its introduction.

Okay. Thanks.

Tycho Peterson, JPMorgan.

Thanks. Ben, I may try to ask you that exact same question a different way. But as we think about the six orders you did take, is there any way you could break them up in terms of how many were kind of pure academic research versus more in production or applied customers?

So, I think some of those categories, they get sort of overlapping a bit. And generally speaking, there's a heavy sort of academic bent to them. And maybe just a generalization, there is not a high content of, let's say, industry kind of stuff, like pharmaceutical or industrial type customers. There are more on the earlier, let's say, academic or research side of things.

And then maybe going back to the original question on applications. Mike, I know you've talked about a number of core areas, targeted resequencing genome assembly and base modification analysis. Of those that you've talked about, is there an area that you see as most exciting, given your long history in the space? Are there obvious next markets to move into? Or, to your comments, are you going to really rely on customers to figure a lot of that out?

Well, we've used the first group of customers to kind of hone in on where we need to develop more of a full solution. It doesn't mean that we don't support a very broad array of applications on the technology at some level. It's just a question of what you focus on to start really putting the whole solution together for them. I think all of those represent substantial opportunities, and they all rely on some of the unique capabilities of the RS system, in one way or another. What is most exciting depends upon, from a customer's perspective, what you are doing in those areas.

But clearly, if one needs to do -- and I think in the end most people will, need to do de novo type assemblies, to underlying -- to figure out what's there that's important in individual genomes, you have to have long read technologies to make that work. And so people in that are really trying to work hard to figure out, on the really small ones, like bacteria, where you can pretty close to get de novo, and sort of single technology assembly completely with our technology, all the way up to a million genomes, where even a relatively small amount of coverage with long reads really improves the quality of the genome data that is there. And as we get more throughput, then it becomes more and more valuable to the higher organisms.

In the case of the validation type experiments, or the resequencing to look at very targeted groups of genes, we've got lots of advantages. The long reads are an important part of that. The non-systematic error profile that we have, the random error profile, the way to look at it, gives higher accuracy to those kinds of measurements than other technologies that are out there right now. And so that's of value to them.

In the case of the base modification studies, the ability to do kinetic measurements and the way that we employ the technology is a unique capability, and we think will allow customers over time to begin to look in a broader sense at base modification, levels they could never deal with before, because there just aren't good simple, scalable technologies for most of the modifications that are out there.

So, all of those we think are very important applications. I'm not sure that I know which in the end will be the longest. I could make a guess. But I think they are all important.

And then, how do we think about things like methylation and RNA, which you've talked about in the past. How important is that to the strategy going forward?

Well, the methylation is part of the broader concept of doing base modifications. [Dimethyl C] is one of them, but it's by far not the only one that is out there. There are two dozen or so that have been identified that are important in one organism or another, for one genetic control reason or another. And we've got the ability, in the end, to go at a broad range of those.

My own view right now is that the RNA sequencing is best addressed by the long read capabilities to deal with cDNA copies of RNA, where by virtue of the long reads, you've got a better chance of looking at certain issues having to do with variant splicing and so forth of entrons that give you different forms of expressed genes. I think we are a ways off from having a broadly usable direct RNA sequencing methodology.

And then, as we think about kind of pricing trends in the market, any thought or color you can provide on how you're viewing your ability to kind of hold price in an environment, where obviously there's been a migration down in terms overall box price?

Well, some box prices have gone up, too. So it's kind of hard to know.

I think the key for us is less the price issue than it is the value issue. And the more people can get unique value that they want out of our system, then price is less of an issue. We haven't really seen price pressures, I don't think per se, on our technology at this point. The issue is if the performance keeps going up, I think that will be stable for quite a while.

Okay. And then last one, you mentioned there's a hardware upgrade involved with C2 as well. Can you just clarify what that is? And I think also in your comments, Mike, you talked about sample prep. Were you just alluding to working with RainDance and Fluidyme, or are there other initiatives internally that you're doing around sample prep? Thanks.

Well, I'm not sure I said exactly hardware. I said firmware was updated, which is a component, in one sense of the hardware, in terms of how the hardware operates. There are some changes, if you consider the chips as part of hardware. But the sort of hardware changes that we are making per se part of Q2 are more to address particularly -- particular component reliability issues and stuff like that. That's an ongoing development, independent of Z2 itself.

So, it's not what you would think of as the PacBio RS when you look at it. Just the actual physical pieces. It's more, I guess, the inside software and things that are more related to that, that are being updated in addition to chemistry in the chips.

I'm sorry, I missed the last part of your question.

The second question was just to your comment on, you had mentioned developments in sample prep. Just wondering whether you were alluding to kind of the collaborations with RainDance and Fluidyme and others, or whether there are internal initiatives as well we should think about?

The answer is yes. It's both of those, as well as some other partners. But a lot of it has to do with just -- you've got all these opportunities for people out there to prepare samples with their own methodologies or using others. It's us giving them the ground rules of what we think works best. So in some cases, it's protocols that we supply directly through our own reagent kits; and in some cases it's, if you're going to do this step in the process for this reason, this is the sample prep that you want to use. If you're doing some other type of experiment, you want to use another approach. And so a lot of it is just guidance that's appropriate to a set of customers who don't want to go out and figure it out themselves, they want some kind of direction.

Okay. Thank you.

Bryan Brokmeier, Maxim Group.

Hello. Good afternoon. Is your sales force telling customers that they can make installations in the first half of 2012? So --?

I think I get the question. I think we try to work with all of our customers in terms of meeting their requirements. And so if a customer really needs to have it installed in the first half, then we're going to try to certainly work with them. I mean, that's our intent here.

Okay. So, -- that just kind of makes it sound like you could meet the customer's needs, but we shouldn't be expecting that any new bookings will be installed in the first half of the year?

No. I got to take another shot at this, Bryan, because I want to make it really clear. We will absolutely have bookings in the first half of the year. There's no question about it. So we weren't trying to be cagey at all with the guidance. The guidance is literally -- okay, this is how much you have in backlog, that's what you have visibility of, and so that's what we can certainly deliver on. If we get bookings and if we can get through all of the 48 installs -- sorry, upgrades, and the other 16 installs, and then still get through some additional installs for the bookings that we have in Q1 and Q2, can we have more revenue in Q1 and Q2? The answer is absolutely yes.

Okay.

I hope that it helps clarify that a little bit.

We just want to make sure you understand that we're guiding to what we know for certain, that's part of the script in there, too.

Right. But there's no reason -- you're just sticking with that 16, but even specifically to the first quarter, there's no reason that you wouldn't be able to install more than 8 in that first quarter?

Well, we are, as Mike mentioned, we have begun the upgrades for C2, and there are 48 of those to do. So there is a lot of focused activity in our field force right now to get through a bunch of upgrades.

Okay.

-- which are just now starting. And to be honest, we don't know exactly how long each of those is going to take. And hopefully, it will take less time as we go through more of them. But there are a lot to do. And so that's why we're trying to be somewhat cautious about what we can rationally expect our organization to accomplish in that time.

Okay. And then, you installed more systems during the quarter than I was expecting, and it was also more than -- you exceeded your revenue guidance. What allowed you to make those additional installations? Was there anything -- did you streamline the process, or has the installation process improved in any way?

Someone else asked me that, too. So, we did install 17. And at any point in time, we have more systems that are out there in the process of being installed than what actually finishes installation by the end of any quarter or time period. So, when we gave guidance at the end of the previous quarter, we took what we thought was a reasonable estimate of the number of those that were complete installations, and fortunately we were able to finish a couple of them earlier than we thought. So, that's all there is to it.

That's why we also caveat all of these forecasts, saying when you have a big capital item that represents a significant portion of your quarterly revenue, that certainly has the ability to give you significant fluctuations given that the numbers here are not really big individual numbers.

Alright. Great. Thanks a lot.

(Operator Instructions) David Ferriero, Oppenheimer.

Thanks for taking my questions. Just a couple of quick ones on the C2 chemistry and the upgrade. Is the C2 upgrade free for your current installed base?

The upgrade is free. Obviously, it includes consumables which they will be buying, as they use them.

Okay, okay. Is there any change -- and I guess a more specific question on pricing. Is there any change to the pricing of your consumables, following the C2 upgrade?

No. We maintain the same pricing on the consumables for our customers, and they've been very appreciative of that.

Sure. And then, in the past you've spoken about, I guess, pretty regular upgrades to the system, like the C2, going forward. Should we expect another C2 type upgrade, maybe a C3 upgrade later this year, or is that too far forward?

Well, my philosophy on that. I think that what you would expect to see, or customers would expect to see, are a continuous set of improvements in performance to the system. Whether we call that C3 or we just call it individual improvements, I think depends on the scale of what we're trying to change at any one point in time. And we would make improvements on an ad hoc basis to deal with specific firmware, software fixes and so forth for updates. We may change chemistry components that require other changes in the system. We may change system components or reagent components without affecting the rest of the system, but still improving performance. So, I think one thing that you are likely to see are a set of a more modest improvements, maybe on a more frequent basis.

Okay, okay. And then one last question, I guess more of a market outlook type question ahead of AGBT. Once again, nanopore sequencing is kind of making noise, especially given that AGBT is next week. I was wondering if you could talk about maybe where you think that's going to position in the marketplace and if you perceive that as a potential threat to your year technology?

I'm surprised that was this late in the question period. Well, the nanopore type technology has been around as a concept for over 20 years. A lot of people have worked on it. A lot of people have tried and failed. So I think I'll reserve judgment on it until I see what the results are. I have my own guesses of what I think the limitations of the technology are. It's not something that currently keeps me up at night.

Okay. Fair enough. Thank you.

Operator, I think we have time for one more question.

Zarak Khurshid, Wedbush Securities.

Great. Good afternoon. Thanks for taking the questions, everyone. With respect to the C2 performance improvements, the 2X read length improvement, what does that represent terms of absolute read length? And then as a quick follow-up, what's happening on the legal front currently? Thanks.

Okay, so the first question's there. So on the read lengths, what we tried to guide to is that it's roughly a twofold increase in read length from where we were nine months ago. Now, there are times when particular experiments you get actually a much bigger increase than that. There are times when you don't get such an increase. It depends on what you are trying to deal with. And we certainly have seen results that are 2.5 times or more in terms of results, presented by some of our customers. You're likely to see some of those at AGBT that are upwards of almost 3,000 base pair read lengths, on average. But again, it depends on the nature of the experiment, the kind of sample prep that people are using, what kind of size inserts, a whole slew of other factors, as to exactly what you get. So trying to pin it down to one number as a spec is kind of hard. And the guidance we've given is we expect to get at least a twofold increase in read length. It translates to a higher increase in the amount of mapable DNA sequence, for a couple of other reasons, having to do with the yield, in terms of numbers, wells that get loaded, (inaudible) and so forth.

On the legal front, we're an early stage high technology company, and it is kind of hard in this space not to be involved in IP or other kinds of legal issues. We don't comment on those individually. We'll let the legal process wend its way through. We feel pretty confident of our position in all of them.

Okay. Thank you.

So, in closing, I've only had the COO for a few weeks, I have had the privilege working with the PacBio team as a Board member for the past six years. I am proud to be a part of a team of really very talented people who are dedicated to improving biological and biomedical research through development and delivery of products using our SMRT technology. We're excited to be launching our C2 release this quarter, and look forward to sharing some of the results with you in three months time.

With that, I thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.