Is Profitiablity in Pacific Biosciences of California's DNA?

Source: Pacific Biosciences.

If you ignore the lumpiness of payments from its partner Roche -- which you should -- it was a solid quarter for Pacific Biosciences of California (PACB 1.47%). After the bell on Thursday, the company presented its earnings and gave investors an update on how customers are receiving its new DNA sequencer, the Sequel System.

Pacific Biosciences results: The raw numbers

What happened with Pacific Biosciences this quarter?

• Product and services revenue is the more important than total revenue because it doesn't include payments from Roche, which aren't regular.
• Revenue growth is being driven by an increase in consumables, which grew 64% year over year and made up more than half of product and services revenue. The more instruments Pacific Biosciences can place, the more the more revenue from consumables will grow.
• Revenue from sales of instruments decreased year over year, but that's to be expected with the launch of the Sequel System. No one wants to buy an old RS II system that'll be outdated before the kids stop using the box as a fort, so Pacific Biosciences is renting the RS II systems that will hopefully get converted into sales of Sequel Systems down the road.
• While Pacific Biosciences posted a gain for the quarter, it was entirely due to a one-time payment on an amendment to its lease. If you back that out, the company lost $21 million in the third quarter.

What management had to say 
To give investors an idea of just how much more popular the Sequel System is than its predecessor, Chairman, President, and CEO Mike Hunkapiller gave this comparison: "In the first two weeks since the initial product announcement, we received a similar number of requests for quotes for Sequel Systems as we had received collectively in the prior nine months for the RS II." Requests for quotes aren't sales, but that's quite impressive.

When might Pacific Biosciences be profitable? Management hasn't hazarded a guess yet, but Hunkapiller did give some details on the substantially increased margins on the Sequel System that'll help it get there: "Manufacturing costs of the Sequel System are approximately one-fourth that of the RS II. This allows us to price the system at half the selling price of the RS II and still begin delivering reasonable gross margins on instrument sales, thus facilitating our progress toward profitability."

Looking forward
Pacific Biosciences couldn't compete with Illumina (ILMN -1.48%) and its RS II system. The RS II found a niche for sequencing projects where Illumina's machines weren't up to the task, but that's a pretty small niche.

The question is whether the Sequel System can actually take some of that market share away from Illumina. It's hard to say at the moment because the company has only announced the cost of the machine, not the cost of whole genome sequencing, which includes the consumable costs. Pacific Biosciences expects the price to come down as throughput ramps up, so we could see accelerated growth as the new technology catches on.

The other big unknown comes from revenue associated with Roche's diagnostic tests. There will be some Sequel System sales to Roche initially for the company to develop tests, but the bulk of the potential demand comes from labs that want to run the diagnostic assays. Roche plans to start selling assays for clinical research in the second half of next year followed by diagnostic tests. So the revenue growth from diagnostic tests is likely to come in 2017 and beyond.