Investors with a long-term mind-set might have found a lot to like about Fluidigm (NASDAQ:FLDM) at the beginning of the year. The laboratory hardware developer was still a few years away from profitability, but appeared to be on the path to achieving sustainable operations thanks to strength from its core instrument platform. That observation prompted me to make the case for staking a small position in the slow-growing hardware business in February.

Then things got a little crazy. Fluidigm made an appearance on Mad Money's Lighting Round segment shortly thereafter. Shares climbed to a 60% year-to-date gain by April -- not exactly what I had in mind when I pleaded patience and a long time horizon. The epic rise was followed by a precipitous fall when the business reported lackluster second-quarter 2019 operating results in August. Shares have now lost 35% on the year.

The volatility hasn't been fun, but the business still has the same potential now as it did at the beginning of the year. Investors simply need the proper perspective for defining the company's success and progress. Luckily, it all boils down to one metric.

A kid looking through a monocular.

Image source: Getty Images.

How did Fluidigm get here?

Fluidigm is a leader in microfluidics and single-cell analysis. It's taken time to figure out how to profit from the techniques, but the company appears to have finally found the right application: mass cytometry.

Mass cytometry allows researchers to interrogate living systems in more granular detail to better understand biology. For example, rather than make general observations about a tissue sample such as what genes are being expressed in the entire sample, mass cytometry can be used to understand what genes are being expressed in specific regions of the tissue sample. That information can be much more valuable for drug discovery and drug development efforts.

The value created for customers is evident in recent income statements. In 2018, the company's mass cytometry portfolio reported year-over-year growth of 27%, compared to a 3% decline for all other products offered by the business. That allowed Fluidigm to grow total revenue 11%, gross profit 18%, and shrink operating loss in that span.

The momentum continued in the first half of 2019. Total revenue and gross profit climbed 13% and 20%, respectively, compared to the year-ago period. Mass cytometry drove the improvement, while older instruments weighed on the upward trajectory. Wall Street freaked out a little over just how much the legacy machines sapped progress, but that isn't necessarily the most important thing for investors to watch for Fluidigm.

A row of centrifuge tubes filled with liquids in a lab.

Image source: Getty Images.

This 1 metric will dictate success

Most lab equipment companies deploy the same business model: develop an instrument that provides value to customers, sell as many as possible, and generate recurring revenue for years to come from selling consumables needed to run the installed base of instruments. 

Consumables revenue includes sales of products such as chemical reagents, disposable plastics, and diagnostic kits or assays. It's the most important revenue category for a laboratory hardware developer -- by a long shot. The most successful businesses derive at least two-thirds of total revenue from consumables. It's a trend that plays out again and again. 

For instance, DNA sequencing leader Illumina generated 67% of total revenue from consumables in the first half of this year, not sales of its sequencing machines. The business reported an operating margin of 24% in that span. The struggling peer Illumina is trying to acquire, Pacific Biosciences, leaned on consumables for just 40% of total revenue in that span. It reported an operating margin of negative 132% in the first six months of 2019.  

Single-cell analysis darling 10X Genomics (NASDAQ:TXG) reported that 84% of its total revenue was derived from consumables in the first half of 2019. It reported an operating margin of negative 12% in that span, but mostly because the business is scaling rapidly (revenue more than doubled in 2017 and 2018) and paying dearly for a patent infringement suit from Bio-Rad. Either way, investors have happily handed it a $5.5 billion market cap following a successful initial public offering (IPO). That 84% figure has a lot to do with it, whether investors realize it or not. 

While Fluidigm has shown steady improvement in the percentage of revenue derived from consumables, there's plenty of progress to be made. The business leans on consumables for only about 40% of total revenue today.  

Metric

First-Half 2019

2018

2017

2016

Instrument revenue

$25.0 million

$45.5 million

$42.5 million

$46.8 million

Consumables revenue

$23.0 million

$48.1 million

$41.9 million

$42.2 million

Total revenue

$58.3 million

$112.9 million

$101.9 million

$104.4 million

Instrument revenue, % of total

42.9%

40.3%

41.7%

44.8%

Consumables revenue, % of total

39.5%

42.6%

41.1%

40.4%

Data source: SEC filing. NOTE: Service revenue not shown.

The apparent weakness to start this year can be explained by the timing of consumables orders and the launch of a new instrument, but the upward trend established in recent years should resume in the second half of 2019. More important, management is keenly aware of the long-term importance of consumables revenue. 

Mass cytometry consumables revenue grew 35% in the first half of 2019 compared to the year-ago period. Meanwhile, Fluidigm recently launched a new product that can quantify the amount of RNA in a biological sample and can run on the company's legacy microfluidics machines. That could reinvigorate growth (or at least reverse a shrinking footprint) for the company's weakest portfolio. 

Investors are right to wonder whether the installed base of machines is large enough today to drive significant growth in consumables revenue in the near future. Despite painfully slow progress, Fluidigm appears to be on the right track. If management could identify targets (say, deriving 50% of total revenue from consumables by 2021), then it might go a long way to building trust with and setting expectations for investors. Until then, investors know what to watch.