Illumina, Inc. (ILMN) Earnings Call Transcript & Summary

[Audio Gap] Jacquie Ross from Illumina to the Cowen conference. As everybody here knows, Illumina's been the leading supplier of next-generation sequencing tools to the world for the past decade plus. We have a lot to get through over the next half hour. We'll see how far we get. But before we jump into it, thanks again for being here. Any opening remarks or we also have the safe harbor, right?

Yes. So let me start by saying thank you, Doug, and the entire Cowen team for hosting us today. Thank all of you for making the time to be here. Let me start by reading our safe harbor statement. I've been asked to remind you that my comments today could include forward-looking statements you should refer to our SEC filings for a discussion of the risks and uncertainties that could cause results to differ materially from our current expectations. It is our intent that all forward-looking statements regarding our financial results and commercial activity made during today's discussion will be protected under the Private Securities Litigation Reform Act of 1995.

All right. Great. Thanks, Francis. Maybe to kick off with a topic that's at the forefront of all of our minds right now, and we've been asking everybody who we've done these discussions with over the past 2 days to comment on COVID-19 and what your -- really what your business exposure is from a revenue risk standpoint, the supply chain positioning perspective, how you're positioned when it comes to supply chain and then also what opportunities have you found to be helpful when I would think, in your case, moving along with diagnostics and monitoring of the outbreak?

Sure. As you can imagine, COVID-19 is top of mind for us, and there are a number of aspects that we are monitoring closely. First and foremost, we want to make sure that our employees are safe, and so we've put into place programs to make sure that they stay safe. For example, in China, our employees are working from home. We are limiting travel, certainly, to some regions in the world. But in general, we're limiting travel to sort of business essential travel. The other thing we're doing is monitoring our supply chain and our ability to continuously serve our customers. The reality is we don't really do manufacturing in China. And as we've gone through our suppliers, we have a small number of suppliers out of China. At this point, they are continuing to able to supply to us. In addition, we're monitoring our ability to deliver our products to customers in China. And at this point, we're still able to do that. Our dispensation is for certain types of products to be distributed within China, and we fall within that category. The other change that's taking place is the 5% tariff that had been imposed on our hardware going into China has been removed. And so that's played out over the last few weeks. From a business perspective, we expect that the majority of the impact from a revenue perspective in Q1 to be in China, and we're monitoring that closely. China, as you know, represents about 10% of our business. And there are a number of things playing out. One thing that's playing out is that the authorities in the Chinese CDC are using our sequencers as part of managing the outbreak. And so some of you may have seen the photo in the Chinese Daily of the iSeqs in -- but it's iSeqs, it's MiSeqs, it's MiniSeqs that are being used as part of managing the outbreak. And so on the one hand, we expect some impact from increased use of sequencing in that application, which historically has not been a big application for us. We expect that there may be some prebuying by customers taking place. On the other hand, it could be that there is an impact where people don't go into hospitals to get routine testing. And so we're monitoring to see how those puts and takes play out, and we'll update you as we have more information.

Recognizing this is no longer just a China challenge, is it just too early to even have a handle on how this might impact business in places like Italy and South Korea and some of the other places where the outbreak has been a little bit more pronounced over the last week or so?

Yes, it's too early at this stage. The dynamics we expect will be similar. There will be increased use for infectious disease monitoring. In fact, I think once we get through the COVID-19, I think you will see this potentially as a catalyzing event to say we truly do need a global surveillance network that will watch for naturally occurring viruses like we're seeing right now, but also for things like antimicrobial resistance or potentially even bioterror. And so I think there is an awakening in the -- certainly in the infectious disease community around the need for a global surveillance network long term. So I think as we come out of that, there will be more of a conversation around that. In terms of impact in those countries, it is too early, and I think you'll see the same dynamics, increased infectious disease, a question about whether the hospital capacity is there for routine testing.

Okay. All right. Thank you for that. Now let's just talk about -- to the extent we can put COVID-19 aside, just let's talk a little bit about the outlook for 2020 and the thought process behind your guidance, kind of the puts and takes and the different inputs there. So you set 2020 revenue growth guidance at around 9% to 11%. This is an improvement relative to 2019, but you're still below your trailing 5-year revenue CAGR, which is in mid-teens. And you've been very helpful in providing some very specific assumptions in terms of what you're folding in for things like POPSEQ assumptions. So first off, 2019 the financial performance wasn't always on target with what you expected, and the mix wasn't always what you expected. Yes, I know that's not the norm, and I know it's not something you strive for, of course. How does that play into how you approach the 2020 targets?

Sure. If we look back at 2019, we ended the year with 6% growth for the whole year. And as you pointed out, that came in short of where we expect it to be, which was 13% to 14% for the year. Coming into -- as we reflect back on 2019, coming into 2019, we're coming off a very strong 2018. We had 21% growth in 2018, which significantly exceeded our expectations at the beginning of 2018, where we expected 13% to 14% growth. So we're coming into 2019 with a lot of momentum, again, having significantly beat the numbers. And as we looked to 2019, there were a few things that we called out as drivers for the year. One, we called out the NovaSeq upgrade cycle as an important thing for the year. And one of the things we called out is that we expected to ship more NovaSeqs in 2019 than we had shipped in 2018, which is more than we'd shipped in 2017. So for the first time, we were calling out sort of a growing upgrade cycle. And typically, we see the first couple of years be big, and then it slowed down, and we've been very intentional about the NovaSeq upgrade cycle. And so one of the things we said to look for was the NovaSeq upgrade cycle. The second thing we said would be a story of the year was to look for the population sequencing deals. And we had a number of big deals that we were looking to get done in 2019: a deal with the U.K. NHS, a deal in the U.S. around the All of Us Research effort and the UK Biobank deal that we were working on. And we've been working very closely with those customers. And based on where we were with them, we expected those deals to close last year and to start sequencing last year. And the UK Biobank deal did close but closed later in the year than we expected. So instead of having a material first half impact, it really started to be a story of the second half. And then both the All of Us deal and the NHS deal in the U.K. pushed out of the year, and so that left us with a significant shortfall for the year. And the other thing that played out over the course of the year was we were starting to see the direct-to-consumer market turn. We had started to see a slowdown play out in the back half of '18, but we didn't expect what we ended up seeing last year. I think nobody did in that market, where we actually saw that market decline after several years of strong growth. And so those are the 2 headwinds that played out over the course of the year. We saw some population sequencing deals get pushed out, and then we saw the DTC market start to decline, and those resulted in the revenue shortfall. So we beat Q1. We saw these impacts in Q2, and so we revised our guidance down to 6%, which we made for the year, and then we beat Q3 and Q4. And so as we come into this year, we're absorbing those lessons, right? So one, from a DTC perspective, we are calling that market down again this year. And there was a little bit of a difference between how we looked at it and I think how The Street looked at it where they were expecting that market to be flat. Based on everything we saw last year, we called it down for this year, and we continue to expect that to be the case. And then in population sequencing, we are coming into this year in a significantly stronger position. We still expect those 3 deals to be contributors to revenue this year. But the...

One of those is already ramping.

That's right. UK Biobank already came into the year at full force, and it's continuing to go full force. So I think that's in a really strong position. We signed up to be the provider, the service provider for the NHS. We expect that to ramp in the middle of the year. And the All of Us deal is continuing to work. So those are the 3 deals. We're being very transparent with where they are, and those are the ones in our revenue. And so that's how we thought about this year.

One, I won't drag everybody through the mathematical logic. But I think there's a way to conclude based on the components of your revenue guide that you're assuming you're going to place roughly 800 NextSeqs this year. That seems like a big number relative to the last couple of years of placements where you placed closer to 600 NextSeqs per year. On the other hand, there's a lot of older instruments, keeping in mind when the NextSeq launched that are up for replacement. And so we've gone back and looked at Illumina's history. Illumina -- again, recognizing last year was a little bit of an anomaly. Illumina's typically very good at predicting number of placements in year 1 of an instrument rollout. So I guess the question is, on one hand, 800 seems like a big number. On the other hand, you talked about your guidance philosophy and the company has a good track record of hitting, if not exceeding, placement targets in years -- year 1. How would you tell the investment community to kind of balance these observations?

Yes. So I'll start by saying that what we've said publicly is we expect to sell 500 of the new instrument, the 2000 this year. And based on the data we've given you, our 800 number is right around where we expect it to be. There are going to be 3 components to what drives that 800, right? So one is going to be customers that were adding capacity. And that's -- those are the customers that were driving that 600 placement that we talked about for last year. They're going to continue to add capacity to their business, and it will be a mix between the new 2000. Some of them will buy that and some of them will buy the existing 550s or the Dx boxes. So one component is going to be the capacity adds, the people that were driving the 600. So where is the extra 200 going to come from? There are 2 buckets. One is the upgrade cycle. And so because of the superior economics from the workflow of the 2000, we do expect, as you pointed out, some of those customers with older machines to -- that have depreciated their machines to initiate the upgrade cycle. And those will be in addition to capacity adds. And then the third bucket is we expect new-to-Illumina, new-to-sequencing customers. Because of this price point, which is a new price point in this part of the market, we do expect some customers to be created new. NovaSeq was 1/3 of our orders. We're being a little more cautious than that, but we definitely expecting new. So those are the 3 buckets, the capacity adds, and those are the people that drove the 600, the 600-ish number, the upgrades and the new.

So does your -- recognizing there's no reason to stick your neck out on the stuff, I mean, that's all very logical. Would you say the visibility is pretty high in terms of where you're going to place these?

This visibility is very good. I mean this is, as you pointed out, an exercise we've done many times in terms of predicting. It is a bigger installed base, and so we're having to cover more ground, but there is good visibility around where we expect it to go. The early interest we're getting are from areas we expected. It is areas like RNA, single cell, panels, exomes, exactly as we expected.

I want to dig in on a couple of other things. I want to talk specifically about what's going on in China specifically from -- separate from COVID-19. I want to talk about competitive dynamics and then some of the new announcements at AGBT. But at a high level, maybe just 2 more questions. Well, actually, first, let me ask on POPSEQ. We talked about that already. I mean fair to say right now things are going in terms of -- going to plan in terms of what you're expecting for this year.

Yes, playing out as we expect.

Okay. And the other bars, I mean, I guess, there's always potential for programs to be delayed, but 2 of the 3 -- 1 of the 3 is already cranking. And then what you don't have in your guidance is upside associated with other POPSEQ programs coming on onboard this year.

And we've trimmed back the expectation in terms of the number of samples from 2 of those programs that haven't kicked off.

Okay. So then the high-level question is really one about just overall business philosophy, and I could go in a lot of different directions here. But I think one of the things that people didn't like about Illumina in the first 10 years post Solexa was really this kind of boom/bust, roll out a new instrument; beat numbers; year 2 comp gets tough; year 3, everybody thinks you're dead; and year 4, new instrument and repeat. And I think you wanted to get out of this boom-bust cycle. I mean I think that's something we've talked about over the years. Is that still -- how important is that to you today, given you're a pretty tenured CEO at this point at Illumina?

Yes, it's important for us to give more stable, more predictable growth to our investors. And much as investors didn't like the boom-bust cycle, we didn't like...

It's hard to run a business that way.

Exactly. And so we definitely want to move away from that. There are some things that are playing out that will get us away from that. One is we are intentionally planning our upgrade cycles to be multiyear cycles. You saw that play out with NovaSeq. So Instead of being the 2-year upgrade cycle, we actually saw the number of NovaSeqs grow from year 1 to year 2, year 2 to year 3. And so we said this is a 3- to 5-year upgrade cycle. It's playing out that way. We were very intentional in how we brought flow sales to the market and activated different parts of the market. So there are things we're doing about that, about driving a multiyear upgrade cycle that will help with the boom-bust cycle. Two, as you get just to bigger numbers, as our business gets bigger, the percentage of our revenue that comes from instruments gets smaller. So in 2015, it was 27% of our business. Last year, it was 15% of our business. And so naturally, you'll start seeing attenuation of that boom-bust cycle. And as we have more products in the market, no one upgrade cycle will have that same effect on the upside or the downside. And so there are a number of things in place, some intentional, some just where we are in the market that hopefully will give a more predictable consistent revenue growth.

All right. Super helpful. All right. China, so sales grew 25% in 2018. They were fairly nominal, if I remember correctly, in 2020 -- I'm sorry, 2019. On the fourth quarter call, you emphasized that you expect a rebound in China. Now again, COVID-19 changes things. But you are expecting growth. And I think, hopefully, as you get past -- as we all get past COVID-19, the expectation is you'll return to growth in China, and you've talked about this largely being driven by clinical applications. What -- I don't know if 2019 in China came together the way you thought it was going to. You called out research funding challenges. I mean other than that, are there things in China that didn't come together the way you thought they were going to come together last year?

I think the biggest driver of the slowdown last year was the research funding. And that tracks sort of a GDP slowdown translated into a shorter-duration cycle, but we're continuing to see good growth and very strong competitive position in the clinical markets, specifically oncology testing, where we are a -- we're a strong market leader, and then in NIPT, where we compete with BGI and we about have half the market reach.

Yes. Yes. In Europe, is it fair to say the competitive dynamics in China are a little bit different than they are in the rest of the world for you?

They are a little bit different in the sense that it is the home court for BGI, and we have a strong partner ecosystem that we go to the market with. So it's definitely a little bit different than the rest of the world.

So using that as a segue to broader competitive questions. So at AGBT, there were a series of announcements from folks like BGI, MGI, who we just talked about. On the relatively lower end, there's GenapSys. Recognizing there's a history of overpromising and underdelivering at AGBT over the years, I have to say that, at least in my humble opinion, the progress made by some of these companies over the past year was probably more than I would have expected. Do you think that the competitive environment is on the cusp of intensifying not just in China but globally?

As you pointed out, every year at AGBT, we do see new entrants. It's a great venue. And so there's a long history of sort of new, especially at the low end, new companies coming in. There's a long history of big promises. It continues to be a competitive environment. We continue to see venture money pouring in. We continue to see new companies emerge. Having said all that, if I look at our competitive position today, I think it's the strongest it's ever been in terms of where we are in the market today. Now we do watch the space very closely, and we're continuing to look for new technologies that emerge that could be disruptive in the long term. But at this point, I think our competitive position is very strong.

And do you feel like if you were to -- well, let me take a step back. I mean I think Illumina is confident in their competitive positioning but not dismissive of emerging competitors. And to some extent, you have to assume that folks are going to make progress, not to -- at the risk of putting words in your mouth. But let's say somebody is successful. I talked to a CEO of another sequencing-based company. And he said, "Well, if I were going to take on Illumina, I wouldn't take them on in short-read." And he asserted that you have plenty of levers to pull if a short-read competitor is more successful than some people might think. I mean is that a fair characterization in terms of what you can do in terms of the headroom to improve technology and the ability to reduce costs maybe a little more quickly than you would have otherwise planned? I mean is that a fair characterization?

Yes. I think that's very fair. And I want to agree with that point you made, which is, look, we want to stay humble and be very focused on where potential disruptions could come from. We're constantly scanning the marketplace. Technology as a whole and sequencing, in particular, has been a market that had disruptions over the course of time. And so we continue to watch the market. We continue to invest internally in alternative chemistries, alternative technologies across our architecture to see what could be disruptive. Having said that, as you point out, our core technologies have a lot of headroom. SBS, in particular, has surprised everybody with where it's come from, from the Solexa days, and it still has a lot of headroom. And then you add to it the innovations in optics that we talked about, new innovations in computing in the chipset and there's a lot of places we can go with the existing toolkit we have.

And that probably also includes porting some of what you're introducing to the market on NextSeq to either higher or lower end instruments over time.

Yes, very much so. You've seen that happen previously where we've taken core technology components and added it to other parts of our portfolio. But the other thing we're doing is we're pushing ourselves to say, "How would you compete with a competitor that was free?" for example. And that thought exercise is really important for us because what we want to do is make sure that there's enough value in what we are providing to the market and there is a rich enough ecosystem and a strong enough moat that even if somebody came in, and that will give you an example, internally. If you came to me today for Illumina and said, "I will give you a free CRM. Switch from Salesforce." I just wouldn't do it, right? Even though I pay Salesforce millions, the reality is it's just too much work, and it's not worth it. And so we want to make sure that the value we're bringing, it's us, but it's the entire ecosystem of innovation with partners like Roche and Qiagen and Thermo that are building a menu, so they have access to this broad menu. It's also the capabilities like doing federated queries. So if you are in the Illumina ecosystem, and you were trying to diagnose a genetic disease. You federate out a query to the network saying, "I have a child with these mutations. Has anybody seen that?" Well, that's unique value that we can provide because we have an installed base of customers. And so we want to keep pushing ourselves to say how do we create enough value that it creates a very strong competitive position.

This network effect that you can continue to build and enhance.

Yes. And I think it can be very powerful in this space especially.

Okay. I brought up the AGBT a few times. There were lots of announcements from you last week. A lot of focus on NextSeq, a lot of focus on Sample Prep. The integration of DRAGEN was pretty interesting, and that came up on our panel yesterday as being probably more positive in terms of how it's been received than I expected. What do you think investors should be most focused on in terms of what came out of the meeting last week?

Yes. I'd say a couple of things. You talked about the library prep work we're doing around with the PCR free workflow, the RNA workflow. But the 2 things I want to touch on specifically are, one, NextSeq 2000. A lot of people, it was their first chance to actually interact with NextSeq 2000, and we're getting really positive feedback. I think people are keen to sort of get their hands on it. And so it's a great opportunity to come out, if you like, with the NextSeq 2000. And then DRAGEN. And for us, DRAGEN is very strategic. It's going to drive some revenue to us, but it's a strategic move to us to move the definition of the sequencer from outputting base calls to outputting variance. And the NextSeq 2000 is the first time where we're building that into the sequencer. And so that's something to continue to watch and say if we can move the market from base calls to variance, that creates another significant competitive advantage to us and reshapes what you need to do as a provider to compete with the sequencer. So over the course of the coming quarters, we expect people to push against that pipeline, to test it, to feel comfortable with it and start to move to variance as the output of the sequencer.

Very exciting and interesting. All right. So we've made it somehow 24 minutes into this discussion without me bringing up NovaSeq, which is probably a new record. So you've mentioned this before. I mean you currently expect to place slightly fewer NovaSeqs in 2020 than you did in 2019. And I think you continue to expect that 1/3 of orders will come from folks who are new to sequencing. Who are these new-to-sequencing customers? And then do you think you can keep that 1/3 of placement ratio up within that customer group?

Yes. So overall, as you pointed out, that we continue to expect the shape of the curve to be such that we're in that 3- to 5-year upgrade cycle. So we continue to expect to place NovaSeqs, but less than we did last year. Consistent with the road map we've laid out, we were surprised that 1/3 of NovaSeq orders were coming from some -- these high throughput, but we weren't sure in the first year whether that was just sort of a launch number and it would taper down, but it has been very consistent now for 3 years as you pointed out. The -- what we're finding is that it's enabling new high-throughput labs. One company that's been public about it is PerkinElmer, for example, where people have created business plans saying they now have access to a high-throughput box, and they can buy it in the 1 or 2 and still be competitive with the existing large labs. And so we've seen that happen here in the U.S. It's also been a global story, where we've seen more high-throughput labs emerge in countries that nobody expected. We placed one in Bangladesh, for example. And so the accessibility that NovaSeq provides to high-throughput sequencing has really opened up a bit of a geographic story for us too. And so we expect that to continue to play out.

But one of the things, I think, folks were surprised by, including me, was just the change in the HiSeq installed base that you shared with us at the end of the year. And you really just cleaned up your numbers for the installed base. I think where we've got questions, and I know you have got questions, is how does that change how you think about the replacement opportunity? It's still a lot of labs, but it's fewer than I think what we're talking about a couple of quarters in terms of which labs had HiSeqs, but hadn't bought a NovaSeq yet. Does it at some level change how you think about the replacement opportunity for NovaSeqs, this cleanup you did towards the end of last year?

Overall, it doesn't. It's still a big enough number that we're pretty comfortable with the numbers we had in terms of NovaSeq placement. What -- and it doesn't have, as you pointed, there's no real impact in terms of actual revenue, it just gives us better visibility into which machines are actually being used. What that allows us to do is then arm our sales team to have a more focused conversation...

Better targets?

Exactly, which machines to actually target for upgrades and which one should be retired. And so that level of customer intimacy and insight is something you should expect us to continue to push to get more and more of, so we can have more targeted conversations with customers.

Who are these customers who haven't adopted yet and why haven't they? What are we? Year 4 now?

Yes. Approaching year 4.

So who -- what's the profile of these folks?

So the majority of them are the smaller cores, right? And so the first 2 years of the NovaSeq upgrade cycle, we already targeted the larger genome centers. And it was really only last year with the S Prime and the lowered price on the S1 and S2 that we started to address the smaller genome centers. And so they started the upgrade cycle last year. They're the ones that we're going to be focused on this year and next year for the upgrade cycle. Now there is also a backstop, which is in 2023, we're no longer going to sell the 2500, so we're end-of-life-ing it completely. And then in 2024, we're end-of-life-ing the 4000 and the Xs. And so it's this year, next year and thereafter, really, that we're focusing on getting them upgraded. So it's the smaller core lab that only started in earnest looking at an upgrade cycle last year.

So I think one thing that's come up a bit as well is the potential for some of these customers to maybe be more appropriately targeted for the new NextSeqs versus a NovaSeq. So on one hand, there's the concern about cannibalization of the opportunity because NextSeqs are a lot cheaper. On the other hand, is there an argument to be made, say, if they were ripe for the new NextSeq anyway, they probably weren't buying a NovaSeq regardless?

That's exactly right, Doug. I mean from our perspective, we have set it up so we are generally indifferent, and we want to make sure that the customer buys the right machine. And the way the products have been spec-ed and the way they have been priced, very few customers, I think, will be caught betwixt and between. If you have the right number of samples -- if you have a lot of samples, then NovaSeq is the right machine all day long. And if you don't, the NextSeq is the right machine all day long. And it's rare that you will get caught to say "Well, either could work." And what we've done is, as a company, we're indifferent. Yes, you get -- you pay $300,000 for the 2000 versus $900,000 for the NovaSeq, but the NovaSeq gives you a much lower cost per gene. So over time, we want to stay indifferent. And the same is true for our reps. We want to make sure that our reps understand that we're long-term bringing on customers, that we want to make sure they get the right box for them, and the economics will work out.

Very quickly, just closing with a couple of strategic questions. So you guys have been at the forefront of innovation, enabling high-end genetic analysis with fantastic tools for a long time, even going back beyond before sequencing. You have, what, over $3 billion in cash, as we're sitting here today. Obviously, you tried to do PacBio. You ran into some regulatory challenges. So I think the question is what comes next? I mean as a rule, would you consider doing something dilutive?

We'd absolutely. I mean we meet every 6 weeks. And we try and we look at the landscape to try to understand what's out there, what makes sense for us to buy. And the only lens is what creates long-term shareholder value? And it could be something small like a technology tuck-in or a capability buy. We'd be open to looking at something big, even if it was dilutive for a period, if it created long-term shareholder value. So it's much more our lens around what's our long-term strategic plan, what creates the most value.

Would you do something that's not sequencing-specific?

If it created the value...

The same criteria, okay.

Exactly. Then we would -- but it has to be something that makes sense for us as a company, fits with our core competencies, complementary to what we do.

Okay. All right. Unfortunately, we're out of time. We covered a lot. Always a lot to cover, so I would love to do more, but we'll save it for another day. So thanks, Francis.

Thank you. Thank you, everyone.