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

Hey, everyone. Good afternoon. I'm Tejas Savant, I cover the life sciences here at Morgan Stanley. Before we begin, for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales rep. So it's my pleasure this afternoon to host Pacific Biosciences. Speaking on behalf of the company, we have Christian Henry, CEO. Thanks, Christian, for joining us, much appreciated. So maybe just to kick things off, not unlike many of the life science companies out there, it's been a challenging year for instrument vendors like PacBio. Despite the ongoing challenges, what are the key accomplishments through the year that you're most proud of? And what are you looking forward to as you head to next year?

Yes. Well, it has been a challenging year. And first of all, thank you to Morgan Stanley and Tejas. Thank you for all the support over the years and for this opportunity. But it certainly has been a challenging year for the company. And when I start to think about the things that have gone well, in particular, our team has done a great job of sticking together through a challenging time. And we've made progress in a couple of fundamental areas. First of all, our gross margin is starting to move in the right direction. We had a 400 basis point improvement last quarter. And the reason why the margins are fundamentally improving is because we've been able to -- through a partnership between R&D and operations drive the production costs of Revio significantly down. And that Revio is our flagship sequencing instrument, and we've been able to take the costs -- almost 20% of the cost out of the instrument. That doesn't happen very often in life sciences where you're able to take the production costs out. So I'm certainly proud of that. I'm also proud of the progress we're making in R&D on new platforms. When I joined the company, I put a bold strategy for us to develop a multiproduct portfolio of sequencers and instruments that would reach all aspects of the market. We launched Revio. We started shipping that in early 2023. Now we're working on a benchtop sequencer and we're making incredible progress there. We're also making progress on a very high throughput short-read sequencer. And finally, we're also making fantastic progress on super high throughput long-read sequencer. And so I'm really proud of the R&D team for not only the breakthroughs, but also keeping us largely on schedule even with a significant reduction in force. And I guess that would be the last thing. When we weren't achieving the results that we had hoped to achieve this year, we were very aggressive and early in making very significant cuts just to preserve our capital, but yet, we're still making all of the progress in R&D. And so we said our goal was to achieve at least $75 million in run-rate savings. And the reality is, as we've achieved significantly more than that. And it happened in a reasonably quick time frame, very definitively. And so I'm proud of the management team for making some tough decisions. So in spite of the revenue performance this year, we're making a lot of really great progress, and I'm very optimistic about the future.

Got it. So let's start with Revio placements. I mean, the elongated instrument purchasing cycles continue to present a challenge for placements. What proportion of the shortfall will you attribute to budget cuts versus more approvals being required before an order can be placed versus just a significant amount of long-read capacity being added which is taking a little bit of time to get absorbed?

Yes. I mean, there are certainly components of all 3 of those. I think the funding environment for capital equipment has been challenging because -- for different reasons in different parts of the world. In China, the general economy has been challenged. So the investments in R&D have been curtailed somewhat. High interest rates in the United States have certainly created more anxiety and purchasing agents and Europe, the combination of the situation in Ukraine, higher energy prices as well as interest rates have all put purchasers of large pieces of capital equipment on notice, which have driven both principally longer approval cycles, more -- we can just do this next quarter? Do we really have to do this quarter? Can we wait? We've heard that quite a bit. With respect to fundamental funding going away like not coming back, there have been a few limited situations where we've seen that with some high-profile programs. And so we've seen that a little bit. But I would say it's really that middle category of people just saying, "Hey, we can pass and we will get started next quarter. " And we've seen that with our results. We said at the end of the first quarter, 13 instruments slipped at the end of the first quarter. Many of those have already been -- some of them got purchased in the second quarter. The third quarter is still underway. So it's not as if those deals have gone away permanently, but they have certainly been delayed. And if you look at our sales funding, one of the questions I get a lot is how much of it is that there's just too much capacity in the market versus the funding -- kind of these funding delays we talked about. And when you look at our sales funnels, the demand has never been more -- has been higher. The funnels are continuing to grow, and there's more conversations, more publications, more talking about the long-read technology, now that the economics have improved, our capability across the portfolio from sample extraction through analysis, continues to fundamentally get better. And so those are indications to me that it's not that the overcapacity, although maybe in certain situations with expansions -- accelerating expansions, have been impacted, but not the fundamental drivers of that demand.

So you noted that based on the sales funnel, placements are expected to improve, and July was the best first month of any quarter so far in '24. Was that largely a function of those European orders that were awaiting approval coming through? Or the underlying trends actually start to get a little bit better? And on that note, what are you seeing in the market in August in terms of customer behavior?

So what we're seeing is that July was -- we had a strong July. We said that on our earnings call. It was a combination of both improving the utilization of consumables as well as some instruments getting across the goal line as you suggested. When you look at these life science capital equipment businesses, generally, month 3 of the quarter is really where the majority of the capital activity comes in. So it's difficult to predict and game out the whole quarter from one month of results. But we did see a very nice July and actually August, the utilization has been improving, and we've been seeing tick-ups in consumable utilization in many parts of the world. And so that's actually quite encouraging and gives you a sense that, okay, people are starting to use their instruments. The sales funnels, the majority of the sales occur in the third month of the quarter. So it's impossible to know in the first week of September, how the quarter is going to end. But we certainly are seeing the sales funnels and the activity, be it at paces that we kind of expected to see.

Got it. You've put in a significant amount of effort to just reduce the upfront capital requirement for Revio, including the leasing and the rental programs with Mitsubishi as well as new -- you've got a $99,000 trade and promotion for Onso as well. Have those efforts proved helpful in closing deals and shortening the sales cycle?

I think it's still a bit early to tell in total, but they certainly have done what we've intended to do. And when you put in these promotional programs, the objective of the program is to drive the next conversation with the customer to push them to the next spot in the sales cycle. Sometimes it's through, hey, okay, we're going to take this leasing program or this rental program or this trade in, as you've talked about. Other times, it's to drive the conversation and then through the discovery of what the customer really is looking for, you say, okay, well, we'll give you -- they say, "Well, I really don't want to lease. But if you give me another $10,000 discount, then we will move." And so the promotions have been extremely effective at building -- driving those next conversations. And they're a great option for our customers to take advantage of. And for PacBio, what's amazing about it is the fact that virtually all these promotions, what happens is that our leasing partner actually pays PacBio for the full price of the system. And so we effectively agree on the sale. We get the cash flow. We don't take any financial risk, and our revenue gets recognized in that quarter. One thing I will say with respect to Onso specifically, the $99,000 promotion has created a very, very significant increase in the sales funnel, which we are anticipating will drive a significant increase in placements over the back half of the year.

Got it. That's great to hear. Going back to the Revio utilization, if you will, you've helped us think through the 3 categories, right, the high, mid and low utilization buckets of your customer base. Where do you think those 3 categories settle out in steady state? I think you called out more mid-utilization customers coming through in the second quarter. But then you've also got migration of people sort of moving to higher throughput sort of categories.

Yes. It's always a difficult thing to predict. But when you think about PacBio's business, what's exciting about what we're doing is that we are reaching a whole new set of customers. And so roughly almost half of our orders now are coming from brand-new customers that haven't done long-read sequencing or maybe they've outsourced some samples or maybe they're coming from another long-read provider. But the reality is the vast majority are coming from short-read sequencing. And there is a greater start-up period. And so that first bucket of utilization, I think, will be very significant, probably for the foreseeable future because we're still so young in our market penetration that we'll see a lot of that. And we'll also see on the high end, we have several really high throughput customers. And I do think you're going to see from the mid utilization, a couple of customers, maybe 3 or 4 customers every 6 months kind of moving into that high-definition bucket. And of course, this is dependent on projects and funding cycles and lots of different things. But I do see the proportion of higher throughput customers, those with multiple Revios or expanded fleets, moving into that high utilization. But at the end of the day, when things finally settle out, you would expect it to look a bit like a bell curve, probably with the low end being a little bit higher than normal than the high end, a typical bell curve, which that middle utilization bucket will be predominant. One other thing that's happening, Tejas, that's interesting is we are seeing a lot more excitement about using long-read sequencing in clinical applications. And second quarter, for example, almost 1/3 of our instruments were sold to kind of translational/clinical type accounts. We talked about Quest buying some systems last quarter. Children's Mercy Kansas City expanded their Revio fleet and remember, they were the first to have a first-line translational tests that they do using Revio for all the kids with rare and undiagnosed disease. And so that's actually very exciting to see that research happening, really helping these families. But I think the reason why I bring that up in the context of utilization is these more clinically focused customers have much more durable revenue streams, much more consistent utilization and therefore, probably going to move much closer to the high end of utilization much sooner. And we're seeing that in rare disease, of course, also in carrier -- in people preparing for carrier testing assays, basically using our targeted sequencing capability that we launched. We launched a new product called PureTarget back in Q1. And that panel is really a targeted sequencing long-read targeted sequencing panel that targets all of the genes that targeted sequencing have a really hard time sequencing. And so as a result, these customers are saying, "Wow, I can take this panel. I can customize it a little bit, and now I can run thousands of samples through my Revio every single day and build businesses around it." And that's a really, really important milestone for the company going forward.

Got it. You've talked about that low utilization bucket that has ticked down in terms of the pull-through from I think it's marginal 120,000 to 110,000 probably just quarter-over-quarter variation. But due to PacBio customers now ticking higher and representing almost sort of half the orders, what does that mean for that 300,000 to 400,000 pull-through sort of framework that you had talked about in the past?

Yes. I think when you -- it means that timing is everything, right? And as we go in this journey to kind of penetrate the market more deeply with new customers using Revio, we will have fluctuations in the pull through. I think, right now, we're thinking that pull-through for 2024 will be roughly around 260 or somewhere in that sort of range, which is below, obviously, the 300,000 to 400,000. I don't think the 300,000 to 400,000 range is out of the question. But I do think given this funding environment and given the new customers, it were probably on -- we're more likely on the lower end of that than the higher end. Whether that settles out at 275, 325, 350, 300. I do think that there is a lot of variability. And we're still early enough in the product cycle where we don't know definitively where I can say, okay, well, look, everyone's model should be 308 that's where we settle out.

Fair enough. You've got the new sample, the consumable kits coming out that has lower sample input requirement in question. I mean can we expect it at ASHG, and as you think about the market expansion that, that unlocks for you, can you just share some color on that?

Sure. Well, today, I'm not announcing the timing of any product launches...

But at ASHG, you will...

Well, I didn't say that. Obviously, we want to talk about new products in front of our customers first, I think, is what we want to do. But what we're doing, I think, Tejas, what we're really focused on is we're figuring out how do we continue to add value to the Revio system through chemistry, through software, through other changes. And part of that journey is driving sample through -- driving sample input requirements down. But when I first started at the company, we were looking at 15 micrograms of DNA required for 1 human sample. Then we moved it down to 5 micrograms and now down to 1 to 2 micrograms, and we are moving very quickly towards a paradigm of nanogram level, not 1 nanogram, but in nanogram scale. Why does that matter? That matters because it enables access to samples, millions upon millions of samples that we perhaps couldn't get onto the long-read sequencer and put this on par with the short-read sequencers from that perspective. One specific area would be newborn screening assays, for example. The ability to take a heel prick and get enough high-quality DNA off of that heel prick and still have some DNA left over for other experiments is completely enabling when you're looking at nanogram-level quantities, which means that we could get into markets that we would have a really hard time getting into otherwise. And so at the end of the day, we're focused very much on improving the performance of the Revio platform from end to end. And the lowering the input requirements is really fundamental because it enables us to basically reach the entirety of the market, whereas in the past, we've been on a journey to get there, and we're really there at this point.

Got it. I want to ask you on Illumina's [ 5-based ] genome. How does that affect your value proposition for native long reads? Now, there's errant limitations to a short-read genome and I'm not sure this sort of gets around that. But Illumina does intend to offer it at no additional cost. So walk us through how you think about the use cases and then to the extent that might become a factor for your customers. And on a related note, what are your plans to launch [indiscernible]?

Yes. So we'll start with kind of the perspective that our competitors are trying to launch [ 5 base ] genomes. The first thing, let's just all acknowledge that it's a recognition that looking at epigenetics is really important. And when you look at single molecule sequencing, long-read sequencing using PacBio, we have been sequencing metal C for quite a long time now, and it's native with every single run, and it's free with every single run. So that is a significant advantage. The other advantage that we have is that we can see all parts of the genome and short-read technologies can't. So the reality is even if they have that product, if they can't see the part of the genome that matters, I'm not sure it really matters that much. And so we have a significant advantage there. So the acknowledgment that it's important, I think, is interesting and useful. And then the reality is, with our single molecule sequencing framework, we can see it natively and then we can see it across the entirety of the genome where others can't. Now the other thing is that we are not only working on methylation as we already have it, but then also hydroxy methylation as well as metal A 6 months late, which isn't super important in human genetics, but in microbial genetics is a really big deal. And so our technology is fundamentally amenable because of the way we make measurements on the system to look at all 3 of those and as we continue to improve the Revio system, we will be introducing these further epigenetic markers, which I think will have just more value for our customers and further application to show why long reads have major fundamental advantages over short reads.

Got it. Quickly on China. Talk to us about the breadth of interest in the Revio beyond those long-term customers you have in the region? Or is that sort of really contingent on you launching your benchtop long-read box? And then are you starting to see any noise in the market from BGI push of their Nanopore platform?

Yes. So starting with BGI and working backwards, we really haven't seen any pushback on that or any penetration that would have impacted our business. And so we're watching, I'm sure, as everyone is, how they operate and what they do and whether they can commercialize outside of China or not, that will all uncertain remain to be seen. With respect to Revio, inside of China, there is interest for Revio inside of China beyond the core service providers. But certainly, the benchtop system at its much lower capital cost point will be accessible to hundreds, if not thousands of different customers throughout the country. And today, we go to market through a distributor network, a channel partner network. But the reality is most of our revenue comes from a set of core service providers that have their own sales force. And so we get that multiplier effect from them. As we get the benchtop system to market, I believe we'll be able to see a combination of both where we'll be able to penetrate more deeply into the market directly with the benchtop system and still have the power of Revio. And if you go back to the fundamental strategy of the company, the reason why you develop a benchtop system is so that you can make the technology more ubiquitous with the number of people that you see in the market. And over time, as those people get familiarity -- that's great. The fire alarm has been tested. So over time, as you place more and more instruments into the market, people get more familiar with the power of HiFi and long-read sequencing. And as they scale up their science, it's a natural sell into Revio. So that's a really important thing, whether it's in China, the United States, Europe, other parts of Asia. The other piece that's actually really important is it gives us a way to protect price of the Revio system and those capabilities. And you set the dynamics -- the pricing dynamics in such a way that the capital will be more expensive, but the running cost of Revio will be dramatically cheaper. The capital cost of the smaller system will be dramatically cheaper, but the running cost will be dramatically higher. And for those level of pull through, the higher cost per G, so to speak, it won't be -- it's not a factor in enabling the science.

Got it. Fair enough. One quick follow-up on China. How is the July strength in consumables held up? And any updates on what you're hearing from your customers with respect to stimulus funding? And is that starting to bubble up in your funnel conversations?

Yes. The stimulus, it's a bit of serial, I think. I think there is a stimulus happening -- has it been funded yet? It's difficult to know. We're not really seeing that yet or at least in the conversations that I've been having with our GM. So that's one data point. With respect to the consumable pool, actually, the utilization of the Chinese customers has been actually quite strong. And so that is a market difference than earlier this year. And we'll see what does that really mean over the next 6 to 9 months? It's difficult to know, but it is nice to see that they're using their systems.

Fair enough. Quickly on academic funding, Christian. What are you hearing in terms of the environment into next year? Obviously, Europe is looking at some horizon cuts in expense spending, the NIH budget here, muted growth at best, and you called out the all-of-us situation and starting in October, I think, is when the cut goes into effect. So as we think about the funding for not just research, but even these big PopSeq projects, what's your perspective?

Interestingly, with respect to core academic funding, I do think the NIH cuts create anxiety but not fundamental changes to the dynamic of what's actually happening on the ground. I don't think sales cycles -- I don't think the prolonging of sales cycles immediately transitions back to say what it was 3 or 4 years ago, but I also don't think it gets much worse. With respect to population sequencing programs, there's still incredible interest globally to do PopSeq, particularly with long reads now as they become economic across the board from the sample prep side through the informatics side and the sequencing. And so we're heavily involved in the PRECISE program in Singapore, and that's sequencing. We won this project in Estonia, which they are -- they -- that we won that project against both of our core competitors. And so we have got the entirety of that project and we're pretty excited about that. The sequencing is going fantastic. They will soon have some data to share, which I think will be useful. So when you start to think about population scale sequencing, NIH funding is important, but there's all kinds of different funding sources that is driving that. And we're in conversations kind of on a global basis. The other thing that's really interesting is that I do think the philanthropic organizations are excited about picking up the load. Now, sure, they're not the NIH, but the ability to do, for example, we won the GREGoR Consortium project, and we're seeing the sequencing going on with them, and that's basically funding through philanthropy. We have our long-read sequencing capability with HiFi gives us the ability to sequence the areas that haven't really been sequenced very well. So neuro diseases, for example, and there's lots of excitement in funding in autism and ALS and Huntington's and DMD and all these different areas where there are opportunities to do large scale. They may not be PopSeq projects as we typically think, but they could be projects in the 10,000-plus sample range that really take advantage of the power of long read. So I'm actually pretty encouraged that even if the NIH is noisy, which it certainly is, there's no question about that, that our opportunity really doesn't change.

Got it. You talked earlier, Christian about a really nice backlog for Onso, [indiscernible]. You lowered your price per GB as well over there. So 2 part over there, right? So on the one hand, you're clearly seeing that elasticity of demand come through. But what does that mean for the price per Insight philosophy, right, that essentially ultimately lowering the cost and the price per GB is hard to get away from in consumer negotiations? And on the other end of the spectrum, Illumina is now trying to make a push towards workflow-based pricing as well. And just given how large they are in the sequencing market, does that essentially create an umbrella benefit for everyone else as well in terms of moving towards price per insight over the medium term?

Yes. I think there certainly is a move where it can't be just a race to the bottom. There has to be value created. And for PacBio to be successful in short-read sequencing, we have to demonstrate that our technology provides insights or values that others don't. Recently, there was a paper published that demonstrated that PacBio short-read sequencing was 10x more accurate than Illumina sequencing. Now people can debate how much does accuracy matter or not matter, but it certainly helps with respect to driving the cost of sequencing down, but probably more importantly, in specific assays where you're looking for a needle in a haystack. And you need to know that, that base is right or that variant is right. The change in accuracy matters a lot. And that -- our whole thesis is to build platforms that enable you to push into that part of the market. And the reason why we think that's so important is because in our view, the MRD market, the liquid biopsy market over the next decade is probably going to be the fastest growing and most valuable part of the sequencing landscape. And by having a platform that has strengths that play right into that market, give us an opportunity to create a big business. The last thing I'll say about this topic really is starting to think about how do you create coordinated insights across different multiomic data sets across leveraging the power of AI or other tools to go way beyond just I can sequence this. I think the future and the way you're going to create competitive advantages is by developing capabilities to be able to look at multiple types of data and have software capabilities to help interpret that data. That allows you to do a couple of things. It allows you to think about your business model differently. It gives you specific competitive advantages. It also allows you to sell at multiple levels. You can sell at the scientist level or the technician level, so to speak, where the sample is touching your system, but you can also sell at the decision support level. And that level -- that ability allows you to perhaps show that even though you're a lot smaller than, say, your competition, you can do something that they can and perhaps drive revenue opportunity that way. So the Onso platform itself is an important platform for us to demonstrate the power of the data type. And then as you know, we made that acquisition of Apton to develop a very high throughput system and that R&D program is going exceptionally well right now. And that's really where we think we can leverage the technology to create a workhorse for us to carve out our own bit of space in that what we think is going to be a really big market that can support multiple players.

Got it. Quickly on the pipeline because we're almost out of time. Benchtop long read is ASHG, a reasonable sort of like time frame. And then the ultra-high throughput instrument on the long-read side, is 2026 still the right ZIP code?

Well, we haven't said when we're going to launch the benchtop system. So I don't want to get anyone to get over their skis on that. With respect to the ultra-high throughput system, the core technologies are being created right now, and we're actually seeing some pretty remarkable results. And so as we get a little bit further along in terms of wrapping the system around that core technology, we'll be able to kind of more clearly elucidate that, but it's not going to happen next year.

Got it. Last question, we'll get you out of here. How are you feeling about the ramp embedded in the guide? You called out really good Onso placement expectations in the back half of the year, a few of the PopSeq programs as well. But on those Revio placements that you have baked into that sort of 4Q ramp, what's your latest thinking?

Yes. I mean I think, look, we built the forecast looking at the actual sales funnels and conversations with sales reps and customers and the like. So we do see the world improving from where we are or where we've been in the last couple of quarters. Let's face it, the first half of 2024 was really challenging for the company. We're seeing a lot of great results come from our customers and papers being published, and we talked about the expansion in kind of those translational and diagnostic type opportunities starting to manifest themselves. So you're seeing a lot of really strong green shoots that give you a lot more positive confidence towards achieving what is a nice ramp in the second half. And although it's not where we originally thought our expectations would be, we do think the environment is generally starting to see some signs of improvement, which give us some belief that -- we believe that the second half will be stronger than the first half. And then 2025, we'll see when we get there. But yes, we're feeling a little bit better.

Got it. Good to know. And thank you so much for spending the time with me. Appreciate it.

That was a lot of fun. Thank you.