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Ladies and gentlemen, thank you for standing by, and welcome to the Pacific Biosciences of California, Inc. First Quarter 2020 Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to your first speaker today, Ms. Trevin Rard. Ma’am, please go ahead.
Good afternoon, and welcome to the Pacific Biosciences first quarter 2020 conference call. We hope that you are keeping well during this time. We’re hosting our call from a number of different locations today, so please bear with us if there are any technical challenges or pauses.
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, 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 Chief Executive Officer; Susan Barnes, our Chief Financial Officer; and Ben Gong, our Vice President of Finance and Treasurer.
Before we begin, I would like to remind you that on today’s call, we may be making forward-looking statements, including plans and expectations relating to our financial projections, products and other future events, such as the impact of COVID-19 pandemic on our business partners, customers and employees and the use of our products in COVID-19 research.
You should not place undue reliance on forward-looking statements because they are subject to assumptions, risks and uncertainties and may differ materially from actual results. In particular, the extent of COVID-19’s continued impact on our business will depend on several factors including the severity, duration and the extent of the pandemic as well as actions taken by governments, businesses and consumers in response to the pandemic, all of which continued to evolve and remain uncertain at this time.
These risks and uncertainties are more fully described in our Securities and Exchange Commission filings, including our most recently filed reports on Forms 8-K, 10-K and Form 10-Q. Pacific Biosciences undertakes no obligation to update forward-looking statements.
In addition, please note that today’s call is being recorded and will be available for audio replay on the Investors section of our website shortly after the call. Investors electing to use the audio replay are cautioned that forward-looking statements made on today’s call may differ or may change materially after the completion of our live call.
I’d now like to turn the call over to Mike.
Thanks, Trevin. Good afternoon and thank you for joining us today. On this call, we will review our results for the previous quarter as usual. We will also describe how the COVID-19 pandemic has impacted our business and how we have been responding.
I’ll start with some highlights of our Q1 2020 financial results. Consumable revenue for the quarter was $8.3 million, up 6% from Q1 2019 and down 11% sequentially from Q4 2019. This result was generally in line with our expectations going into the quarter. As anticipated, our consumable sales into China were down sequentially due to seasonality and early impacts of customer shutdowns in China due to COVID-19. Meanwhile, our consumable sales in the U.S. and Europe were generally strong for most of the quarter with customers only starting to cut back in the latter part of March.
Instrument revenue for the first quarter was $4 million, down 28% from Q1 2019. Our instrument revenue was negatively impacted by COVID-19 as many customers postponed taking delivery of instruments they had ordered. Our instrument sales and installs are usually weighted heavily towards the end of each quarter. However, as customers across the U.S. and Europe, again shutting down their operations in March, we were unable to complete numerous installations. We ended the quarter with an installed base of 125 Sequel II Systems.
Total revenue for the first quarter was $15.6 million, down 5% from Q1 2019. In the early part of the quarter, we expected our Q1 revenue to increase compared to last year. However, this was before COVID-19 had begun to spread in areas outside of China. The picture changed drastically in mid-March as many of our customers in the U.S. and Europe shutdown operations. As a result, the revenue we generated in the last weeks of the quarter were much weaker than usual. Gross margin for the first quarter was 48%, up from 31% in Q1 2019 and up from 46% in Q4 2019.
Per the terms of the merger termination agreement with Illumina, we received a total of $132 million from Illumina during the first quarter out of which we recorded $34 million as non-operating income. As a result, we generated positive net income of $1.3 million for the quarter. We ended the quarter with $142.6 million in cash and investments on hand.
Now I’ll provide a few comments regarding our current state of operations. Our headquarters and manufacturing facility is located in one of the countries that first issued shelter in place orders on March 16th. These orders forced many businesses in our area to shutdown. However, essential businesses have been permitted to continue operating. We are considered an essential business by virtue of the fact that we were a life sciences company that supplies other essential businesses with tools and consumables necessary for them to carry out critical activities.
However, for the safety of our employees and those close to them, we were having the majority of our employees work from home. We had maintained limited onsite operations at our Menlo Park facility to provide a continued supply of consumables and instruments to our customers who are still operating. A certain number of our employees in the field were also providing onsite support to customers as needed. In addition, we are continuing to conduct certain research and wet lab activities largely in supportive efforts related to COVID-19. I’d like to acknowledge the efforts of all the employees who are working to ensure that our customers can continue their important work on COVID-19 and other essential areas.
Now I would like to offer some perspectives on how PacBio’s products and technology can be useful in the fight against COVID-19 pandemic. First of all, the high demand in the near-term for testing individuals to see if they have been infected by the virus is not an application suited for PacBio’s products or other sequencing technologies. Such test are based on reverse transcriptase polymerase chain reaction or RT-PCR, which can generate a relatively fast inexpensive diagnostic tests from a sample taken from an individual.
PacBio’s products on the other hand could be valuable for studying how the virus responsible for COVID-19 namely SARS’ CoV-2 evolves over time. Viruses in general tend to mutate over time in order to adapt to their environments. Researchers can sequence different samples collected at different times within an individual, within a community or across regions in order to track how the virus may have evolved or how the virus has spread across different regions. By identifying which strains of the virus are present. PacBio sequencing technology can be particularly valuable for this type of research because it allows researchers to easily detect multiple mutations and individual virus particles genome with very high accuracy.
As an example, we have partnered with LabCorp is well positioned to conduct studies on the SARS’ CoV-2 virus using PacBio sequencing systems. LabCorp is already an experienced user of smart sequencing for applications in human biomedical research and we are pleased and honored that they are expanding their use of our products for COVID-19 research. In the future, the scientists and researchers develop antiviral therapeutics to combat COVID-19 it will also be valuable to understand how the virus may mutate and it is response to both drugs and vaccines.
Another valuable application for PacBio sequencing is the analysis and study of the host immune response to the virus. Researchers can sequence the genomes of people who have been infected with SARS CoV-2 to identify antibodies that these patients who generated the fight the virus. The study of protective antibodies in recovering patients can be very valuable in the ongoing development of vaccine candidates. Researchers are also interested in studying the genetic background of hosts to understand how different people are affected by exposure to the virus.
While we have seen how exposure to the virus can be deadly for some people, others who have tested positive have experienced very little negative impact. The explanation for why there is such a wide range of reactions across different hosts maybe hidden in the underlying differences within the host genomes. PacBio sequencing has proven to be a valuable tool for sequencing the complex regions within the human genome that control immune response.
We are proud to be serving multiple customers who are engaged in various studies aimed at fighting the COVID-19 pandemic. That said in the near term, our business has decreased significantly. At this time, a majority of our customers with Sequel and Sequel II systems have shutdown most of their operations. And it's difficult to estimate when these sites will come back online and resume running to PacBio systems. It will likely vary region by region and state by state. In the long run, we remain confident that the demand for high value PacBio sequencing will continue to increase. We are privileged to provide a technology that can truly make a difference to science and society and we're seeing that play out today with our customers' response to the COVID-19 pandemic.
Before concluding my initial remarks, I think it's worth noting, that while most of our time and energy today is being spent on the response to the COVID-19 pandemic. Our traditional customers who are working on diverse areas, including human biomedical research and plant and animal sciences have made tremendous progress using PacBio tools and products in the past several months. Generating the most accurate and comprehensive genomes in their respective fields.
We assure you that we will continue to push on improvements to our products and the advancement of SMRT sequencing into a growing number of applications. We look forward to reengaging with a lot of our customers who are temporarily adhering to stay at home orders, when they are able to return back to their labs.
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 the financial overview of our first quarter that ended March 31, 2020. I will then provide details of our operating results for the quarter with the comparison to Q1 of 2019. I will conclude my remarks with a brief discussion of our balance sheet.
Starting with our first quarter 2020 financial highlights, during the quarter, we recorded revenue of $15.6 million and recognized net income of $1.3 million. We ended the quarter with $142.6 million in cash and investments.
Turning to revenue, the $15.6 million of product, service and other revenue in Q1 of 2020 was 5% lower than the $16.4 million of product, service and other revenue, we recorded in Q1 of 2019. Breaking down the revenue, instrument revenue recognized in Q1 2020 was $4 million down from $5.6 million recognized in Q1 of 2019. Consumable revenue for the first quarter of 2020 was $8.3 million, up from $7.8 million reported in the first quarter of 2019. Service and other revenue was $3.3 million in the quarter compared to $3 million in Q1 of 2019.
With regards to gross profit and margins, in Q1 of 2020, we generated a gross profit of $7.5 million resolving in a gross margin of approximately 48%. This is up from $5.1 million of gross profit and 31% gross margin in Q1 2019.
Moving to operating expenses, operating expenses in the first quarter of 2020 totaled $40.2 million, compared to $35.3 million in Q1 of 2019. This increase was primarily the result of a $6 million advisory fee incurred in conjunction with the termination of the merger agreement with Illumina.
Non-cash stock-based compensation included in operating expenses was $3.5 million in Q1 of 2020, down from $3.9 million in Q1 of 2019. Breaking down our operating expenses, R&D expenses in the quarter were $15.3 million slightly down from the $15.5 million incurred in Q1 of 2019.
Sales, general and administration expenses in the quarter were $24.9 million, up $5.1 million from the $19.8 million in Q1 of 2019. This increase was result of $6 million advisory fee I mentioned earlier. In Q1 2020, we recorded a $34 million gain below the operating income line. This was a result of the continuation advances we received from Illumina, larger as a result of the $34 million gain, we recorded net income of $3.1 million in Q1 2020, compared to a net loss of $30.3 million in Q1 of 2019.
Turning to our balance sheet. As I mentioned at the beginning of my comments, our balance of unrestricted cash and investments was $142.6 million at the end of the first quarter compared with $49.1 million at the end of the fourth quarter 2019. This increase was primarily a result of that $132 million received from Illumina, which was a combination of $34 million of continuation advances and the $98 million merger termination fee.
Inventory balances increased in Q1 to $16.1 million from $13.3 million at the end of Q4 2019. Accounts receivable decreased in Q1 to $7.3 million from $15.3 million at the end of Q4 2019. And finally in February2020, the debt we had outstanding under the facility agreement matured. We repaid the principal balance of $60 million to retire it.
This concludes my remarks on the financial results for the quarter. I would like to turn the call over to Ben.
Thank you, Susan. In light of the uncertainty caused by the COVID-19 pandemic, we will not be providing a revenue forecast. That said, we are continuing to experience the headwind caused by the pandemic. As Mike mentioned earlier, our majority of the sites with PacBio systems are currently shutdown. At this time, we're not able to predict when the sites who have shutdown will resume their normal operations. We are still supplying those sites that running with consumables.
Moving on to gross margin, we were pleased to see the improvement in our gross margin during the first quarter. For most of Q1, we were running our manufacturing facility at a production rate and output level similar to that of Q4. However, since the middle of March we have significantly reduced our manufacturing output leading to idle capacity. As a result, we expect our gross margin to decrease significantly in the near term.
Now moving to operating expenses. In Q1, we recognized a one-time expense of $6 million related to the termination of our merger agreement with Illumina. Since there are no further such expenses scheduled to occur, we expect our operating expenses in subsequent quarters this year to be significantly lower than what we recorded in Q1.
Below the operating income line, we noted earlier that we received the $98 million reverse termination fee from Illumina in Q1, but did not recognize this as income in Q1. We anticipate recognizing this as non-operating income later in the year. In addition, since we retired our debt in February, we will no longer be incurring the interest expense associated with it.
Finally, regarding our cash, we ended the quarter with $142.6 million in cash and investments on hand. While, this represents a higher cash balance than what we have had over the past several years due to the ongoing uncertainty in our sales as a result of the COVID-19 pandemic, we are not providing a specific forecast or a future cash usage at this time.
That concludes our prepared remarks and we will now open the call up for questions.
The first question is from Doug Schenkel of Cowen. Your line is open.
This is Subbu on for Doug. 30% of your sales are from Asia Pacific and much of this is in China. How did revenue progress in China over the course of Q1? I know its quick bit, but now that it's stabilizing, how has it solved this through April and what does the steady over the outlook for the rest of the year for Sequel development and utilization? And I have a couple of follow-up.
I’m sorry, but only caught about half of what you said there, but I gathered is that you're asking how do we see the revenue plus or minus going forward, is that correct?
Yes, in China, yes, that’s correct.
Well, it's been noted. I think that the issue for us is, we ended last year, what we thought was a pretty strong position. The success of our Sequel II and production, about this time last year, like at the end of April, and particularly the success of the HiFi chemistry approach that we demonstrated on that system, that gives highly accurate long reads for the first time. It put us in a pretty strong position. And the COVID-19 obviously caught everybody off guard in that. And while we have a lot of customers operating right now still, although the number of sites has gone way down they're mostly focused on COVID-19 or very closely related activities and they've cut down a lot on the other kind of things that were a lot of the bread and butter of our customer base.
And as how fast we recover from that is totally dependent upon how fast the sites are able to get up and running. A lot of our academic customers, for example, unless they were doing research in this area, had been impacted pretty strongly. And it really is dependent on when the reopening of the world, particularly in the U.S. and Europe happens, China, given as where it started is actually come back earlier than the rest of the world for us. And so it's hard for us to give a meaningful forecast until we get a better sense. As the U.S., and some of the countries in Europe are starting slowly to reopened. We can get a better handle on what the uptake timeline is going to be. But right now, that's really difficult I think for everybody around the world.
So then based on your comments for something Q2, China, maybe turning into a tailwind, how should we toggle between these, as we think about updating our models?
Well, I have to be honest. Your guess is as good as ours at this point. It really is – because a lot of our businesses is obviously in the U.S. and Europe. China is an important customer for us. But we saw the impact of China first than the U.S., certainly, on our reagents and we mentioned that in the last conference call. But it's really been the downturn in the U.S. and Europe and other places in Asia that impacted. What we're seeing now and it all depends on whether a light switch gets flipped, which I'm certainly doubtful of the kind of slow uptick of people getting back into an operating mode. And I don't think the U.S. government understands that enough to give good projections. And certainly we don't.
And if I’m just might add the – I’ll just might add the – within the quarter, obviously, China was the first to get hit and we saw, China's utilization of systems go down sharpest in February. But within the quarter, China just start coming back, and maybe not exactly to where it was, let's say Q4, but it's come back a pretty fair amount. So I think one of your questions was particularly, how we've seen things in China. And I think Mike alluded to it before that, it has come back quite a bit.
Okay. That's encouraging. And I have one last tough question. As the pandemic, you were just about to progress with broader commercial efforts with presumably additional hiring and while managing cash makes sense. On the other hand, you also want to be ready to play some support instruments and things do get back to normal and once everything starts to look encouraging. So and it takes time for new hires to become efficient. So how do you balance within these seemingly conflicting dynamics?
You want to take that one, Ben?
Sure. So as we mentioned on our last call, we did set out in Q1 to hire some more folks in the field. And in fact, we are pleased with our ability to hire some of those people over the past few months. So we are making some progress there. I think we also mentioned that it takes time to actually bring those people onboard. So it's probably going to be something that we're going to continue to work on. Generally speaking in terms of your point, as watching expenses, some of the things that we can do right away is, we're shipping less product, as just to balance out the sort of supply and demand, we're also receiving less product. So that helps. Obviously, we are currently saving on things like travel and utilities. But at this time, we have not instituted anything draconian like reducing headcount. We've maintained our head count.
Got it. That's helpful. Thank you, guys.
The next question is from Rachel Vatnsdal of Piper Sandler. Your line is open.
Hey guys, thanks for taking the questions. So my first question is around the install base. So can you talk about how placements were tracking relative to your expectations prior to the slowdown in March? And then can you give us any incremental color on the orders you received that you couldn't place those last few weeks due to the shutdowns? And I have a few follow-ups as well.
I can give you a qualitative thing and then in necessary, Ben can add to that. So as it's been pointed out, we do as most instrument companies do tend to do a lot of their instrument installs late in the quarter. And I think that until sort of the – maybe the early part of March, we were kind of tracking on what we expected to be able to do in that space, even with the uncertainty that was growing at that point in China. But there – the minute that in particular the U.S., countries started shutting down. A lot of the universities started closing up. The ability to just to get into sites to do installs just changed overnight. And that kind of put us up and you can kind of see that a little bit, but the fact that our inventories shot up more than it normally would.
And it hits you in two ways. One is you can't get in and do installs. The second is that, just arranging for those that you can winds up being slow. Aircraft that got a little more confused. The ability to, even if somebody wanted the lab and still have their lab open to get through the bureaucracy there, to get somebody onsite, who wasn't an employee of the site could become an issue. And we certainly saw that in the last month a lot. Relative to new orders, we feel pretty confident about where we're going there from a pipeline. But right now in all of these places, since they're effectively shutdown, you don't even have a purchasing operation there for a lot of things. And so it's obviously been a struggle, but from everything that we've seen – we haven't lost opportunities. It's just been that the process is either blocked or very, very slow.
Yes, I don't have much to add to that, Rachel. I mean we did end up with the install base of Sequel II at the end of the quarter of 125, which means that we were actually only able to complete installs of 11 Sequel II’s tools during the quarter. As Mike mentioned, we tend to do a fair amount at the end of the quarter and that's why it ended up being a pretty small number for Q1.
Yes, that all makes sense. Thank you, guys. Next, can you just kind of walk us through what you're seeing for customers upgrading from Sequel I to Sequel II? Obviously, I'm sure that was disrupted given the same comments that you said to my first question, but in the first few weeks of the quarter where things were more normalized was that transition happening faster or slower than your expectations?
Well, the upgrades can come in two forms. There are people, who with limited budgets have an old instrument upgrade, where we go in and do apart replacement and so forth to bring a Sequel I up to Sequel II. You might expect that's even more difficult in these times because that's a process that in a lab can take as much as a week. So that has been pretty well stopped, while we're doing this for most of the sites that you just don't have the opportunity to get in there that long. And so, the alternative is people, they've had a Sequel I, they've been happy with it, but they want the increased performance strictly on throughput perspective of the Sequel II. And there they're buying additional Sequel II’s.
And we still see that happening in a limited way given the other constraints of a lot of people being shutdown. So they're – either upgrade path has been slowed down in the same way, but completely new customer has been slowed down. I mean that said, we have had individual sites who, if they were really actively involved in COVID-19 research, maybe push forward a little bit their purchase or an upgrade of the system.
Great. And then last question for me. So I appreciate all the comments on China to some of the first questions. So looking at their consumables, you should starting to come back, given they had an earlier onset of the COVID breakout. Can you tell us about any of the trends you're seeing consumable usage in the U.S. and Europe from the trends of late March to now April and early May? And you started to see it rebound at all, for example. Thank you.
I'll let Ben handle that one. But I think in general, certainly this month or last month has been much slower in the U.S. and Europe then it would have been. I mean, that's where the impact really started to get felt in those areas. It's right at the beginning of April.
Yes. The only thing I would add is, it dropped fairly rapidly in the U.S. and Europe. But I would say, it stabilized in terms of the utilization that we're able to kind of monitor that. It has been fairly stable on the sites that are still open throughout the – really most of April. So we're looking forward to when the other sites are actually able to reopen. But it doesn't look like we have any sort of continuing trend of, say more people shutting down.
Yes. I mean, it added pretty quickly. And what you saw is that people – a lot of them who continued to operate were ones who were switching what they were working on in terms of the samples they were sequencing. Because, people were doing other things on the system and they've – once they got back up even working on their systems, it was to use projects that are focused around the pandemic response to a large degree, but not completely, but in the U.S. and Europe mostly.
Great. That's it for me. Thank you.
[Operator Instructions] The next question is from Kyle Mikson of Cantor Fitzgerald. Your line is open.
Thanks for taking my questions. So last call, you had mentioned plans to release chemistry and software upgrade throughout the year. Just given the near-term uncertainty to the pandemic, will those upgrades be delayed or maybe adoption is going to be – will further more muted. Just kind of trying to understand how COVID is going to affect the timeline going forward. Thanks.
Well, we were ready for a software release at the beginning of this quarter, which we have ready to go. But we delayed doing it since so many people are shutdown and the other – lot of the ones that were still going, we're obviously doing critical projects and didn't want to interrupt that in the short-term. So, that in a sense is from a development perspective ready to go, but we will look at what the right time to get that out there. The bigger issue for us is getting the throughput up and our goal for the year has been to get and still is, to get the point where a single cell run is enough for a quite good human genome level look at variation in the genome structure of an individual.
And to get that down from the sort of two cells it takes now to down to one, particularly for looking for structural variance. And that's still our goal for this year. It may be a little bit later in Q4 then, October 1st date. But we're still targeting that. And we're starting to get back a little bit more into the lab to continue working on that. People have been able to do a lot of the planning to get ready for that, while we're shutdown. But I think they're pretty much planned out at this point with video conferences. And so, we begun to open up the labs just in the last week a little bit more to get people going to make sure that we meet those timelines.
Okay. Perfect. Thank you. I was also wondering, how much inventory your customers are holding and what's the shelf life of the consumable products? I'm trying to understand how long the customer is going to have before they have to start reordering and how that's going to affect consumables throughout the year.
Do you want to take that one, Ben?
Sure. I would say even though it varies plus or minus customers usually try to target around a month's worth of inventory. And our shelf lives on our products are typically we shoot for six months or a little bit more than that. So there shouldn't be that much of a – let's say, delay when people are back up and running for people to kind of run through whatever inventory they have and need to reorder.
Okay. That makes sense. And then just one housekeeping question. Can you break out these consumables revenue in the quarter for Sequel I and II?
So we broke that out in the fourth quarter and actually in the first quarter it was kind of similar. So Sequel II represented at least 50%, a little more than half, and Sequel I was around 40%. So it's pretty stable from where it was in Q4.
Yes. But well we do expect that to continue to evolve. A lot of the – some of the diagnostic labs that were using the system to do COVID-19 work were on Sequel I’s. And so there was probably a disproportionate from a normal perspective, uptake in the sales there for consumables. But we're – even there, we're starting to see as people start to switch over to the higher throughput the Sequel II Systems. They just take longer than a research lab because they have to go back and validate any new instrument that they're going to use for testing.
Yes. Sorry, I should have said that the remainder it was RS II and the RS II component is less than 10%.
Then what'd you say for Sequel I? I think I missed that.
So in the first quarters Sequel I comprised around 40%, maybe a little bit more than 40% of the total consumables.
Okay, perfect. Thank you.
There are no further questions at this time. I would now like to turn the conference back to Mr. Mike Hunkapiller, sir.
Thank you. In closing, we remain steadfast in our commitment to bringing the advantages of our smart technology and products to our customers and the scientific community. We believe that smart sequencing provides the industry's most complete and accurate picture of genomes due to its superior performance and sequencing accuracy, universe formity of coverage, long read length and ability to characterize DNA based modifications. These attributes can be particularly important to understanding the complicated mutation patterns and evolving viral populations as well as the genetic characteristics of host immune response to viral infection. I'd like to acknowledge the team at PacBio who despite the challenging environment brought about by the COVID-19 pandemic a responder in fantastic fashion to assist in the global pandemic response. Thank you for joining us and we look forward to talking again in three months time.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.