Trevin Rard Michael W. Hunkapiller – Executive Chairman, Chief Executive Officer, President and Member of Compensation Committee Susan K. Barnes – Chief Financial Officer and Executive Vice President Ben Gong.

Bryan Brokmeier – Maxim Group LLC William Quirk – Piper Jaffray Tejas Savant – JP Morgan Chase & Co..

Good day, ladies and gentlemen, thank you for standing by and welcome to the Pacific Biosciences Third Quarter 2014 Earnings Release Conference. (Operator instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference to our host, Trevin Rard..

Good afternoon, and welcome to the Pacific Biosciences Third Quarter 2014 Conference Call.

Earlier today, we issued a press release outlining the financial results we'll be discussing on today's call, a copy of which is available on the Investors section of our website at www.pacb.com, or alternatively, as furnished on the 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, our Vice President of Finance and Treasurer.

Before we begin, I'd like to remind you that on today's call, we'll be making forward-looking statements, including plans and expectations related to our financial projections and products 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 quarterly report on Form 10-Q. Pacific Biosciences undertakes no obligation to update forward-looking statements.

In addition, please note that today's call is being recorded and will be available for audio replay on the Investors section of our website shortly after the call. Investors electing to use the audio replay are cautioned that the forward-looking statements made on today's call may differ or change materially after the completion of the live call.

With that I like to turn the call over to Mike..

Thanks, Trevin. Good afternoon and thank you for joining us today. We have quite a number of business highlights to share on today's call starting with some very good financial results.

Highlights of our third quarter financial results are as follows; we booked orders for 16 PacBio RS II systems in the third quarter representing more than triple the bookings we had in Q3 of last year. And it brings our year-to-date bookings to 30 systems compared with 16 systems booked for the first three quarters of 2013.

We delivered six systems during the quarter and as at the end of Q3, our backlog of system stood at 20. Consumable revenue for the third quarter was $3.3 million, up 57% from the prior year Q3 consumable revenue of $2.1 million and up 7% sequentially from Q2 of this year.

We were pleased to see a sequential increase in consumable sales despite the seasonally slower summer months. We continue to average over $120,000 in consumable revenue per year per installed system. Total revenue for the third quarter was $20.6 million up 178% from Q3 2013.

This included $10 million payment we earned from Roche for meeting the first development milestone associated with the collaboration agreement we signed with Roche last year. As a reminder we established multiple milestones from which we expect earn a total of $40 million over time.

With the $10 million enhancement to revenues, this year we now expect our total 2014 revenue to be more than double our 2013 revenue. Now turning to some other business highlights. Last week we announced multiple new products, including an enhanced chemistry, which significantly improves the performance of the PacBio RS II.

Our C4 chemistry set delivers average read lengths between 10,000 and 15,000 bases with the longest reads in excess of 50,000 bases. Throughput in the C4 is expected to be between 500 million to 1 billion bases for SMRT cell depending on the sample being sequenced.

Importantly, we have also enhanced the accuracy characteristics so that users can obtain high consensus accuracy using less fold coverage. This means that it takes fewer SMRT cells to complete large projects making SMRT sequencing more cost efficient.

Our continuing efforts to increase read length and throughput and to reduce project cost has enabled us to expand our business into larger scale projects, including a growing number of human sequencing projects. This has been a key driver for generating higher consumable sales and new system sales.

We also announced our new SMRT Analysis 2.3 software release, which includes a powerful set of tools for driving adoption of high value applications of SMRT sequencing.

Key features of this release include Long Amplicon Analysis to support the sequencing of HLA class II genes, improve the assembly algorithms to support the de novo assembly of large genomes, new isoseek tools for isoform discovery and tools for studying full-length HIV variants.

We have established a cadence for releasing new software tools about every six months, so our customers continue to see increased value for their PacBio investment. We continue to see frequent scientific publications and presentations highlighting the use of PacBio technology to gain new insights across a myriad of applications.

I will give you a brief update on two of these areas, the first being microbiology. In our last earnings call, I highlighted a study lead by Dr. Julie Segre from the National Human Genome Research Institute on antibiotic-resistant bacteria and the role the plasmids play in the spreading of those particularly deadly strains.

That study has drawn more attention in the past few months and a perspective from a scientist at the University of Queensland was published recently in the Journal of Science. They refer to plasmids as the dark matter or short-read sequencing assemblies.

As genomic studies with short read technology conspicuously avoid the complexities of plasmid structure, they go on to conclude that “Long-read genome assembly offers clear advantages for the resolution of complete plasmid sequences that can discriminate plasmid diversity, antimicrobial-resistance gene context, and multiplicity.

Such information will enhance our understanding of plasmid carriage, transfer, epidemiology, and evolution.” One of the unique characteristics of the PacBio technology is this ability to define the epigenome of bacteria directly from the primary DNA sequence data.

Two recent papers highlight the importance of this capability, and an emerging area of importance in the study of infectious diseases, which is methylome-related virulence in human pathogens.

The first paper was published in Nature Communications by scientists from the University of Leicester in England, in collaboration with international experts entitled, a random six-phase switch regulates pneumococcal virulence via global epigenetic changes.

This group studies this virulence in Streptococcus pneumoniae, a bacterium responsible for serious infectious diseases. Worldwide one person dies every ten seconds as a result of s. pneumoniae induced illnesses such as pneumonia.

Using SMRT sequencing they found six different biological phases in the organism, each associated with a different level of virulence and characterized by distinctive methylation pattern. Perhaps most importantly they found a genetic switch that enables cells to randomly assigned to one of these six phases.

Deposits of this system is a key regulatory element designed to keep – to help the organism adapt to different host niches.

In the paper the scientist conclude “We believe these findings represent a new paradigm in gene regulation in bacteria and therefore are of great significance to the infectious disease field.” The finding solved the mystery regarding the shifting virulence of this organism going back many years since simple single nucleotide variation that failed to reveal the source of this phenomenon.

Gaining knowledge of the six unique states of s. pneumoniae could help in the development of tailored vaccines to fight against this deadly organism. The second paper came out recently in the journal of the Federation of American Societies for Experimental Biology with a similar theme.

Scientists from [Indiscernible] university and the Research Institute at Nationwide Children's Hospital published a study on the pathogenicity of a bacterium associated with childhood ear infections and chronic obstructive pulmonary disease.

They use SMRT sequencing to study and characterize the methylome of Moraxella catarrhalis and found evidence suggesting that a phasevarion regulates expression in genes linked to infection, colonization and defense against host organisms.

We are excited by PacBio's ability to detect and characterize base modifications responsible for these characteristics, information which we believe could lead to faster development of remedies to fight infectious diseases.

While the use of SMRT sequencing for studying infectious diseases continues to create a growing commercial opportunity for PacBio, we are also seeing an increased interest from scientists studying sequence variation in the human genome, the second major application area I will highlight.

At this year’s American Society of Human Genetics meeting in San Diego several speakers described the use of SMRT sequencing to study diverse types of sequence variation in the human genome that had previously been refractory to analysis by short read technologies.

Doctors Evan Eichler and Mark Chaisson at the University of Washington describe their group’s use of SMRT sequencing to identify over 22,000 novel structural variants in the human genome. Dr.

Stuart Scott from the Icahn School of Medicine at Mount Sinai described using SMRT sequencing of multiplexed amplicons to study epigenetics and pharmacogenetics in human samples. Dr.

Hagen Tilgner from the Stanford University School of Medicine described using PacBio's ability to sequence full-length MRNAs to define the first personal, allele-specific long-read human transcriptome. Dr. Jonas Korlach, PacBio’s CSO described his collaboration with Genentech scientist that produced de novo assemblies of two related cancer cell lines.

Notably in addition to producing high [linked] assemblies, they were able to provide genome wide methylation profiles in the sequence data to help define RNA expression differences between the two cell lines. The second industry conference we attended recently is the American Society for Histocompatibility and Immunogenetics conference in Denver.

This by the way is still going on through the end of this week. Industry leaders in HLA typing were there to give updates on recent advances in technologies and offer their perspectives in the future direction of this evolving field. Professor Steve Marsh and Dr. Neema Mayor from the Anthony Nolan Research Institute, Dr.

Nezih Cereb from HistoGenetics, Dr. Martin Meyers from the National Bone Marrow Program and Dr. Daniel Geraghty from the Fred Hutchinson Cancer Research Center all described the importance of PacBio long-reads to studying complex gene families such as HLA and KIR.

Before we move off the topic of industry conferences, I would like to announce that we successfully obtained the gold sponsorship of the upcoming AGBT meeting in February 2015.

Considering all the recent exciting activities surrounding SMRT sequencing, particularly in the human sequencing space we felt it was important through the extended time in the workshop that comes with the gold sponsorship.

We expect our customers to have new data to share at the AGBT meeting and we are looking forward to heading a strong agenda of speakers in this venue. I would also like to call your attention to a series of recent podcasts by Mendelspod that highlight the importance of PacBio long-read technology to human genome studies. Dr. Geraghty , Dr.

Eric Schadt from Mount Sinai, Dr. Michael Snyder from Stanford, Dr. [Indiscernible] and Dr. Eugene Myers from the Max Planck Institute in Dresden offer valuable insights into various areas of human genome analysis best done with PacBio technology. When asked about the role of PacBio for human projects, Dr.

Geraghty stated “Any large human genome sequencing projects just using short-read technology are not going to acquire useable data for these very complex regions. It’s as simple as that. The long-read data will give you really what everybody has been after all along without realizing it.

It will give you the phase and the detail in the polymorphism and is [Indiscernible] regions”. Moving onto our commercial highlights, as I mentioned at the beginning of the call, we had a very strong quarter for bookings with a total of 16 systems booked.

The jump in bookings this past quarter was characterized by multiple unit system orders and repeat sales to existing customers. We sold two more instruments for the Centers for Disease Control this past quarter bringing the total up to three PacBio systems.

The CDC has become one of our largest costumers and was the key user for us in the infectious disease base. Also purchasing a third system this past quarter was Mount Sinai. They have been a leader in using PacBio to study human disease and they plan on installing this third system in a new facility they are opening that has added sequencing capacity.

We sold a second system to University of Zurich and the University of Tokyo as well. Another significant driver for recent bookings has been the growing interest in human reference sequencing with PacBio, Macrogen in Korea and Human Longevity in San Diego each ordered two PacBio systems to focus on whole human genome sequencing.

Both have been engaged in population sequencing with Illumina X Ten Systems and both realized that they require PacBio sequencing to capture structural variation in the complex regions of the human genome such as the major histocompatibility complex or MHC region as well as genes that code for major diseases such as fragile X and autism.

The system bookings we had for Q3 were significantly higher than in any previous quarter. So I would like to offer some perspective. First as we have mentioned in the past our quarterly bookings are subject to fluctuation and no single quarter's bookings should be considered an indicator of our future run rate.

That said, our pipeline has broadened across multiple customers and applications this past year. The 30 systems we booked in the first three quarters of this year compared with the 16 booked for the first three quarters of last year are a result of the increasing adoption of our technology for a growing number of applications.

While we are not providing a forecast for future bookings, we are pleased with the pace of growth we have seen over the past year. With regard to consumable revenue the combination of a growing installed base and increased utilization resulted in very solid year-over-year growth.

We are seeing increases driven by projects in the vertical markets of infectious disease, ag-bio and human biomedical research. As we drive deeper into these markets with more capable products and software tools we expect our consumables business to increase even more.

Finally on our earnings call last quarter we mentioned that we are on track to reach our first gross milestone – gross development milestone this year and we were pleased to have gotten there a little earlier than we estimated.

As I mentioned earlier, we recorded $10 million in revenues as a result and we received a cash payment from Roche within the third quarter. Our project with Roche is progressing nicely. As we achieve more milestones we plan to provide updates accordingly.

That concludes my remarks, and I will now turn it over to Susan to provide more details on the 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, 2014.

I will then provide details on our operating results for both the third quarter and year-to-date with a comparison to the third quarter of 2013 and year-to-date comparison to the first three quarters of 2013. 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 third quarter, we recognized revenue of $20.6 million, and incurred a net loss of $9.2 million. This brings our year-to-date total revenue to $43.7 million and our net loss to $47.2 million. We ended the quarter with $99.3 million in cash and investments.

This is $5.7 million lower than the $105 million reported at the end of Q2, and it includes the $10 million milestone payment from Roche. Turning to revenue, revenue increased substantially in Q3 year-over-year as a result of the recognition of the $10 million Roche milestone as well as large increases in consumable and service revenues.

Total revenue for the quarter of $20.6 million was 178% greater than the $7.4 million recognized in Q3 of 2013. Year-to-date revenue in 2014 was $43.7 million, up 129% above the revenue of $19 million recognized in the first three quarters of 2013.

The increase in year-to-date revenue stem from substantial increases in all product categories including systems, consumables and service as well as the addition of the contractual revenue from Roche. Instrument revenue decreased slightly to $3.5 million in Q3 2014, from $3.7 million during the same period last year.

Year-to-date, instrument revenue has increased 62% to $13.5 million in 2014 versus $8.3 million in the first three quarters of 2013. The year-to-date instrument revenue increase reflects 23 instruments recognized year-to-date in 2014 compared to 12 instruments recognized in the first three quarters of 2013.

Consumable revenue was also strong during the quarter, increasing 57% to $3.3 million for the current quarter, up the $2.1 million reported during the third quarter of 2013. Year-to-date, consumable revenue increased 50% to $8.9 million in 2014 compared to $5.9 million in the first three quarters of 2013.

Service and other revenue increased 35% to $2.1 million in the quarter compared to $1.6 million in Q3 of 2013 and up 30% year-to-date to $6.2 million in 2014 from $4.8 million in 2013.

And finally, we recognized $10 million associated with the Roche milestone achieved in Q3 and continue to recognize $1.7 million of revenue per quarter associated with the $35 million upfront payment that we received from Roche in Q3 of 2013.

Gross profit was $13.2 million in Q3 of 2014, representing a gross margin of 64% and year-to-date gross profit recognized in 2014 was $19 million, corresponding to a gross margin of 43%.

In Q3 of 2013, we recognized $1.2 million of gross profit with a gross margin of 17% and year-to-date gross profit in 2013 was $3.2 million also with gross margin of 17%.

Gross profit increases in 2014 are a function of the $10 million Roche milestone achievement and the $1.7 million of margin per quarter related to the upfront $35 million Roche payment received last year. While revenues for the quarter and the year were up significantly year-over-year, operating expenses were relatively flat year-over-year.

Operating expenses in the third quarter of 2014 totaled $21.6 million compared to $21.2 million incurred in Q3 of 2013. Year-to-date, total operating expenses were $63.9 million compared to $63.8 million in the first three quarters of 2013.

Breaking down our operating expenses, R&D expenses in the quarter were $11.7 million, up from $10.4 million of expenses in Q3 2013. Year-to-date, expenses in R&D were $35.9 million, also up from the expenses incurred year-to-date in 2013 of $34.1 million.

In both comparisons, R&D expense increases were primarily a result of higher product development expenses incurred in 2014 versus 2013. R&D expenses for this quarter included $900,000 of noncash stock-based compensation expense. Sales, general and administration expenses for the quarter were down in Q3 2014.

We had $9 million in SG&A expenses in Q3 2014 compared to $10.8 million incurred in Q3 of 2013. The decrease in expense this year-over-year is a result of higher expenses incurred in Q3 of last year associated with the execution of the Roche agreement.

This year we have recorded $28 million year-to-date in SG&A expenses compared to $29.7 million incurred in the first three quarters of 2013. SG&A expense for this quarter included $1.3 million of non-cash, stock-based compensation expense.

Also, in the area of other income and expense, in Q3, we reported $800,000 of other expense, primarily related to the interest expense associated with the debt that we took on in Q2 2013. Year-to-date we have incurred $2.3 million of other expense. Ben will provide further guidance on our ongoing expense rates later in the call.

Now turning to our balance sheet, as I mentioned at the beginning of my comments, cash and investments decreased $5.7 million to $99.3 million at the end of the third quarter, primarily reflecting our third quarter net loss of $9.2 million, less $3.5 million in non-cash expenses from stock based compensation expense and depreciation.

Inventory balances rose $2 million in Q3 to $11.4 million up from the $9.4 million balance at the end of Q2. This increase is necessary to ensure the timely fulfillment in product orders being generated in 2014. Accounts receivable decreased to $2.4 million at the end of Q3 compared to $4.3 million at the end of Q2.

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

Thank you, Susan. I will be providing an update to our 2014 financial forecast. Starting with revenue, with our strong bookings in Q3 and the addition of $10 million in revenue which we recorded from Roche, we are increasing our forecast from 70% growth to over 100% growth in revenue for the year.

We expect total revenue for the year to be over $58 million. With regard to instrument revenue, we had 20 instruments in backlog at the end of Q3 and we expect to install majority of these systems in Q4. Moving onto gross margin, the $10 million Roche milestone we achieved and recorded in Q3 brings up our forecast for the year.

Previously we had estimated our gross margin for the year to be between 25% and 27%. We now estimate our gross margin for 2014 to come in at approximately 38%. With regard to fourth quarter gross margin, we are expecting a high mix of systems revenue, which has a lower gross margin than consumables.

So our Q4 gross margin is expected to be lower than it has been in recent quarters. We have taken this into account for our annual estimate of 38%. Operating expense for Q3 of $21.6 million included a $600,000 cost recorded in SG&A associated with the Roche payment we received.

While R&D expenses came in a little lower than usual due to the timing of certain expenditures. Taking into account these normal fluctuations we expect our Q4 operating expense to be roughly the same in total at between $21 million and $22 million.

As a reminder our operating expenses include non-cash, stock compensation expense, and depreciation expense together amounts to between $3 million and $4 million per quarter. With regard to cash, we are right on target with the plan we had set out at the beginning of the year.

Our goal was to consume $16 million or less for the year, and after three quarters we consumed about $44 million.

Adding back the $10 million we collected from Roche and about $21 million we raised earlier in the year using our [market] facility our cash balance at the end of Q3 of $99 million is about $13 million less than where we had started for the year.

Assuming we consume approximately $15 million again this quarter, we should end the year with at least $84 million in cash and investments. And with that we will open the call to your questions..

(Operator instructions) Our first question comes from Bryan Brokmeier from Maxim Group. Please go ahead..

Hi, good afternoon.

The booking numbers was well above what we were expecting could you – is that as of the end of the third quarter or is that as of today?.

The end of the third quarter..

Okay.

And can you provide us some details on the types of customers that are in the backlog and how that has changed from what you have seen recently?.

Well, we actually enumerated I think quite half of the bookings in the listing that Mike was giving you. So for them once that we had a press release on before so two from Macrogen and two from Human Longevity and you got two in there for the CDC. Then you have got these repeat orders from Mount Sinai, Zurich and Tokyo.

So that gives you a pretty good cross section. The other ones, we don't identify everyone but it's a combination again of a variety of academic and commercial sites..

But is the rest of that pretty similar to what it normally is and so then these additional bookings that you detailed are sort of how the backlog has changed?.

Well this is Mike, I think the one thing it's really new out of that group is the beginnings of a bit of a trend that we are seeing where people who have invested in the Illumina X Ten system for really large scale massive human sequencing/genotyping studies to begin to add to that the use of PacBio for looking at structural variation and the kind of complex regions that are kind of missing from the short-read analyses.

That’s really the new component relative to what we have seen in the past. .

But we do not lose track of the fact sheet – that you lose track of the fact that we are gaining traction in the ag-bio, the micro-bio, as well as the human and the HLA. So we think there is a nice mix of all three areas in that backlog..

And do you expect to encounter any capacity constraints installing the instruments, and are you going to have to add, expand your sales force given the backlog in the new demand that you are seeing?.

[Indiscernible] easily install the instruments but we are pleased I think with the capacity on your team that's in place..

I will just add that we are prepared to install a majority of those 20 in the fourth quarter end. What is – I will say good news is that good numbers of customers have told us that they would like their systems to be installed in Q4. So we should have a pretty healthy amount of installs in that quarter..

Yes the rate of install is not so much our capacity issues, it's whether or not the customers’ labs are prepared and ready to go for the installs and that frequently has taken one to two quarters from order..

Okay. Thanks a lot. .

Our next question comes from Will Quirk of Piper Jaffray. Please go ahead..

So I guess just a follow-up on the other question I mean is it reasonable to assume guys that we could start to see some sort of X Ten RS II matching in other words, the additional customers and Illumina obviously has some overlap there but how are you thinking about those as a relatively near term replacement opportunity?.

Well I don't think we are going to match the number of units.

I mean it's more with an X Ten you get ten super [Indiscernible] equivalents and we have seen sort of one to two instruments to start with from the PacBio side that people feel are appropriate at this point for the sort of full de novo approach that they are going to use for certain numbers of samples.

But we have seen it first from other of those sites than the one, the two that we have highlighted. So it is something that we are actively following. .

And as we said before, we have the robust pipeline built and calling it in any one particular quarter on where that order comes in we are not that good at this point in time..

I certainly understand that obviously you can – you could see a fair amount of movement around the timings there.

On the consumable side, obviously it was nice to see them stay kind of flattish sequentially given as you noted typically a pretty seasonally slow quarter, how should we be thinking about consumables utilization with the new chemistry release. I guess I intuitively think that it could go higher but we would love some color there. Thank you. .

I will take a shot. I think that in general the added capabilities of the chemistry release should open up more applications but beside that fact we are just seeing overall increases in utilization and you have this growing installed base. So we are expecting sequential growth in consumable revenues from Q3 to Q4. .

The other thing is that I think it's pretty obvious from the capabilities is that it opens up larger projects being done more often because it makes it less – prohibitively expensive to do really big genome projects as opposed to the smaller ones.

And so it means that the number of SMRT cells that we use to complete a project is higher than it is for say doing bacteria works basically one SMRT cell for organism and that means that people have the opportunity to utilize the machine more frequently because they have the sample ready to go..

Understood. And I guess maybe just I guess just to kind of ask one last thing at is there any price difference in the new chemistry or is it similar pricing to what we had previously and obviously Mike to your point if we see larger more frequent studies no doubt the average consumables will rise and follow..

Yes, it's similar pricing. So we are not expecting a difference just due to any sort of price change. .

Okay, got it. Thank you..

Our next question comes from Amanda Murphy of William Blair. Please go ahead..

Hey thanks.

So just to follow-up to some of the discussions around the derivative opportunities if you will from the X Ten, I am just curious is there a way we can frame what that might look like, I know it's early days but if you were to say okay let's say we sequence 10,000 genomes on the X Ten what percentage of those might need sort of this higher quality assembly type concept just trying to frame out what that might look like in terms of opportunity for you guys..

Well I think it's early days on that. I think it depends on how fast people wrap up their [information], capability and their choice of samples that they take to go into more de novo sequencing approach. I think it will probably for a while remain a relatively small portion of the total.

That said, given that the return for us per genome because of the kind of [Indiscernible] trying to get out of that it's a lot higher than a single sample that you get from the Illumina. Now our price is not near to $1000 per genome.

And so I think that will have some limitation in terms of how many samples people will be able to run early on but as we have sort of seen the sort of two PacBio RS to a full X Ten set as being something that seems reasonable for people at this stage. .

Got it, okay.

And then just a couple on the reagent side so in terms of the new chemistry kit, I guess I have two questions one obviously other than kind of throughput, which you continue to increase over time, is there anything that you maybe need to continue to improve to fully take advantage of the opportunity on the human side and then second question is you have been pretty consistent about kind of wanting new chemistry kits every six months or so do you sort of plan to continue to do so sort of in the context of your current instrumentation?.

I think the answer to most of those is yes taken in the back.

So one of the things that we clearly need to do is to continue to work on the sample front end because that's a key limiter to how much sequence data that customers get out of a given sample, which is even more important to bigger projects than it is with bacteria, which is almost [Indiscernible] experiment now.

And so we will stay tuned but you will see or should see over the next several months continued improvement in that, which by itself going to actually extend read lengths and throughput. I think the other thing is on the informatics side.

So we have now worked with a one of our Japanese customers who has come up with a very clever way of looking at whole genome level in the human or above the bacterial space for epigenetic study and one of the things that we like to do is to get that more broadly available to people so they can do the kind of experiments that we have done with the [Indiscernible] sample that I mentioned and so there is a lot on the software side as well as the sample prep.

We will certainly continue to work on the more efficient usage of the SMRT cell capacity that's there in terms of the number of reaction wells that can be loaded and sequenced simultaneously.

So we have a lot to go for, for our next year's increase of [Indiscernible] that we have traditionally used as our measure of how to improve our performance every year..

Got it, thanks so much. .

(Operator instructions) And our next question comes from Tycho Peterson of JP Morgan. Please go ahead..

Hi guys it's Tejas in for Tycho. Thanks for taking the question.

Just had a quick one on gross margin I mean adjusted for the contribution from Roche in terms of the milestone as well as the $1.7 million ongoing payment, gross margins were flat versus last year roughly around 16% so can you share any thoughts on how you see that evolving over time, I mean obviously there is a mix issue at play here, but just what is the tipping point where the consumable gross margins begin to dominate?.

Yes Tejas, this is Ben. I think your math is right. I would say that sometimes the total gross revenue amounts we are talking about, little subtle changes can actually make changes in the percentage that could easily move at least a couple of points. In the long term no question, we are moving and driving towards higher gross margins in general.

And the consumables generate higher gross margins for us as a percentage of revenue and the systems and so the growth in the consumables that should help in driving overall growth in gross margins.

That said we are actually pretty delighted that the growth in instrument revenues this year over last year is going to be quite significant, and so when you take a look at year-to-date maybe you are not going to have that much difference on the percentage but hopefully you are going to have higher gross margin dollars because you do have higher revenues..

Okay.

And then in terms of gross margins on the instrument side, can you share any sort of particular components of the bill of material that you could potentially see yourself reducing over time, and I mean following-up on that I mean would that mean that you have a little bit of pricing flexibility as well as the need were to arise down the line based upon competitive dynamics.

.

Yes Tejas, we don't typically go into that level of detail. We do have ongoing discussions with all of our vendors and we take each of those projects on one at a time. Of course we are trying to drive cost reductions across the entire bill of materials but that's just not something that we are sharing with the broader audience. .

Okay, fair enough, and then just one last one on Roche, I know you have got that $10 million in milestone this year, so that leaves about $30 million over the next couple of years, is that a fair way to think about it that $10 million would be the approximate size of these milestone payments and it's fair to amortize them over the next couple of years or could it be lumpier than that?.

Well it's likely to be lumpier. I mean obviously $10 million was a pretty big lump to start with and I don't think that we are prepared at this point to give a time line on those, stay tuned for that. .

Okay.

And can you perhaps highlight sort of priorities for your R&D spending going forward?.

Well obviously one is to continue to improve the performance of the system from the sequence or itself to the sample prep and the chemistry that goes into it to the software, back in, we clearly are focused on our development program with Roche to create a diagnostic compatible device for them to sell into the human in vitro diagnostic marketplace, so we might expect that's a pretty big priority as well..

Okay, great. Thanks and congrats on the great bookings this quarter..

Thank you..

Thanks..

There are no further questions at this time. I would like to turn it back to Michael Hunkapiller for closing remarks. .

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

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

Over this past year, we have made substantial progress driving the adoption of our products in key markets including infectious disease, ag-bio, human bio-medical research and immunology.

At the recent ASHG and ASHI meetings we started seeing a lot more activity in the human sequencing space and we expect to see much more at the upcoming AGBT meeting in February. We are still very early in the adoption cycle for SMRT sequencing but it is becoming more clear that we have a great potential for building PacBio's business.

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

Ladies and gentlemen, this does conclude today's conference. Thank you for your attendance. You may now disconnect. Everyone have a great day..