Trevin Rard - Investor Relations Michael Hunkapiller - Chairman, CEO & President Susan K. Barnes - Chief Financial Officer and Executive Vice President Ben Gong - Vice President of Finance and Treasurer.

Bryan Brokmeier - Maxim Group Alexander Nowak - Piper Jaffray Zarak Khurshid - Wedbush.

Good day, ladies and gentlemen. And welcome to the Pacific Biosciences of California Inc. Fourth Quarter 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions].

As a reminder, today's program maybe recorded. I would now like to introduce your host for today's program, Trevin Rard, Investor Relations. Please go ahead..

Good afternoon, and welcome to the Pacific Biosciences fourth quarter and fiscal year 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 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 will be making forward-looking statements, including plans and expectations relating 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 current report on Form 8-K. 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 selecting 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'll now turn the call over to Mike..

Thanks Trevin. Good afternoon, and thank you for joining us today. We are pleased with our fourth quarter results and the progress we made throughout 2014 on driving our overall business. Reflecting back on 2014 as a whole, we successfully executed in all of the major aspects of the plans we put into place at the beginning of the year.

I'll provide some highlights of our yearly performance as we go along on this call. Highlights for our financial results were as follows. We booked orders for 10 PacBio RS II systems in the fourth quarter, which brought out total bookings for 2014 up to 40, compared with 25 systems booked in the previous year.

We delivered 15 PacBio systems during the fourth quarter, for the full year we delivered 38 systems. As of the end of the year, our installed base stood at approximately 125, and our backlog of systems was at 15. Consumable revenue for the fourth quarter was $4.3 million, up 64% from Q4 of 2013 and up sequentially by $1 million from Q3 of 2014.

For the year we recorded $13.2 million in consumable revenue, up 55% from $8.5 million in 2013. Pull through revenue per installed system averaged over $120,000 for the full year. Total revenue for the fourth quarter grew to approximately $17 million, up 85% from Q4 2013.

For the year total revenues were over $60 million, up 115% to $28 million in revenue recorded in 2013. This included about $17 million in Roche collaboration revenue in 2014, compared with about $1.7 million in Roche revenue in 2013. Excluding the Roche revenue for both years, total revenue was up 65%.

Overall we are very pleased with the financial results we achieved in 2014. Our sales growth stems from the progress we have made over the past few years in multiple parts of our business, from product development to manufacturing and onto customer delivery and support.

Our team at PacBio has done a great job of achieving this progress, and we look forward to continuing momentum and building our business. Now turning to product enhancements.

At the beginning of last year we had a goal of increasing the effective throughput of the PacBio system by a factor of four, which was similar to what we had achieved in each of the previous two years. Judging from the results, our customers have been getting with our latest P6 C4 chemistry, we believe we've met that goal again.

Some of our customers are generating over 1 billion bases per SMRT cell, along with average read links between 10,000 and 15,000 bases, the longest reads being generated with the PacBio system are now over 60,000 bases.

The raw accuracy has also increased, so that it requires much less data to achieve high consistent accuracy, and to complete large projects. The end result is that the cost of attaining highly accurate sequences of the PacBio system has come down accordingly. I'll elaborate further on that in a few moments.

In addition to providing raw performance improvements in sequencing, we have enhanced the software tools available to enable applications to take advantage of the high-quality data being generated.

For example, the Iso-Seq application we introduced last year have provided customers with the ability to study the human and other transcriptomes in unprecedented detail, that has already lead a discovery of hundreds of new geno isoforms.

We also introduced tools for studying full length HLA genes, and faster and more capable assembly tools for assembling large and complex genomes. Looking forward over the next year, we plan on providing another four-fold increase in throughput performance, and increasing the average read length to between 15,000 and 20,000 bases.

We are also working on bar coding solutions for multiplexing many samples at one time, to take advantage of our higher throughput. We will continue to tune software and protocols for streamlining high value applications. In terms of expanding the addressable applications for SMRT sequencing, we've continued to make significant progress.

Going back a few years when the throughput of the PacBio system was much lower, we focused on sequencing small genomes such as bacteria and other microbes.

Even with lower throughput, we brought many advantages to microbial sequencing, as we provided highly accurate complete genomes, along with epigenetic profiles and identification of plasmids and mobile elements.

Since then we have become the gold standard for microbial sequencing, and the area of infectious disease represents a significant market opportunity for us. As we expanded the system throughput, we started gaining traction in plant and animal sequencing.

In fact at the Plant and Animal Genome Conference last month, there were 60 customer presentations and poster on PacBio sequencing, which is about 10 times the number we had two years ago.

The benefit of obtaining higher quality reference genomes for crops like spinach, rice, and cotton, has resonated with many customers and they have realized what SMRT sequencing reveals about this complex genomes that is not obtained using short-read technology.

The traction we have gained in plant and animal sequencing has driven a significant amount of the increase in system utilization over the past two years. We believe we are still very early in penetrating this area. The ag biomarket represents a large opportunity for us, as we continue to bring down the cost of SMRT sequencing.

The largest impact to our recent sales has come from the increased interest in human genome sequencing with PacBio. With successful four-fold increases in throughput in each of the past three years, the cost of generating higher quality human genome sequences have become accessible to a growing number of customers.

Researchers such as Evan Eichler from the University of Washington, have presented and published data revealing an astounding amount of information that is missed with short read sequencing, but easily accessible with PacBio.

Estimates are that as much as 75% of the variation of human genomes is being missed with sequences generated from short read sequencing alone. The demand for high quality human sequencing is continuing to grow for applications in cancer research, immunology, and other biomedical research.

We are satisfying a very small portion of that demand today, but as we continue to bring down the cost of sequencing human genomes with our technology, we expect to capture a larger share of the market. Later this month we will be attending the Advances in Genome Biology and Technology Conference as a gold sponsor.

The full agenda has not yet been finalized for the conference. However there are already a large number of presentations and posters featuring PacBio sequencing in the schedule. As a preview, we plan to have five customer presentations at our two hour workshop. All featuring human sequencing projects performed with our latest P6-C4 chemistry.

The advances achieved by our customers on human reference genomes and cancer genomes are quite impressive and we are excited to have them share the results with the broader community. We plan on providing highlights of these presentations on our next earnings call, if not before.

Finally, on our earnings call last quarter, we mentioned that we met our first significant milestone associated with our Roche collaboration on schedule and earned $10 million as a result. Our project with Roche continues to progress nicely and we expect to earn another $10 million in milestone revenue this year.

When we entered the agreement with Roche in September 2013, we expected to take approximately three years to develop a system that they could sell – then sell into the regulated diagnostics market. We continue to work along that timeline. That concludes my remarks, and I'll now turn it over to Susan to provide more details on our financial results..

Thank you Mike, and good afternoon everyone. I'll begin my remarks today with the financial overview of our fourth quarter that ended December 31st, 2014. I will then provide details on our operating results for both the fourth quarter and the full year of 2014, with a comparison to the fourth quarter and full year of 2013.

I will conclude my remarks with a brief discussion of our balance sheet. Starting with our fourth quarter and year-to-date financial highlights, as Mike said during the fourth quarter we recognized revenue of $16.9 million and incurred a net loss of $19 million. This brings our 2014 total revenue to $60.6 million and our net loss to $66.2 million.

We ended the year with $101.3 million in cash and investments. Turning to revenue, revenue increased in Q4 year-over-year as a result of the recognition of 15 instruments and a record quarter of consumable sales. Total revenue for the quarter was $16.9 million, 85% greater than the $9.1 million recognized in Q4 of 2013.

Total revenue in 2014 was $60.6 million, up 115% over the revenue of $28.2 million recognized in all of 2013.

The revenue increase year-over-year stemmed from substantial increases in all product categories, including systems, consumables and service, as well as an increase in Roche related contractual revenue in 2014 of $15.1 million over the prior year.

Instrument revenue in the fourth quarter of 2014 was $8.6 million, a 171% increase over the $3.2 million of instrument revenue recognized in Q4 of 2013. For the year 2014 instrument revenue was $22.1 million, $10.6 million over the instrument revenue recognized in 2013, a growth of 92%.

Total annual instrument revenue reflects 38 instruments recognized in 2014, compared to 17 instruments recognized in 2013. Consumable revenue was also strong during the quarter increasing 64% to $4.3 million for the current quarter, up from $2.6 million reported during the fourth quarter of 2013.

For the year consumables revenue increased 55% to $13.2 million in 2014, compared to $8.5 million in 2013. Service and other revenue increased 39% to $2.3 million in the quarter, compared to $1.6 million in Q4 of 2013. For the year service revenue totaled $8.5 million, up 32% from $6.4 million of service revenue in 2013.

Gross profit was $4.4 million in Q4 of 2014, represented gross margin of 26%. Q4 2013 gross profit was $3.2 million with a gross margin of 35%.

The profit growth of $1.2 million year-over-year was consistent with the higher revenue recognized in Q4 2014 versus Q4 2013, while the lower gross margin percentage was due to an increased mix of lower margin instrument revenue recognized in Q4 2014. Gross profit recognized for the full year of 2014 was $23.4 million with a gross margin of 39%.

This compares favorably to the $6.4 million of gross profit and 23% gross margin realized in 2013. For the year gross profit and margins were favorable primarily out of the additional $15.1 million of gross profit realized as part of the Roche agreement in 2014 versus that realized in 2013.

In expenses operating expenses in the fourth quarter of 2014 totaled $22.3 million, compared to $20.2 million incurred in Q4 of 2013. Year-to-date total operating expenses were $86.3 million, compared to $84 million in 2013.

Breaking down our operating expenses, R&D expenses in the quarter were $12.3 million, up from the $11.1 million of expenses in Q4 of 2013. Year-to-date expenses in R&D were $48.2 million, also up from the expenses incurred in 2013 of $45.2 million. R&D expenses in the current quarter included $1.2 million of non-cash stock-based compensation expense.

We incurred $10 million of SG&A expenses in Q4 2014, compared to $9.1 million incurred in Q4 of 2013. Total 2014 SG&A expenses were $38 million, compared to $38.7 million incurred in 2013. SG&A expenses for this quarter included $1.5 million of non-cash stock-based compensation expense.

Also in the area of other income and expense, in Q4 of 2014 we recorded $1.1 million of other expense, $900,000 greater than the $200,000 incurred in Q4 of 2013.

The difference was due to an accounting charge of $200,000 incurred as a result of a derivative valuation of our debt, and $100,000 of FX losses in 2014, compared to a $300,000 accounting gain realized on the derivative of our debt and $100,000 of FX gains in Q4 of 2013.

For the full year of 2014 we incurred $3.3 million of other expenses, compared to $1.8 million of other expense in 2013. Ben will provide further guidance on all of our ongoing expense rates later in the call.

Now turning to our balance sheet, cash and investments increased $2 million to $101.3 million at the end of the fourth quarter, primarily reflecting our fourth quarter net loss of $19 million, plus $3.9 million in non-cash expenses from stock-based compensation expense and depreciation in the quarter, and the addition of $17.3 million of equity funding in Q4 2014 from our ATM facility.

Inventory balances were relatively flat in Q4, decreasing $100,000 to $11.3 million from $11.4 million in Q3. This inventory level was necessary to ensure timely fulfillment of product orders in 2015.

Accounts Receivable increased $1 million to $3.4 million at the end of Q4, compared to $2.4 million at the end of Q3, consistent with the increase in Q4 of both instrument installations and consumable sales. This concludes my remarks on the financial results for the quarter, and I would now like to turn the call over to Ben..

Thank you, Susan. I will be providing guidance on our near term and 2015 financial performance. Starting with revenue, we expect our strengthening market position and broader adoption across multiple application areas to drive continued growth in our product and service revenues for 2015.

In addition as Mike mentioned earlier, we expect to earn another $10 million in Roche milestone revenue this year. We're continuing to amortize a portion of the initial $35 million we collected from Roche each quarter, so that in total we expect to record at least as much revenue from our Roche collaboration in 2015 as we recorded in 2014.

As a result we're forecasting at least 20% growth in total revenue for the year. Looking at revenue in the near-term, we started Q1 with 15 systems in backlog.

Typically we install between half and three quarters of our beginning backlog each quarter, and since we were able to deliver a total of 15 systems in the fourth quarter, we expect instrument revenue to decrease sequentially in Q1.

With regard to consumable sales, the growing installed base and rising utilization rates have driven significant growth in recent quarters. However, we expect consumable revenues to flatten out somewhat in Q1, due to seasonality effects. Taking these factors into account, we expect total revenue in Q1 to decrease sequentially from Q4.

However, we are targeting significant growth in revenue this quarter compared with Q1 of last year. Moving on to gross margin, with our current mix of revenues, we expect our quarterly gross margin percentage to remain in the mid-20s.

An exception to this is when we earn additional milestone revenue at 100% gross margin, our total gross margin will tend to spike, as it did last year when we recorded milestone revenues. With regard to expenses, we plan on making some modest increases in both R&D and sales and marketing expenses this year.

We expect our total operating expense to increase approximately 10% over last year. As a reminder our operating expenses continue to include non-cash stock compensation expense and depreciation expense that together amounts to approximately $4 million per quarter.

As Susan mentioned earlier, the interest and other expense of $1.1 million we recorded in the fourth quarter, includes some non-cash revaluation expenses which are not recurring in nature.

As a reminder the cash interest on our debt is $450,000 for the quarter, and scheduled non-cash amortization expense is running at approximately $270,000 per quarter. Consequently for 2015 we expect to record between $700,000 and $750,000 in net interest expense per quarter.

With regard to cash usage, we ended 2014 with $101 million in cash and investments, compared with $113 million at the end of the previous year. Excluding the $38 million in cash we raised from our ATM equity offerings, we consumed roughly $50 million. Our target is to consume less than $50 million for the full year in 2015.

However, in Q1 we expect to consume approximately $18 million in cash based on anticipated timing of payments. And with that, we'll open the call to your questions..

[Operator Instructions] Our first question comes from the line of Bryan Brokmeier from Maxim Group. Your question, please..

Hi. Good afternoon. So the pull-through in my model reached 145, which is the biggest increase I think you've ever had in a quarter. I know you said, Ben, that you expect it to be relatively flat in the first quarter due to seasonality.

But where could we see consumables revenue going over the course of the year, and also was the increase largely driven by the new chemistry, or at what point in the quarter was the new chemistry introduced? Thanks..

Yes. We introduced the new chemistry at the beginning of the quarter, and actually one of the highlights is by the end of the quarter the majority of our customers were actually already using the P6-C4 chemistry, so that transition happened very quickly. Bryan, I think your calculations are right on.

If you annualize the $4.3 million in consumable revenues in Q4, and you just did a measurement off of that, it's quite a bit higher than the $120,000 on an annual basis. But what we tend to do, because we do have these quarterly fluctuations on consumables is we take it over a larger time period. The $120,000 is actually over a one year period.

But you can tell since Q4 was higher, that we're on an upward trend. So, you should take into account, I think the fact that Q1 is probably going to be seasonally flat compared to last year. We expressed the same thing in Q1 of 2014, but as a matter of fact – but in general we see things increasing..

Okay. Thanks. And in the human sequencing market, it's an area where you haven't been as strong, but certainly made some very positive traction over the last year, with some big customer wins.

Are there more changes that you think you need to make to really start to penetrate the market in the near-term or do you see it being more of a later this year might be with more chemistry and software introductions may be, or do you believe that more chemistry and software introductions may be necessary to start to become more widely adopted?.

This is Mike. Well, I think that what we've seen are in selected customer sites, where they really understand the advantages of being able to look at the kind of structural variation that you can really only see with long reads.

We're starting to get pretty good up-tick, and one of the reasons as we said before that we're investing in the gold sponsorship at AGBT this year, was to be able it highlight that in a variety of areas.

So I think part of what we need to do is just get the message out, through our customers who have been the early adopters of the technology in sort of whole genome sequencing. Clearly that helps, but it's an evolving process.

As we continue to increase the throughput, and hence pull the costs down, then it's amenable to a larger and larger set of applications and customers. So I think it’s – we made progress, we're doing pretty well at this point.

We clearly would have as aspirations for a much bigger share than we currently have, and the technology we think could be pushed in that regard..

Okay. And just a quick one.

I just want to make sure I heard you clearly that for 2015 you expect revenue growth to be at least 20% is that correct?.

That's correct..

Okay. Thanks..

Thank you. Our next question comes from the line of Bill Quirk from Piper Jaffray. Your question, please..

Great. Thanks. This is actually Alex Nowak filling in for Bill. First question kind of related to the last question there. Is how are the talks going with the High Sic X10 [ph] owners? I know last quarter you saw a few purchase a couple of units.

I was wondering if you saw any X10 users go ahead and purchase any RS IIs in this quarter?.

We did..

Okay. All right. Perfect. And I know last quarter it was about two units per customer.

Can you say if these customers add any more, are they doing three units now, four units?.

Well, we didn't get I don't think any additional orders in the quarter from the ones that we had announced the previous quarter. I think we just probably did the installs on them in the last quarter. I think it's a mix. We've seen groups who are buying one, groups who are buying two.

It depends a little on the scale of which they invested in the X10 platform. But the ones who had sort of more than one, tended to get more than one X10 group, tended to get more than one RS..

Okay. Perfect.

And then on the Roche collaboration, when should we expect some more product details or some data coming from that or is that kind of up to Roche?.

I think we've always said the milestones are development milestones, so that they're very proprietary, and we really don't talk about those along the way..

All right. Perfect. Thank you..

Thank you. Our next question comes from the line of Amanda Murphy from William Blair. Your question, please..

Hi, everyone. This is actually J.P. in for Amanda. Ben, I wanted to dig into guidance a little bit if you could. I mean, first do you guys expect bookings to be up year-over-year? And then just doing some quick math, if you exclude Roche, most of the growth implied next year is coming from consumables.

So I'm just trying to see what you're thinking from an instrument sales number next year?.

Yes, J.P. We've not been giving guidance on the actual bookings numbers. So we're not planning on giving you guidance on bookings. But we are expecting growth in all the product and service revenue lines. So there's going to be I guess, some variation in that, and this is the beginning of the year.

So we just want to be a little bit cautious about being that exact on the year. But what we are seeing is, at least what we're expecting is growth in all of the revenue categories..

Okay. And then I didn't catch it earlier.

Is the consumable pull-through that you guys had in Q4, is that an oddity and do you expect it to go back to around the 120 range or could 140s be a good peg to go forward with?.

Well, you have to be careful about the 140, 145 collection because remember, we just installed 15 units in the quarter. So….

Yes..

We find blending the year is a better kind of metric as you go along..

Got it.

And what have you guys seen on that note in terms of, kind of lag time until they ramp in terms of these new installs?.

It varies. It's some of them they ramp-up pretty quickly and others it takes them a while to kind of get their own informatics and infrastructure aligned with the SMRT read data, and others it takes them a while to gear up the biology that's going to feed samples into it.

I would say probably in the last six months or so, some of the customers have gotten in line more quickly than they had in the past..

And the other element is if they buy one because of a capacity issue, you can take it in half right away quickly and then build-up faster, because they do know the bio informatics of the sample prep, but there is an effect on capacity shifting as well..

Got it. Thank you for taking the questions, and congratulations on the year..

Thank you..

Thank you. [Operator Instructions] Our next question comes from the line of Zarak Khurshid from Wedbush. Your question, please..

Hi there. Good afternoon everybody. Thanks for taking the questions. I had a follow up on utilization. Where do you think that number goes in the next year or two, and for these systems that are going out affiliated with the X10’s? How does the utilization on those systems sort of compare to the broader group? Thanks..

Well, if you go back a couple of years, we've seen a very substantial increase in consumable pull-through, and we expect that to continue. We're not at the average that we are now, at full system utilization across the-board.

That said, we have seen over the last year a number of customers who were what I would call as kind of the low utilization move up into a higher category and we've seen more of the customers who were in the middle group move up to a reasonable category.

So we've seen kind of across-the-board pretty much an increase in usage per instrument, and those who have large projects, whether they be plant or animal or human, tend to be able to amortize their sample prep investments across a large number of SMRT cells, because it takes a fair number of SMRT cells to finish a big project.

And so, if they've got those kind of samples, they can ramp up to a higher usage more quickly. As we pointed out, I think some of our largest usage customers have been in the plant space, where the projects are large, they're doing de novo genomes, and they really want a quality reference to work off of.

And we're starting to see that in these big human genome projects, again where the amount of sequencing required to kind of get full advantage of the system is pretty large per sample. And that bodes for higher throughput usage in those customers. As we get more of those, you tend to drive the average usage up..

Yes. This is Ben. The only other thing I'd say I mean, these are qualitative answers I admit.

When you go to the installed base as much as we have, which is probably about 40% over the past year, sometimes it takes a little time to catch up to get all of those guys to get up, and it refers to an earlier question, is how long does it take people to get up and running on average, because there is variation from site to site.

But one thing to be careful of is that, if you do a sort of compounding on the growth rate of the installed base and the growth rate of the utilization, you can get a really high number, and usually things don't change quite that fast..

The other thing that happens is once customers get up to a certain usage level, then it starts to get them to consider buying another instrument, and that will help at some point plateau out the average consumables per box..

Sure. Great. Thank you..

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back for any further remarks..

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 this SMRT sequencing provides the industry's most complete and accurate picture of genomes, due to a superior performance in sequencing accuracy, uniformity of coverage, extremely long read lengths and 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, and human biomedical research. We are still very early in the adoption cycle for SMRT sequencing, but it's becoming more clear that we have a very large potential for building PacBio's business.

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

Thank you. Ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day..