Pacific Biosciences of California Inc (PACB) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Pacific Biosciences of California, Inc. third-quarter 2015 earnings conference call. (Operator Instructions) As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Trevin Rard. You may begin, ma'am.

Thank you. Good afternoon and welcome to the Pacific Biosciences third-quarter 2015 conference call. Earlier today, we issued a press release outlining the financial results we'll be discussing on today's call, a copy of which is available on the investor section of our website at 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 Chairman and Chief Executive Officer; Susan Barnes, our Chief Financial Officer; and Ben Gong, and our Vice President of Finance and Treasurer.

Before we begin, I'd like to remind you that on today's call, we will be making forward-looking statements, including plans and expectations relating to our financial projections, products, and other future events that 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 Forms 8-K and 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 available for audio replay on the investor section of our website shortly after the call. Investors electing to use the audio replay are cautioned that forward-looking statements made on today's call may differ or change materially after the completion of the live call.

I would like to now turn the call over to Mike.

Thanks, Trevin. Good afternoon and thank you for joining us today. We are pleased with our third-quarter results and the progress we are making in driving growth in our business. In particular, the announcement of our new Sequel platform has been extremely well received, which I will expand on later in the call.

Highlights of our Q3 2015 financial results are as follows. Total revenue for the quarter was approximately $14 million compared with over $21 million in Q3 of last year. As we described in our earnings call last quarter, we expected our total revenue for the quarter to be lower than last year due to the $10 million Roche milestone revenue we recorded during Q3 2014. Excluding the milestone revenue and the quarterly amortization of Roche contractual revenue from both years, our total revenue grew by 16% quarter over quarter and grew 29% year-to-date 2015 over year-to-date 2014.

Consumable revenue for the third quarter was $5.4 million, up 64% from $3.3 million in Q3 2014. Year to date, our consumable revenue has increased 60% over 2014. System utilization continues to be robust and our average annual consumable revenue per installed system has exceeded $135,000 over the last year.

Instrument revenue for the quarter was $2.2 million compared to $3.5 million in Q3 of 2014. The number of new orders for RS II Systems in the quarter was actually the highest since the commercial launch of the RS in May 2011.

However, as we near the transition from the RS II to Sequel sales, in selected instances, some RS II placements made in the quarter were made as rentals. Revenue from these placements will be recorded in the service and other category in coming months.

While we reported a modest net profit for the quarter, this resulted from a one-time operating expense credit. Susan will provide the details of this credit a little later in the call.

Now I'd like to provide some color and perspective on our recent Sequel product announcement. Four and half years ago, we introduced SMRT sequencing to the research community. Since that time, we have worked to demonstrate the value of the technology's key attributes: long sequencing reads, high consensus accuracy, uniform genomic coverage, and integrated methylation detection.

Also during that time, we were able to decrease the consumable cost of SMRT sequencing projects by a factor of approximately 100 due to the development of new sample preparation techniques, improved sequencing chemistries, and more sophisticated data analysis tools. We were able to drive early adoption of our products in microbial plant and nonhuman animal sequencing applications, where de novo genome assembly was already recognized as being very important.

More recently, we have worked with several customers to demonstrate the value of such assembly in human applications, particularly to elucidate the importance of structural genomic variation largely hidden in short-read sequencing studies. The success of these efforts was evident at the recent meeting of the American Society of Human Genetics, or ASHG, in Baltimore. We had a very strong scientific presence at the conference with twice as many customer presentations and posters featuring PacBio at this year's conference versus compared to last year's.

While SMRT sequencing is increasingly recognized as an important advance for a growing array of applications. The upfront price of the RS II and its associated throughput and operating cost have been a hindrance to its wider adoption.

With the introduction of our recently announced Sequel System, we believe we are now well positioned to take advantage of the efforts we have made to establish the value of SMRT sequencing. Its lower price -- half that of the RS II -- and higher throughput -- approximately seven times the number of DNA molecules that can be analyzed in a single SMRT cell -- has been well received in the few weeks since we made the product announcement and showed Sequel at the ASHG meeting.

We were particularly pleased with reception of the Sequel System at ASHG and Sequel's introduction was widely regarded as the technology event of the conference. In the first two weeks since the initial product announcement, we received a similar number of requests for quotes for Sequel Systems as we had received collectively in the prior nine months for the RS II. And several of these have already been converted into orders.

As we've previously announced, we expect to ship approximately 10 Sequel Systems to US customers, including Roche, in Q4. We will be working to ramp up production capacity for both the Sequel System and its new SMRT cells early in 2016 and then begin broader shipment, including to customers outside the US.

The product transition so far has been fairly smooth. Customers who had ordered an RS II System and were in our backlog at the end of Q3 understand the Sequel System is not broadly available for shipment right away. So those who need access to SMRT sequencing in the near term are following through with their scheduled shipments.

As I mentioned earlier, we booked quite a few RS II orders in Q3, so shipments of RS II systems have continued regularly into Q4. Not surprisingly, the majority of new orders being booked in Q4 are for Sequel Systems.

Now that we have announced the Sequel System for research use, we are stepping up our preparations for supplying Roche with systems and consumables for their sales into the clinical market. As we announced earlier, we expect Roche to launch their version of the Sequel System for clinical research in the second half of next year to be followed later with the launch for in vitro human diagnostic applications. In the meantime, we are planning to ship a number of Sequel Systems to Roche for them to use in internal assay development.

The system that Roche plans to sell will be similar to the Sequel System, but with the Roche brand clearly designated and with modified software to recognize Roche-labeled consumables. We expect to earn the final $20 million milestone payment under our agreement with Roche in Q4.

The development and introduction of the Sequel System has involved the concerted efforts of the outstanding employees of PacBio. And in addition to providing a sequencing system capable of producing substantially increased throughput compared to its predecessor, they have engineered a new SMRT cell architecture that provides the capability of further substantial sequencing throughput increases in future versions of the SMRT cell.

Moreover, manufacturing costs of the Sequel System are approximately one-fourth that of the RS II. This allows us to price the system at half the selling price of the RS II and still begin delivering reasonable gross margins on instrument sales, thus facilitating our progress towards profitability.

That concludes my 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 third quarter that ended September 30, 2015. I will then provide details on our operating results for the quarter and year-to-date 2015, with a comparison to the same periods last year. I will conclude my remarks with a brief discussion of our balance sheet.

Starting with our third-quarter and year-to-date financial highlights. During the quarter, we recognized revenue of $13.9 million and net income of $1.8 million. This brings our year-to-date total revenue to $56.5 million and net loss to $30.3 million.

We ended the quarter with $58.9 million in cash and investments, $13.8 million lower than the $72.7 million reported at the end of the second quarter and $42.4 million lower than the $101.3 million reported at the end of 2014.

Turning to revenue, total revenue for the quarter was $13.9 million, down $6.7 million from the $20.6 million recognized in Q3 of 2014. Year-to-date total revenue in 2015 is $56.5 million, up 29% over the revenue of $43.7 million recognized through Q3 in 2014.

Breaking down the revenue, instrument revenue quarter over quarter was down from last year, with $2.2 million recognized in Q3 2015 compared to $3.5 million recognized in Q3 of 2014. As Mike mentioned earlier on this call, the decrease reflects the fact that some of our instrument installations this quarter had lease arrangements. The corresponding revenue from these leased instruments will be recognized as service and other revenue and will be recognized over the leased period.

Year to date, instrument revenue was $13.5 million -- flat to that recognized during the same period last year. Consumable revenue continues to be very strong, increasing 64% to $5.4 million in the current quarter, up from $3.3 million reported during the third quarter of 2014.

Year to date, consumable revenues increased 60% to $14.2 million in 2015 compared to $8.9 million year to date through Q3 of 2014. Service and other revenue increased 27% to $2.7 million in the quarter compared to $2.1 million in Q3 of 2014 and was up 29% year to date to $8 million from $6.2 million in 2014.

Roche-related revenue recognized this quarter was $3.6 million, which was $8.1 million lower than the $11.7 million recognized in Q3 of 2014. Year to date, Roche revenue is $20.8 million, $5.7 million greater than the $15.1 million recognized through the first 3 quarters of 2014. The variance of the Roche-related revenue quarter over quarter and year to date versus year to date reflects the past timing of our achievement of Roche milestones and a revision to our Roche-related revenue amortization schedule in 2015.

I will now provide detail. In Q3 of 2014, we recognized $10 million associated with the achievement of the first Roche development milestone. In Q2 of 2015, we achieved the second Roche milestone and recognized another $10 million. Year to date, these numbers are the same, but we recognized our second milestone one quarter earlier in 2015.

In addition to milestone-related revenues, in Q1 of 2015, the estimated development period for the Roche contract became more certain. In response to this, as we have highlighted throughout this year, we revised the revenue amortization schedule associated with the $35 million upfront payment that we received from Roche back in 2013. This revision added an incremental $1.9 million of Roche revenue in each quarter of 2015.

Moving to gross profit and margin. We generated a gross profit of $6.6 million in Q3 of 2015, representing a gross margin of 47%. This was down from the $13.2 million of gross profit and 64% gross margin recognized in Q3 of 2014. As with revenue, the decrease in margin quarter over quarter was resolved with the $10 million of Roche-related revenue recognized in Q3 of 2014, which had a 100% margin.

Year to date, gross profit was $27 million, representing a gross margin of 48% compared with 2014 year-to-date gross profit of $18.9 million with a gross margin of 43%. Year-to-date gross profits and margins in 2015 have increased over 2014 levels as a result of the growth of the higher-margin consumable revenues and the previously mentioned revision of the Roche amortized revenue, which has added an incremental $5.7 million of revenues at 100% margin year to date in 2015.

Moving to operating expenses. This quarter, we booked a one-time $23 million gain associated with the amendment to our facilities leases. This was an offset to our operating expenses and is the cause of the large variances to operating expense totals from previous years and quarters.

Operating expenses in the third quarter of 2015 totaled $3.9 million, much lower than the $21.6 million incurred in Q3 of 2014. Year to date, operating expenses decreased to $55.1 million from $63.9 million in 2014.

Further breaking down our operating expenses. R&D expenses in the quarter were $16.1 million, $4.4 million higher than the $11.7 million of expenses incurred in Q3 of 2014. Year to date, R&D expenses were $45.7 million, a $9.8 million increase over the $35.9 million of expenses in 2014.

The R&D expense increase in 2015 has been a result of higher compensation-related expenses as well as an increase in consulting, product development, and regulatory costs associated with developing the Sequel product. R&D expenses this quarter included $1.2 million of non-cash stock-based compensation expense, a $300,000 increase over Q3 of 2014.

Sales, general, and administration expenses for the quarter were up $900,000 from a year ago. In Q3 2015, we incurred $10.8 million in expenses compared with $9.9 million in Q3 of 2014. Year to date, SG&A expenses increased $4.4 million to $32.4 million in 2015, up from $28 million year-to-date 2014.

The SG&A expense increase in 2015 has been a result of higher compensation expenses associated with an increase in the sales, marketing, and administrative resource levels required to support the new Sequel product. SG&A expenses in the quarter included $1.7 million of non-cash stock-based compensation expense, up $300,000 from the $1.4 million recognized in Q3 of 2014.

In the area of other income and expense in Q3, we reported $900,000 of net other expense, primarily related to interest expense related to the debt we took on in Q1 of 2013. Year to date, our net other expenses have totaled $2.3 million.

And finally, a comment about our net income in Q3 2015 and net loss year-to-date 2015. As previously stated, in large part due to the $23 million lease amendment-related operating gain in the quarter, we recognized net income of $1.8 million in Q3 of 2015. This resulted in an earnings per share of $0.02 on 80.2 million diluted shares.

For the year, we have incurred a net loss of $30.3 million, resulting in a loss per share of $0.41 on 74.7 million basic shares. Ben will provide further guidance on our ongoing expense rate later in the call.

Now turning to our balance sheet. As I mentioned in the beginning of my comments, cash and investments decreased to $58.9 million at the end of the third quarter. This is a $13.8 million decrease during the quarter. Our cash use primarily reflects our Q3 net income of $1.8 million, adjusted for non-cash revenue and expenses, including the Roche amortization revenue, operating gains related to the lease facility amendment, stock compensation expense, and depreciation expense.

Accounts receivable increased $200,000 in the quarter to $40.2 million at the end of Q3 2015. Inventory balances decreased $400,000 in the quarter to $11.6 million at the end of Q3.

This concludes my remarks on the financial results for the quarter. I'd like to now turn the call over to Ben.

Thank you, Susan. I will be providing an update to our 2015 financial forecast, which at this time is essentially an updated forecast for the fourth quarter.

Starting with revenue, as we saw in both the second and third quarters, our quarterly revenue comparisons between 2014 and 2015 are greatly affected by the timing of Roche milestones. The first $10 million milestone came in Q3 of 2014 followed by the second $10 million milestone in Q2 of 2015. And now, with the final $20 million milestone expected to be achieved in Q4 of 2015, we expect to report a significant revenue increase in Q4.

Meanwhile, we plan to begin shipments of the Sequel System and continue to manage shipments of existing orders for RS II Systems. The timing of shipments and installations may vary, which is typical during significant product transitions. Taking this into account, we are increasing our revenue forecast for the year, expecting annual revenue growth of between 50% and 55% over last year, which is up from our previous forecast of at least 40% growth.

Moving on to gross margin, our Q3 margins were higher than anticipated as we had a favorable mix of high-margin consumable revenues. In Q4, we expect to record a much higher gross margin as we anticipate recording the $20 million Roche milestone revenue at 100% margin. This will likely increase our gross margin up to approximately 70% for Q4.

With regard to operating expenses, excluding the nonrecurring $23 million gain we recorded in Q3, our operating expenses grew in conjunction with increased development costs associated with the Sequel launch. Much of those costs are expected to continue in Q4; therefore, we expect our Q4 operating expenses will be similar to the $27 million we recorded in Q3, excluding the nonrecurring gain. As a reminder, our operating expenses include non-cash stock compensation expense and depreciation expense that together amounts to approximately $4 million per quarter.

Finally, with regard to our 2015 annual forecast, as a result of the nonrecurring gain of $23 million that we recorded in Q3 and the anticipated $20 million milestone revenue we expect to record in Q4, our net loss for the year is expected to be approximately one-half of the net loss we reported for 2014.

Since we announced the launch of our Sequel platform, we have had a number of questions regarding our expectations for 2016 revenue growth. While we are not yet ready to provide a specific forecast for 2016, we can provide some insights.

First, the Roche contractual revenue, which we have been amortizing since late 2013, is expected to tail off significantly by the fourth quarter of next year. Secondly, based on the early demand we are seeing for Sequel, we expect to generate significant growth in instrument and consumable sales next year.

In addition, while we do not have any milestone revenue scheduled for next year, we are planning for significant product sales to Roche next year as we expect them to launch their Sequel-based products in the second half of the year.

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

(Operator Instructions)

Tycho Peterson, JPMorgan.

Thanks for taking the question. I know it's still early days on Sequel, but just given the interest you've seen out of ASHG, I'm wondering if you can comment a little bit on how much of the demand is coming from RS users versus maybe customers using competitive systems, maybe versus customers new to sequencing altogether?

I don't think there's so many from the latter. I think it's actually been about equal between existing customers and new customers.

Okay. And then Mike, do you have any color on how customers will be using the system? Are you getting a better feel for applications and the use case when they get installed?

Well, in looking at it broadly, I'd say there's obviously been a growing increase in the human sequencing side through the year. I think that's certainly continued based on the list of people that I know have asked for quotations. But I would say that it's actually been pretty broad across the whole spectrum of potential uses that people have applied the RS to.

Okay. And then --

The biggest difference is that we are now getting into a price range that people feel much more comfortable being able to acquire quickly.

And what are you promising on shipment times for people that place orders today? Is it first quarter? Or how do we think about when you will deliver?

Well, it depends on who they are, to put it mildly. And obviously, we have tended to focus early -- I think as we mentioned this on the last call -- on customers that we knew were very comfortable with taking on a new technology or a new version of a technology that had the right kind of development people in house to be able to incorporate that into their programs more equal -- [morphist fastily] than somebody who hadn't used the technology at all.

But we've tried to make it clear, particularly to people outside the US -- we just rolled this out into our distributors in Asia late last week -- that they will probably not get any significant number of shipments into their areas until, say, the second quarter of next year.

In the US, it's depending on who they are and what we think their capabilities are of taking on new technology. We'd expect to be shipping into the US more in Q1 and Europe and Asia more in Q2. Again, we deal with those on a case-by-case basis. There will be exceptions to that in both cases.

Okay. And then last one, maybe for Ben or Susan -- I appreciate some of the thoughts on 2016. As we think about OpEx, can you maybe just help us think about what a reasonable run rate is? Is kind of $25 million per quarter the right way to think about it take or will you have a decent step up in 2016?

I think you have to think of it that we did a lot to step up to get this product out. So that's about as far as we can go with that one.

Okay. Thank you.

Bryan Brokmeier, Cantor Fitzgerald.

Hi, good afternoon. You had an acceleration in consumer revenue pull-through. What were the major drivers behind the increase?

They were running more SMRT cells. We've seen that all along -- at least for the last couple of years. And since we're giving you a number based on the previous 12 years, as that's increased, it means it's continuing to increase during the year. And eventually as long as that's true, the past 12-month number goes up. So it was even higher than that in the last quarter.

But I do think as the throughput of machine has gone up, we are seeing more and more big projects coming on to the system that we didn't see earlier in the RS life.

Bryan, one thing: as we were doing our sort of analytical work. As you noticed, it jumped up quite a bit. And as far as we can tell, we're not having any issues with seasonality in Q3 with respect to the consumable revenues.

One thing that as pointed out, which was we were real somewhat surprised by actually is that in a lot of areas in the world, like Europe, who normally shut their machines down for a good fraction of the summer quarter, they kept them running this time. And in a lot of cases, we mentioned that we've continued to be able to place RSs.

And we expected this quarter, for example, and even the end of last quarter -- since they knew they weren't likely to get a Sequel in the next two or three months, they had enough of a demand that they went ahead and are taking their RS IIs in order to keep up with that demand. So we're seeing it across the board and it wasn't just in a few customer sites; it was broadly an increase throughout the whole customers. Some of whom were running at full steam and needed additional equipment in order to keep up with their load. And others who were running at a lower rates, but had stepped up because they had more demand.

Okay. That's great. And what was -- were the instruments that you leased during the quarter, are those any sort of higher margin, then, instruments that you sell?

No, Bryan. I think we also try to point that out to help you with why the instrument revenue actually decreased. The revenues from those leased systems is going to show up in that service and other line in ensuing quarters. But in terms of the -- I don't know -- the value of the leases versus purchase, other than they are sort of at a lease rate, they are not materially different, I would say.

Okay. And can we assume that the instruments that you are placing on lease with customers that they will be replaced by Sequels in 2016?

They may or not may not. But we did this consciously in order to address for some customers who, quite frankly, are Sequel customers who, as Mike just mentioned, had immediate need for access to SMRT sequencing. And since they can't necessarily get into the queue very quickly, or we don't anticipate them getting into the queue very quickly for Sequel System, it made sense to offer them just a leasing option.

Okay. And have any of the Sequels been delivered to customers thus far in the quarter? Or what's the timeline for the 10 instruments to be delivered?

We haven't delivered any of them yet, but we are still planning on delivering approximately 10 this quarter.

Okay. Thanks a lot.

Amanda Murphy, William Blair.

Hi, thank you. Good afternoon. So I just had a question about the Sequel. I don't think you had it in the hands of customers pre- the launch -- I'm not totally sure about that. But I guess I'm just curious what the key risks are around the performance metrics might be upon launch?

I know investors, for example, have asked us at least about kind of raw read accuracy and whatnot and I'm not sure that's the right thing for us to be thinking about. So it would be helpful I think to frame what to be looking for from a performance perspective.

Well, I think we expect the performance metrics to be comparable in gross respects to the RS, other than the throughput issue, which we expect to be much higher. You know, the risks are what they are for any new product introduction. You are going to have issues with bugs in the software that you didn't find early on until customers started hitting buttons in different orders than your testers did internally, things like that. There is always the risk that we designed a part wrong.

It's the normal sort of new item things that you worry about more than anything else. So we're working really closely with our internal testers and our service people and manufacturing people to make sure that we have as few of those as possible. I don't expect to avoid them entirely. I've never done that in 30 years in this business, so I don't expect to do it this time either.

Right. We did hear a rumor at ASHG that there was something about our new optical system that would have an accuracy hit. That did not come from anything that PacBio was saying or had experienced. So we don't expect --.

Okay.

So there will be things that we don't know until we get them out in their hands. Obviously, given the transition from an ongoing product to a new product, we were very careful about keeping things as internal as possible. We didn't rollout the system to our sales force until two days before ASHG started, for example, to give them both credibility as well as minimizing the chance that what we were doing would leak out prematurely because obviously, a product transition of this type could completely stall business for a long time if it's out there too early.

So we were pretty careful about that. But we've got enough experienced real users internally to know how we're doing on the development process to handle this. And obviously, we had a lot of interaction with Roche, who was an inside future customer on the development as well.

Yes. Okay. Makes sense. And I guess similar question on the capacity constraints for the first year. So it sounds like you'll be predominately through that, I think, in the first half -- maybe that's the wrong assumption. But maybe just talk through what are the key variables there, too, in terms of what might make you be more constrained or less constrained next year as you ramp?

Well, it's less about the instrument than it is about the SMRT cells. And we'll be in the process sometime in the first half of next year switching from Imec, which has been our development partner out of Belgium on designing the SMRT cell and the early manufacture, to a high-volume manufacturer.

Imec is essentially an R&D very early manufacturing house, mostly R&D. And when that's done they help you transition to a high-volume full-time fab manufacturing operation, which we have been in the process of for the last several months, but there's a lag as to how quick that transitions.

So our early manufacturer chips will be from Imec and then our longer-term one from a high-volume supplier. The timing of that is -- depends on how quickly things go. So far, they've been doing very well and are ahead of schedule perhaps, but we try to be a little cautious about --.

It's not only timing; it's yield. Any new wafer process takes time to get the yields up, too. So we want to be cautious on several levels there.

Okay. And maybe just last one for me. Any chance you could help us understand in terms of Roche what that demand might look like in aggregate for next year in terms of, I don't know, percent -- maybe you are not willing to give percentages. But even just qualitatively how big of a customer really they might be?

They will be our biggest customer, by a lot. And it will be a substantial fraction, we think, of the sales based on the forecasts that they give us. It won't be a majority next year, by any means.

So I will point out, in case people haven't seen it: it's no totally random event that they have secured the gold sponsorship at AGBT. We've secured the top silver sponsor and we will jointly give a lot more clearance on their program collectively at those two presentations -- or workshops there.

Got it. Thanks very much.

Bill Quirk, Piper Jaffray.

Thanks. Good afternoon, everybody. First question is kind of going back to the OpEx comment or guidance that you gave us, Ben. Shouldn't we assume here at some point that your R&D spend related to Sequel starts to roll off? It's certainly jumped up noticeably over the past couple of years as you guys ramped up development there.

Yes. That's what we meant to say, quite frankly, Bill. But in Q4, we are continuing to do a fair amount of work there. So the point is that we expect the R&D expenses in Q4 to still be fairly high. But you are right: at some point in time, it should start tailing off a bit.

Okay. All right. Good to know. And then just going back to the leased RS IIs. I certainly recognize that over time, a lot of these are going to transition to Sequel. Just for modeling purposes, should we be assuming that these leases actually extend beyond 2016 or would you expect to have more or less transition everybody over to a Sequel at that point?

Bill, this is more of a product transition sort of activity as opposed to a long-term activity as of today. So we specifically went into it with the Sequel introduction in mind to kind of help people transition who are in that position of needing capacity right away, but couldn't get their hands on a Sequel right away.

With that said, there are some selected customers in there who are very big users and have multiple instruments who are looking at having spent a lot of time validating in a commercial setting the utility of the RS who have expressed some reasonable expectations that they may be continuing with the RS that they've invested in for quite some time.

I think the thing we want to be careful about is -- and we don't know this; your model is as good as ours at this point. But there is a stickiness to an installed base. We'll have the capacity to serve it as well as what we said at ASHG: the intention to continue to release enhancements that serve that installed base.

Okay. Understood. And then --.

Let me add to that a little bit. So one expectation that these guys have is that if they continue to be successful and expand some of their commercial operations, what they told us is that they would invest in the RS II first. And those are ones that we talk to specifically in some cases about leases. But then follow-up with that with additional capacity on the Sequel platform as it gets out and is fully vetted.

It's one thing for people in a totally R&D setting to take on a new instrument and technology; it's another for a commercial operation that has a set of protocols and a set of applications that they have spent a lot of time wiring in place to work really well. They sometimes hang on to older technologies much longer than somebody with just an R&D mindset would think about.

Okay. No, I appreciate all the color there; recognize there's a lot of moving parts to the rental side of things. Last one for me is just thinking -- not trying to put the cart before the horse here, but thinking about further improvements to Sequel. We've all obviously had the chance to take a look at the system at ASHG.

And so, Mike, I just wanted to clarify: in terms of future system enhancements, are there going to be any hardware changes necessary? In other words, would you have to swap out the optics if you decrease the spacing of the zero mode waveguides on the chip? Would you have to change out any of the fluidics? Or is the system robust enough at this point such that you can be able to essentially introduce new chips on a fairly seamless basis for customers?

Well, the optical system is designed so that we don't anticipate any significant changes to it in order to address some reasonable level of capacity increase on the chips. At some -- and I don't think the robotics platform on the workstation wouldn't need to be changed.

In order to get more capacity in terms of, say, having higher density SMRT cells, the one thing that we probably would have to do is increase the computing capacity in the system. But it was designed so that it's got space for additional boards to be able to accomplish that on a more or less linear basis versus the increase in the numbers of ZMWs in the chip. But other than that, we spent a lot of time and effort working on a platform that allowed us that kind of expansion.

To add another lever to increasing throughput, we've been able to increase the throughput pretty dramatically over the years on the RS System by improving read length through chemistry, through sample prep technology, through improved software that requires less coverage in order to get the kind of answer that people are looking for.

We still have all those levers in the new system, but we have the additional lever, which we really didn't have access to, being able to upscale the capacity of the SMRT chip itself, as we did with Sequel.

Got it. Understood. Okay. Thanks very much, guys. Appreciate it.

(Operator Instructions)

Zarak Khurshid, Wedbush Securities.

Yes, Zarak at Wedbush. Thanks for taking the questions. A question on manufacturing: how are the operations there shaping up? And what kind of investment is required to meet the demand for Sequel?

I think the operations are shaping up very well. We are very proud of our operating group. They were integrated in the Sequel development and the design for manufacturability as well as the vendor and supplier agreements along the way.

We are a final assembly and test packaging kind of company. We are not a build it from raw material up, so we do have ways of handling through -- a subassembly is a very efficient manufacturing process. So we are supporting both RS lines on our reagents and our chemistry and our instruments for a bit of time, and our chips. But we feel that we have a capacity that will not involve a huge step up in fixed-cost function to get there.

That said, Zarak, let me just comment -- and this dovetails with the $23 million gain that we recognized this quarter. So as we've kind of talked about in the past, we have these plans on moving our facilities not far away from where we are today and increasing our effective space by something on the order of 20%. A lot of that additional space actually is going to be devoted toward manufacturing.

So even though -- Susan is absolutely right. There's a lot of efficiencies for us to gain; we expect to have a significantly higher volume in terms of manufacturing products going forward. So the expansion for the new facilities is going to go a long ways to accommodate that.

Sounds good; thanks for that. And then a follow-up to Bill's question. Given the change in the supplier and any other developments out there, can you provide an update on how you think the Sequel throughput will improve through the course of 2016?

Well, I'll maybe give you a little bit more input on that at the beginning of the year. As I said, we've got all the same levers we had. We fully expect to turn the chemistry once, probably twice during the year, which will improve things as we've done because we've already learned a lot more than what we knew even two months ago in that regard.

We are learning a lot about how to load the ZMWs more efficiently in the context of what we call [sewer pasan]. Right now, it's a random loading process and you want to load one and only one molecule of DNA in each ZMW.

But the way you do now, it is a statistical thing. If you load a few of them, most of them are singles. If you try to load more and more of the holes, you wind up getting a lot of doubles, which is negative. You don't get necessarily a sequence out of that. And we have technology we've been working on some time that we are getting ready to roll out in beta sites on the RS System that allow a much higher percentage of single-load ZMWs, which increases your effective throughput. And we plan on rolling that out on the Sequel System in next year.

So my target would always be a factor of four. We're a little early in the process of getting Sequel out, so we'll see how well we do on that and the timing we can have, but there's no fundamental reason we can't do that.

Great. Thanks for the color there. Last one -- just housekeeping. What was the CapEx in the quarter and how do you think about that going forward? Thanks, guys.

I think it's on the -- we filed the 8-K and I think you have it in there. I think it was something on the order of $2 million or something like that for the quarter and for the whole year, I think it's something like $3 million. So we did do some CapEx for this quarter.

It's mostly in the IT space, if I remember correctly.

Yes.

And going forward?

Going forward -- actually, next year, there is going to be a significant amount of capital deployed in the new facility. But again, if you wade through all these 8-Ks that we've been filing on this thing, it's largely going to be kind of an offset from some of the funding that we got from modifying these terms on the existing lease.

So if you kind of put two and two together, this $23 million gain that we recognized in Q3, a lot of that is funding, if you will, that we are going to deploy toward a significant amount of capital that will be required to outfit the new building.

Right. And the rest of the cash that we will spend in that gain, a lot of that will be basically if it's not funding the new building, it's moving. So it's not really a funding event and we just wanted you to be cautious about that.

But we are not a highly capital-intensive business, so to increase capacity and drive what we believe truly will be -- as Ben said earlier -- a significant increase in Sequel sales, it's not a huge capital dollar investment that you see in some industries.

So Zarak, I just found the page. It's actually only about $2 million year to date on CapEx. So it's not that much.

Super. Thanks for the color, guys.

Jonathan Abodeely, XLCR Capital.

Thanks for taking my question. Just regarding the contribution that PacBio is making to the RainDance collaboration, specifically the amplification technology that you bring to the table, can you elaborate just what that is, Mike, in terms of its proprietary -- I understand it's amplification technology that's a meaningful positive if you guys can get it to work the way you think you can work with a smaller amount of input. So if you can just give us some appreciation for that technology and maybe the milestones that you hope to achieve? Thank you.

Well, I'm not going to tell you what the technology is at this point. You know, it's based on things that we've learned from the biochemical studies that we've done with our sequencing system. Most amplification systems of DNA are built around polymerases of one kind or another.

But what we hope to be able to do is be able to do very efficient long-range amplification without any substantial bias against certain kinds of DNA sequences -- either high AT or high GC, which is common to the polymerase chain reaction-type technologies that are generally employed. And to be able to do it on long pieces of DNA as opposed to just short pieces.

So from a performance perspective, that's what we're after as opposed to trying to give you the details of what that chemistry is, which we are not willing to disclose at this point.

Understood. And it is proprietary technology on your part. You are bringing that to the table, correct?

That's correct.

Understood. And that's --

RainDance is focused on how to do the unique labeling and fragmentation of large numbers of long single molecules in droplets before you get ready to do the amplification step.

And is it fair to say that I think you've commented in the past that there is no new hardware that would be required to make this project a go?

Well, there's no new hardware from our side. They're probably -- I'm not going to go -- I'll let RainDance go into the details of what they are doing, but they probably would require new consumables that go into their systems.

I don't know whether you call that hardware. It's not just reagents; it's a disposable consumable. But it depends on how much they can accomplish all the steps they need in their current consumable platform versus some new ones, but it's not a major change, I don't think, in the hardware.

Understood. Well, thank you very much for the update and look forward to hearing more.

And I'm not showing any further questions. I would now like to turn the call back to Mike for any further 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 and sequencing accuracy, uniformity of coverage, extremely long read lengths, and ability to characterize DNA-based modifications. We're very excited about our new Sequel System and the opportunity it presents for us to deliver SMRT sequencing to a much broader set of customers.

Our focus for the next quarter will be to execute well on the product launch and to ramp up on our production of Sequel instruments and SMRT cells. Thank you for joining us and we look forward to talking again in three months' time.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the call. You may all disconnect. Everyone, have a great day.