Pacific Biosciences Of California: Leveraging Scale and Product Development (PACB)

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The six months to October 2022 saw the return of Pacific Biosciences of California awards (NASDAQ:PACB) gain ⁓14% after lagging in the year-over-year analysis by -60%. With its third quarter 2022 results expected on November 3, 2022, investors will be keen to see an enhanced product portfolio including the SMRT Cell 8M, Sequel II/IIe systems and recent acquisitions from Circulomics and Omniome.

Thesis

PacBio has unveiled the tandem repeat genotyping tool, also known as TRGT, with the ability to sequence larger sections of DNA. This computational analysis method is considered to give scientists and clinicians a robust advantage in detecting disease-related sections of DNA. Although having fewer instruments for sale in the second quarter of 2022, PacBio was able to increase the average selling price of instruments, realizing an increase in instrument revenue. The company is on a mission to grow the installed base of its Sequel II/IIe placements through the remainder of 2022 due to increased customer demand. However, the supply chain is facing a global shortage of semiconductors and rising inflation that have led to cost increases that have hurt margins.

Q2 2022 Key Highlights

PacBio’s instrument revenue increased 9% (TQ) to $15.6 million from $14.3 million in the second quarter of 2021. Recent instrument releases, such as Sequel II systems, have achieved higher selling prices, including a multi-instrument order with a larger volume of consumable service revenue. During the quarter, PacBio increased its installed base for Sequel II/IIe to 460 from 282 systems in Q2 2021.

In my opinion, the company’s strategy has always involved growing its Sequel system. After its launch in 2015, PacBio began phasing out production of the RS II instruments in an effort to improve gene computing capability. Later in April 2019, it launched the Sequel II system which helps customers generate PacBio HiFi readings more efficiently. PacBio has declared that it is the only sequencing technology that provides HiFi reads with 99.9% accuracy since a typical HiFi read of 20,000 bp has 8 incorrect bases.

Generating HiFi Playbacks

PacBio

In April 2021, PacBio released its new HiFi sequencing workflow which further increased the accuracy of HiFi reads with a limited sample set. Advanced scientific research in the contemporary world needs not only accurate but also complete sequencing data, even with limited sample quantities. Not surprisingly, the company increased its installed base to 460 Sequel II/IIe from 282 in the second quarter of 2021. Total revenue in the three months ending June 30, 2022 was 35.47 million dollars, up 15.87% (YoY) from $30.61. million made in Q2 2021.

These higher revenues were realized through increased product sales. In the 6 months to June 30, 2022, product sales alone peaked at $58.42 million from the $51.84 million recorded on June 30, 2021. We note here that PacBio maintained the consistency in the sale of its nucleic acid sequencing products/services given that it competes with the big names in the market. Companies like Illumina (ILMN), BGI Genomics, Thermo Fisher Scientific (TMO) and Oxford Nanopore Technologies (OTCPK: ONTTF), among others, have longer operating histories than PACB.

Market situation

Illumina’s gene sequencers are known to power many recent breakthroughs in biology and medicine with regards to genome science. However, the company with a market capitalization of $34.61 billion has not launched a new product (with complete end-to-end workflows) in the past 5 years. It’s no wonder Illumina tried to buy PacBio in 2018, through a planned merger that was later terminated in January 2020.

By the end of September 2022, Illumina announcement that it had scheduled two products to launch in 2023. The two include Novaseq 6000 Dx, a high-throughput in vitro diagnostic (IVD) sequencer that uses continuous long reads to extend genome completeness 30X, and Illumina Complete Long -reads formerly called Infinity – an enrichment panel that targets hard map regions of the genome.

Over the past 5 years, PacBio’s price return has gained 79.05% versus +7.67% for Illumina.

PACB's best price performance over 5 years

Looking for Alpha

The PACB has made notable gains, especially in 2021, despite the recent decline of more than 75% from its 52-week high of $31.10.

CEO Christian Henry has led the company for two years and promised investors that PacBio will leverage its long-standing technology to expand commercialization and drive growth. PACB acquired Omniome and Circulomics in September 2022 to complement its product portfolio and create value for customers. The company’s GAAP operating expenses increased to $84.2 million as non-GAAP operating expenses increased 74% (year-over-year) to $89.6 million in the second quarter of 2022. This increase is mainly due to the acquisition of Omniome (in September 2021) and the increase in R&D expenses to $51.3 million. . For Circulomics (acquired in July 2021), PacBio paid $29.5 million in cash for all of its outstanding common stock.

PacBio intends to commercialize both Omniome, a short-read platform, and Circulomics, a Nanobind technology. To increase the value, Circulomics will be integrated with HiFi to enable a smoother sequencing workflow. While the specs are impressive considering the increased accuracy of the upgraded HiFi model, it will be important to consider whether customers will be willing to pay extra for this product.

Continuous improvement of short-read and long-read sequencing systems

PacBio also announced Onso, a highly accurate short-read sequencing platform, and Revio a new long-read sequencing system on October 25, 2022. In the announcement, PacBio declared that Revio was designed to give customers the ability to sequence up to 1,300 human whole genomes per year with 30x coverage for less than $1,000 per genome. PacBio has not only benefited from scalability, but also from pricing, as it will use HiFi sequencing to conduct large studies including human genetics, cancer research and agricultural economics.

In his statement on Revio, CEO Christian Henry declared,

We designed an entirely new SMRT cell with three times the density of our existing 8M SMRT cell, resulting in 25 million ZMW. Revio will run up to four SMRT cells in parallel, providing up to 100 million ZMW for concurrent single molecule sequencing. Combined with significant advancements in our computing, Revio will deliver faster runtimes and a 15x increase in HiFi data. I’m excited to see what researchers can discover using the power of Revio.”

The other product, the Onso Short Read Sequencing System is expected use PacBio sequencing by linking [SBB] Technology. PACB expects to begin taking orders for Onso in Q1 2023 and begin shipments in H1 2023 after completing its external beta program.

Downside risks

PacBio’s management is relatively new given that it has only been in place since September 2020. However, Christian Henry, the CEO, had been with Illumina since 2005 where he started as CFO. I believe he brings a wealth of experience, particularly in marketing strategy and product development.

In my opinion, PacBio is trying to be aggressive on sales as total revenue increased to $35.5 million in Q2 2022 from $33.2 million in Q1 2022. Additionally, gross profit increased almost doubled between the 12 months and September 2020, where it stood at $34.1. million to $63.2 million in the 12 months to June 2022. This represents an increase of 85% (according to TTM analysis). However, it remains to be seen whether customers will be willing to pay a premium for the higher precision products provided by Omniome and Circulomics technologies until 2023. Additionally, applications dealing with nucleic acid sequencing are new, it will take so maybe PacBio time to establish new customers.

The global shortage of semiconductors and rising inflation could continue to hurt PacBio’s business. Revenue cost increased 1.5% (T/T) to $19.1 million, leading the company to post a net loss of $71.4 million in the quarter. However, this net loss represents a reduction of 12.4% (TQ) accumulated in Q1 2022 when it amounted to $81.5 million.

PacBio’s cash levels decreased 13.9% (TQ) to $899.2 million in the second quarter of 2022. The company’s total conventional debt stands at $950.2 million. He doesn’t have enough cash to offset the debt as he will be left with a $51 million deficit. Positively however, in the six months ending June 30, 2022, PacBio spent a total of $157.82 million in operating activities and capital expenditures. Without taking into account the risk of offsetting the debt balance (within a year), PacBio has enough liquidity to operate until 2023.

Conclusion

PacBio’s strategic revolution has been characterized by aggressive investments in product development. The company aims to commercialize its long and short read technologies while promoting new technologies to improve the accuracy of its Sequel II/IIe platforms. The company had a strong balance sheet with cash of $899.2 million sufficient to fuel operations and capital expenditures through the second quarter of 2023.

However, the CEO of the company has been in charge of the company for 2 years and I think it will take time to update the turnaround strategy. PacBio also faces other macroeconomic issues such as inflation and a shortage of semiconductors that could hamper product production. Yet the company is in a better position to advance its product development with a higher level of automation, not only to increase revenue, but also for long-term average return. For these reasons, we offer a holding rating for the title.

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