Microchip Technology Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 8, 2024

There are 14 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the 4th 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.

Speaker 1

Hello, everyone, and welcome to our earnings call for the Q4 year end 2023. During the call today, we will review the financial results we released after the close of market and offer commentary on our commercial and regulatory activity, after which we will host a question and answer session. Our earnings release can be found in the Investor Relations section of our website at alumina.com. Participating for Illumina today will be Jacob Tyson, Chief Executive Officer and Joydeep Goswami, Chief Financial and Chief Strategy and Corporate Development Officer. Jacob will provide an update on the state of Illumina's business and Joydeep will review our financial results, which include GRAIL.

Speaker 1

As a reminder, GRAIL must be held and operated separately and independently from Illumina pursuant to the transitional 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.

Speaker 1

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 10Q and 10 ks. With that, I'll now turn the call over to Jacob.

Speaker 2

Thank you, Sally. Good afternoon, everyone. As you know, I joined Illumina as CEO a little over 4 months ago. In this time, part of my focus has been on meeting with customers to understand their priorities, Hear that feedback and develop more collaborative relationships. Our customer thinks highly of Illumina and our solutions.

Speaker 2

And they want to work in strategic partnerships with us to move the whole NGS ecosystem forward. Now that we have announced that we will divest Graeme, it has been easier for our customers to plan what their future looks like with Illumina. These meetings have been instructive and inspiring. During my recent trip to Europe, I was able to see firsthand How we are working with our customers, governments and the broader genomics community to accelerate whole genome sequencing adoption safely And more effectively and to understand rare diseases and cancers as a part of the standard of care. I've also learned about Germany's model project that aims to fully integrate comprehensive genomic testing into the healthcare system there beginning in Q2 this year.

Speaker 2

Within the hallways of our headquarters and in several global offices, I have also been connecting with our talented employees who are committed to driving innovation and continuing to build out the Genomics ecosystem. I've also had an opportunity to engage with many of you at recent investor conferences. These conversations are informing my leadership agenda. And importantly, having reinforced my confidence in Illumina's core business. 2023 was a dynamic year for Illumina.

Speaker 2

NovaSeq X has been the most successful high throughput product launched in our history. We ended the year with 352 NovaSeq X Shipments above the 330 to 340 we expected amid a challenging macro Economic backdrop that we saw many of our customers remaining constrained in their purchasing decisions. In the 4th quarter, We delivered higher than expected consolidated revenue of approximately $1,120,000,000 Americas revenue, which is more than half of our business was flat year on year. Europe revenue was up 17% year on year on a relatively easy prior year comparable. Aimia revenue declined 1%, although that included a 10% point impact from sanctions in Russia.

Speaker 2

Greater China revenue was down 13% year over year, reflecting continued geopolitical challenges and local competition in mid throughput. As I've noted before, China and our customers there are important to Illumina. We've already taken certain pricing and other We will share more specifics on our progress there over time. Globally, we expect our customers will remain cautious. And for now, we continue to expect 2024 to look very similar to 2023.

Speaker 2

While some macro headlines are encouraging, we haven't yet seen that translate to increased investment in our industry and therefore have not reflected it in our guidance. Jairajeep will take you through more details in our guidance While we cannot control the external environment, the management team and I remain committed to accelerating value creations across the enterprise. As you are aware, I have laid out 3 key priorities that I believe will position Illumina for accelerated growth And profitability as market conditions improve. My first priority, driving our top line is centered on continuing to grow our installed base and helping customers accelerate utilization of these instruments in new and existing applications. I discussed earlier how pleased we are with the 1st year of NovaSeq X shipments.

Speaker 2

For high throughput more broadly, across the NovaSeq X And NovaSeq6000 replaced more than 400 instruments in 2023. In 2024, We will support this growing installed base as customers launch large projects and more sequencing intensive applications like Nutiomix, liquid biopsy and minimal residual disease or MRD. We anticipate ongoing high throughput instrument orders throughout 2024, primarily coming from further conversion of Nova six thousand customers to the X from customer fleet expansions and long term from new to high throughput customers. With that said, given the significant number of placements in 2023, we believe we will ultimately ship fewer High throughput instruments in 2024. As you're aware, XLEAP SBS chemistry has been the engine for our X platform delivering significant improvements in quality, turnaround time and cost.

Speaker 2

This quarter, we'll be making XLEAP available to our mid throughput customers on the existing NextSeap 1ks2ks instruments without having to upgrade the instruments. This offering will further strengthen our leadership position around the world and drive progress in markets such as single cell, spatial and proteomics. As we grow installed base, we remain focused on Our customers as they launch new projects. This will build momentum for consumables demand this year and going forward. Already our efforts to develop this demand is paying off.

Speaker 2

In Q4, we saw higher than expected growth in ex consumable sales Following the late October launch of our much anticipated 25b rating kit, more recently in January, we launched a 1.5b kit, which together with the 25B and the 10B flow cells allows us to offer a full suite of products to the NovaSeq X customers. While we will continue to see customers reduce their inventories of NovaSeq 6,000 consumables as they transition to the X, Building pull through on the NovaSeq X will drive our overall high throughput consumables growth this year. Turning to my second priority, I'm focused on delivering operational excellence by applying greater rigor throughout our P and L, while sustaining innovation and growth. We have launched a multiyear effort focusing on improving our margins through greater productivity And pursuing additional areas for cost savings. In January, we took an additional action to further optimize our global workforce.

Speaker 2

Over the past year, we have made cumulative roll reductions totaling approximately 12%. Our most recent actions including adjustment that we aligned with our late 2023 portfolio optimization efforts. You'll see us continue to take steps to not only manage our near term cost, but also to build our agility to deliver more sustained growth and margins over time. Illumina is taking a highly disciplined approach to support our customers, employees and partners and to deliver shareholder returns throughout a range of macroeconomic environments. Moving to my 3rd priority, which is working to resolve GRAIL as Since joining Illumina, I've made it an imperative to move with speed on Gray.

Speaker 2

In December, we announced that we would divest Gray with a goal of finalizing the terms of the transactions by the end of the Q2 this year. We'll continue to pursue ParaPath. The divestiture will be executed through a 3rd party sale or capital markets transaction consistent with the European Commission's divestiture order. To date, we've been able to make swift progress. GRAIL's Form 10 has been confidentially filed with the SEC.

Speaker 2

Advisors are actively moving the process forward on both sale and capital market path. The Special Committee of the Board that we established in Q3 continues to help ensure this process move forward efficiently. I'm encouraged by the momentum we've entered 2024 with and I'm committed to seeing our initiative through. For now, I will ask Jadeep to share more detail on our results for 2023 and our outlook for 2024.

Speaker 3

Thank you, Jacob. 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 2024. I'll be discussing non GAAP results, which include stock based compensation. I encourage you to review 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. In the Q4, consolidated revenue of $1,120,000,000 was up 4% year over year, both on a reported and constant currency basis.

Speaker 3

Consolidated revenue was flat from the Q3 of 2023. Non GAAP net income was $22,000,000 or $0.14 per diluted share, which included dilution from Grail's non GAAP operating loss of $152,000,000 for the quarter. Non GAAP EPS exceeded our expectations, driven by higher revenue and gross margin and lower operating expense for the quarter. Our non GAAP tax rate was 55.4% for the quarter and 41.8% for Full year 2023 compared to 29.3% in Q4 2022 and 26% for full year 2022. Although both periods reflect the impact of R and D capitalization requirements, the impact to our effective tax rate from the consolidation of GRAIL's losses.

Speaker 3

Absent the impact of GRAIL, our full year 2023 core tax rate was in the mid-20s. Our non GAAP weighted average diluted share count for the quarter was approximately 159,000,000. Moving to segment results. Core Illumina 4th quarter revenue of 1.1 $1,000,000,000 was up 3% year over year on both a reported and constant currency basis and included an anticipated reduction of approximately 5 percentage points from 2 primary categories. 1, the decrease In COVID surveillance and the effect of sanctions in Russia that together represented approximately 3 percentage points and 2, The year over year reduction in China revenue that represented approximately 2 percentage points.

Speaker 3

Despite these impacts, Core Illumina revenue exceeded expectations due to stronger than projected NovaSeq ex placements and uptake in ex consumables with strong early demand for the 25 bead flow cell that launched in Q4. Core Illumina sequencing consumables revenue of were largely offset by the anticipated reduction in NovaSeq 6000 consumables and the impact of pricing transitions as customers continue to adopt the NovaSeq X. Total sequencing consumables revenue was also impacted by COVID, Russia and China factors that I previously noted, as well as the continued impact of macroeconomic conditions on customers' purchasing behavior. COVID surveillance contributed approximately $4,000,000 in total revenue in Q4 2023 compared to $20,000,000 in Q4 2022. Turning to sequencing activity.

Speaker 3

Total activity on our connected high and mid throughput instruments grew 46% year over year in the quarter Following the 29% year over year growth we reported in Q3. Sequentially, Q4 sequencing activity grew 13% from Q3. 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. Sequencing instruments revenue for core Illumina of $161,000,000 grew 10% year over year in Q4, driven primarily by NovaSeq X, which more than offset the decline in NovaSeq 6,000 shipments. Growth in high throughput instruments was partially offset by the expected decline in mid and low throughput shipments due to capital purchase and cash flow constraints that continue to impact our customers' purchasing behaviors as well as local competition in China.

Speaker 3

For NovaSeq X, we exited Q4 with 3.90 orders since launch. Our shipments of 79 NovaSeq X instruments in Q4 brought our total installed base to 3 52 instruments. While we expect most of our NovaSeq 6000 customers to transition to the NovaSeq X over time, we are still very early in this transition. As of the end of 2023, our net installed base for NovaSeq 6,000 was approximately 17 70 instruments, which reflects approximately 110 instruments that have been deactivated between 20172023. The majority of these were in 2023 due to customer transitions to NovaSeq X.

Speaker 3

We expect this to increase in 2024 as customers continue to ramp up utilization of NovaSeq X. Additionally, going forward, we will be reporting our annual instrument installed base figures on a net basis, which accounts for instruments that have been decommissioned or inactivated since launch. The information included on this slide includes additional details to help you with your modeling. We will be posting this presentation to our Investor Relations website following our prepared remarks. Core Illumina sequencing service and other revenue of $152,000,000 was up 16 Moving to the rest of core Illumina P and L.

Speaker 3

Core Illumina non GAAP gross margin of 64.7% for the quarter decreased 260 basis points year over year, primarily driven by the mix of lower margin strategic partnership revenue, Lower instrument margins due to the NovaSeq X launch, which is typical with a new platform introduction and increased field services and installation costs, partially offset by lower freight costs. Core Illumina non GAAP operating expenses of $507,000,000 were down $21,000,000 year over year, primarily due to continued expense reduction initiatives and lower performance based 18.5% in Q4 2023 compared to 17.8% in Q4 2022. Transitioning to financial results for GRAIL. GRAIL revenue of $30,000,000 for the quarter grew 30 Year over year, driven primarily by adoption of Galleri. Rail non GAAP operating expenses totaled $167,000,000 and increased $1,000,000 year over year.

Speaker 3

Moving to consolidated cash flow and balance sheet items for the quarter. Cash flow provided by operations was $224,000,000 Capital expenditures were $51,000,000 and free cash flow was $173,000,000 We did not repurchase any common stock. We ended the quarter with approximately $1,050,000,000 in cash, cash equivalents and short term investments. Moving now to 2024 guidance. As Illumina continues to move as quickly as possible to resolve GRAIL, given the uncertainty around the specific timing And impact of the GRAIL divestment, the company is focusing its 2024 financial outlook on core Illumina.

Speaker 3

Our guidance does not assume any impact for the potential divestment of Grail in 2024. Upon the completion of We will provide non GAAP EPS guidance for the full year 2024. As Jacob mentioned, our outlook assumes the Current challenging macroeconomic environment persists in 2024 and tighter funding and budget pressures continue to impact our customers' purchasing decisions. We expect full year 2024 core revenue to be approximately flat from 2023, reflecting the following offsetting factors. We expect core Illumina sequencing instrument revenue to decline in the high teens year over year, driven primarily by a decrease in NovaSeq X instrument placements.

Speaker 3

The reduction reflects the expected transition in our Adoption curve to early majority customers from early adopters and the lower backlog entering 2024 compared to 2023. We also expect capital and cash flow constraints to continue to impact purchasing behavior and moderate instrument placements in 2024. We expect core Illumina sequencing consumables revenue to grow in the low single digits year over year, driven primarily by modest growth in high throughput consumables as increased NovaSeq ex consumables purchases and sequencing volume outpaced the expected decline in NovaSeq 6,000 consumables and the impact of pricing transitions. Moving to annual pull through, going forward, we will be calculating and providing pull through figures based on the instrument's Net install base. As I mentioned previously, supplemental information is included in our earnings presentation to help with modeling, which will be posted to our Investor Relations website following our prepared remarks.

Speaker 3

Importantly, this does not change reported revenue in any way. We expect annual pull through for NovaSeq 6000 of approximately $700,000 to $800,000 per system in 2024, as customers continue to transition sequencing volume to NovaSeq X. We expect annual pull through for NextSeq 1ks2ks in the range of $80,000 to $130,000 per system in 2024, which primarily reflects the impact of customers transitioning to XLETE chemistry as it becomes available on NextSeq 1ks, 2ks. We expect annual pull through for MiSeq in the range of $30,000 to $40,000 We expect the remainder of our pull through ranges to be in line with historical guidance. We expect core Illumina total sequencing Revenue to be approximately flat year over year.

Speaker 3

This includes intercompany sales to GRAIL of approximately $30,000,000 which are eliminated in consolidation. We expect core Illumina non GAAP operating margin of approximately 20%. Our operating margin expectations reflect the benefit of our continued gross margin improvement and expense reduction initiatives, offset by normalization of our performance based compensation as well as the impacts of inflation and market based merit increases. For the Q1 of 2024, we expect core Illumina revenue in the range of $1,030,000,000 to $1,040,000,000 reflecting a year over year decrease of 3.5% to 4.5% driven predominantly by the following factors. We expect lower NovaSeq X instrument shipments year over year given that we are entering 2024 with a more modest backlog compared to the Significant pre order book reentered 2023 following the launch of NovaSeq X.

Speaker 3

We expect the increase in NovaSeq X Consumables purchases year over year to be largely offset by the anticipated reduction in NovaSeq 6,000 consumables and the impact of pricing transitions consistent with the trend we saw in Q4. We expect an increase in sequencing service and other revenue year over year, driven by strategic partnership initiatives and higher instrument service contract revenue on a growing installed base. For the Q1, we expect core Illumina non GAAP operating margin of approximately 18%. Lastly, for the Q1, We expect core Illumina non GAAP net other expense of approximately $12,000,000 with the year over year increase driven

Speaker 2

I will now turn it back over to Jacob for his closing remarks. Thank you. Thanks, Jadeep. Before we close and move to Q and A, I want to discuss what I believe success looks like both this year and the years ahead. Illumina has the opportunity to Truly drive the next generation sequencing ecosystem forward.

Speaker 2

We will deepen our relationships with our customers and seek out greater ways to collaborate and partner with them to drive greater adoption of NGS. Our goal is to make our customers the heroes in their labs and to support them as they expand their work in genomics and multiomics. In turn, this will help capitalize our market leading innovation and continue to differentiate Illumina and maintain our industry leading position across research and clinical markets. We will also continue to drive innovation that is focused on our customers' priorities. This include involving our sequencing platform and delivering greater sample to answer solutions.

Speaker 2

There is an opportunity to further integrate customers' workflow to build our share of wallet as we create greater value for our customers. Our comprehensive strategy work is well underway and we will share more with you later this year. I'm excited to be part of Illumina's leadership team that is driving our unmatched core business forward. Thank you for joining. I'll now invite the operator to open the line for Q and A.

Operator

Thank And our first question will come from Doug Schenkel with Wolfe Research.

Speaker 4

Hey, good afternoon, everybody, and thank you for taking the questions. I want to ask just about The 25b chip release and what you're seeing in the field entering The early part of the year. As you know, 25b reduces the cost per genome to about $200 but it also requires customers to have enough Samples to run to fully use up the flow cells. So what are you seeing in the 1st few months of availability? What spending on ex consumables?

Speaker 4

How did that trend relative to Q3? And are you seeing signs in the field that sample access This is not a problem as you see folks move to the 25 gs. Thank you.

Speaker 2

Thanks, Doug. And that was a nice one question there. So let me start by saying that we've been very pleased with the pickup of the 25B since the launch in late November. In fact, it kind of Performed over our expectations and have been very well received with our customers. So we continue to expect that this will continue to really drive Ex performance, but also of course it's completely now on lease the full performance of the instrument and thereby we also expect That the 25B, the availability of the 25B will have more customers to jump on to the X wagon here.

Speaker 2

I think we are seeing customers being able to load it. Of course, many of them are still doing validation work, but we are seeing that they have big enough Projects to load the closeout.

Speaker 3

Yes. And just maybe one quick add, right? About 40% of our ex customers so far have adopted the 25B.

Speaker 2

Correct.

Operator

And our next question will come from Puneet Souda with Leerink Partners.

Speaker 5

Yes. Hi, Jacob. Jojid, thanks for taking the question. So maybe just following up on that point, I mean, Sort of help us just understand how do you get to the low single digit growth rate this year? There is obviously 25b, there's reductions that are happening in from just the ex installs, cost per database is lower, China continues to be challenging and then the market backdrop is challenging too.

Speaker 5

So just maybe talk to us a little bit about sort of how do Continue to have confidence in the sort of a low single digit sequencing consumable growth rate. And I would really appreciate if you could provide us some Context around and details around GRAIL as well, what's the progress there? Any level of interest that you're finding? And what are you contemplating for spend on GRAIL this year? Thank you so much.

Speaker 2

All right. Thanks for that Puneet. And let me start by the latter part of this question about GRAIL and then I will have Jadeep chime in on our expectations here on consumers growth. But As I mentioned, we are very pleased with the announcement that we made here in December that we're now divesting Grails for sure. And I'm actually very pleased with the progress so far.

Speaker 2

We have our advisers really moving ahead and are in In connection and in conversations with the ruling parties, we are continuing to run a dual track.

Operator

Of course,

Speaker 2

it can be a capital market initiative or it can be a transaction. And so We still expect to be on track with the time line we were previously talking about that we would have all the terms finalized So we are at this point, we are not talking about since we are expecting To finish up with grade this year, we're not having any guidance on the expenditure for grade this year.

Speaker 3

Yes. And to address your question about the low single digits consumables growth, Puneet, so let me start by saying we were Very encouraged by the uptake of the 25B and 10B flow cells that we saw in the Q4. We're also very pleased to see the elasticity, The growth in underlying sequencing activity being driven by ex customers, right? So both of those are good. We saw that Uptick on sequencing activity now for the Q2 in a row.

Speaker 3

So again, it's broad based, it's both research and clinical customers And it's quarter on quarter and year on year growth. So what's offsetting that expected growth in ex consumables, as you rightly pointed out, is the expected Price transition as customers move from the NovaSeq 6000 to the X. This is very similar to the price transition that you saw when you were moving from HiSeq to 6 ks. And then of course some of the expected again reduction in 6 ks consumables as customers switch from one platform to the other, right. So that is the really big piece on the What's leading to the lower or the low single digit growth rate in consumables in 2024?

Operator

And our next question will come from Vijay Kumar with Evercore ISI.

Speaker 6

Hey, guys. Thanks for taking my question. And I had a 2 part question on this GRAIL. I know it was a confidential S-one. When will that be made public?

Speaker 6

And the reason I ask is Macquariell's operating losses were $700,000,000 last year. It's really hard to foresee a capital market transaction with those kind of spend levels. So I would be very curious to see What the S-one assumptions are on GRAYL? And on consumable pull through $700,000 to $800,000 on Nova 6000,

Speaker 7

Jyadip, is there like

Speaker 6

a cadence perhaps Q1 we're starting at the low end and is the assumption we exit Q4 at the high end of that range?

Speaker 2

Yes. So let's start with a great question and obviously we'd like to provide us much information to all of you as possible. Right now as you say The filing is confidential and I don't think it will be public available before very late in Q1 maybe dripping into Q2 here. So I think that's where we are at this. But as soon as it's available, we make sure you know.

Speaker 3

Okay. And then, Vijay, I want to be sure, you're asking about NextSeq 6,000 sorry, NovaSeq 6,000 pull through Numbers and how they modulate through the year?

Speaker 6

Correct, Rajdeep. Is there an assumption we start at the low end and exit the year at the high end or above the high end of

Speaker 3

No, there isn't. I think, again, pull through I will reemphasize is a calculated number. So it's more of The total amount of consumables sold in any quarter divided by the number of now the active installed base In the quarter, right. So and we don't have an assumption in terms of quarterly spread on that.

Operator

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

Speaker 4

Good afternoon, guys. Thanks for the questions. Jacob or Jodi, on the 6000 to X transition and just sort of thinking about the A big part of that bucket are these commercial labs that are watching their own margins pretty tightly and trying to find ways to be It's more efficient. So are you sensing that maybe you could see X adoption faster than maybe in a normal environment in order for those folks Take advantage of the cost savings. It seems like they're incentivized to do that, but I also know that the clinical wheel It's been slowly, so I'm just not sure whether that's a factor for them.

Speaker 2

Yes, of course, it's a relevant hypothesis come in with, what we have seen is that most of our clinical customers are using the opportunity with a lower cost and extra expand than the depth of sequencing, Providing bigger panels and so on. So what we are seeing is that most of the current panels continue to run on the Nova 66,000 and thereby continue to also drive Volume there and then they are right now validating many of the new assays or the new assays that Might not have been possible in the 6,000 due to the cost and so on to be on the X. So we're quite encouraged about that. We've also seen Several of our Specialty Labs customer now order tens of no CAGEX. So I'm encouraged that we will see a lot of volume here going forward on this.

Operator

And our next question will come from Subbu Nambi with Guggenheim Securities.

Speaker 8

Thank you guys. Thank you for taking the questions. You spent about $1,000,000,000 on R and D in 2023. Relative to 2019, the revenue has grown at 6% CAGR. However, R and D has grown 12% CAGR.

Speaker 8

Why don't you reduce R and D spend in dollar terms from current levels over the next 1 or 2 years? Can you outline where the spend is allocating?

Speaker 2

Yes, thank you. You're right that we continue to believe that there's a lot of innovation that Acquired and thereby investment into R and D in order to drive the whole NGS ecosystem forward. As I said, one of the things what I said previously is one of the things that I was really excited about is the pipeline of innovation that we in running right now and thereby also that will be a lot of innovation coming out from Illumina over the next period of time here. And we continue to believe that we are in the early stages of the whole opportunities NGS, but even also in Nutiomix and thereby we continue to make investment into that. You're also right that there has been an increase In R and D, and we're certainly looking to change that trajectory over time.

Speaker 2

We still believe that High level of investments required, but you will see here over the next years that the percentage spend in R and D versus revenue will start to come down.

Speaker 3

Just to add, Subbu, I think we have made reductions in R and D over the last year. It's been very strategic in terms of Specific aspects of the portfolio that we had considered as longer much longer pay time of payoffs are more risky. And we've also our overall R and D includes spend in certain areas like medical affairs, etcetera, that we were doing to Support customers and as they have matured, right, we have been able to pull back on investment there without affecting innovation.

Operator

And we'll take a question from Mason Carico with Stephens.

Speaker 9

Hey, guys. Thanks for the question. So for high throughput customers who have already purchased the NEXT, could you talk about the conversations You're having around potential fleet expansions. I mean, what portion of those opportunities, whether it's orders or shipments, Have already come through and how many remain an opportunity this year?

Speaker 2

Yes, I think I mean we certainly see a lot of our high end customers or high volume customers that started buying 1 or 2 NovaSeq X Starting to consider purchasing more instruments. So they're using the first few X to validate as they're on And then they want to expand into use the additional access to actually run-in production, but very few customers still gone into production mode and thereby there is a real big opportunity in front of us. I think that Less than half of our high volume customers have purchased an ex so far. So I think there's still a lot of opportunities there. But as also mentioned, some of the high volume customers that have purchased 1 or 2 have now put orders in for 10 instruments.

Speaker 2

So I think we're still in the very early stages and there should be a lot of opportunities here both in 'twenty four and 'twenty five to drive More placements. Yes.

Speaker 3

I'll just add, we weren't expecting to see that before the launch of the 25b flow cell, right? So really you're in very early innings there and we do expect to see those fleet expansions coming in this year.

Operator

And we have a question from David Westenberg with Piper Sandler.

Speaker 5

Hi. Thank you for taking the question. I'm actually going to hit on Some of the competition coming in, a couple of different things we saw at AGBT, for example, a combination of spatial and sequencing on one platform. How do you see that stacking competitively? Would you pursue a strategy like that?

Speaker 5

And then on Ultima and the $100 genome, Some of the specs look significantly better than it did a couple of years ago. How do you feel stacked up against the $100 price with some of your key bells and whistles? Thank you very much.

Speaker 2

Thanks, Dave. And of course we are tracking of course everything that is happening on the market and we take our competition very seriously. But I think you've also heard me On the multiomics place, I think you've heard me speak multiple times about multiomics. So we have And intention also to be in that space. I think we've been out talking about moving forward as a starting point with the proteomics here with our relationships with SomaLogic.

Speaker 2

But I think you can see that that actually we believe there is many more modalities that can be available on the instrument. So I think the Where we where Illumina is doing is that we will go out and provide that insight when we're ready to put something in the market and Speak less about it when it's more in the future. Secondly, we feel with the NovaSeq X where we come out with a very Back to price point for a lot of different applications and not only a very few ones. So I think we feel that we have a very attractive solution. But I also remind you that it's not only the cost per sequencing that anymore that is relevant, but also you need to look at the whole cost The whole workflow, how many manual steps you have, how much waste you are, is instrument spending and so on.

Speaker 2

So I think if you dig into the details, you will actually realize that Illumina has a very attractive and very differentiated platform.

Operator

And we'll take a question from Connor McNamara with RBC.

Speaker 10

Hey guys, and thanks for taking the questions. Appreciate it. Just a financial question on margins. You got into 18% in Q1 and 20% for the whole year, so how do we think about the cadence of the margin progression? And I guess same on tax rate, just you talked about a mid-20s for the core Illumina tax How should we think about that in 2024?

Speaker 3

Yes. So the tax rate again is something that You should expect to be relatively constant as you go into and so again for core Illumina into 2024. And this is again core Illumina, right? We are not giving guidance this year yet on the consolidated number. In terms of the operating margin cadence, again, that is typically that does go up as the gross margins tend to go up as we move into greater volume and through the year.

Speaker 3

In terms of operating margin, you will see A decrease in potentially in Q2 as the merit and the other inflation related aspects come Into play, but then you will see after that a quarter on quarter increase as we move into the rest of the year.

Operator

And we'll be happy to take that.

Speaker 3

Yes. And then of course, I think on the sorry, just one other thing, right. I know there's been some movement in terms of The R and D capitalization piece, but that is something we're monitoring very carefully. It has passed the House, but it still needs to get through the Senate and the President signing. If we get that, you can expect a further improvement in the tax rate, right?

Speaker 3

But we are not building that into our assumptions at this

Operator

And our next question will come from Sung Ji Nam with Scotiabank.

Speaker 11

Hi, thanks for taking the question. Just on the MRD assay under development with Janssen, I was wondering if you might be able to comment whether That's a tumor informed or tumor naive approach or something different altogether, and whether that might have whether there might be potential for that to be developed into an IVD assay in the future for clinical applications? Thank you.

Speaker 3

Yes. Thanks for the question. So again, To remind everyone, the approach that Illumina has is quite unique. It's a whole genome based MRD assay. It is initially a tumor informed assay, but it does have the potential with More data and behind it to at some point move into a tumor naive, right.

Speaker 3

In terms of being capable of being IBD, of course, as you know, we have invested very heavily in platforms and technologies and Structure that allow us to move assays to BIVD when the time is right, right? So right now, the agreement we have With Pharma has been mainly to explore this in various forms, but we can go move into IVD when the time is right.

Speaker 2

Let me also add that we have no intention of providing that through a clear lab, a commercial clear lab. We do have our clear lab that Of course, it's running very few samples, but we're not going out and commercialize it through our K Lab. In fact, we're very interested to work with Customers and partners to continue to develop this.

Operator

And we'll take our next question from from Patrick Donnelly with Citi.

Speaker 12

Hey, guys. Thanks for taking the questions. Joydeep, maybe a quick one for you and the follow-up would be probably More for Jacob, but just on the gross margin piece, can you talk about 4Q stepped down a little bit, came in a little light where we were. Can you just talk about anything that impacted that 4Q is the right way to think about the progression there throughout 2024? And then on the gross margin kind of pricing initiatives, Jacob, how are you thinking about just the price side?

Speaker 12

Again, I know someone mentioned AGBT competitors are making noise, kind of saying they're seeing discounting in the market, particularly on Kind of the mid throughput side. So just curious as you've taken a look here, what you're thinking about on the pricing side? Thanks guys.

Speaker 3

Yes. So Patrick, in terms of sequential decrease in Q4 on gross margin, There's several factors there, right? 1, revenue was lower. So that has an impact obviously in terms of Just absorption of fixed costs. We also did have a higher than expected ex Contribution and that coupled with more Of the partnership revenue, which tends to be lower margin driven, all affected our gross margin numbers.

Speaker 3

And then lastly, I will say there was a mix shift from 6 ks consumables Ex consumables and that also had an impact in our overall gross margin number for Q4. I will I'd say and I think it leads into your question to Jacob. We have made a lot of progress in 2023 in terms of COGS productivity and we started seeing the benefits of that as we rolled out of 2023 and into 2024 as well and beyond.

Speaker 2

Yes, if I when coming into the company here, Patrick and looking into pricing and how we are thinking about pricing going forward, first, I will say that Illumina is presenting a premium product and thereby I think also our customers are seeing that we can command Premium pricing in the industry, but I think more importantly is that only talking about cost per gigabase is probably too simplistic for most Our customers, they are more interested in the cost for the whole for samples for insights for the whole workflows. And that is of course including sample prep automation, but probably even more importantly, informatics, Which is also a key cost driver for our customers. So really with the Dragon platform and what we have in our comprehensive informatics Offering, we actually can provide the customer via very cost attractive solution. So Therefore, the thing about just talking cost per gigabase is kind of the maybe the old way of looking at in the future way we look at a little more Comprehensive. So I feel really good about that where we are and that said we will now with in the mid throughput with the XLEAP SBS chemistry will be available.

Speaker 2

We are coming out with a more attractive pricing, quality and more capacity on our 1 ks and 2 ks instruments. So I'm really excited about that and again driving elasticity based on that new price point. So you will see us really Move the knots on many more elements to just one pricing element.

Operator

And our next question comes from Eve Bernstein with Bernstein Research.

Speaker 1

Hi, there. Thanks a lot for taking the question. I wanted to ask about next seat placement. So there you ended the year With 885 placements and that's comfortably above where you were pre pandemic, but it's also below where you've been for the last two years. So how much of this do you attribute to just changing needs, obviously, post pandemic?

Speaker 1

How much do you attribute to the capital purchase and cash flow constraints that you talked about? And how much do you attribute to Competitive dynamics, which you also talked about, and then how should we think about what normalized demand here looks like going forward?

Speaker 3

Yes. So I think the major factors I would put 2, maybe 3, right? And then there's a subfactor. So The major factors as you rightly pointed out, coming out of COVID in 2021 2022, we had A real uptick in the amount of mid throughput instruments and low throughput instrument sales, right. And that has normalized a little bit as The COVID threat thankfully has reduced.

Speaker 3

We also at the same time did see in 2023 some of the macroeconomic conditions that led to More conservatism is at our customers and more conservatism in the purchases on capital come through. The third factor in mid throughput especially was also China, right. So if you're looking at an overall number, we did get impacted in China For competition and for macroeconomic reasons as we have repeatedly stated in our 2023 earnings calls. As far as competition goes, I mean, clearly that was a factor in China, but that does not seem to be a huge factor In the rest of the world, right? And we did see our we track our competitive win rates fairly closely and we did see that stabilize in Q3 and in Q4.

Operator

And moving on to Dan Brennan with TD Cowen.

Speaker 7

Great. Thanks for the questions, guys. On the ex pull through, we would come out of around $1,000,000 in the 4th quarter. And some quick math, we arrive at something like maybe $850,000 in 2024. So any comment on those numbers that they seem reasonable?

Speaker 7

And if so, could you just speak to like what would drive the assumption for that kind of sequential step down? Thank you.

Speaker 2

So thanks, Dan. And I think you've done more math than that than we have at this point since it's still way too early In the way early innings here to start to look at pull through from the X. So we haven't really done that math as of yet and we will provide that math We think we are more in a stable situation where it makes sense. Any other comments on that, Jardeep?

Speaker 3

No, I think I'll reiterate, look, it is early. I think Jacob stated earlier that many customers are just going through validation, especially on the 25B. So I will disagree with We haven't done the math, but the math is not relevant and we don't want to confuse you. When this stabilizes, right, we will absolutely come out with a number. But so far what we have seen has been encouraging to us.

Operator

And we have a question from Dan Leonard with UBS.

Speaker 13

Thank you. Jacob, I'm curious if you could elaborate further on the health of your diagnostics markets Following your customer listening tour and with looming FDA regulation of LDTs, how does that impact demand for your products or not?

Speaker 2

Yes. No, I think that's a good question. It's something also I really was eager to understand better Coming into Illumina, as you know, I have a background in IBD and I have a lot of passion for cancer diagnostic, but really fighting cancers. I think how we think about it, of course, that we serve a lot of clinical customers out there that is using the Illumina ecosystem and Bill, the company is on top of that primarily into the LDT space. And then we have our own offerings in other LDT, but in our place also IVD on Especially the TSO500 and the NRP and other places where and if you look into our TSO500 business, it's been growing really fast Over the last period of time and it's more than $100,000,000 now and we expect to have high double digit growth also Into this year and we don't see any end to that right now.

Speaker 2

So I'm really bullish around where we can bring that And we are of course looking into a strategic review right now on how does that fit into the overall Call business strategy, but clearly, we would also like to play in that space going forward. It wasn't another wasn't a second part of that question?

Speaker 3

Regulation impact.

Speaker 2

Yes, okay. So I think the second part was The impact of the regulation. I mean, of course, we're monitoring that very deeply right now and there's of course again A conversation with our customers and we're helping some customers make sure they're ready for that. Our the larger customers can of course go through a single site PMA, We've helped them, but there's also changes maybe in the leveling of the different So some of the Class III products are considered being brought down to Class II products right now. It's still kind of on the table for consideration.

Speaker 2

But if that happens, that will certainly also reduce the requirements for getting through clinical trials and so on. So, I think there's still a lot of moving elements, But what I can tell you is that I think Illumina is very well positioned to support the markets going forward almost independent on where FDA is landing on this one.

Speaker 3

I'll just add, Jacob, that we are about the only company that has, even in our REO products, ISO 13,485 classification on all our instruments and most of our consumables and we have obviously the path to IVD should Our customers want it, right. So we're well positioned to serve whichever direction they want to go in.

Operator

And our next question will come from Kyle Mixon with Canaccord.

Speaker 7

Hey, guys. Thanks for the questions. Just following guidance. So it seems like you probably had that opportunity to kind of establish an outlook that was softer than what you said in November, could have set a low bar. You kept the range though, risks Clearly remain.

Speaker 7

How much like visibility or confidence do you have? And how much conservatism are you kind of baking in compared to prior years? And you listed some, but what are the most material swing factors and kind of risks that we should consider in 1Q and then first half or second half? And if I could just ask one for you, Joydeep, on 6,000 pull through, the 700,000 to 800,000 seems like possibly aggressive compared to how high see kind of decline in its years post the 6,000 launch. So Just kind of walk through what you're thinking about in terms of the decline, I guess, or deterioration in 6,000 folder?

Speaker 7

Thanks.

Speaker 3

Let me address the 6,000 piece first. It's maybe an easier one, right? So remember when HiSeq was well, NovaSeq 6,000 was introduced. We didn't have as many clinical customers, right? So now we have clinical about 50% of our Conn's revenue is coming from clinical customers who have these validated assays, right, where you're not going to change platforms in the short term.

Speaker 3

So The overall reduction in pull through will be more mitigated compared to what you saw with HiSeq. Jacob, you want to comment on the overall guidance or you want me to? You can continue. Okay. So I think overall, look, We have repeatedly said, right, we see this as a prudent approach to the overall forecast, right.

Speaker 3

And while there have been Some signs in some markets that the macroeconomic conditions might be turning. We have not assumed this in our forecast. And the only place we have been pessimistic and of course has been in China, right, where the recent news also seems to corroborate That piece. As far as the puts and takes, look, it's a lot about adoption of the X, right? So We are spending an inordinate amount of time making sure that our ex customers can transition quickly, can adopt and get on with their assays as As quickly as possible and we will continue to do that.

Speaker 3

And of course if the markets pick up, we are very well positioned then to benefit from Any of the upsides. On the flip side, it's further macroeconomic headwinds that further reduce our customers' ability to bring on the X The spend on consumables will affect us as well. Jacob, I don't know if there's anything else you want to add. Okay. We're good.

Operator

And our next question will come from Rachel Van Stel with JPMorgan.

Speaker 1

Great. Good afternoon. Thanks for taking the questions. I just want to follow-up to your answer on Patrick's question earlier. You mentioned that the gross margin line in 4Q was lighter due to that consumables mix shift from 6,000 to the X.

Speaker 1

So can you just walk us through that dynamic a little bit more? Is this just a function of the axles ramping so there's less volume leverage at this point? Or is there something where as consumables are structurally lower margin and then how should we think about that consumables mix impacting gross margin throughout 2024 as well?

Speaker 3

Yes. So, 1st easy part is, no, we have said right all through, right, that we had designed The X and X consumables that at scale, right, they would we would expect the margins to be comparable to X consumables at scale. What you're seeing is, of course, early on in the adoption, you're going to see the consumables margins be lower. We haven't fully scaled up. And as we move through 2024, you will see that more or less normalized.

Speaker 3

Now as you go into 2024, overall gross margins will be Have several factors, right? So one, we will have a little bit of a benefit From the lower placement of instruments, as we've said right there that we do expect that to Declines are a little bit more consumables that will lead to an increase in gross margin. We also will benefit from Some uptick in terms of all the actions we have taken to improve COGS productivity. So those are the 2 Largest things that will serve to improve our gross margins as we get into 2024.

Operator

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

Speaker 1

Thank you 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.

Operator

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
Microchip Technology Q4 2023
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