Illumina Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 9, 2023

There are 12 speakers on the call.

Operator

Good day,

Speaker 1

ladies and gentlemen, and welcome to the Second Quarter 2023 Illumina Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Sallie Schwartz, Vice President of Investor Relations.

Operator

Hello, everyone, and welcome to our earnings call for the Q2 of 2023. During the call today, we will review the financial results released after the close of the market and offer commentary on our commercial activity, after which we will host a question and answer session. If you have not had a chance to review the earnings release, it can be found in the Investor Relations section of our website at illumina.com. Participating for Illumina today will be Charles Dazwell, Interim Chief Executive Officer and General Counsel and Joydeep Goswami, Chief Financial Officer and Chief Strategy and Corporate Development Officer. Chuck will provide an update on the state of Illumina's business and Joydeep will review our financial results, which include GRAIL.

Operator

As a reminder, GRAIL must be held and operated separately and independently from Illumina pursuant to the interim measures ordered by the European Commission, which prohibited our acquisition of Grail under the EU Merger Regulation. This call is being recorded and the audio portion will be archived in the Investors section of our website. It is our intent that all forward looking statements regarding our financial results and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Forward looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed.

Operator

All forward looking statements are based upon current available information and Illumina assumes no obligation to update these statements. To better understand the risks and uncertainties that could cause actual results to differ, We refer you to the documents that Illumina files with the Securities and Exchange Commission, including Illumina's most recent Forms 10 Q and 10 ks. With that, I will now turn the call over to Chuck.

Speaker 2

Thank you, Sally. Good afternoon, everyone, and thank you for joining today's call. As you know, I assumed the role of Illumina's Interim CEO 2 months ago. Our search for a CEO is underway and we look forward to updating you soon. Our Board is pleased with the outstanding candidates they're seeing.

Speaker 2

Before going to our Q2 results, I wanted to take a moment to acknowledge and thank our former CEO, Francis Sousa and our former Chairman of the Board, John Thompson, for their thoughtfulness and commitment while at Illumina. I would also like to welcome our new Board members, Stephen McMillan, our new Chairman of the Board as well as Andrew Tenno and Scott Ullam. I also want to acknowledge changes in our executive leadership team, including the departures of our Chief Technology Officer, Alex Aravonis and our Chief Medical Officer, Phil Febbo. I speak for the whole company in wishing both of them every success for the future. We're also pleased to announce that Steve Bernard, a 25 year Illumina employee and distinguished scientists in our field will drive Illumina's legacy of innovation forward as our next Chief Technology Officer.

Speaker 2

We'll be conducting a search for our next Chief Medical Officer. Turning to second quarter results. In Q2, Illumina delivered revenue We shipped 109 NovaSeq X instruments in the quarter and have increased our expectations for our full year supply capacity to more than 390 instruments. However, as you saw from our earnings release, we are reducing our guidance and now expect core Illumina full year 2023 revenue to be approximately flat with 2022, primarily as a result of 3 factors. 1st, a larger than expected temporary decline in high through book consumables as we transition more than expected customers to the NovaSeq X.

Speaker 2

2nd, many of our customers are remaining more cautious in their purchasing And finally, in China, there's a more protracted economic recovery and an increasingly challenged competitive landscape. In contrast to the Americas and Europe, we're still expecting year over year growth in 2023. Joydeep will provide additional details on our revised guidance during his remarks. One area I'd like to touch on further is the rollout of NovaSeq X. This has been a more challenging process than we anticipated.

Speaker 2

NovaSeq X is the most sophisticated platform we have ever launched and includes the most comprehensive end to end software we have ever released. Also, the rollout of the X has occurred at an unprecedented magnitude and pace, and we have identified issues in the field that are typical in new product releases. To address these issues, we have taken actions, including a planned software update that was released in June after our first customer shipment in March. We have deployed Illumina technical teams worldwide to work with our customers to accelerate bringing their systems online. While the rollout of NovaSeq X will take longer than we originally expected, the continued strong interest and commitment of capital purchased NovaSeq Xs remains encouraging.

Speaker 2

To date, 20% of customers who have purchased NovaSeq X have ordered more than one instrument. This early demand for multiple instruments and They represent underscores our confidence that customers are planning to increase their sequencing activity. Customers have clear intentions to do more sequencing in the future. Our customers have commented that larger scale single cell and spatial analysis experiments have become more practical with Nova And they are requesting funding for these applications. Customers engaged in large population genomics initiatives have stated they plan to run additional multi omic programs for population specific variants, which can be used to develop treatments for various demographics that will be more effective in those populations.

Speaker 2

And as some of you've heard, several of our largest customers are using the X to accelerate move from targeted panels and exomes to whole genome sequencing. We expect these types of projects to scale and ramp in the near future and we'll be closely engaged with our customers to support their needs. We continue to consciously and actively reduce our expense base and have accelerated actions with $100,000,000 plus annual run rate expense reduction program we announced at our last earnings call. As you saw in our late June 8 ks filing, we have reduced our global headcount and are downsizing our global real estate footprint. We're also optimizing our 3rd party vendor spend and have reduced travel related and other costs.

Speaker 2

For 2023, these steps are helping mitigate the impact of lower full year revenue on our operating margin. Looking forward, these actions will continue to support our margins and create Flexibility for further investment in high growth areas. Let me give you an update on a couple of our platforms. We saw continued global interest in the NovaSeq X Series Q2 and we exited the quarter with more than 260 orders since launch. Our shipments of 109 NovaSeq X instruments in Q2 were above our expectation of 80 for the quarter and brought our total installed base to 176 instruments.

Speaker 2

We now expect to be able More than 390 NovaSeq X instruments this year, up from the 330 we had previously expected for the year. In mid throughput, we shipped approximately 160 NextSeq 1ks2ks units in the 2nd quarter, an increase of 8% year over year as customers expanded their current fleets or migrated from the MiSeq or NextSeq 550. More than 20% of NextSeq 1ks2ks units in Q2 were placed with new to Illumina customers. We continue to experience lengthened sales cycles, in some cases as customers take time to raise funding or prioritize their investment dollars and in other cases as they run longer procurement processes. Our win rate across the mid throughput segment outside of China increased from the Q1.

Speaker 2

We believe there is a long runway of differentiation for the 1 ks2 ks, notably with XLEAP SBS chemistry coming available on these instruments next year. Moving to our markets. In Q2, clinical represented approximately 53% of our total sequencing consumables revenue. In oncology, progress continued for next generation sequencing based testing reimbursement. Anthem, the 2nd largest commercial payer in the U.

Speaker 2

S. And Blue Cross Blue Shield of Michigan both added coverage for comprehensive genomic profiling for patients with advanced cancers, adding more than 30,000,000 additional covered lives. We also saw coverage continue to progress in Europe with Switzerland now reimbursing large Next generation sequencing panels including comprehensive genomic profiling. Illumina's market leading TruSight oncology assay TSO500 remains on track to exceed more than $100,000,000 in 2023 revenue. Growth continues to be driven by greater utilization and broader adoption of our assay.

Speaker 2

In Q2, we also completed our TSO comprehensive submission for IVD registration in the United States. Also in oncology, GRAIL continues to achieve solid progress in the adoption of its Galleri multi cancer early detection test. In Q2, Grail achieved its 100,000th commercial gallery test milestone and the test has now been prescribed by more than 7,500 providers in the U. S. And ordered in more than 80 health systems.

Speaker 2

As an update, on the NHS GALLERY study, in Q2, GRAIL completed 2nd year follow-up visits, in which 130,000 participants returned, giving the trial a retention rate of 91.3%. Invitations for the 3rd and final year visits have begun and the first appointments for those visits are expected this fall. Evidence for Galleri continues to grow. At the most recent annual meeting held by the American Society of Clinical Oncology, GRAIL announced results from the University of Oxford sponsored SIMPLIFY study, reporting high specificity, positive predictive value and accuracy of the cancer signal detected and the cancer signal of origin prediction as well as demonstrating the feasibility of using an MSED test to assist clinicians with decisions regarding referrals from primary care physicians. GRAIL is also making progress on its unique multi cancer minimal residual disease test.

Speaker 2

At the American Association For Cancer Research Annual Meeting, GRAIL and AstraZeneca presented new data that supports the use of GRAIL's methylation platform to identify residual cancer in post treatment settings. GRAIL's technology had a cancer detection rate of 92% in patients with relapsed refractory disease across 6 hematological malignancies. These findings demonstrate that Garell's blood based methylation approach offers additional options to clinicians as they evaluate patients in efforts to achieve remission and improve survival. Returning to core Illumina, in reproductive health in the U. S, 5 state Medicaid programs in Louisiana, Michigan, North Carolina, Rhode Island and Tennessee updated their policies and are now covering non invasive prenatal testing for all pregnancies.

Speaker 2

In Europe, NIPT is now available for all pregnancies in the Netherlands and has been approved for broader coverage in Italy. Turning to our Research and Applied Markets, as we announced in mid July, the Alliance for Genomic Discovery launched by Illumina and National Biosciences in 2022 now includes 5 founding members AbbVie, Amgen, AstraZeneca, Bayer and Merck. It now represents novel industry led collaboration to to accelerate the development of therapeutics through the large scale genomics. Members will co fund whole genome sequencing of 250,000 samples and all have access to the resulting data for use in drug discovery and therapeutic development. The first phase in the alliance was announced in January and it involved whole genome sequencing for 35,000 samples, primarily made of DNA from individuals of African ancestry.

Speaker 2

Before we move to Joydeep and then go to Q and A, I wanted to point out a couple of additional innovations that we recently announced. In June, Our Primate AI 3d, an AI algorithm that predicts disease causing genetic mutations in patients with unprecedented accuracy was featured in articles as the cover story of Science Magazine's June issue. And in July, we announced the latest version of our Dragon for analysis of next generation sequencing data. Dragon 4.2 expands award winning accuracy combined with the flexibility and scalability to enable efficient workflows and extract meaningful insights from genomic data. It improves identification of the causes of genetic disease and further aids in both drug discovery and population genomic analysis.

Speaker 2

While the year hasn't progressed the way we expected, We remain focused on execution, innovation and supporting our customers as they ramp their NovaSeq X instruments. We continue to progress on margin improvement while prioritizing investment in proprietary technology that generates differentiated products that are valued by our customers and will drive growth. These include upcoming product launches including the highly anticipated 25b flow cell for NovaSeq X, the Illumina complete long reach enrichment assay and XLEAP SBS chemistry on NextSeq 1K2 ks as well as future offerings for emerging markets like proteomics, multiomics and spatial where we see opportunities to address researchers' needs, deliver complete, integrated and accessible workflows. In short, Illumina will continue to deliver impactful outcomes. We empower researchers and clinicians with the data and technology they need to make life's changing discoveries and decisions for patients.

Speaker 2

Our employees take pride in being part of Illumina's mission to improve human health by unlocking the power of the genome. And we are the global engine of genomics innovation, positioning us today and in the future to maximize shareholder value. With that, I'd like to turn the call over to Joydeep to discuss additional details on our results and outlook and from there we'll go to Q and A. Jodi?

Speaker 3

Thank you, Chuck. I'll start by reviewing our consolidated financial results followed by segment results for core Illumina and GRAIL and then conclude with my remarks on our current outlook for 2023. I will be discussing non GAAP results, which include stock based compensation. I encourage you to view the GAAP reconciliation of these non GAAP measures, which can be found in today's release and in the supplementary data available on our website. As Chuck noted, in the 2nd quarter, Consolidated revenue was $1,180,000,000 up 8% for the Q1 of 2023 and exceeding the high end of our guidance range on stronger than expected shipments of NovaSeq X.

Speaker 3

Consolidated revenue was up 1% year over year and up 3% on a constant currency basis. Non GAAP net income was $50,000,000 or $0.32 per diluted share, which includes dilution from Grail's non GAAP operating loss $164,000,000 for the quarter. Non GAAP EPS exceeded our expectations primarily due to continued execution of expense reduction initiatives, gross margin favorability and our higher revenue for the quarter. Our non GAAP tax rate was 39.3% for the quarter, which increased from 25.8 percent in Q2 2022, with both quarters reflecting the impact of R and D capitalization requirements. Although the non GAAP tax expense impact of R and D capitalization requirements in dollars was the same in both periods, The impact to our effective tax rate in Q2 2023 was more significant due to our lower earnings.

Speaker 3

Our non GAAP weighted average diluted share count for the quarter was approximately 158,000,000. Moving to segment results. Core Illumina revenue of $1,160,000,000 was approximately flat year over year were up 2% on a constant currency basis, which included an anticipated reduction from COVID surveillance of approximately 180 basis points. COVID surveillance contributed approximately $6,000,000 in total revenue in Q2 2023 compared to $27,000,000 in Q2 2022. Core Illumina sequencing consumables revenue of $739,000,000 was down 1% year over year.

Speaker 3

Mid teens growth in clinical led by continued momentum in basis point reduction from COVID surveillance as well as sanctions in Russia, the impact of NovaSeq 6 ks consumables as customers start to transition to, but before they're fully ramped up on NovaSeq X and constrained funding impacting many of our customers globally. Total sequencing activity on our connected high and mid throughput instruments grew 3% from Q1 2023 9% year over year. Research and Applied was flat from Q1 and declined 1% year over year. Clinical sequencing activity growth remains strong, up 6% from Q1 and 23% year over year. As a reminder, we believe this data is a useful reference that shows the general activity trends across our installed base and is directionally correlated with revenue over time.

Speaker 3

We have been providing this information on the basis of number of sequencing runs, but in the future, we will disclose these metrics in terms of gigabases sequenced to better reflect activity trends given the significant increase in output per run enabled by NovaSeq X and NextSeq 1ks2ks. Sequencing instruments revenue for core Illumina of $193,000,000 grew 2% year over year. Stronger than expected shipments of NovaSeq X more than offset the anticipated decline in NovaSeq 6,000 shipments globally and NextSeq 550 placements in China, as well as a decrease in MiSeq shipments as customers transition to NextSeq 1ks2ks. We continue to see strong demand for NextSeq 1ks2ks from new to Illumina customers with shipments growing 8% year over year. Core Illumina sequencing service and other revenue of $134,000,000 was up 7% year over year, driven primarily by higher instrument service contract revenue on a growing installed base, partially offset by lower contributions from co development partnerships.

Speaker 3

Moving to regional results for core Illumina. All regions continue to be impacted by tighter funding and budget pressures that are affecting customers' project planning and purchasing behaviors. Additionally, all regions face the impact of high throughput customers transitioning to NovaSeq X, where we saw customers reduce NovaSeq 6 ks consumables purchases before they have fully ramped up activity on NovaSeq X. As Chuck mentioned, although I anticipated, This effect was magnified by the larger than expected number of NovaSeq X deliveries and a slower than expected ramp of these instruments coming online in Q2. Continued global demand for NovaSeq X Instruments and our stronger than anticipated supply in Q2 helped offset these factors.

Speaker 3

Strong momentum in clinical also continued across the Americas, Europe and EMEA with consumable shipments to clinical customers in these regions growing just under 20% year over year. Europe also benefited from the NIPT reimbursement decision in Germany last year and the National NIPT Program in the Netherlands. America's revenue of $623,000,000 was down 2% year over year And Europe revenue of $303,000,000 grew 11% year over year or 14% on a constant currency basis. Aimia revenue of $118,000,000 declined 10% year over year or 6% on a constant currency basis, which included a 14 percentage point impact from sanctions affecting our ability to conduct business in Russia. As a reminder, These regions also continued to be impacted by the slowdown in COVID surveillance year over year.

Speaker 3

Greater China revenue of $115,000,000 presented a 3% decrease year over year or a 1% increase on a constant currency basis. In addition to persistent macroeconomic and geopolitical Challenges that are impacting this region, revenue was negatively impacted by the local competitive landscape, particularly in mid throughput. Moving to the rest of core Illumina P and L. Core Illumina non GAAP gross margin of 67% decreased 280 basis points year over year primarily driven by lower instrument margins due to the NovaSeq X launch, which is typical in a launch year, as well as less fixed cost leverage on lower manufacturing volumes and higher field services and installation costs. Core Illumina non GAAP operating expenses of $531,000,000 were up $12,000,000 year over year, primarily due to the full year impact of our headcount growth in 2022.

Speaker 3

Non GAAP operating expenses were lower than expected due to the acceleration of our expense reduction initiative and lower performance based compensation. As a result of the above, Core Illumina non GAAP operating margin was 21.2% in Q2 2023 compared to 24.9% in Q2 2022. Transitioning to the financial results for GRAIL. GRAIL revenue of $22,000,000 for the quarter grew 83% year over year, driven primarily by accelerating adoption of Galleri. Grail non GAAP operating expenses totaled $174,000,000 and increased $18,000,000 year over year driven primarily by continued investments to scale Grail's commercial organization.

Speaker 3

Moving to consolidated cash flow and balance sheet items. Cash flow provided by operations was $105,000,000 Q2 of 2023 capital expenditures were $47,000,000 and free cash flow was $58,000,000 We did not repurchase any common stock in the quarter. We ended the quarter with approximately $1,600,000,000 in cash, cash equivalents and short term investments. As you're aware, we have $750,000,000 in convertible debt that matures this month. Additionally, on July 12, 2023, the European Commission imposed a €432,000,000 fine on Illumina due to the completion of the Grail acquisition during the pendency of the European Commission's review.

Speaker 3

We plan to issue a guarantee and defer the payment of the fine pending the outcome of the appeal of the EU General Court's ruling that the European Commission has the jurisdiction to review the Grail acquisition. Moving now to 2023 guidance. We now expect full year 2023 consolidated revenue to grow approximately 1%, including core Illumina revenue that's approximately flat with 2022. As a reminder, these ranges include anticipated reductions from COVID surveillance of approximately 200 basis points, The impact on our business from sanctions on Russia of approximately 100 basis points as well as a year over year negative impact from foreign exchange rates. GRAIL revenue is still expected to be in the range of $90,000,000 to $110,000,000 for 2023.

Speaker 3

For fiscal 2023, we now expect core Illumina sequencing instrument revenue growth of approximately 3% year over year, reflecting our higher NovaSeq ex shipment expectation, partially offset by capital and cash flow constraints that have continued to impact our customers' purchasing behaviors, including in China, which also had an increased impact from local competition, primarily affecting midgroup. We also expect core Illumina sequencing consumables revenue to decline approximately 3% year over year, driven predominantly by: 1, A more persistent impact of funding issues and cautious purchasing behaviors causing project delays 2, A more meaningful decrease in NovaSeq 6000 sequencing ahead of planned transitions to NovaSeq X, in part due to our higher shipment expectations for NovaSeq X. 3, a delay in the expected ramp of consumables on NovaSeq X and 4, a slower than anticipated second half recovery in China. We now expect annual pull through for NovaSeq 6000 of approximately $800,000 to $900,000 per instrument in 2023, NextSeq 550 pull through in the range of $80,000 to $130,000 and pull through for MiSeq in the range of $30,000 to $40,000 We still expect pull through for NextSeq 1ks2ks to be within the historical guidance range of $120,000 to $170,000 and MiniSeq pull through is still expected to be within the historical range of $20,000 to $25,000 per instrument.

Speaker 3

With regard to core Illumina sequencing revenue, we expect it to be approximately flat year over year. This includes intercompany sales to GRAIL of approximately $30,000,000 which are eliminated in consolidation. We now expect consolidated non GAAP operating margin of approximately 5% and core Illumina non GAAP operating margin of approximately 20%. Our revised operating margins reflect our lower revenue expectations for the year and lower gross margins given lower manufacturing volumes and fixed cost leverage. These impacts are partially offset by acceleration of our $100,000,000 plus Annual run rate expense reduction initiatives spanning headcount, real estate and other costs that Chuck mentioned earlier.

Speaker 3

We now expect our non GAAP tax rate to be approximately 41% for 2023, which continues to include an approximately $75,000,000 tax Although the non GAAP tax expense impact of R and D capitalization requirements in dollars hasn't changed, The impact to our effective tax rate in 2023 has increased as a result of our lower earnings. Lastly, we now expect non GAAP earnings per diluted share in the range of $0.75 to $0.90 for 2023, which continues to include dilution from Grail's non GAAP operating loss of approximately $670,000,000 Before we go to Q and A, I'd like to cover guidance for the Q3 of 2023. We expect consolidated Q3 2023 revenue to grow approximately 2% year over year to approximately $1,140,000,000 This reflects a sequential decrease of approximately 320 basis points from Q2 2023, primarily driven by a sequential decrease in NovaSeq 6,000 consumables as customers continue to transition to NovaSeq For the Q3, we expect non GAAP diluted EPS of approximately $0.10 to $0.15 reflecting Consolidated non GAAP operating margin of approximately 4% and core Illumina non GAAP operating margin of approximately 19%. I will now invite the operator to open the line for Q and A.

Speaker 3

Thank you.

Speaker 1

Thank you. Is turned off to allow your signal to reach our so that we can accommodate as many analysts as possible. You are welcome to reenter the queue if you have additional questions. And our first question will come from Puneet Souda with Leerink Partners.

Speaker 4

Yes. Hi, guys. Thanks for taking the question. So The NovaSeq field challenges that you're having in the market, can you talk a little bit about that? How soon can you fix these challenges?

Speaker 4

What is getting this recovery? And what does that mean for the installs in the 3rd Q4 and maybe even 2020 I mean, my question there is, does the market sort of freezes to see if these challenges are resolved before taking on more instruments? And then on the last digit demand, clearly, there is significantly more higher dip this year. There's Line in sequencing consumables versus when we look at the last product launch of NovaSeq6000. You mentioned a number of factors, but Just trying to understand how much of that is due to the challenges that you're facing in the field.

Speaker 4

And Look, the NovaSeq is definitely selling despite these challenges. So maybe could you just update us on the CO search as well? Thank you.

Speaker 2

Yes, Puneet. Thanks for the question. I've been listening to you guys now for a long time and it's nice to be able to be part of the conversation. So, as far as the NovaSeq X, right, some of the positives of the launch of an instrument of this magnitude Our that we've placed more instruments than we thought. It also has some of the biggest software placements that we've ever seen And it's revolutionary from the ground up.

Speaker 2

What we did is we underestimated the amount of time it would ultimately take to bring these instruments online, But our technical teams are working with our customers to bring them up to speed as quickly as we can.

Speaker 3

Yes. And Puneet, maybe I'll jump in. Nice to hear from you again. So a couple of things, right? First, as you know with any of these launches of this magnitude, As you go out into the field and as you start installing it, you find some bugs that you have to go resolve.

Speaker 3

So what we have seen in Q2 It was nothing out of the ordinary. We have actually already have fixes for the issues that we have seen and are in the process of Deploying these fixes to our customers. So it has meant a little bit of delay in our original expectations of when These instruments would be fully up to speed, but it doesn't hasn't changed any of our or our customer expectations on Novus And I will also really urge you to consider that it's not all customers that see this, right. So some customers are fully ramped up, While others as they have experienced these issues, we are really have all hands on deck to go fix these issues in the field. The other thing is you talked about elasticity and in terms of Look, we are not seeing any fundamental change to elasticity.

Speaker 3

And the issues that you've seen are more related to transition to the X. So what we have seen is because of the larger number of Xs Installed in the area because of the we moved up some of the supply of Xs. We have seen that the Decline in the 6 gig consumables has been faster and larger than we had expected. Again, this is the flip side of People really being excited about the X and our ability to deliver more Xs. So that's what has happened.

Speaker 3

It's a temporary decline And we expect that as we ramp up fully on the Xs that that volume will come back In terms of ex consumables, what you're seeing now is this timing gap that we have between those two events. And you said something about, I think it was whether these challenges on the X Are continuing or they'll cause a stall in the market. Actually, they haven't caused a stall in the market. We have seen demand for the X and our late stage pipeline Continue to ramp up. We are, as Chuck mentioned in his prepared remarks, that we have seen the X Actually enable experiments and solutions that were not hitherto possible.

Speaker 3

So we do see continued interest in the X and the continued interest And doing things that were not possible before. And Chuck, I'll turn it back over to you to for the CEO search.

Speaker 2

Yes. With regards to the CEO search, the Board is actively searching for our new CEO. The search includes both internal and external candidates. I've been really encouraged about the outstanding quality of the candidates they're seeing. But of course, you know that the details of the Board's processes on this are confidential.

Speaker 1

And our next question will come from Dan Brennan with TD Cowen.

Speaker 5

Thanks for taking the questions. So maybe a couple here, packed into 1, I guess. The $25,000,000,000 flow cell, is that still on track? When will that chip given some of the issues that you've cited? 2nd part, China.

Speaker 5

China actually grew in the quarter, but I know you called out some pressure there. So kind of what's baked in now for China in the back half of the year? 3rd part would be you referenced customer challenges throughout, which obviously the broader tool space is at a really challenging second quarter. But that said, the academic and government And Mark, it's actually been pretty robust outside of China. So I'm wondering if you can discuss a little bit where you're seeing these challenges.

Speaker 5

And then the final point would just be on the NovaSeq Consumable pull through cut and you're mentioning customers are switching faster over to the X. I guess, How do we get comfortable that you're not seeing some either competitive impact or some dampening of utilization, I guess? Kind of what was different this time around, do you think, in terms

Speaker 2

Yes, Dan. So I think first, we continue to prioritize our investments. They're proprietary and we still continue to focus On the differentiation of products, we probably have the biggest and the best proprietary pipeline in the industry, and we continue to lean on it. The 25b flow cell remains on track for launch in the second half of twenty twenty three. We continue to push forward on the Illumina the Illumina CLR enrichment assay, Particularly when that's particularly compelling when you're using it with the 25b flow cell.

Speaker 2

We continue to move forward on the XLEAP SBS chemistry for 1 ks, 2 ks and we're going to have future offerings for emerging markets for things like proteomics, multiomics and spatial.

Speaker 3

Yes, maybe I'll jump in on China, right. So yes, we did see like other companies a Slower than expected recovery in the second half of the year. Remember, we had expected China in the first half of the year to be Somewhat soft and recovering from the COVID challenges and then we had expected an acceleration in that recovery in the second half of the year. We do not currently see that happening both because of some of the challenges that you've seen to the broader economy in China, but also for us from an increased competitive intensity that we are seeing in China on the mid throughput and low throughput segments. I think with respect to sorry, your second part of the question was on The oh, yes, everything ex China, right.

Speaker 3

So there it's a little bit of a I don't think the situation is Dire as it was in last year, it was more what we are seeing is a little bit of conservatism given the economic uncertainty in The speed at which people are coming back online or purchasing. So we have seen a little bit of lengthening of cycles in terms of purchasing behavior, Both on our instruments side were mid throughput and low throughput and also on some of the consumables Activity as I indicated remains strong, but it's just that any newer projects or new instruments that are coming in are slower than we had expected. Our win rate in and we track this pretty closely in terms of both mid throughput and of course on the high throughput side remains high. In fact, it picked up slightly compared to Q1 and Q2. So again, I think it's more that it's more of a Lengthening out of cycles and purchasing cycles rather than anything related to competitive intensity on those fronts.

Speaker 3

And then sorry, I just want to make sure I'm hitting everything. So customer challenges, yes. Yes. And then on the X, the issue is not competition at all, right. We as I indicated, I mean, we are seeing continued strong interest and strong interest From, of course, our existing customers, but also newer customers or people that are moving up from mid throughput.

Speaker 3

We continue to see that our ability to actually deliver on the instruments is Continues to maintain that interest. And then in terms of as Chuck mentioned, right, in terms of what these instruments are enabling, there's a whole new set of experiments that are on a larger scale Going forward, again, this is a lead indicator for us. Obviously, people have not ramped up on the X fully, but it is a lot about Transitioning to the X and being able to take advantage of the many capabilities that it's providing beyond just the price aspect of it, right. So the Dragon on board, the faster capabilities, the simplicity of the workflow, obviously The ambient ship reagents. So there's a lot that goes into that beyond just that the focus on, oh, it's going to help us With the lower price per GB.

Speaker 1

And our next question will come from Dan Arias with Stifel.

Speaker 6

Good afternoon, guys. Thanks for the questions. Joydeep, obviously quite a few moving parts On the top line and the OpEx line, and it looks like what you're doing in terms of cost reduction and expense management is part of a multiyear effort. So I guess given where this year is headed, how are you thinking about op margins next year for the core business relative to the 25% target that you talked about last quarter? Thanks.

Speaker 3

Yes, absolutely. Thanks, Dan, for the question. So a couple of things, right? So one, you're right, We started off and as we committed to in our Q1 earnings call, we started off a broad look at our cost structure and Actually at the end of Q1, we proceeded with beginning a cost reset that we have executed on and actually have taken out On a run rate basis more than $100,000,000 annually of cost. During the second half of the year, just given some of the uncertainties in the broader economic space, we continue to keep a very close Eye on managing expenses and being very careful about allocating expenses to the highest return areas including the innovation areas that Chuck talked about.

Speaker 3

Given the challenges we are having this year, obviously, we acknowledge that getting to Margins next year is going to seem like a stretch, but we remain very committed to planning for and delivering on those margins And that's the way we're moving forward.

Speaker 1

And we have a question from Vijay Kumar with Evercore ISI.

Speaker 7

Hey, guys. Thanks for taking my question. I had a 2 part question, mostly on the guidance here. Your I think for Q3 you said 3%. Your comps for Q4 look pretty easy.

Speaker 7

Historically, when I've looked at your sequential revenue ramp from Q2, it's always been up. Now look at your 2nd quarter trends, Sequentially, instruments are up, consumables are up, your pull through for boxes up, China was up. So is there anything incremental headwinds that we should be thinking about for the back half? Why your back half shouldn't follow historical patterns? I think a related question here.

Speaker 7

You mentioned 800,000 to 900,000 pull through on the Nova 6 ks. I think there's been some concern The pull through on the NovaSeq X perhaps might be lower because of the lower sample price point. Maybe can you just walk us through your assumptions around pull through for the Noah X? Could we perhaps see have rebound because I'm assuming inventory levels here for customers are pretty low and they need to restock.

Speaker 3

Wow, Vijay, good to hear from you and that was a long multipart question. So let me try to get to unpack So first of all, for the full year guidance, given that it has come down, the components roughly fall into 3 categories. About 25% of the reduction in guidance really comes from China. And as I mentioned earlier, for China, that's a 2 part thing. We are seeing A slower than expected recovery in the larger economy, including some liquidity challenges for mainly our clinical customers.

Speaker 3

And we are seeing a higher competitive intensity that affect the mid throughput and low throughput segments. That's 25%. The other 75% is roughly equally split into 2 buckets. So one part is around the transition to the X and The gap we are seeing in terms of the high throughput consumables, right? And this is an issue of The 6 ks consumables going down pretty rapidly as people are planning to transition to the X and again exacerbated somewhat by The larger number of Xs we are delivering and the other part is a slightly slower than expected ramp up on the full utilization of the X.

Speaker 3

The other 50% of that 75% is coming from some of the customer conservatism that we are seeing in terms of Longer sales cycles and slower than expected recovery on across the board, right, but in across beyond China. So now in Q3 versus Q2 sorry, Q2 versus Q1 and then Q3 versus Q2. So we did see a ramp up from Q1 into Q2 across many dimensions. Obviously, we shipped more excess, so we saw A jump on the instrument side. We did see a healthy ramp up on our 6 ks consumables, Primarily driven by the clinical segment.

Speaker 3

And you're right, we did actually see a jump from Q1 to Q2 in China, But that was expected given China was really depressed for us and other companies in Q1. Moving on to Q3, what you're Seeing in some of the sequential ramp down, there are 2 big reasons for it, right. 1, the aforementioned 6 ks consumable reduction is going to hit sort of a local maxima there Because of the larger transition expected to the X. So we're shipping more Xs, that impact on the 6 ks consumables Going to ramp up and we don't yet have a full ramp up on our ex consumables yet, right. We expect that in Q4 And I'll come back to that.

Speaker 3

And the other piece is we do expect China to actually be down slightly from Q2 again because of the expectation that The recovery is proceeding unfortunately more slowly than we had expected. And then the last piece around that is just we do expect Q4 to be up Significantly. And Q4 is the Q1 you actually start seeing the ex consumables come in. You see your traditional End of the year ramp up and some of the spend from company. So you are still seeing that and that's built into our guidance.

Speaker 3

The last thing you mentioned was about pull through. And pull through, by the way, we only we have not given you pull through on X. We as with all new instruments, we'll only Come out with that once the instrument ramp up has stabilized. So we do expect given the interest in X and the kinds of Cohort studies and experiments that our customers are telling us they want to do ONEX, we do expect that our initial assumptions and pull 2 are still justified. On the NovaSeq 6000, which is probably what you were referring to, We are we have called down our pull through numbers for this year, but that is really driven by The transition to DX and the larger than expected impact of that transition that I've talked about.

Speaker 1

And we'll take a question from Tejas Savant with Morgan Stanley.

Speaker 8

Hey, guys. Good evening. So one, Chuck, for you on the leadership changes here. Perhaps, Joadeep, feel free to chime in as well. Dan asked about sort of margins and your commitment to 25%, and you Call that sort of stretchy, but something that you're certainly committed to.

Speaker 8

Would that sort of framing apply to your mid teens that you had talked about at the Analyst Day as well for core Illumina. And Chuck for you on the leadership changes, I mean beyond sort of CEO seat, obviously the CTO and CMO search is underway as well. Any color you can share there on the thought process behind that? And then on the base business itself, on the NovaSeq, placements here for the X clearly came in, I think it was 28 to 30 units above at least where we were, but instrument sequencing instrument revenue was beat us by only about 5% to 6 Right. So the question really is, are you seeing more aggressive discounting?

Speaker 8

I mean, is that something Illumina is pushing through in response to the macro environment? You called out sort of BGI starting to be sort of competitive in China, but just any color on just the pricing dynamics on the instrument side

Speaker 2

Yes, Tesh. Thanks for the question. On the executive team and on the process here, So I think the first thing we want to do is just both thank Alex and Phil for all the things that they've done for Illumina. With Alex, What we know is that he's moving on to a new role. He'll be taking the CEO in another company.

Speaker 2

And I think that we should be really proud to see the kind of Leadership that we grow out of Illumina. So Alex started with Illumina, went over to GRAIL and came back to Illumina, Now he's going to land as a CEO and we're all looking forward to kind of where that's going to be. We have a really deep bench in our R and D program And it's really heartening to see employee number 4, Steve Bernard, who is the first scientist that the company ever hired, bringing him into that role. He knows the technology, he knows the team, and he'll be able to seamlessly pick up where Alex left off. On the Chief Medical Officer, we're going to take some time and look at that organization.

Speaker 2

We're going to evaluate where we are on the Clinical side and on the medical side, our commitment to our clinical customers, our clinical markets and our clinical programs continues And we'll open up that search after we have some time to examine exactly where that organization fits and what we need.

Speaker 3

Yes, Tejas, thank you. Picking up on your other questions. First of all, in terms of Margins and the implied long term growth in mid teens. So look, the long term growth in mid teens, By the way, our expectations on that have not changed, right? And that was, as you know, underpinned on 2 things, right?

Speaker 3

1, A large and growing market that NGS is still underpenetrated in. And the ability then by through our innovations addressing the core needs of that market for NGS and Illumina And that then manifests itself in the sequencing volume growth along the three dimensions I had mentioned earlier. First, Ron, ever increasing number of samples, again, more cohorts and things like spatial and Single cell really driving more of that. The increasing number of analyses per sample, so again that's really being driven by NGS being able to handle more of the multi omic side of the questions that our customers are asking. And lastly, just the higher sequencing intensity, Right.

Speaker 3

So as you move towards larger panels, as you do more things in liquid biopsy or things like MRD, So all those remain intact. I think where we are really looking for in the next A year or so, right, as X kind of comes online and enables a lot of these moves into things that we talked about, how quickly does that ramp take place. So but in the long term, nothing of what we had guided Really has changed in our mind and we are looking forward to seeing how the X kind of evolves us down that path. You had asked 2 other questions. So one was around, oh yes, the X and the revenue Growth on the instrument side not being that high.

Speaker 3

So as I mentioned, right, so we are very pleased that we were able to deliver on the X and ramp up our supply much faster than expected. I think this is a good thing in the long run. What offset that higher number of Xs was 2 fold 2 things that I mentioned earlier. So one, We did see on the China side that we did have a lower than expected number of mid throughput and high throughput Not mid throughput and low throughput instruments. And in general, overall, Given some of the lengthening of these of the purchasing cycles, we did see a lower than expected mid throughput and low throughput instrument sales across the world.

Speaker 3

Now unlike as in China where competitive intensity was a factor, In the rest of the world, we actually did not see our win rate go down. We actually saw it climb a little bit in Q2. Also with respect to pricing, we track this very closely, right. So in China, yes, we are being very surgical about When to use price and given the type of customer, but we did see a price decline overall in China. In the rest of the world, our price actually remains on track to where we expected it to be.

Speaker 3

And we're Proceeding along what we wanted to do with using price as a means to encourage faster adoption of our technologies. And I see, did I cover all your questions? Yes, I think I covered them. Thank you.

Speaker 1

And our next question is from Sung Ji Nam with Scotiabank.

Speaker 9

Thanks for taking the question. Just a clarification question. In terms of the cautious purchasing behavior, is that more for your Academic customers, or is it also across clinical as well? And then sorry if I missed it, but Kind of roughly what percentage, I guess, of that the consumable delay in purchase is attributable to The launch of the higher density, the 25B and kind of waiting for the higher better economics in terms of sequencing? Thank you.

Speaker 3

So thanks for the question. So, no, the cautious purchasing behavior again broadly ex of China is across both academic and clinical segments, right. The reasons are slightly different. I think a lot of our clinical customers Our not profit making companies, right. So they are managing their cash as you would expect them to.

Speaker 3

And while they're they continue to have sequencing at their core, we have seen that their purchasing Yes, intensity has come up less quickly than we had expected it to. In terms of your second question on how much of a delay is there for 25B, I don't think there's a delay in 25B. So what I was trying to Articulate is off the reset in guidance for the whole year, about 25% of that came from the impact from China. The other 75 About 50% of that 75% really came down to this impact on high throughput consumables due to the transition on X, right? So that includes, as I said, more transition on the 6 ks faster And then a little bit of a delay given some of the issues I mentioned in Q2 that we are already deploying solutions in the field.

Speaker 3

There's a little bit of delay that is flowing through in 2023.

Speaker 1

And we have a question from Rachel Van Stel with JPMorgan.

Speaker 10

Great. Thanks for taking the questions and good So first up on guidance, you cut revenue growth by 7.50 basis points at the midpoint for the year. You walked through a few of the moving pieces between more cautious CapEx environment, China and then some of these lower consumables as customers are transitioning to the new platform. So can you just give us a more granular breakdown of From that 750 basis point cut, how is it really broken out across those three areas? And then as a follow-up, I just want to follow-up on some of the earlier comments on China, Just mainly relating to some of these stimulus packages, we've heard that there could potentially be another tranche of stimulus in 4Q.

Speaker 10

So what are you hearing regarding stimulus packages? I know you guys weren't seeing much of a benefit in 1Q, but did you see anything in 2Q? And then How is Simulife contemplated in guidance for the back half

Operator

of the year? Thank you.

Speaker 3

Yes. So I'm going to go through, I mentioned The breakdown is early. So very quickly, Rachel, I think about 25% of that guidance reset is really Coming from the impact from China, of the remaining 75%, approximately 50% of That 75% really was coming from the impact on high throughput consumables related to the transition to the X. And then the other 50% ex You know is some of the cash conservatism that we are seeing with customers outside of China, right? So that's roughly the math how we see the math Well, working out.

Speaker 3

In China, first of all, there is no stimulus built into our expectations for the second half of the year. There never was in our guidance as well. As far as we could see the stimulus in the first half of the year benefited more of the industrial segments, which we don't play in. And there is no we didn't see any stimulus in the second half sorry, the second quarter either, right? So it's consistent.

Speaker 3

We have not built it in And we hadn't initially as well.

Speaker 1

And our next question will come from John Sauerbier with UBS.

Speaker 11

Hi. Thanks for the question here. Maybe just a couple of clarifications. So appreciate confirming the long term guidance It does sound though that some of the China headwinds there could be structural with some of the competition increases there. I guess just have the long term Outlook for that market changed at all?

Speaker 11

And then just follow-up here, just on the complete long reads, any color there on what you've seen the demand for that launch? Thanks.

Speaker 3

Yes, let me take those in order, right. So I think you're in For China in terms of the long term outlook, look, I think China remains an important market for us And we are committed to serving our customers in China. There is a our brand in China actually is Very positive and again, we remain committed to serving that market. Now again, given some of the changes we're seeing, We will continue to kind of refine our strategy in terms of how we go to market there, the kinds of partners we choose in order to reach the relevant segments, the highest growing segments of the market better and more efficiently. So none of that has changed, but we continue to observe how China is going to evolve from its current condition as most other people in our space are.

Speaker 3

In terms of the Illumina complete long reads So the interest on that has been very high, right. We have a large number of customers that have taken the current WGS product And I've are working on it. I think really we had always anticipated that the real jump into this technology would come from the enrichment product which we are on track to delivering, but that also is coupled because of the economics involved in it, Really coupled with the launch of the 25b flow cell, right? So we are that is still coming through towards the end of this year and really pick up into as we go into 2024.

Speaker 1

And that concludes our Q and A session. I will now hand the call back over to Sallie Schwartz.

Operator

Thank you again for joining us today. As a reminder, a replay of this call will be available in the Investors section of our website. This concludes our call and we look forward to seeing you at upcoming conferences and other events.

Speaker 1

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.

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Earnings Conference Call
Illumina Q2 2023
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