Pacific Biosciences of California, Inc. (PACB) Earnings Call Transcript & Summary

Hey, guys. Good afternoon. My name is Tejas Savant, and I'm the life sciences analyst here at Morgan Stanley. Before we begin, for important disclosures, please see the MS research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, do reach out to your sales rep. So it's my pleasure this afternoon to host PacBio. And speaking on behalf of the company, we have Christian Henry, CEO. I'm not sure if Susan is here. I guess she's not here. No worries. Thank you for joining us, Christian. Maybe just to set the stage, it's been a really eventful action packed sort of year for PacBio. Sometimes, some investors feel like you've bitten off more than you can chew because you have all these different initiatives underway. What key accomplishments are you most sort of proud of year-to-date? And what gives you the confidence that you've got this?

Well, I think -- first of all, Tejas, thank you for the opportunity to speak here today. This is always a great conference, and so we appreciate that. And also, just a reminder, check our website too, for disclosures. I may make forward-looking comments, so.

We encourage them.

Yes. And I know Tejas will get them out of me. But when I think about our story in PacBio in 2023, what I'm most proud about is that we've really set out to -- we've accomplished everything that we said we were going to accomplish back in late 2020 and early 2021 when I became the CEO. At -- In early 2021, we said we were going to build a commercial team and drive placements of the Sequel 2 platform at the time and then drive innovation to create new long-read platforms. Later in 2021, we acquired a company called Omniome to develop some short-read technology. We said that would take -- to develop the products would take about 2 years. And -- so as you got into 2023, we started shipping Revio, a completely groundbreaking long-read sequencer that is 15x more powerful than anything that we had ever created before. Customer uptake has been nothing short of dramatic, and quite remarkable. And then in August, we started shipping the Onso platform, which is our short-read offering as a result of the acquisition of Omniome. So quite frankly, in less than 2 years from the date of acquisition, we're now shipping that product. So I'm very proud of those accomplishments because we want to be perceived as a company that when we say we're going to do something, we get it done in the time frame. The other thing I would say -- the last thing I'll say, and I'll let you move on to the next, is that I'm really proud of the team that we've built. We've built a very experienced leadership team in life sciences that knows the genomics market extremely well that has been involved in major product launches, major execution, has tremendous customer relationships. And so, when you put the combination of those things together, we started with a strong vision where, quite frankly, we're ahead of schedule. And so I'm quite gratified by that.

Let's start with Revio topic to your ship of the order curve there. After the second quarter, when we spoke, Christian, you talked about, it's an increasing curve, and you hit a plateau and then you increase again. And Revio orders, at least to the end of the second quarter, you thought were sort of the tail end of that initial bolus and then heading into that plateau phase, right? Now can you just sort of provide some context for why you think that's how things generally shake out? And that second inflection that you talked about, is that more of a first-half '24 phenomenon or do you think it's more of a second-half '24 phenomenon?

Yes. That's a good question. I think -- on the conference call when I talked about this, I probably didn't characterize it as well. And it's a typical place you'd have an hour to talk about, something that's a little bit nuance. When I think about the market and the demand for sequencers in any new technology or product cycle, the first bolus of demand, very first, comes from those customers that are already existing customers that are willing to buy your product sight unseen. You put out the press release or you show them the demo of the instrument at the trade show booth and POs come in. The second group of customers is that group of customers that are believers and they've seen the technology and they know it works, but they want to trust, but verify, so to speak. They want to verify that the system works. The next group of customers are those that haven't been engaged in the technology but have always wanted to get engaged and now you've reached a level of either economic performance or technical performance that pushes them over the edge. And then the last group is that group that, quite frankly, didn't even know about your company, and you needed a new product like a Revio to engage those customers. So that's the shape of the curve, and you can use crossing the chasm, or whatever term you want to use, but that's what really happens. And what happened was we had a very, very fast start of the customer's buying sight unseen. And my only -- what I was trying to elucidate in that conference call was the group that were trust but verify, were just starting to emerge. Either they didn't have budget in place. Either they wanted to see how the system worked. They -- for other various reasons, they weren't ready to buy yet. And my point was the people that were buying sight unseen were kind of reaching the tail end of those people. The reality is that, that's fine because now we've got lots of Revios in the field, lots of great data being generated and early publication showing how powerful the system is. And so, that next bolus of customers has completely engaged. And I think the other thing that you have to remember is that, at the end of the day, orders are great, and they're -- obviously, they're the first part of the process. Backlog isn't so great, really. Because the reality is that the bigger your backlog is, the less revenue you could be generating on consumables. This is a razor blade business model. So every Revio that's sitting in a [ crate ], even though it's allocated to an order, isn't generating the lifetime value of that revenue or that instrument. And so it's really important. And it wasn't able to get that point across as well. And so my expectation is that shipments are going to go up every single quarter. Now, how far out that is? Well, I don't know, and today I'm not going to give '24 guidance. But the reality is that we're seeing increasing excitement, increasing demand, we're increasing our shipments, and we expect to be increasing shipments every quarter through the remainder of this year and into next year. And so, on balance, I think the business is -- quite frankly, it's in the best place it's ever been.

That's a great segue into my next question. You announced the launch of PacBio Capital this morning.

Yes.

It sounds like it's basically a way for customers to leave sequencing systems, not just the Revio, but also the Onso and then Sequel as well. Tell us more about sort of the rationale behind launching that program? And in terms of the Revio context, to your point around the trust but verify or perhaps the more hesitant customers, how does this impact their decision in your mind? Or was it just a response to sort of macroeconomic realities?

Yes. So we've had leasing programs in place for several years. So this is nothing new. There's no fundamental change. We announced it today because it's ready today. We have a new leasing partner, and it's branded PacBio. So that's what's cool. The point of leasing programs is to give customers more flexibility. Some customers have budget allocations that are heavy on capital and light on operating expenses. Some have low capital but lots of operating expenses. Some have a lot -- have a need, but necessarily don't have all the capital today, that are willing to pay over time. This gives us the ability to serve all of those different customers and get into the Revio or Onso that much faster. So it's really just increasing flexibility. It represents on any given quarter over the last many quarters. It's a small portion of our orders. I don't know the exact numbers. I'm not going to quote them here, but it's a small portion every quarter that we've had. So it's not a new thing at all. It's not in response to macroeconomic. It's just a way for conditions -- It's a way for us to increase customer flexibility, enable them to get into technology sooner, reach more customer segments and then also do creative bundles, because you can do things with the leasing company. So for example, you could do a bundle where, hey, we're going to ship your reagents every month, and we're going to ship you the instrument and you're going to pay a monthly charge that's spread out over x amount of time. So it just gives us a lot more flexibility.

One of the things that was impressive in the second quarter was about a little less than half of the orders were new to PacBio customers. Can you just share some color around the types of applications that these new customers are using, the Revio 4? And what was the clinching factor for them in terms of platform specs? Was it just throughput or was it something else that really [ sold ] them on Revio?

Yes. So the new customers -- Tejas is right. We have a very significant proportion of -- over 40% of our new orders are new customers at this point. And to start, that is the most -- in my view, probably the most important metric for people to look at because, if we're going to create a scaled business as we move towards $500 million in revenue and $1 billion in revenue and beyond, we have to acquire those new customers. Why are those customers coming to PacBio? First of all, they see the Revio is industrialized, reliable, the most powerful long-read sequencer on the market, clearly. But there -- what we're doing is we're starting to reach the economics and throughput barriers that we had been unable to reach in the past. In 2019, we developed HiFi, which allowed -- HiFi chemistry allows us to have highly accurate sequencing, so very competitive against short-read. But Revio really allows us to have the throughput to do scaled science and the economics on a price per sample. And some of the core applications are really all about whole genome sequencing, both in clinical translational context but also in a research context. There's new customers in agriculture. There's new customers in targeted sequencing and RNA. Our MAS-Seq kit which we launched last year, really is enabling us to do whole transcriptome research in a way no other technology has ever been able to do. We can look at -- quite frankly, it's the most elegant gene expression tool that's perhaps ever existed. And yes, I'm probably biased, but the reality is you can see the entire transcriptome, you can see all the splice variation at incredible resolution. And so these are all game-changing applications that we're bringing to the market.

Quickly on manufacturing and installation capacity, Christian. Are you essentially at steady state at this point or is there more work to be done there in terms of scaling it further, to your point around shipping sequentially greater number of Revios every quarter for the foreseeable future?

I think we're at a good first spot, but our intent is to scale further. What we wanted to do is we want to start whittling our backlog down as we start generating revenue. We want to keep growing. We do believe we'll keep growing orders and shipments so that we keep growing. And as a result, we'll need to scale the manufacturing further at some point here. The key is to scaling a really all -- for now and actually into the reasonable foreseeable future is really driving supply chain and acquiring the components that we need for scaling earlier because we have a very large footprint. And so we have a lot of optimization in terms of multiple shifts, more leverage of the CM, our contract manufacturer, so that we can drive the throughput of the factory, which will, in fact, drive gross margins up too at the same time. And so where we sit today, we can scale within 1 quarter, 1.5 quarters, to whatever we need because it's really driven off of the supply chain and purchasing. We may have to hire a few people at the margin, but we have the footprint and the core capability right now to do whatever we need to do.

What's the customer experience been like? I mean, as with most launches, there's usually some sort of pain points, hiccups during the initial rollout. What's been your experience with the Revio? And second, you've talked about sort of system updates to add more functionality and improve performance later this year. Can you just like share some color on what those entail? Is ASHG sort of the natural venue to be sort of looking forward to those?

Yes. I think -- so going back to -- starting with customer experience, we have a corporate goal, which our bonus plan is -- partly predicated on is heart failures of Revio in the field. And we set a very tough metric for 6 months post launch. Quite frankly, we were achieving that metric 3 months out of the gate basically. And so, so far, heart failures have been just a couple of percentage points. It's a very low heart failure rate. The out-of-box experience has been pretty good for customers. Yes, we did have some -- every platform launch had some challenges, and we had some out-of-box issues that we had to manage. And when I say out-of-box issues, what I mean is we track everything with all the paperwork in the box. Was every screw tied down to the right specification, et cetera, et cetera. We dramatically reduced those. And quite frankly, the vast, vast majority of those issues, customer never even saw them. They were just internally focused issues. And so, so far, the experience has been pretty good. We've had a couple of software patches. Software is always the -- at the end of the day, when you're developing these sophisticated instruments, software is always the hardest thing. It happens at the end of the development process. We are pushing them really hard. And so we've had a couple of patches that have gone through to improve the performance. And so on balance, we've actually seen the systems continue to get better. We haven't had any real catastrophic issues, so to speak. Coming in the future, we do -- one of the value propositions of working with PacBio is that we're very focused on taking the instrumentation we have and improving it over time and actually improving the entirety of the workflow. And so we will have software updates and other kinds of updates that will come. And ASHG is a great time to talk about a lot of those. But by the end of the year, we would expect to have increases in functionality that we want to have, user-friendly features, things like being able to look at smaller inserts. So for example, part of the power of long-read sequencing is you want to look at long-reads. But sometimes, customers only want to look at a 5kb read or a 3kb read or a 7kb read when we're looking at [ 15 ] to 20kb reads. And so the system today is optimized for looking at [ 15 ] to 20kb, but adding functionality into the protocols and the software and the way we do our sequencing so that you can look at [ 3 ] or 5kb. Those are the kinds of improvements that we'll make this year that they didn't get into the product at initial launch, but they'll be available. Expands our customer base, makes our customers happy because they have more flexibility on what they do with the instrument, et cetera.

I think you or perhaps, Mark, I can't remember, have talked about sort of 25% to 40% utilization versus a theoretical maximum as a reasonable way to frame pull-through across the installed base in steady state. But clearly, you've started off stronger than that. I mean you're already at -- I think, last quarter, it was [ $440,000 ]. Now there's a stocking element to it. But beyond that, given that you're selecting the customers that have samples ready to go early in the launch and they are generally long-read power users, if you will, do you expect consumable pull-through to dip a little bit and then sort of start inflecting again?

You know what, it's difficult to know. And we have been very crystal clear that we're not going to predict and gain this thing out because, until you have a couple of hundred instruments in the field, it's difficult to know what the true rate is. But you are right, Tejas. We had a very nice start to Revio, and we've seen very strong people actually using and using their systems quite a bit. And so my expectation is, yes, it probably will be -- probably be flattish and maybe up a little bit higher, maybe lower a little bit, but kind of in that sort of range. And then over time -- and that over time could be anywhere from 2 quarters to 2 years, quite frankly, that you would see it trend down a bit. But this is what I want -- the takeaway is the following. First of all, we're selling each instrument for more than twice as much as what we sold the Sequel 2s. The pull-through on each instrument is probably 3 to 4, maybe even 5x as much as any historical instrument and we're getting 40% new customers every quarter. The combination of all those sets us up extremely well for long-term growth. And the market's there, right? And it's there for us to execute on, and we're executing.

I want to talk a little bit about the competition. Are you starting to run into Oxford Nanopore [ at all ]? They've had significant improvements on the accuracy, I think now it's at like Q20 or even perhaps Q30. They've talked about enabling a sub sort of $700 like 30x coverage genome. What are your thoughts on their view that perhaps the All of Us paper used an older paper and older pore and then perhaps the performance in customer hands is better than that? I mean, does that sort of shift the competitive dynamic that you are seeing in terms of the feedback you hear from salespeople, et cetera?

Well, I guess, I think -- look, the sequencing market is large and it's certainly competitive, whether it's short-read sequencing competing against long-reads or long-reads against long-reads. I can't necessarily comment on all the [ L&T ], what they're doing or not doing. But what I do know is that if you're generating Q20 data, and we're generating Q30 data, our data is 10x -- tenfold more accurate, and that's pretty much indisputable. I do think that their accuracy, as they've claimed it to be, improving over time. But they're also -- what we also are seeing is that by implementing duplex reads and other types of things, the level of sequencing required to get a whole genome at that level of [ accuracy ], quite frankly, is cost prohibitive. And we've done our internal calculations that Q30 genome using duplex reads cost thousands and thousands of dollars. I also know that the data type and the run time -- It's not just about the accuracy of the system, it's about the entirety of the workflow. When you come up to a Revio machine, in 2 minutes, you load your samples and you walk away in 24 hours. Not only do you get your data, you get your data fully processed into HiFi reads. So you don't need to do incremental processing. With other technologies the runs are 72 hours long. They require manual intervention 3x during the run, where you have to actually go up to the machine, manually pipe it onto the flow cells and to make sure that you have enough sample. And then at the end of the day, you get 2.4 terabytes of data out that needs to be processed [indiscernible] process, it's very expensive to store. And when you're storing 2.5 terabytes of -- even at cheap -- in a very inexpensive storage, that's still $600-plus a year. So if the actual sequencing is $600, let's just say, and it costs $600 to store it, it's still pretty expensive where it costs -- Now you'll say, well, gosh, don't you guys have to pay for storage too? Of course, we do. Our storage costs are like less than $50 a genome per year, much more competitive with short-reads. And so it's a very different proposition. I do think that long-reads in general are gaining traction against short-reads, which I think is good for both companies. I do think that the industrialization and the simplicity and the thought we've put into creating a scaled system to do big time biology is giving us very significant competitive advantages. Now we're growing faster. There's -- we're certainly growing faster than they are, according to at least the reports that we've all seen. And I'm quite encouraged by what we've got going on.

I want to switch quickly to Onso, Christian. Recent launch. I mean, any color you can share on the early user experience? Are these mainly [ NextSeq ] users were placing a premium and higher accuracy relative to throughput?

Yes, I think that -- so far, the early experience -- it's still very early. We're not going to ship 50 units this quarter, kind of -- it's not like a Revio launch. It's a lot -- we have -- it's a new technology, and so we're going slow with that. But the experience has been tremendous in the sense that what they're -- what many customers or some of our core customers are doing is they're doing actual head-to-head comparisons, what can I see with Onso, and what can I see with other short-read technologies. And what -- the simple fact is that you can see variance that you just can't see even with UMIs or other molecular biology tricks. And so these customers are very excited about that, and they're focused in MRD and cancer identification and different kinds of collaborations or different kinds of applications, that are -- why we actually -- why we built Onso in the first place. We didn't build Onso to be the sequence germline genomics, oncology, et cetera, to be a jack-of-all-trade sequencer. We're really focused on where the power of looking deep into a sample to find those needles in the haystack because, for example, our belief is that in an MRD application, if you could see a variant earlier, perhaps you can do something about it sooner. Now that needs to be proven out and that's what these early customers are working on. What's great about it is Onso will help prove out the value of accuracy and drive that mid-throughput market. And then we acquired Apton in August, and Apton, that acquisition will give us the ability to launch a high-throughput sequencer capable of billions and billions of reads per run -- billions and billions of reads per flow cell -- actually multi-flow cell set up so you can really create a very high throughput system. And if you can leverage Q4 to your better reads at high throughput capability, you'll have a very, very competitive entry as you start to think of scaling into MRD in a clinical context. And so that's kind of the strategy. And my long-term view is that the sequencing market, we kind of estimate the TAM to be $12 billion to $14 billion depending on how you look at it. But we actually believe that germline genomics over the next 5 years will largely move to long-read applications because of the comprehensiveness, because of the economics and now the throughput is where it needs to be. And somatic and looking for variants will continue to be a heavily short-read platform. And so the cool thing for us is we're going to talk to customers about selling a solution, not a technology. And that's why we're seeing nice traction on bundling, people wanting to buy an Onso and a Revio. Of course, we're giving a nice economic discount for that. But we're leveraging our channel. We're leveraging our technology. We're leveraging our heavy, heavy differentiation. The combination of all those things are enabling us to make competitive inroads against the largest sequencing companies in the world and to have a strong position against all the emerging companies. And so it puts us in a very nice position.

On Apton, Christian, I mean, our checks suggest that the optics on the platform were particularly impressive and then a point of differentiation. Can you just elaborate on that? And then how long does it take for optimization and scale up now that you've established that SBB chemistry will work on that instrument?

Yes. So, Tejas, you're exactly right. The optics -- when you think about sequencing systems, the most advanced is -- there are really 2 fundamental -- The fundamental chemistry and the optics. And everything else around it is kind of the supporting cast. The optics in this case, what they've done is they've actually taken experience from telecom and other industries and implemented the ability to see single molecule resolution in highly packed clusters on pieces of glass. Pretty amazing stuff, very impressive. This super resolution that we call it, we are going to take that and then embed SBB on top of it. It takes -- it will take us some time. It takes couple of years or less. It's kind of a framework. So what I've been saying so far is that this product should have an impact on our -- in our guidance window that we've given to 2026. So we should be generating on revenue, but we don't have the exact dates yet. But what we have to -- here's what we have to do. We have to marry the optics with the chemistry in a much more robust and consistent way. We need to modify the ID of the instrument a little bit, adjust the fluidics because, when you're looking at that high level of resolution, the viscosity of the reagents and the way the reagents actually have a pretty big impact, the amount of heat generated, we also have to integrate the compute into the instrument, and so we have to do that. But these are not -- these are engineering problems, not necessarily innovation problems. And so the combination of that gives me a lot of confidence that we'll be able to create a pretty cool product in a reasonably short window, make us very competitive in the market.

Last question on China and the guide. A lot of companies here are sounding increasingly worried about what's happening in China. I think it's about 13% of your total revenue. What are you seeing in the region? Clearly, 2Q was fine, but the concern is more around, does this perhaps limit upside to the guide? And has anything changed, I guess, in July and August?

Nothing's changed from our perspective. And Q2 was the best quarter we've ever had in the history of the company in China. So it was fine. I agree, but it was really the best quarter we've ever had. What we're seeing is -- we kind of are unique. We have a very concentrated customer base. The customer base are principally service providers. And so those service providers are serving the Chinese market as Chinese companies. And then the last piece, of course, and probably perhaps the most important piece is that there, our technology is so differentiated. There are no other long-read offerings in China by Chinese companies. And so from a competitive dynamic, we are it. From a customer perspective, we're very concentrated. Could we be doing better in China if the environment was better? Perhaps. But I don't think China on its own has an impact on our guide or our numbers so far July and August. It's not as big a deal for us perhaps it is for others. But we're also in a new product cycle. So we have a lot of favorable factors in this context. So, I'm probably not the best person to ask for, well, how long is it going to persist or what is it. I know there's some companies at this conference that are much bigger than we are, that have much more entrenched into China. And we're just not feeling the impact as much.

Great. That's a great place to leave it out. Thank you so much, Christian. I appreciate it.

Thank you, Tejas.

Yes, of course.

Thank you, everyone.