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

Okay. Great. Welcome, everyone to the SVB Leerink Healthcare Conference -- Global Healthcare Conference. It's my pleasure to be hosting Sam Samad, CFO of Illumina. Sam, wonderful to have you here. Thanks for joining us.

Thank you, Puneet, for hosting us. It's a pleasure to be here.

Okay. So a quick reminder before we get into the conversation, please submit your questions on the website, and I'll address it as we go through the conversation. I'll do a brief two-second view of my view of Illumina, and I'll turn it over to Sam for some quick prepared remarks. As many of you know, I mean, Illumina, as a leading sequencing company, needs no introduction. And the company is leading in both the research applied and the diagnostic market. In fact, the company has reached its sort of promise that it made to the market many years ago to being a leader in diagnostics and cancer diagnostics, and that's driving significant growth for the company. But new products are coming out, new chemistries, maybe new instruments to go with that. And the company is committed to GRAIL as well, which is a very large opportunity in screening. So lots to talk about. So I'll turn it over to Sam for some remarks.

Yes. Thank you, Puneet. And again, pleasure to be here. I do have to go through a safe harbor before we start, and then maybe we can jump right into questions. So let me go through the safe harbor bit first. 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. As a reminder, pending the outcome of the European Commission's investigation into Illumina's acquisition of GRAIL, the commission has adopted an order requiring Illumina and GRAIL to be held and operated as distinct and separate entities for an interim period. Compliance with the order is monitored by a monitoring trustee. During this period, Illumina and GRAIL are not permitted to share confidential business information unless legally required, and GRAIL must be run independently, exclusively in the best interests of GRAIL. Commercial interactions between the two companies must be undertaken at arm's length. All right. With that out of the way, Puneet, I'll -- we can go straight into the questions.

Okay. Great. Thanks, Sam. So first one is really what I was just talking about in terms of Illumina truly seeing the benefits of cancer and hereditary testing and oncology testing and NIPT, after all these years. As you look at it from your sort of long-term model perspective, how sustainable is this momentum, distilling it all down to Illumina? And how does this -- maybe if you could talk about what underpins the growth rate of the market? And how does that translate to Illumina?

Sure. Yes. There's a lot there, Puneet, to unpack it here in terms of -- maybe start with comments about 2021, which was a standout year for us in terms of clinical markets. And in terms of our clinical applications and our growth, we grew in our sequencing consumables business, almost 42% during the year and our clinical applications. We've seen a number of notable developments in our clinical business. We've seen almost 1 billion people across the globe now covered for genomic clinical tests. We've seen guidelines expand on the oncology testing side to now cover comprehensive genomic profiling. We've seen genome sequencing become much more adopted in genetic disease testing. We've seen in NIPT, ACOG approve basically or recommend in its guidelines, the coverage of average risk for NIPT testing. So a number of developments. And really, the outcome of that was very, very strong growth for the year, as I mentioned, 42% in terms of clinical consumables growth. As we look forward, Puneet, I mean here are a few things that I think about in terms of what's going to shape the next few years. First of all, I think over the next few years, we expect that, that 1 billion individuals or lives covered for genomic tests will be 2 billion. So we expect that to double and with notable growth in the U.S. but outside the U.S. as well. We expect genetic disease testing, which is right now penetrated at approximately -- very low single digits, maybe even 1% penetration, we expect that to grow significantly as we go forward. And we expect whole -- clinical whole genome sequencing to become eventually the standard for genetic disease diagnosis and treatment. NIPT testing as well, we expect growth outside the U.S. We are launching diagnostics as well that are -- to be IVD approved both in the U.S. and outside the U.S., TruSight NIPT for approval in the U.S. as an end-to-end diagnostic that's clinically -- that's regulatory approved. So I see a lot of momentum in terms of our growth that started in -- over the last few years that will continue over the next few years. In terms of what that means as a growth rate, I think to answer your question, we have said that we expect Illumina's growth rate, core Illumina outside of GRAIL -- so I'm not even counting the early cancer screening business, but core Illumina, so therapy selection, NIPT, genetic disease testing and other applications like infectious disease testing, maybe cardiovascular. So we expect core Illumina overall to be in the mid-teens and clinical growth to be exceeding that over the next few years, so exceeding mid-teens. I won't give a specific number, but needless to say, significant growth in our clinical business as we look forward.

Got it. Okay. Super helpful. And you had a strong year in FY '21, 40% growth for the year. Some of it maybe in the earlier part of the year was maybe pent-up demand, some obviously COVID surveillance here. A bunch of it is, as you said, the recognition of the cancer diagnostic market overall. But within that 13% to 15% core Illumina growth that you're guiding at these levels, the 18% sequencing consumables growth, I mean, sort of what gives you the confidence at a time when we are coming off of these high comparables and at the same time when the COVID guide is -- that number is stepping down?

Yes. A number of things give us confidence, Puneet. Let's talk about those for a second. And then I'll talk a little bit about the -- what's in the assumptions around the guide as well. But the instrument backlog entering 2022 is double what it was entering 2021, and it's a record backlog. So an instrument backlog is a good precursor for demand because it tells you what the order activity is. For those that haven't followed us for a while, it's a very important precursor. Labs, academic institutions, clinical labs, they don't order instruments unless they see the demand coming down the road, and that will lead to consumables utilization. So the fact that we're entering 2022 with record instrument backlog gives us a lot of confidence. We saw in 2021, record placements of over 3,200 placements. That was a record for Illumina with record NovaSeq placements, our highest throughput instrument. That also is a precursor for additional demand as we look to consumables utilization. As we look at capacity utilization across our installed base, at least the instruments that are connected that we have visibility to, which is a healthy number in the U.S. as a percentage, it's over 70%. And as you go outside the U.S., it's a little bit less, but still in Europe, we have good visibility also to the installed base. Less so in China because the connectivity is less there. But capacity is the lowest it's been for a number of years. In other words, our instruments are being utilized more than they have been utilized and the percentage of available capacity on each instrument is the lowest that it's been for a number of years, which is, again, a great precursor and indicator of what demand might be. The momentum in the clinical business, I think COVID is -- at least in our estimates this year, would be potentially a headwind year-over-year because we saw a lot of sequencing of positive variance last year. We don't expect at least the instrument placements of that in this year, but there is a lot of momentum in our clinical business, as I've talked about to your previous question. So in terms of the balance, but to tell you why we believe this guide is also very achievable and not incredibly aggressive and we don't have a line of sight to achieving it, we have built in some expectations in the guide of headwinds year-over-year. So one of the headwinds is a $60 million headwind related to the U.K. biobank. So our population genomics business is expected to be down $60 million year-over-year. We're not building in any, I would say, speculative population genomics revenue in our base. We are building in, as I said, approximately $80 million at the midpoint of less COVID surveillance revenues this year than we had last year. So I think the guide is very balanced, Puneet. And I think it's also -- we feel really, really good about the achievability of it, especially given how we're entering the year with the backlog that we have and the momentum that we have.

Sure. That's super helpful. I want to come back to the backlog question in a second here, but maybe even a bigger sort of question there on instrument launches and philosophy around a new product introduction. Just wanted to get a view from you. And it's obviously -- when you launched the NovaSeq product back in 2017, that was completely packaged and launched onto the market. Lately, we have been hearing about new product launches coming. So maybe just talk to us about this change in the philosophy of completing a fully ready-to-go product and then unveiling it versus informing about a new product that's going to launch. And that does have impact on expectations and whatnot. So maybe just talk about the philosophy -- a change in the philosophy there. And how should we think about the product launches going forward?

Sure. Yes. Let's talk about the launches that we've announced over the last couple of months. And then -- I really don't see it as a change of philosophy, Puneet. I see it as really just more of a concerted approach of introducing our technologies and giving a preview of our technologies. So I'm specifically referring now to Chemistry X. But the 2 key launches that we talked about earlier in the year at the other conference in January, we said we are going to be introducing Chemistry X, and that's its codename right now, but it will be introduced. It's a breakthrough technology that's, we believe, transformational and new chemistry that is not just an iteration of SBS, but really a redesign. And we started talking about this in January of 2021, when we talked about improved cluster density, improved accuracy. We talked about longer reads, better cycle times. And so we gave that preview back then. We wanted to give much more of a, I would say, specific overview in this conference, which we did. And this Chemistry X, yes, it will be launched. We haven't given a date yet. It will be the backbone and the platform for every single new introduction that we have. So every new instrument that we launch will be on Chemistry X. But we also said there's a possibility, and we're still contemplating this, we haven't decided, whether it could be also ported to the older instruments, whether it could work on a NextSeq 2000, a NextSeq 1000 or other instruments or all of the other older instruments. That's still something that we're debating. We also announced Infinity, which is our long-read workflow that we talked about. And again, we said that we will give more information about exactly when's the launch date. We also talked about NovaSeq Dx, which will be launched this year in the second half of the year. But that, NovaSeq Dx, we've been talking about for a couple of years now, we gave that overview -- and we did give that overview to be fair. I think 2 years ago to say that that's a product that's coming down the pipe. So philosophically, it's not a change from our approach. We wanted to really give a preview on Chemistry X, starting with last year then this year, to help guide this transformation of the investors, customers to what this transformational new product looks like. And in terms of new instruments, Puneet, I mean, over the next few years, we will be looking at every aspect of our throughput continuum and really launching instruments across all of the throughputs. And we haven't given a time frame as to when that is in terms of high throughput, mid-throughput. I mean we launched NextSeq 2000, 1000 back in 2020. So we have had a recent launch in terms of mid-throughput. But we will be upgrading all of the instrument classes over the next few years.

Okay. Got it. That's super helpful. And coming back to the instrument backlog question, I mean Illumina is a product company and obviously, anything that moves the product outlook meaningfully is bound to get attention. So Francis called out Chemistry X as the biggest advance since Solexa days. I mean that's a big deal. But maybe at a high level, sort of what is driving you to announce the product launch for Chemistry X sort of now? I mean in the sense that you have a backlog, you -- sort of what gives you confidence the customers will keep buying sequencers at the same rate before seeing the Chemistry X? I mean there's a genuine question here about the market impact from Chemistry X and why shouldn't a customer pause and look at that Chemistry X and potentially, a new instrument launch to go with it to then evaluate what they're going to buy? And is that included in the 10% instrument guide that you have contemplated?

Yes. I mean the 10% instrument guide includes the demand that we expect from the applications that we have. It includes -- I mean, we're not saying that we're launching a product, but all of these assumptions are included in it. And it also includes the impact of the COVID instrument headwind, Puneet, that I talked about earlier, which is the surveillance -- the fact that the surveillance last year, the infrastructure, we believe, was built up for at least COVID-19 surveillance and we're not expecting that in 2022, at least more instrument placements around COVID surveillance. But in terms of what the philosophy is again and why we feel confident talking about Chemistry X and it not impacting customer demand, first of all, the market is very different than it was more than 5 years ago. It started to change with NovaSeq. And I think the market now is very different. I mean you're seeing record demand for NovaSeq in its fifth year of launch, something we didn't used to see before with existing instruments, as you know. And we're seeing more than 30% of the instrument placements for NovaSeq, our highest throughput instrument going to oncology testing. So a lot more clinical demand as part of that mix. With clinical demand, it changes the market fundamentals a little bit. Because unlike research projects, where they are much more -- I would say, there's more of an appetite to buy the newest instrument right away, I think with clinical demand, it's -- there's more validated workflows. It's more of a measured and lengthier process before they decide to upgrade to a new instrument. They will eventually, but the market's more clinical. And with that, what it means is they will continue to work on their existing instruments and the demand is much more patient-based and end-based from the patient perspective. In other words, if they have certain tests that they need to process, if there's certain demand driven by patients, they're going to need to basically buy capacity in order to perform the test that they need to perform. They can't wait 6 months to go and say, okay, maybe there's a new instrument that's going to come out. And I'm now just going to put all my samples on hold until I do that. It's a little bit more flexible, as you know, with research demand because there's research projects that have a finite end and a specific beginning. So the market being much more clinical, I think it's -- we are very confident with the clinical demand that we're seeing. And the fact that capacity is low, as I mentioned earlier, and it necessitates customers continuing to order to fulfill that demand that they have from patient samples. And we're seeing it. We're seeing it in terms of the continued strength of the clinical business.

So that's super helpful. And following up on that, just another sort of high-level question. I mean should we assume that the new product launches or the new product development is going to be focused more towards a diagnostic end? And largely asking that because, I mean, 45% or so of sequencing consumables is served by the diagnostic market. And I mean, at least it's my expectation, I think market expectation too that that's going to continue to increase.

It will increase. And I mean our products, obviously, we do have validated products, instruments like NovaSeq Dx that's going to come out, which will be a validated product specifically for clinical, but our -- NovaSeq is being used for clinical and for research applications. Any product that we introduce, which is not necessarily an IVD product could be used both in research and clinical. So it's catered to both markets. But -- so we will continue with that approach, Puneet. There will be a real emphasis and importance and our product road map as well around end-to-end diagnostics. We already have significant collaborations with many IVD partners out there, and we're going to continue to introduce end-to-end diagnostics like we've done with TruSight Oncology 500, which has been submitted for IVD approval, TruSight NIPT. And in terms of instrument demand, I mean, I think the demand will be both multifaceted, both clinical and research. And if your question is also around like the pricing dynamics in terms of clinical, it's any high-throughput product, any Chemistry X innovation that drives pricing reductions. Although elasticity maybe is more on the research side, it drives larger cohorts, it drives more budgets to do more work, it is still very important on the clinical side as well because it allows you -- think about it, it allows you to do a few things. It allows you to do more sequencing with less shifts. It allows you to do continuous sequencing without having to have downtime in the clinical lab. It allows you with the overhead that you have to have lower sequencing costs. It allows you to move from panels to whole genomes. It allows you to move to comprehensive genomic profiling at a lower cost. All of those are important to clinical labs. And that will still be a focus. I think there's a bit of a -- some perspective that maybe price is not important for clinical. I think price is less important for clinical and research and maybe it's one of the many things that are important for clinical as opposed to the only thing, but it's still very important.

Got it. So talking about pricing, tell us sort of how meaningful is Chemistry X. But when we -- I don't want to go into the details of sort of 2x faster, 2x long-read and all of that, but all of that eventually boils down to, I think, in terms of speed, faster but also, most importantly, pricing for the customer. So from a CFO seat, how do you see -- how significant is Chemistry X pricing drop in sort of dollars per gigabase or cost of the genome? How do you see the margin impact near term and sort of longer term on gross margins on that?

Yes, that's a great question, Puneet. Because it's one that I -- as you said, I'm very interested in, and that's obviously a big focus of mine, working with the R&D and product development group to make sure that we are growing margins as we introduce these pricing reductions and growing demand as well. As we saw with the version 1.5 consumables on NovaSeq, that had really, with that introduction at the right time, catalyzed demand significantly. The demand that we're seeing on NovaSeq is unlike anything we've seen before. And so Chemistry X, to your question, is the chemistry that's going to take us to the $100 genome and below. It's actually going to -- now we see line of sight to below the $100 genome. And for those applications like proteomics and single cell and spatial and other applications that are very highly sequencing-intensive, it's going to be really important in terms of, if when introduced at the right time, and we believe that for some of those applications, the right time is very close and very soon, it opens up a lot of sample demand because that pricing drives adoption. Even in clinical, there are some of those same dynamics with regards to the larger panel demand that's needed, clinical whole genome sequencing that's needed. And we're seeing that migration to high throughput. So that's going to be really important. That introduction is going to drive demand when it's introduced at the right time, it's going to take us over time to the $100 genome. And I'll give you my commitment around margins. I mean margins, given the innovations that we have, the productivity we have in our R&D department and product development margins will, if anything, over time, improve with this introduction as opposed to be impacted negatively because of the fact we're taking price. And anybody that doubts that just needs to look at our last 10-, 15-year history to really see that.

Yes. That's very interesting. Okay. Great. On -- just a quick question on supply chain side. Obviously, we're asking that to a number of companies. Anything that you would want to point out there, either direct or indirect effect of supply chain plastics and chip -- tips and things that customers may not be getting? Are you seeing anything from that end?

I'd say nothing material, Puneet. We've -- it's a challenging environment for sure. I wouldn't minimize it for a second in terms of the challenge of having to deal with all of the supply chain challenges that are out there, given COVID. But nothing that's impacting any of our customers materially. I think we're managing it really well. We're building up -- we've built up safety stock on consumables, specifically because of the demand. We've got our manufacturing and operations team working now around the clock on building NovaSeqs given the demand on NovaSeq. We've increased distribution center capacity to fulfill that demand and be closer to customers in certain cases. So we're managing with no real material disruption, but definitely the -- I would say the level of difficulty, has gone up a couple of notches on this one.

I see. Okay. And in terms of inflation and pricing and obviously, maybe that impacts more of the instrumentation side of things, again, but raw material prices are going up everywhere. So at Illumina, as you said, in version 1.5 chemistry, you reduced the pricing. And so how -- tell us how hard it is to lift pricing on some of that if you had to.

Yes. The only thing that we do, which is our standard practice that we do every year, is we'll do a price increase on some of our products at the beginning of the year. And that's something we do every year and we'll do this year. And it's a price increase commensurate with inflation and it will be selective across not all products but certain products. And I think that's a standard practice that we've done for the last number of years. It's nothing new. At this point, I will tell you, we are not taking prices up on our customers other than this onetime price increase that we do annually, which is a regular inflation increase. We are not yet doing any freight surcharges or anything like that, although I wouldn't entirely rule them out down the road, given just how expensive shipping is and how challenging shipping is in freight. But at this point, we're not doing it. So we're committed to continuing to decrease and lower the total cost of sequencing, the total cost that includes instruments and reagents on the sequencers.

Got it. And on -- one question on long-read. It's really the new introduction of Infinity technology that's launching, I believe, in the second half. And maybe, simple question, do you see this as a market expander for the long-read market? Or is it a market share taker in that long-read market?

Yes, it's a good question. I mean this is -- let's talk about those applications. I mean this is about 5% of the total sequencing market that are very specific applications, could be things like doing de novo sequencing, new species sequencing, scaffolding on existing other sort of short-read sequencing. But it's about 5% of the market. And -- but it's growing fast. It's -- last time I talked about it, we said it was growing in the 30 -- close to 30% CAGR, if not more. And so in those applications, Puneet, that's where we see Infinity being really important, really important for a couple of reasons. So the fact that it gives our customers access to both short-read and long-read on one instrument and one workflow, there's no need to now take two workflows and have two separate instruments from two separate companies and do sequencing on them. And so it really merges that. And then there's the advantages, I think, that you saw around less DNA input, significantly less. I mean 90% less DNA input and lower cost, higher throughput. I mean that's really critical. One of the biggest obstacles right now, the bottlenecks of long-read sequencing, why you can't display short-read sequencing is the fact that it's more expensive and lower throughput. But with this, we can really take down the costs quite significantly. So does it expand the market, not sure at this stage. I mean we are -- we see it as a really important introduction and innovation in that -- in those existing long-read applications. Now there are, as you know, with certain customers, needs for instance, on the population genomics side, where there's a complementary benefit. And this is across the board. I mean long-reads are complementary to short-reads. But in population genomics, a lot of customers will do short-read SBS sequencing on Illumina and they'll kind of complement it with some long-read sequencing. And we see that as really critical in those applications as well. Infinity would be very, very well suited for those applications in population genomics.

Got it. Super helpful. Okay. On -- let me switch to GRAIL in the last few minutes we have. The $70 million to $90 million guide for '22, and that was well ahead of our expectations. And you mentioned it's -- majority of that is coming from Galleri versus MRD testing. So maybe could you elaborate a bit more on the customers of this product? And would you expect more of this from the health systems versus pharma in 2022? And then I have a dilution question, but I'll come to that in a second.

Yes. The revenues, Puneet, are concentrated in 2022. That $70 million to $90 million is concentrated on the Galleri side, with health systems with, to some extent, self-insured employers, concierge medicine, but it's really health systems and the fifth -- I mean, we're seeing from GRAIL, great progress that they're having in terms of having now more than 1,500 prescribers basically use and utilize Galleri. So that's the expectation of where these revenues are going to come from. There is a small portion of the revenues, of the $70 million to $90 million that's coming from recurrence monitoring and minimal residual disease partnerships with pharma, but that's, I'd say, a smaller portion of the overall revenues. But where the revenues are coming from are the 8 health systems that they've signed up, the partnerships that they've signed up, including with some banner health systems in cancer like the Mayo Clinic, the Cleveland Clinic and more to come.

Okay. And then on the dilution side, $3.75 dilution that you've talked about in EPS for GRAIL, $0.50 of that is coming from the 4Q shares that you had introduced. But keeping the share dilution aside, do you expect dilution to go higher with trials and the recent trials and other expenses and sales? Just largely because we are seeing this as a product that's launched in the market, but really, at the end of the day, we're still getting a question whether -- what FDA needs to potentially see eventually with a large-scale trial to maybe drive a bigger adoption of this product. So maybe just on the dilution side, is this sort of -- are we seeing the peak of the dilution this year?

Yes. We expect that the $3.25 of operating loss dilution from GRAIL is near the peak dilution of what this deal represents or what this business represents in terms of dilution. I don't want anyone to perceive that as that's the peak and then it starts to improve significantly in years to come. No, what I'm saying is it should not exceed that peak dilution level, but it will still take a few years for it to breakeven and then we expect it to be very profitable in the long term, even more profitable potentially than our core business. But you're right in the sense, Puneet, that there is a portfolio of evidence, clinical evidence that's being built based on the clinical trials, those will continue to be a significant portion of the expenses that GRAIL incurs because the plan is to submit this to the -- to submit the PMA eventually to get approval and to get reimbursement, and there's great progress on those things.

Okay. I know we're overtime, but I'm getting just one quick question from the audience here, and it's just around academic. There are a couple of questions in the market today in academic recovery overall in the labs. Anything that you would want to note in the near term or in -- that you contemplated in your first quarter guide, seeing what's happening in academic labs?

Yes. Maybe just a couple of quick comments, given time. First of all, academic labs grew, the sequencing consumables and research grew by 43% last year. So very, very robust growth. The recovery is, I would say, very strong. We're not seeing right now any notable impact from COVID on the academic side. NovaSeq demand as well is a good testament to that, even though there's a lot of demand for NovaSeq in clinical, there's still a lot of demand in research as well. As we look forward, Puneet, we -- given the funding environment, which is pretty robust right now, a lot of funding going into the space, whether COVID or outside of COVID, but there is a lot of investment in funding that's going into the research and academic space. Our expectation is that it continues to be robust. We're seeing utilization again be very strong in the research labs based on the connected instruments that we have.

Got it. Super. All right. Sam, thanks for staying a minute over. I appreciate your time and always wonderful to have you.

Thank you. Yes, my pleasure. Thanks for having us.