Hello and welcome to the PacBio Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this conference is being recorded. I would now like to turn the call over to Todd Friedman, Head of Investor Relations.. Please go ahead.

Thanks MJ. Good afternoon and welcome to PacBio's second quarter 2023 earnings conference call. Earlier today, we issued a press release outlining the financial results, we will be discussing on today's call, a copy of which is available on the Investors section of our website at www.pacb.com or as furnished on Form 8-K available on the Securities and Exchange Commission website at www.sec.gov. With me today are Christian Henry, President and Chief Executive Officer and Susan Kim, Chief Financial Officer.

You should not place undue reliance on forward-looking statements because they are subject to assumptions, risks and uncertainties that could cause our actual results to differ materially from those projected or discussed, including those inherent in developing and commercializing new products. We refer you to our documents that we have filed with the SEC, including our most recent forms 10-Q and 10-K, and our recent press release to better understand the risks and uncertainties that could cause actual results to differ. We disclaim any obligation to update or revise these forward-looking statements except as required by law. During the call we will also present certain financial information on a non-GAAP basis. Non-GAAP information is not prepared under a comprehensive set of accounting rules and should only be used to supplement an understanding of the company's operating results as reported under U.S. GAAP. Management believes that non-GAAP financial measures, combined with U.S. GAAP financial measures, provide useful information to compare our performance relative to forecasts and strategic plans, and benchmark our performance externally against competitors. Reconciliations between historical U.S. GAAP and non-GAAP results are presented in tables within our earnings release. For future periods, we are unable to reconcile the non-GAAP gross margin and non-GAAP operating expenses without unreasonable efforts due to the uncertainty regarding among other matters certain acquisition related events that may arise during the year, including amortization of developed technology. We will also discuss our recently announced acquisitions of Apton Biosystems. For more information, we have posted a presentation which can be found on the Investors section of our website at www.capb.com. Please note that today's call is being recorded and will be available for replay on the Investors section of our website shortly after the call. Investors electing to use the audio replay are cautioned as forward-looking statements made on today's call may defer or change materially after completion of the live call. We will be hosting a question-and-answer session after our prepared remarks and we ask that analysts please limit themselves to one question, so that we could accommodate everybody in the queue. I will now turn the call over to Christian.

Thank you, everyone joining our call. In today's prepared remarks, I'll update you on several aspects of our business. First, I'll discuss PacBio's record performance in the second quarter and highlight our commercial activities. Second, I'll comment on Revio field performance and customer update in its first full quarter since launch. Next, I'll highlight our recent commercial launch of Onso and our acquisition of Apton Biosystems, which was announced earlier today and then Susan will take us through the financials and guidance in more detail. And finally at the close with half a year behind us, I'll share how we are executing against our 2023 priorities I set forth at the beginning of the year. Starting with Q2 performance, the rapid adoption of Revio drove another record quarter for PacBio as we grew revenue by 34% compared to the second quarter of last year and we exceeded $40 million in quarterly revenue for the first time in our history with each region posting record revenue. The team did an excellent job of scaling manufacturing and ramping installations which enabled us to ship 45 Revios for revenue and brought our installed base to 77 Revio Systems as of June 30. Additionally, we exited the quarter with a healthy backlog of Revio instruments. Revio's momentum and our ability to meet customer demand have further increased our confidence to raise our revenue expectations for 2023. We now expect full year revenue to be between $185 million and $190 million, representing 44% to 48% growth over 2022.

New customers in the quarter also included the Medical University of Innsbruck, which marks the first Revio in Austria. The customer plans to consolidate multi approach workflows used to analyze difficult genes which included short read sequencing, Sanger sequencing and PCR and streamlined it into targeted long read panels utilizing HiFi sequencing. New customer orders in the quarter also included the first instrument order in Indonesia from the YSDF Foundation. The Group collaborates with academic institutions and hospitals across the country to promote genomic research and improve health. They ordered the Revio, Onso bundle to match the best suited sequencing approach with the appropriate sequencing application. They plan to use long-reads in human whole genome sequencing to build a genomic repository across the diverse Indonesian population, as well as metagenomics and targeted applications in difficult to sequence genes. The customer plans to leverage the accuracy of sequencing by binding on Onso to develop targeted panels for liquid biopsy. Revio's increased throughput, accuracy and direct methylation detection continue to expand the long-read sequencing into population genomics programs. In the second quarter Sample, a leading genomic service provider and biorepository based in New Jersey, received its first Revio and expects to start sequencing a cohort of samples for a large scale population genetics program funded by the Department of Veteran Affairs. And in the second quarter the [indiscernible] program released data from over 1000 PacBio genomes. This is an important milestone as more long-read data entering the public research realm can unlock discoveries, prompting more research and interest in long-read genomes, exactly the type of flywheel effect we've been talking about that can accelerate HiFi adoption. Customer utilization and Revio's field performance in the second quarter indicate a strong start to the product launch. Customers are ramping up their Revio usage with…

Additionally, the study compared the latest PacBio HiFi and nanopore methods. Consistent with previous reports, they observed that nanopore data resulted in a much higher error rate in indel calling than HiFi data, and that certain variant classes had lower precision with duplex nanopore data compared to standard nanopore data. Customers are pleased not only with Revio and its game changing throughput and economics, but also with the quality of service that PacBio provides. With that, I am pleased that our annual customer survey was completed in the quarter resulting in a final Net Promoter score of 62. This demonstrates our commitment to delighting our customers and we look forward to continuing to offer best-in-class support to all of our customers around the globe. Switching gears from long-read to short-read, I'm excited to announce that earlier today we shipped our first commercial Onso system. The sequencing by binding or SBB chemistry which is at the core of the Onso system was the early stage technology we acquired from Omniome less than two years ago with the promise of delivering customers an extraordinary level of sequencing accuracy. I congratulate the entire team at PacBio for developing this technology into a highly differentiated platform designed to offer customer sequencing accuracy of 90% of bases at Q40 plus levels or one error in every 10,000 bases, a specification that we believe no other sequencer currently advertises. This is a truly monumental moment for PacBio as it's our second sequencer launched in less than six months. We believe it positions Packed Bio as the only sequencing company to offer systems specifically designed for both long and short-read sequencing and marks the next step in our strategic journey to becoming a multiplatform, multi omni company that aims to deliver solutions across the genomics ecosystem. One…

Additionally, the study compared the latest PacBio HiFi and nanopore methods. Consistent with previous reports, they observed that nanopore data resulted in a much higher error rate in indel calling than HiFi data, and that certain variant classes had lower precision with duplex nanopore data compared to standard nanopore data. Customers are pleased not only with Revio and its game changing throughput and economics, but also with the quality of service that PacBio provides. With that, I am pleased that our annual customer survey was completed in the quarter resulting in a final Net Promoter score of 62. This demonstrates our commitment to delighting our customers and we look forward to continuing to offer best-in-class support to all of our customers around the globe. Switching gears from long-read to short-read, I'm excited to announce that earlier today we shipped our first commercial Onso system. The sequencing by binding or SBB chemistry which is at the core of the Onso system was the early stage technology we acquired from Omniome less than two years ago with the promise of delivering customers an extraordinary level of sequencing accuracy. I congratulate the entire team at PacBio for developing this technology into a highly differentiated platform designed to offer customer sequencing accuracy of 90% of bases at Q40 plus levels or one error in every 10,000 bases, a specification that we believe no other sequencer currently advertises. This is a truly monumental moment for PacBio as it's our second sequencer launched in less than six months. We believe it positions Packed Bio as the only sequencing company to offer systems specifically designed for both long and short-read sequencing and marks the next step in our strategic journey to becoming a multiplatform, multi omni company that aims to deliver solutions across the genomics ecosystem. One…

Thank you, Christian. As discussed, we reported $47.6 million in products, service and other revenue in the second quarter of 2023, which represented an increase of 34.1% from $35.5 million in the second quarter of 2022. Instrument revenue in the second quarter was $29.9 million, an increase of 91.6% from $15.6 million in the second quarter of 2022. The continued momentum of Revio primarily drove the increase in revenue as we shipped 45 Revio systems for revenue in the quarter. We ended the quarter with an installed base of 77 Revio systems. Higher ASPs in the quarter were in part due to the lower customer loyalty discount extended to customers in addition to more new customers who ordered their first Revio in Q2 relative to Q1. Turning to consumables, revenue of $13.7 million in the second quarter declined 5.7% from $14.6 million in the second quarter of last year, with approximately 44% of consumable revenue coming from Revio systems and the remainder from other systems and other consumables. We expect Sequel II and IIe as a percent of total consumables to decline throughout 2023 as we continue shipping Revio and customers transition to the new platform. Finally, service and other revenue was $3.9 million in the second quarter compared to $5.3 million in the second quarter of 2022. From a regional perspective, as Christian mentioned earlier, all regions posted record revenue in the second quarter. America's revenue of $24.0 million grew 10% compared to the second quarter of 2022. Increased instrument placements with higher ASPs more than offset a year-over-year decline in consumables and services related to customers transitioning to the new platform. Instruments include continued adoption from children's hospitals as SickKids became the first customer to receive a Revio in Canada and plans to utilize HiFi long-reads for its…

As a reminder, this commercial milestone represents $200 million with approximately half being paid in cash and half in equity. We expect the weighted average share count for EPS for the full year to be largely unchanged at approximately $255 million. I'll hand it back to Christian for some final remarks. Christian?

Thank you, Susan. With half the year now behind us, I wanted to provide a status update on our five strategic priorities for 2023. Our first goal was to drive rapid adoption of Revio by converting existing Sequel II and IIe customers and attracting new customers. In the first half of this year, 40% of our system orders were to new pack bio instrument customers. And looking at the pipeline in the second-half, we continue to expect about 40% to be new customers, which exceeds our expectations. Further, as shown by our ramp and Revio consumables and decline in Sequel II consumables. Customers are eager to begin sequencing on the new platform. needle-in-a-haystack: With the beta program complete and commercial shipments underway, we look forward to getting Q40 plus accuracy into more customers labs and continuing to hear customer success stories. While commercializing Revio and Onso was a top priority this year, it was just as important that we drive our development efforts towards the next generation of long and short-read sequencers. We continue to make progress on future long-reads, shifting R&D resources from Revio onto the development of our bench top long-read and our ultrahigh throughput long-read systems. Further, Apton now gives us significant head start in developing the high throughput version of Onso, which will allow us to address one of the largest parts of the sequencing market. And as I've been communicating, I expect PacBio to deliver new and differentiated instruments at a much faster cadence than the organization had previously delivered. Next was expanding partnerships across the ecosystem and workflow to drive SBB and HiFi customer adoption. Earlier this year, we launched the PacBio compatible program and signed on nearly 20 partners across extraction and library prep automation, sample prep, and secondary and tertiary analysis. We expect to sign several more partners this year and we've already seen several examples where these collaborations have led to increased PacBio sequencing. Last but certainly not least is our drive toward our goal of being cash flow positive during 2026. On top of executing on our product launch as the PacBio team has done an excellent job on improving our financial position. We achieved record revenues in the second quarter with an expectation of 46% growth this year at the midpoint of our updated guidance. As discussed, we also expect operating expense growth for the year to be 3% to 4% over 2022 levels, which is below our 5% compound annual growth target through 2026. Additionally, we further strengthened our financial position in the second quarter by exchanging a significant portion of our notes due in 2028 and extending the duration of our debt while lowering our coupon payment. As you can see, it's been an exciting and rewarding first half of the year for us at PacBio and we look forward to sharing more as the year progresses. And with that, I'd like to open up the call to questions. Operator?

Thank you very much. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Matt Sykes with Goldman Sachs. Please go ahead.

Hi, good afternoon. Thanks for taking my questions. Congrats on the quarter. Maybe I just want to start out with sort of a high level question on the Apton acquisition. Christian, you talked about being able to leverage the scale up of Onso customers eventually into high throughput. But I'm also wondering, does this open up an additional market for you within short-read that Onso cannot address and that you think has the growth and the size that would warrant the investment that you're making in terms of R&D and development?

Yes, Matt, thank you for the question and thank you for the congrats on the quarter. This certainly opens up more of the market to us and that's why this is -- that's why if you go back and look at our core strategy from the get go has been how do we develop multiproduct, multi Omic portfolio, so that we could reach customers at different levels of demand and optimize our solutions for the problems that that each kind of customer is solving. Onso does a great job of reaching the mid throughput part of the market, particularly given how strong the accuracy is. It in fact for fewer reads you can actually get more work done because the accuracy is so high. We're going to deploy that same kind of chemistry, the SBB chemistry on the apps on platform and that will let us get to the very high end of the market. And we believe that once we develop this system, we'll be capable of delivering a product that delivers billions of reads per flow cell, per run with very competitive economics, with anything else out there. And so you're exactly right, that's part of the strategy is that Apton will enable us to reach part of the market that perhaps Onso couldn't get to and really round out our offerings in the short-read space.

The next question comes from Kyle Mikson with Canaccord. Please go ahead.

Yes. Hi guys. Thanks for taking the questions. Congrats on the quarter and the acquisition and Congrats to John Hannah over there at Apton, I saw you guys. So I guess just two-part questions. First on the guidance, would you mind just talking about Christian, Susan, what you're sort of baking in terms of the macro environment in the second-half of the year? It is kind of evolving, it's quite fluid, but you guys seem to be a little bit more optimistic. And then secondly, on Apton, I mean I guess, just what does PacBio kind of bring to the table to enable Apton to go from like this kind of stuff mode situation to kind of competing with leading an emerging company in like Illuminant Ultima? Thanks.

Sure, Kyle, thank you very much for the questions. You know, it's starting with the guidance we were looking at our forecasts and we were evaluating our performance year-to-date. And what we're really seeing in the market is that Revio is really [indiscernible]. Revio has a lot of momentum. We have a very strong backlog position and so just starting from that position of strength I think helps us in the economic backdrop. One thing that was surprising to me is how fast our Revio customers are starting to utilize their systems and driving the consumable revenue and so that encourages us as we kind of look into the back half of the year. Now the world around us, Revio is certainly, it's nice to have a new very powerful product in the early part of its product cycle in maybe what could be conceived as a pretty tough macro environment particularly in say in China for example. But the truth is we've seen very strong demand and we continue to see strong demand. If you look at China specifically of course you know we have a small customer base and so I don't think we're, I don't think we're as impacted yet by any of those macro headwinds that perhaps some of the larger companies are seeing. So, we looked at our what we've done today, looked at the backlog, looked at the order forecast, looked at the fact that we're gaining so many new customers with Revio and that new customer acquisition really is what's going to help propel the growth not only in 2023 but 2024 and beyond. And so that's kind of how we thought about it. If you look at -- if we move on to Apton, PacBio brings so many things to act on.…

The next question comes from Jack Meehan with Nephron Research. Please go ahead.

Thank you. Good afternoon. First is on consumables, is it possible to share sort of a range of SMRT cell utilization you're seeing for Revio in the field? I understand the consumables can be lumpy, but thought the data generation could be a good early proxy for that. And then second, just maybe more broadly Christian, is it possible to call out like where you think you might be gaining share with Revio versus areas that, or legacy short-read, how does that compare to your expectations a few months ago?

Sure. Thanks Jack for the questions. With respect to consumables, we're not going to break those things out right now. As you can imagine, we're still really early in our launch. What I can tell you is that the utilization metrics have been at what we expected or even a little bit above what we expected. And so we're seeing our customers get off to a good start, which means they understand how to use the system. They've got projects and their goal for it. As I said, or in my prepared remarks, we've been seeing more and more standing orders come in. This is huge for us because as we scale as a company, it allows us to optimize our manufacturing so that we know when we're going to need to be shipping consumables and we know those projects are out there. And so I know the whole world wants to know, is the consumable through, pull through what is that number going to look like and how fast are we going to get to kind of our steady state? And I would say we're on the -- we're certainly on the upward slope of that curve right now. But we're not really prepared to make remarks on where that curve is going to end up, other than to say that, we're off to a good start, probably a little bit better than what we expected. With respect to Revio gaining on the short-read space or market share in general, the one thing, we'll, and I'll just re-point to in our prepared remarks, we did have one significant win in the quarter that I highlighted where there was another long-read technology entrenched in the account and they are converting basically the vast majority of their business to Revio because they see the utility of the product versus other approaches. With respect to short-reads, I think what we're seeing is that in population scale programs in particular, you're seeing us start to take share in the sense of a project that was once going to be completely a short-read project, is now scientific design, experimental design has been thinking through, how do we integrate long-reads into that and taking a portion of those. And we've seen several examples of those already, just in the first little bit here of the Revio story. And we're seeing in our funnels actually major opportunities to take tens of thousands of samples in these kinds of programs. And we'll see how that goes, over the course of the year. But I think what you're seeing is that the comprehensiveness of HiFi coupled with the performance of Revio and the simplicity and the ease of use and the informatics burden is really putting us in a position to make significant gains here. And that's really -- that's been the strategy all along and here we are starting to really execute on it. Hopefully that helps.

The next question comes from Daniel Brennan with TD Cowen. Please go ahead.

Great, thanks. Thanks for the questions. Congrats on the quarter. Maybe just a multi-parter, just Christian, you talked several times throughout about the very strong backlog. Sounds like book-to-bill could have been notably above one. So first question would be any color there? Secondly, I know Susan talked about Revio placements up modestly quarter-to-quarter. Just wondering any color on what drives the pacing? Is it manufacturing capacity? Is it customer readiness? Is it the size of your funnel? And, could you accelerate it further? And then the final one would just be on, implied in the revenue outlook. While you're not going to give a pull through number, could you just help us think through the mix between instruments and consumables?

Sure. Thanks Dan for the questions. So, one thing, we are talking about orders, and I've been making a point of this since JP Morgan actually that we're not going to talk about orders. We did have orders come in on our expectations for the quarter. We are in a healthy backlog situation, as we talked about. Now, backlog is both, it's a blessing of course, because it gives us some predictability of on our revenue, but also every instrument that sits in backlog does not generate consumable revenue and does not propel us forward in terms of long-term growth. And so our strategy is to try to whittle that backlog down over time, which you'll see us start to do. And we've got manufacturing now basically to a steady state where we can deliver on what we expect to deliver for the remainder of the year, and we'll see at the end of the year or basically as we go forth when we need to increase capacity, if we need to increase capacity, et cetera. Revio pacing itself, Susan did say modest increase, sequentially kind of moving forward. I think we're just taking a very straightforward approach to kind of continuing to build the business, continuing to serve our customers well. We've been doing some hiring with the field support teams to make sure that we can address issues in the field. And so, when you look at how we push this business forward, we really are trying to think in totality of how do we create amazing customer experiences so that repeat customers get great data, which creates a flywheel for more leads of -- for instruments for more pull through down the road. And so, when we think about how we deliver for the rest of the year, we try to think through those things. As far as manufacturing goes specifically, I do think we have capability right now to do to do pretty well over the course of the year and we always can increase capacity down the road if we need to. Finally, with respect to product mix, the product mix is going to be really important in 2024. 2023, as we've been saying all along is going to be a very instrument heavy year, and we'll start to see customers ramping their Revio’s. We still, have some questions about how fast Sequel II ramps down and Revio ramps up, so that's an area where we're watching and we're trying to understand. Q2 though, we saw the Revio is growing quite a bit and the Sequel II starting to ramp down. So basically in line with our expectations, maybe Revio’s a little bit higher than we expected in the quarter. And I suspect we'll probably see some of those trends, continue through the rest of the year. So it's a very instrument heavy year going to continue to be, but Revio consumables are starting to really shine.

Hi, thanks for taking the question and congrats on the quarter and the acquisition. Just on the sequencing coverage for Revio, I don't know if it's too early to tell, or I realize it also depends on the application, but I was wondering if you might be seeing more of your customers, especially maybe for the population scale, projects taking advantage of lower coverage given that could provide more attractive economics. Just kind of curious, what trends you might be seeing there. Thank you.

Thank you, Sung Ji. That's actually a great question and I appreciate it. With traditional short-read sequencing, 30x coverage is kind of the benchmark. The truth is that customers always are making their own coverage decisions based on the application. But if you compare 30x short read sequencing with PacBio sequencing, I do think more and more every single week customers are seeing that less than 15x coverage can get you very significant performance relative to 30x coverage. And as a result, you're right, the economics get even better and if we just use 15x and you use $995 list price, which is what our list price is for a genome on Revio, that list, it's basically a $500 genome. So, the economic gap between long and short-reads is really shrinking quickly when you look at it on coverage metrics and thinking about your experiment. And there's no question that the population scale customers are thinking through that and leveraging that ability to get great low coverage and very high accuracy comparable with 30x. Now in other applications, customers are still going to want to do 30x or perhaps even more, perhaps in some oncology, some rare disease. Where you're looking, where you're trying to make a decision about a patient or trying to understand a translational research situation and so in those cases, I suspect they might be doing different coverage models other than that. But it was important for us to start really helping the world understand that you don't need 30x coverage. 30x coverage in long-reads is very different than 30x coverage in short-reads. And I do think, I'm actually really thrilled that the world's seeing that, and some of our best customers are actually promoting that. So that's a great reason for you to be getting into long-reads.

The next question is from Luke Sergott with Barclays. Please go ahead.

Great, thanks guys. So I guess the first one, I just kind of want to get a sense of the timing and the strategy there from Apton. I understand how it fits in the portfolio, et cetera, but I just, you guys are in the midst of the biggest launch of the company's history between the, the two instruments, is there a risk there that you could be biting off more that you could chew from an organization. I know that Christian, you'll drive them hard enough. But just kind of thinking there from a timing perspective, why not build up some cash, get a successful launch out there and then do the deal? Because it was still an early stage seed round, I guess. And then my second one is, as you think, I know you're not going to give any, orders or placements, but it sounds like the orders were less than the shipments and you guys burned down some backlog. Is there something from, the April timeframe where you were kind of going, not full bore there just any kind of color on the pacing of the orders that have been coming in?

Yes. Luke, thanks for the questions. First of all, with respect to Apton, and then I'll get to the backlog. With respect to Apton, we have had this strategy to build out a multi-product portfolio in short-reads, we think it's fundamental to address the entirety of the market and to really maximize the value of SBB chemistry. We have built a team that is highly capable of executing and we'll still be working on, anytime you launch a new platform, you're still working on that platform for a bit of time after. But the Apton technology is far enough along, they've been working on it for many years. It's far enough along where there, we already have working systems you know, the deal's going to close shortly here. And we'll have systems in San Diego and in Menlo Park so that we can start optimizing the chemistry right away. We think that's really, really important because as we start to gain some momentum with Onso and SBB chemistry in particular, we want to convert that momentum into routine usage, perhaps in liquid biopsy applications, for example. And routine usage is going to require high throughput. It's just, there's not no two ways about it. We believe that there's a market window where we can get a new high throughput product to market in a window that will make it highly competitive with anything else out in the world. And so that's, so time is certainly of the essence. You are right, we are pushing the team hard, but I actually think I'm not pushing, I think everyone is pushing me just as hard which is just such a great place to be because the company has never been in that position before. So now is -- the best time to…

The next question comes from Rachel Vatnsdal with JP Morgan. Please go ahead.

Great. Thank you for taking the questions and congrats on the strength this quarter. So I wanted to dig into some of your comments on the gross margin line. Guidance now assumes non-GAAP gross margins of 32% to 34% for the year. We also mentioned that that gross margin line could fluctuate based on Revio ASP and consumables on Sequel II and Sequel IIe. So can you just walk us through what's actually contemplated in that gross margin guidance for the year? And then how should we think about the levers impacting that gross margin progression into 2024? Thank you.

So Susan, do you want to cover the -- what's going on in 2023 and I'll kind of work into 2024?

Yes. So I'm happy to. So this year we have baked in for gross margins the ASP trends for Revio and then also in addition, manufacturing efficiencies with manufacturing the Revio instrument. So if I start on the ASP side, you see that just in terms of calculation, the ASP has improved in Q2 relative to Q1, and given the backlog and the funnel we have ahead of us in terms of orders and instruments we expect to shift, we do expect that the ASP for the Revio instrument will be consistent with where we were in Q2 or slightly better than Q2. So that was baked into how we estimated our gross margins. And then also with respect to manufacturing the instrument, our manufacturing team has done a great job of improving efficiencies with building that instrument. One measurement we have is touch time on building that instrument and that touch time has been coming down, it's come down in Q2 relative to Q1. And we are baking in incremental improvements in those efficiencies to build the Revio instrument, which is helping our gross margins. In our gross margins for the year two are the Revio consumables, and we are improving in terms of yields and how we're doing there, which incrementally reduce the cost to manufacture consumables. So all of that has been factored in when we guide our year.

Yes, and so that's helpful, Susan. And when you think about it, anytime you have a launch year, you certainly have lower gross margins, but we also had, the complexity of a pretty fundamental product transition with Sequel II to Revio and also kind of the lingering effects of COVID. So unfortunately we did have, we have had higher write-offs in the first quarter in particular which impacted our gross margin expectations for the year. And so Susan's, right, as we continue to drive costs out of the system, that's going to help our gross margins, particularly in 2024. And also ASPs will likely kind of achieve steady state by the end of this year and into 2024 and on Revio. And so I think that those are really positive signs and positive signals that are going to help drive gross margins up. And finally, perhaps most importantly of all is the fact that the Revio instrument can drive much higher consumable pull through, and therefore the product mix will start to change. I would imagine, later this year and into 2024 and probably into 2025 too, that you start to see more of a traditional mix of consumables to instrumentation, which will also very significantly help our gross margin over the next few years here. So we're managing aggressively I think the team's doing a good job, but we have a lot of work to do.

The next question is from Tejas Savant with Morgan Stanley. Please go ahead.

Hey guys. Good evening. Thanks for the time. Christian I know you don't want to comment on, on Revio orders and backlog, so maybe I'll take a different tack on that question because I think it's an important one. Can you help us sort of frame, historically at what point in a product sort of launch cycle would it be normal to see the backlog start to come down and any color on what kind of a backlog are you looking at? In terms of where you'll be at year end heading into 2024. And then my second question really is on the Onso side of things. I know you've excluded it sort of prudently from the 2023 guide here, but as we think about that Onso ramp in 2024 any sort of like, thoughts and how you see that inflecting based upon your feedback from early customers? Thank you.

Thanks Tejas. So starting with, kind of the backlog and kind of traditionally what happens when you have a new product cycle, oftentimes you first go to your existing customers and drive, drive heavy orders in that way, and then you work to new customers. And so the order book would look like a bit of a yes, kind of an increasing curve and then a plateau, and then another increasing curve. The right now, I would say we're kind of in the, we're still at the tail end of the increase and starting to be in that plateau phase. And what that means is that new customers are, starting, are really taking notice. They want to see how the data is from the best customers. They want to make sure the system, the system is working as intended. If you look at our sales funnels, our sales funnels continue to grow and be strong globally. And so, I do think our objective is to whittle the backlog down some. I do think that we see incredible opportunities for demand to and as a result, we've raised our guidance significantly this year. And we're off on the, on a whole new trajectory as a company. And I think that's really what we're seeing right now. So very excited about the order book, excited about, we do have a super healthy backlog that continues to propel us forward. We've got to start whittling that backlog down so that we can make sure we get the consumable pull through and the consumable revenue, which will drive our gross margins as I said before. Now, the Onso ramp, what's amazing about Onso is that it's an instrument that we can reach with the sale, same sales team, and the same call point. And…

The next question is from Ross Osborn with Cantor Fitzgerald. Please go ahead

Congrats on the quarter and thanks for taking our questions. So maybe just one for us on the long read market broadly. Historically, I believe the company's views that you and Oxford did not overlap as much as people think. Was this still the case in the quarter? And in terms of new customers to PacBio, were they new users to long read, or did you perhaps see more conversion from Oxford this quarter?

Ross, those are good questions. It is difficult to, I would say customers use multiple technologies. And so when you start to say, conversions, you have, it is not, it's a little more nuanced than that, but I do think when you look at scaled users, the example we pointed out in our opening remarks was really a scaled user moving from Nanopore to Revio because of the capabilities of Revio. In the past, we just never had the throughput or the economics to be truly competitive, even though we had higher accuracy, easier to use workflows, et cetera. But the reality is, we just, scientists couldn't do the experiments they wanted to do. Now with Revio, we're actually penetrating all over the market with a product that really that really meets our customer's needs. And so I would say that, I would say that broadly speaking, we – for high throughput scale users, it's competitive. But we are seriously making inroads. And then there's a part of the long read market that Nanopore technologies serve that we don't serve. And that's the kind of single use $1000 low throughput part of the market, which we're not really that engaged with because that's not where our focus is. And so I would say in the areas where we are focused, we are highly competitive. And both, I think we already lead that part of the market, but we're gaining traction as well.

Today's final question comes from John Sourbeer with UBS. Please go ahead.

Hi, thanks for taking my question here at the end. So I guess now that you're, two, two quarters into the Revio launch, just how are you thinking about the upgrade cycle from here, from the Sequel II, is it three to two, two to one, one-to-one, any color there? And then I ask to follow up on the Onso, just any color on the backlog mix on what are standalone Onso orders versus Revio Onso combo packages? Thanks.

Yes. So John, that's a good question. I still believe that in the long run, it’s more likely to be closer to one-to-one Revio to the Sequel II install base than say anything else. I think in the early days, we have seen, probably more in the three to two or even two to one kind of range. But I think that's because, the system's 15 times more capable than the Sequel II. And so people are scaling into the platform. I'm leveraging a lot of gray hair and a lot of experience with launching platforms that are significantly more powerful than their predecessors. And then, so far, it seems like, in my experience, almost every single case, you've seen a dramatic, ultimately say a couple years post-launch that old install base largely does turn over to the new products on close to a one-to-one basis. It's still too early to see, but I don't think our view has changed any since our last quarter, last our last call last quarter. And then lastly, with respect to the Onso platform, I don't have the numbers right in front of me, but it's about, it probably is about half, right? A little, maybe a little bit less than half are bundled deals of the orders we have so far. But I don't have the numbers right in front of me. My expectation is, I think it's a really powerful, unique offering that PacBio has, and no other company has the ability to have highly accurate short reads and highly capable long reads, in a bundled arrangement where you can, you don't, your technology doesn't drive your experiments, what kinds of applications and what kinds of answers you're looking for drives what your decisions are. And given our ability to work very closely with our customers, perhaps maybe in a different way than others you know, I do think can give our customers a lot of confidence that when they come to PacBio, we're going to serve them and really focus on meeting their needs with great technology. So, thank you for the question.

The only one thing I was going to add, John, is with respect to the, so we gave the statistic that there are a 100 customers that have ordered a Revio system, and if you compare that even to the install base of Sequel II, that's about a third of the customers who have a Sequel II. And so the, the vision that Revio will access more and more of the market and more new customers, even by the fact that the number of orders coming from new customers is 40%. And we expect that to be the case going forward for the next couple quarters, we are accessing more of the market, and so the install base of Revio, we expect it to be much larger than the Sequel II.

Sure. Well, perhaps that's a great place for us to wrap up for today.

Yes, sounds good. Yes, thank you all for joining us today. This will conclude our call and replay of today's call is available on our investor section and we look forward to updating you throughout the quarter and the rest of the year on our progress.

Thank you. The call has now concluded. Thank you for attending today’s presentation. You may now disconnect.