Good day, ladies and gentlemen, and welcome to your Pacific Biosciences of California, Inc. Third Quarter 2015 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 follow at that time. [Operator Instructions].

As a reminder, this call may be recorded. I would now like to introduce your host for today's call, 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 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 will be making forward-looking statements, including plans and expectations relating to our financial projections and 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 report on Form 8-K and Form 10-Q. Pacific Biosciences undertakes no obligation to update forward-looking statement.

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

I'd 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 is being 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 year s, 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 we 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 would like to provide some color and perspective on our recent Sequel product announcement. Four and half years ago, we introduced smart sequencing to the research community. Since that time, we have worked to demonstrate the value of the technology’s key attributes.

Long sequencing rates, high consensus accuracy, uniform genomic coverage and integrated methylation detection.

Also, during that time, we were able to decrease the consumable cost of smart sequencing projects by a factor of approximately 100 this 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 non-human animal sequencing applications for de novo genome assembly was already recognized as being very important.

Well, 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 rate sequencing studies.

The success of these efforts was relevant 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 compared to last year's.

While smart sequencing is increasingly recognized as an important advance for growing array of applications, the upfront price of the RS II and its associated throughput and operating cost have been ahendments 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 smart sequencing.

Its lower price, half that of the RS II, and higher throughput, approximately seven times the number of DNA molecules that could be annualized in single smart 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 request 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 previously announced, we expect to ship approximately 10 Sequel Systems to U.S.

customers including Roche in Q4. We will be working to ramp the production capacity for both the Sequel System and its new smart cells early in 2016 and then begin broader shipment including to customers outside the U.S. The product transition so far has been fairly smooth.

Customers who had ordered an RS II system are in our backlog at the end of Q3 understand that Sequel System is not broadly available for shipment right away. So those who need access to smart sequencing in the near term are following through with our scheduled shipments. As I mentioned earlier, we booked quite a few RS II orders in Q3.

So shipments of RS II systems had 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 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 an internal assay development.

The system at 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 label consumables. We expect to earn the final $20 million milestone payment under our agreement with Roche in Q4.

The development and introduction in Sequel System has involved the conservative efforts of the outstanding employees of PacBio.

In addition to providing a sequencing system capable of producing substantially increased throughput compared to its predecessor, they have engineered a new smart cell architecture that provides the capability of further substantial sequencing throughput increases and future version of the smart cell.

Moreover, manufacturing cost 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, and I will 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 period 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 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 with a $20.6 million recognized in Q3 of 2014. Year-to-date, total revenue in 2015 is $56.5 million, up 29% over 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 with $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 installation for this quarter has lease arrangements.

The corresponding revenue from these leased instruments will be recognized as service and other revenue and will be recognized over the lease 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 revenue has increased 60% to $14.2 million in 2015 compared to $8.9 million year to date 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 three 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 our achievement of Roche milestone and our 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 and we sponsored 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 result of the $10 million of Roche related revenue recognized in Q3 of 2014 which had 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 the 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 consumer 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 because 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 and $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 increase in consulting, product development and regulatory cost associated with developing 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 in 2014.

The SG&A expenses 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 from net other expense, primarily related to interest expense associated with the debt that 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 in 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 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 at 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 would 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 onto 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 report a much higher gross margin that we anticipate reporting $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 non-recurring $23 million gains that we reported in Q3, our operating expenses grow in conjunction with increased development cost associated with the Sequel launch. Much of those cost are expected to continue in Q4.

Therefore, we expect our Q4 operating expenses will be similar to the $27 million that we recorded in Q3 excluding the non-recurring gain. As a reminder, our operating expenses include non-cash stock compensation expense and depreciation expense that together amounts to approximately $4 million for quarter.

Finally, with regard to our 2015 annual forecast, as result of the non-recurring gain of $23 million that we reported in Q3 and the anticipated $20 million milestone revenue we expect to report 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 on our expectations for 2015 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 expected to generate significant growth in instruments and consumable sales next year.

In addition, while we do not have any milestone revenues 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 for your questions..

[Operator Instructions]. And our first question comes from the line of Tycho Peterson from JPMorgan. Your line is now open..

Hey, thanks for taking the question.

I know its early days on Sequel but just given the interest you have 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 all together?.

I don’t think there is so many from the latter; I think it has 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 better feel for applications and the use case when they get installed?.

Well, looking at it broadly, I would say it has 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 has actually been pretty broad across the whole spectrum of potential users the people have applied the RS II..

Okay. And then….

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

And what do 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 primarily.

Obviously, we attended to focus earlier I think we mentioned in the last call on customers that we knew we’re very comfortable with taking on a new technology or a new version of a technology, they have the right kind of development people in house to be able to incorporate that into the programs more equal, more fastly than somebody who hadn’t used the technology at all.

But we've tried to make it clear particularly to people outside the U.S. We just rolled this out in to 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 U.S.

We are depending on who they are, what we think their capabilities are taking new technology, we'd expect to be shipping in the U.S. 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 for quarter is the right way to think about it or will you have a decent step up in 2016?.

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

And our next question comes from the line of Bryan Brokmeier from Cantor Fitzgerald. Your line is now open..

Hi, good afternoon.

You had acceleration in consumer revenue pull through, what were the major drivers behind the increase?.

They were running more smart cells. It we have seen all along at least for the last couple of years. And since we're giving you a number based on the previous 12 years, if that's increased, it means that's continuing to increase during the year. And then eventually as long as that's true, the past 12 months number goes up.

So it was probably, it was even higher than that in the last quarter..

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

Yes, Brian, one thing, as we're 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 considerable revenues..

Yes, I mean one thing that that as I pointed out, which is we were all somewhat surprised by actually is that in a lot of areas in the world like Europe we normally shut the machines down for a good fraction of the summer quarter and they kept them running this time.

And in a lot of cases where we mentioned that we've continued to be able to place our SS, then we expected this quarter, for example, 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 the demand that they went ahead and were taking their RS II's in order to keep up with that demand.

So, we're seeing it across the board and then it wasn't just in a -- a few people -- a few customer sites, it was broadly an increase throughout the whole customer/seller whom we're running at full steam and needed additional equipment in order to keep up with their load and others who were running at a lower rate, 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 than instruments that you sell?.

No, Bryan. I think we also tried to point that out to help you with why the instrument revenue actually decreased and the revenues from those lease systems, that's 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 their sort of at a lease rate they're not materially different I would think..

All right.

And can we assume that the instruments that you're putting -- placing on lease with customers that they will be replaced by Sequels in 2016?.

You know they may or may not.

But we did this constantly in order to address for some customers who quite frankly are Sequel customers, who as Mike just mentioned, had immediate needs for access to smart sequencing and since they can't necessarily get into their queue very quickly, we don't anticipate them getting out into the queue very quickly for a Sequel System, it made sense to offer them this leasing option..

Okay.

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

No, we haven't delivered any of them yet but we're still planning on delivering approximately 10 this quarter..

And our next question comes from the line of Amanda Murphy from William Blair. Your line is now open..

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 who are free to launch, I'm not pretty sure about that.

But I guess I'm just curious what the key risks are around the performance metrics might be from onset, I know, investors for example have asked us at least about kind of broad rate 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 growth respects to the RS, I was in the throughout issue..

Yes..

Which expect to be much higher? The risk of what they offer any new product introduction, you're going to have issues with a bugs in the software that you didn't find early on until customers started hitting bugs in different orders and the testers did internally, things like that.

There's always a list that we design to partner on and it's the normal sort of do new item things that you worry about more than anything else. And so we are working really closely with our internal testers and our service people and manufacturing people to make sure that we have as few results as possible.

I don't expect to avoid them entirely by any some; I've never done that in 30 years in this business so I don't expect it to do it this time either..

Right. We did hear a rumor ASHG that it was something about our new optical system that would have an accuracy test that did not come from anything that that file was saying or had experienced, we don't expect that..

Okay..

So, it's -- there were things that we don’t know.

Right..

Until we get them out into our heads. 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 just to give them both credibility as well as minimizing the chance that that what we were doing would leak out prematurely. So 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 predominantly through that I think in the first half, maybe that's the wrong assumption.

But may be just talk through what are the key variables there to in terms of what -- 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 smart cells and we'll be in the process sometime in the first half of Q -- of the next year, switching from Imac which has been our development partner out of Belgium on designing a smart cell and early manufacturer to a high volume manufacturer.

Imac is a -- essentially an R&D very early manufacturing house, mostly R&D. And then they, when that's done they help you transition to a high volume, full time fab manufacturing operation which we've been in the process of for the last several months.

But there's a lag is to help quit that transition, so our early manufacturer of chips will be from Imac and then our longer-term one from a high volume supplier. And the timing of that is -- well it depends on how quickly things go, so far they've been doing very well and ahead of schedule perhaps but we'll try to be a little cautious of that..

Right. It's not timing and yield, any new wafer process takes time to get yields up to. So we want to be cautious on several levels, yes..

Okay.

And then may be just the 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 percentage may be you're not going to get percentages but just given 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 forecast that they give us. It won't be a majority next year, by any means. So I'll point out, in case people haven't seen it, it's no totally random vent that they have secured the gold sponsorship at ACBT.

We've secured the top silver sponsor and we'll jointly give a lot more clearance on their program collectively at those two presentations, kind of workshops there..

And our next question comes from the line of Bill Quirk from Piper Jaffray. Your line is now open..

So I guess first question is kind of going back to the OpEx comment or guidance that you gave us down.

And shouldn't we assume here at some point that your R&D spend is related to Sequel, starts to roll off and instantly jumped up noticeably over the past couple of years because rapid development there?.

Yes, I mean that's what we meant to say quite frankly, Bill. But that in Q4 we're 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're right, at some point in time that should start tailing off a bit..

Okay, all right. Good enough. And then just going back to the lease RS IIs, yes, so I recognized that over time a lot of these get transitioned to Sequel.

Just for modeling purposes or should we be assuming that these leases actually extend beyond 2016 or would you expect to more or less transition everybody over to Sequel at that point?.

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

I think that that said there are some selective 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 have 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 service it as well as what we said at ASHG the intention to continue to release enhancements that served that installed base..

Okay. Understood..

So 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 talked 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 embedded, it's one thing for people in totally R&D setting to take on a new instrument and technology is another for a commercial operations 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.

And they sometimes hang on to older technologies much longer than somebody who's just an R&D mindset to think about..

Okay. And I appreciate all the color that are recognized lot of moving parts to the rental side of things. Last one from me is just thinking and not trying to put the cart before the horse here, but thinking about further improvements to Sequel, you'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 up the optics if you decrease the spacing that's rear wave guidance on the chip, would you have to change out any of the fluidex [ph] or is the system robust not 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'll thing that the robotics part from the workstation would need to be changed.

In order to get more capacity in terms of saying having higher density, smart 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 in W 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, the chemistry, through sample prep technology, through improved software that requires less coverage in order to get to kind of answer the people are looking for.

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

[Operator Instructions]. And our next question comes from the line of Zarak Khurshid from Wedbush Securities. Your line is now open..

Yes, Zarak at Wedbush, hey guys. Thanks for taking the questions.

Question on may be factoring, how are the operations there shaping up and what kind of investment is required to meet the demand for Sequel?.

I think the operation is shaping up very well, we're very proud of our operating group. They were integrated in the Sequel development and the design for manufacturability as well as 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 subassemblies very efficient manufacturing process. So we make -- we are supporting both RS lines on our reagents and our chemistry and our instance for a bit of time and our chip, we feel that we have a capacity that will not involve a huge step up in fixed cost functions to get there..

That's 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 had these plans on moving our facilities not far away from where we're today and increasing our effective sales by something annually 20% a lot of that additional space actually is coming towards manufacturing.

So even though, Susan, is absolutely right, there is a lot of efficiencies for us to gain, we expect to have a significantly higher volume in terms of manufacturing products going forward and so the expansion for the new facilities is going to go 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 may be 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 have already learned a lot more than what we knew even two months ago in that regard.

We're learning a lot about how to load the ZMWs more efficiently in the context of what we call super-person. And right now it's a random loading process and you want to load one and only molecule DNA in each ZMW.

But you what you do that now is a statistical thing and you load a few of them most of them are singles, if you try to load more and more the holes you will wind up getting all doubles but is negative then you don't get necessary sequence out of that.

And we have technology and we will be working on sometime that we're 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 Systems in next year.

So my target would always be a factor of four, we're little early in the process of getting Sequel out. So we will see how well we do on that and the timing we can have but there is 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, how do you think about that going forward? Thanks guys..

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

I think mostly in the IT space if I remember correctly..

Yes..

And going forward?.

Going forward, actually next year is going to be a significant amount of capital deployed in the new facility. But again as you weigh through all these 8-Ks that we have 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 existing lease.

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

And the rest of the cash that have been 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 I just continue to be cautious about that.

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

So, Zarak, I'd just kind of update it, it's actually only about $2 million year-to-date on CapEx not that much..

And our next question comes from the line of Jonathan Abodeely from XLCR Capital. Your line is now open..

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 understanding, its amplification technology that's a meaningful positive if you guys can get it to work the way you think you can work through the smaller amount of input.

So if you could just us some appreciations for that technology and may be the milestones that you hope to achieve. Thank you..

Well I'm not going to tell you what the technology is at this point. It's based on things that we've learned from the biochemical studies that we've done with our sequencing system. Right, I mean most time with the patientsystems the 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 through IT or IGC 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 are after as opposed to trying to give you the details of what that chemistry is..

Understood.

Because we're not willing disclose at this point..

And that there is proprietary technology on your part; you're bringing that to the table, correct?.

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

And Mike is it fair to say that that I think you come as a fact there is no new hardware that would required to make this project ago?.

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

I don't know what you call it, hardware, it's not just for agents, its 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 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 smart technology and products to our customers and the scientific community in general.

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

We are very excited about our new Sequel System and the opportunity it presents for us to deliver smart sequencing to a much broader set of customers. Our focus for the next quarter will be to execute well in the product launch and to ramp up on our production of Sequel instruments of smart 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..