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

Good afternoon, everybody. Welcome to the 2022 Bank of America Healthcare Conference and our final session. It's been a pleasure to see so many clients here after a 2-year hiatus, and it's great to see everybody there. Thank you for your support, just to start that up. I'm Derik De Bruin, the Senior Life Sciences and Diagnostics Tools Analyst. And with us to close it out, and with us is Sam Samad, Chief Financial Officer. And thanks, Sam, for being here. Appreciate it and glad you could have accommodated us. I know your schedules were really difficult this year. So we certainly appreciate you coming out and helping us.

So I'm a little bit perplexed. So you've put up record instrument placement numbers, right? I mean we've -- I think we've been just shocked at the number of systems that have been placed. And certainly, talking with investors -- certainly, earlier this year, there was a lot of feelings like, if the market goes in recession, Illumina outperformed the last time during the recession, and it looks like a safety play. And I think people are speculating that and looking at this and you're talking about new product launches coming up. So that's a good setup. I guess I'd love to hear what you're hearing from investors. Because the fundamentals of the company on the core Illumina business sound really great and everything there and yet the stock is getting hammered a little bit more like this. So I'd love to hear, first of all, your sort of like your investor feedback on what you think is going on. Because as I said, you look at the numbers and product cycles and huge record backlogs and inflection points in the sequencing market and -- yes.

And without spoiling the party, I do have to go through safe harbor.

Sorry. My apologies. My apologies.

I will go back to your question, for sure. I know exactly where you are. So bear with me. 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's 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 distinctive separate entities for an interim period, compliance with the orders monitored by an independent 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 interest of GRAIL. Commercial interactions between the 2 companies must be undertaken at arm's length. And so now I will get to your point.

Making the lawyers happy. Always a good thing.

Exactly. So without speculating on the market, because these are tough times in the market -- excuse me, there's a lot of volatility out there, so I really prefer not to speculate on the market and what the market noise is. But really talk about our performance and talk about some of the dynamics that we're seeing in our performance, which you've echoed there to some extent. I mean you -- if you look at Q1, for instance, we had 20% growth in terms of instruments. We had record orders in the quarter. We had consumables growth of 13%. We had overall revenues growth of 12%. We had record NovaSeq placements in the quarter. We had -- our pull-through on NovaSeq was within the range of the $1.2 million to $1.3 million. We had, in terms of NovaSeq, almost 50% of those record placements were to clinical customers. So to your point, we are seeing execution fighting at all levels. And again, without speculating about the markets or commenting on what the markets are seeing, I would say there's a general recognition that we are having a very strong period in terms of performance and in terms of the results on the ground. Now there's a lot of noise out there. I mean I know there's noise about competition and announcements that might be coming out and noise about sort of the macro factors. I think China, there are some restrictions there that probably add a bit of noise, not just to us, but across the board. So those are probably adding to already a volatile environment from a macro standpoint. But for us, in particular, we had -- '21 was an incredible year for us, and I think the start of '22 has been very strong as well.

So looking back on '21 and the strength in '22, I think we've just been surprised as you can see the strength of your platforms and even MiSeq is still doing well. And that's a little bit long in the tooth when you talk about -- that's what 2014?

Yes.

Introduction. Yes. So where is the demand coming from, right? And so I mean how much is new sequencing customers versus fleet expansions versus platform upgrades? Can you just give us a feel for what's going on in terms of demand?

Sure. And I'll focus a bit on the high throughput and mid-throughput, which are really driving the growth, at least from a revenue dollar standpoint. But to your point, MiSeq was having record years last year as well in terms of the highest placements that we saw since 2015. But in terms of NovaSeq, so what we're seeing in terms of demand in its sixth year of launch, first of all, is record placements, which is incredibly, incredibly impressive for an instrument that's been around since 2017 to be having record placements now. The reason for that is really the shift of some of that demand to clinical. So we're seeing more demand coming from clinical customers, definitely more demand coming from oncology testing customers than we've ever seen. In Q1 itself, I mentioned a couple of those stats. One is that 50% of the demand was coming -- in terms of orders for NovaSeq was coming from clinical customers, and then 40% was coming from oncology testing customers. So that's a dynamic that has continued to fuel some of those placements that we're seeing in NovaSeq and the strength that we're seeing in its sixth year of launch. The other thing that we're seeing is almost 50% of the placements and orders coming from the new to high-throughput, new to Illumina customer base, which really, again, is not unusual -- non-unusual dynamic given the shift to clinical because what you see is more of a diversification of the customer base, more new customers coming in, whether it's into oncology testing, liquid biopsy customers, a broad base of customers entering into clinical and diversifying that group. And so you see a lot more in terms of the new to high-throughput. In terms of mid-throughput, so NextSeq 2000, 1000, I'll remind the group here, we launched this in early 2020. We have just exceeded an installed base of 1,000 on those 2 platforms. So the success has been very -- I would say, the platform has been very successful. We have doubled almost last year the placements in the mid-throughput space. If you include 550 and 2000, we doubled the placements versus what it was a year before in terms of -- and traditionally in terms of what you saw in terms of mid-throughput placements. NextSeq 2000, 1000, about 1/3 of that demand is coming from, again, new to mid-throughput, new to Illumina. About 1/3 is coming from benchtop customers upgrading. And I would say the other 1/3 is a combination of capacity upgrades of existing customers as well as 550 conversions. But it's pretty broad-based, as you can see, new to the space, benchtop is upgrading. So really, really impressive performance, very pleased with it.

So two questions on that. So you've -- are you -- it doesn't sound like that by tantalizing your customers with the new high-throughput platform with Chemistry X on that historically stalled the market, so can you talk about how you're sort of thinking where a new -- I mean it sounds like you're targeting more like an ultra-high-throughput machine at the end of that versus something like making it backer compatible. Let's clarify that. But I think the one question is also, if all your demand is coming from clinical customers, how do you sort of think about pricing, right? Because the research, your model has historically been let's launch a product, let's drop it, elasticity demand because the research guys buy a lot more products. Clinical, it's not like if you cut the price in half, you're going to see 75% more cancer patients initially up. So how do you balance the high throughput dynamics? And what's the embedded cost lowering versus having to maintain your pricing in your clinical markets?

Sure. Yes. So there's a couple of questions there to unpack, so let me work on that. First of all, in terms of -- I think your first portion of the question was around any stall in demand for announcing a high throughput or Chemistry X that -- and a potential at least speculatively on the part of customers, a potential high-throughput sequencer. We have not seen that. We don't expect to see that. You saw record placements of NovaSeq in Q1, which tells you that, that demand is not slowing. There is a need for high-throughput capacity and for additional sequencing. The reason for that is fairly straightforward. This market is more clinical than it's ever been. And clinical markets are more driven by end demand, by samples availability, by samples testing and clinical customers need capacity. They're not going to wait a year if they think a product is coming out in a year. They're not going to wait 2 years if they think it's going to be coming out in 2 years. They need capacity today, so they're going to continue ordering. Research customers could be a little bit more, hey, let's wait and see. But at the same time, budgets are healthy, research utilization is healthy. So I think we're seeing that demand as well. In terms of the pricing dynamics, Derik, which I think is your other question. So I -- so Chemistry X will definitely drive lower pricing. It's the product and the chemistry that we believe will drive pricing all the way down to the $100 per genome, maybe even less down the road. It's going to open up significant applications in terms of single-cell proteomics, spatial. So those applications that are important today but could be a lot -- could drive a lot more utilization with lower price points, I think, are with Chemistry X and any potential platform that is the foundation of will drive. Clinical, at the same time, will still benefit from some of that cost of sequencing reduction. It's not the end -- it's not the main driver, but it definitely drives more high-intensity work, comprehensive genomic profiling work, the transition and the migration from whole exome to whole genome on genetic disease testing. So I think sometimes we kind of paint it as if it has no impact on sequencing if you drop the price in clinical, but it actually does drive higher intensity sequencing in clinical. Now there are other things that are really important for clinical beyond just the price, which we also balance with any introduction of a new high-throughput sequencer or Chemistry X, so things like potentially as you see with NextSeq 2000, onboard informatics and onboard -- the ability to have onboard compression and stories. That drives -- also, that's a key bottleneck for clinical that a potential sequencer in the clinical -- in the high-throughput space that has those capabilities will drive. And that becomes important. The other thing is end-to-end diagnostics. And those are important for the clinical space, and we're developing those in the pace of TSO 500, IVD and others.

Got it. The -- so just a couple of things on the quarter and expectations. You had about $16 million in sales related to COVID surveillance. It's like what are you sort of expecting for the remainder of the year? And so like how does that market sort of evolve in the surveillance market? I mean people are clearly tired of COVID, as this conference is a good indication of that. Hopefully, it's not a super spreader. And look, people have this short memory, right? The public is like today's threat is tomorrow's who cares. So how do we sort of like think about the surveillance market evolving?

Yes. I mean, yes, I think people are tired of COVID. COVID is not tired of us, unfortunately. We're still seeing case counts increasing. But in terms of surveillance itself, we had approximately $60 million in Q1, $53 million from consumables, $7 million from instruments. We are -- we've reaffirmed our guide for the year of $130 million to $150 million in terms of surveillance revenues for the year. We do expect, obviously, the $60 million, as you can tell is, of the $130 million to $150 million is more heavily weighted in Q1 because we do expect surveillance to taper off as people get tired of COVID, as you maybe do a little bit less testing on positive samples and as positive samples come down. So that's embedded in the expectation or in the guide. Now that's one piece of it, which is COVID-19 surveillance work. The other part is actually pathogen surveillance, preventing future pandemics, understanding pathogen transmission and building that infrastructure to make sure that you're preventing community transmission or catching early any potential future pathogens. That, I think, is going to be more meaningful as we go into '23 and beyond. Because even though we're tired of it, even though people don't want to think about COVID anymore and short-term memories sometimes play a part, but really, shame of us, if we don't, and our governments, if they don't build an effective pathogen surveillance infrastructure and capability. And to this point, the funding is going there. I mean we've got $165 billion of funding that's been allocated over the next 7 to 10 years for pathogen surveillance and monitoring pathogen transmission. I think there's a lot more work being done in the sewage systems, for instance, and detection of how potential transmission of pathogens is in sewage systems and office sewage so that you can understand how it's moving in the community. I mean the last thing I'll say about it is imagine if we had these capabilities and this surveillance infrastructure back in early 2020 or maybe even late 2019 and how much more insights we could have gathered in terms of how COVID was spreading back then undetected.

Yes. So about a 300 basis points impact from China. Can you talk about sort of like the Chinese market? I mean it is one of the geographies where you actually do have a viable competitor at the higher end of the range. So talk about what you're seeing in China, demand there, sort of like -- and also just provide with that and just likes -- like broadly, more broadly in supply chain issues and logistics and as a nature of like risks.

Yes. Okay. So I'll start with China in terms of the demand landscape, the -- how we compete in our positioning. We're very focused on our clinical strategy in China, and we've been having tremendous progress in clinical in China. Last year, we grew more than 40% in China even with BGI being a homegrown competitor. That's a Chinese player. This year, in Q1, demand is strong in China. The problem right now is the restrictions that are starting to play a part. Started in March, we had in Q1 approximately a $10 million impact from restrictions in China, negative impact. But at the same time, we signed up 38 new hospital customers. So we're penetrating the market even more. Our backlog going into Q2 is 15% higher than it's been over the last 2 quarters. So we're seeing higher backlog in China. The problem is purely concentrated right now in terms of actual logistics and getting product to customers and also, obviously, needless to say, closures in terms of customers because some of the testing companies and labs can't do the work. So we did call out 300 basis points of overall impact on enterprise growth because of China, which roughly translates to about a $35 million headwind. To this point, we haven't seen restrictions easing in Shanghai. And Beijing, I think there's ongoing testing and localized closures. And there's closures in about 35 cities in China. It's not just Shanghai, but Shanghai is where the mass restrictions are. So we have not seen that abate yet. We're still monitoring it very closely. And then one other thing, Derik, which we didn't mention, is also FX. FX in Q1 was a negative impact on our performance as well. It was a headwind. And as we look at Q2, the dollar continues to strengthen against some of the basket of currencies where we build in local currency. And so that has a negative impact as well.

And supply chain issues, just...

And supply chain. So supply chain, first of all, I'll speak to China. I mean we're only impacted there in the sense of getting product to customers. We're not impacted as much. Very little actually of our impact relates to Chinese suppliers that get product out of China and into our supply chain overall. So I think we've got good redundancy in the supply chain where we are not really reliant on Chinese suppliers. And so that's not an impact for us, not material, I should say. And overall supply chain, kudos to our supply chain team, we've managed through this. We don't have any notable disruptions. We don't have any significant disruptions. It's a challenging situation. We're working through it, but we're able to get products on time to customers. We're not facing any material disruptions from supply chain issues.

Got it. And obviously, there's been some ongoing news on the patent litigation with BGI, some developments last week. I guess at this point in time, what's your expectations for when they could launch a product in the U.S.?

Well, I mean they have an injunction in the U.S. right now. So let's be clear on the facts. This doesn't change anything around the fact that BGI is currently blocked in the U.S. There's an injunction on certain European countries where we've basically been granted an injunction on their IP and on their ability to enter those markets. But in the U.S., and this doesn't change with this court case there. In the U.S., they can enter with their standard chemistry in 2023 because that's when the IP runs out and they can enter with their cool NPS chemistry at the end of 2022. But let me just also make sure that I'm clear on the fact that with Chemistry X, we have the new sort of foundation in terms of chemistry with new IP that takes us all the way into potentially 2039 with a 17-year road map in terms of new IP. So they will have access to the old IP. In terms of this case, just to mention a couple of things on it to make sure everybody is clear and on the same page. First of all, this was a jury verdict. They awarded BGI past damages of $334 million on 3 products, NextSeq, NovaSeq and MiniSeq. And the way the amount was determined, it was approximately a 5.5% royalty that determined that $334 million. The award is only for past damages. So there's nothing right now that's forward-looking. This was the jury award. Now the process going forward is there will be post-trial motions with the judge determining eventually his own -- what the damages are. We aren't going to pursue vacating the jury verdict. That's over the next 6 months. So that's our first course of action. If that doesn't happen, then we will appeal. And the appeal will take us probably until late '23, maybe '24. But we feel confident that on appeal, this will be reversed, but that's the course that we're going to take. There's nothing been assessed so far in terms of royalties on future revenues. It's only been $334 million on past damages.

Right. But they're still -- but can they launch it? They can't launch anything. So...

They can't launch anything and we don't expect that this has any impact in terms of any injunction on us also in terms of our new products.

Got it. All right. I think let's go to a couple of points. So let's go to GRAIL first. So look, I mean, I think when we've talked with investors and I think there still has been some skepticism on that and also sort of you look at the valuations of like the competitor companies and with the biopsy space needs to come down from their peaks. A lot of the conversations we've had is like while I could only invest in stand-alone Illumina, I'd love to because -- but I can't do it because GRAIL is such a black hole of costs at this point in time and the visibility into the products is there. It's like, can we sort of just update on your sort of like thinking behind this? And it's like, is this still something that you want to be behind, I mean, given that I would argue it's probably putting some negative value in your stock price right now?

This is absolutely something we want to be behind. We have all the confidence that GRAIL is going to be a -- and it is already. The Galleri is going to be a transformational test in the early cancer space. This is a market that could potentially be a $45 billion market, which is the biggest market in oncology. We think oncology overall is a $75 billion market. We think early cancer screening is $45 billion of that. We think therapy selection is approximately $15 billion. We think MRD is about $15 billion. We play in the therapy selection space, potentially in the MRD space as well and GRAIL obviously focused on early cancer screening. We believe this product is transformational. No other product can compete with the positive predictive value with the false positive rate of 99-point or of the 0.5% false positive rate and with the sensitivity of the product across 50 types of cancer. We think this company and Galleri itself and other revenue from GRAIL could potentially be even larger than our core business with our core business growing in the mid-teens, which is what we expect. So that's how transformational this product is, Derik. Now having said this, yes, there is noise right now around the court process, the EU Phase II review, the Luxembourg jurisdiction case. So I think there's obviously some noise around that until we can get past that. But we feel confident we've closed the transaction. We feel confident that we can integrate very fast as soon as we get a positive outcome. We're, at this point, respecting the whole separate process with EU.

So let's go through time line. So like the [indiscernible] say the legal time lines was broking up a bit. And then when do we get the definitive large-scale prospective clinical trial data coming out of GRAIL for Galleri and saying that, "Oh my God, this is really everything you guys claim it's going to be." So like how do we sort of look at that time line?

Sure. So let's talk about the -- first, the legal process. I mean there are 2 cases right now going on in the EU -- not cases, but 1 -- 2 processes, I should say. One process is the Phase II review by the EU, and we expect that to be late Q2, early Q3 outcome. And there's also the jurisdiction case around whether the EU had actually jurisdiction to invoke Article 22, the way they did, which was, by the way, the first time they did it on a company. And whether they have the jurisdiction to do that, given that there are no -- this is -- the market doesn't exist in Europe, there are no players in the EU. And so we believe that the EU didn't really have jurisdiction here. So that -- also, that outcome will also be in late Q2, potentially early Q3. So those are kind of moving at the same -- with the same time frame. That's what we're seeing there with regards to the court case. In the U.S., there was no impediment to close. So we've closed in the U.S. There was no impediment. And we just have the administrative process going on with the FTC. Eventually, if that goes the way of the FTC, I mean, it's an FTC court at the end of the day. So if it's a positive outcome for the FTC, we will just appeal that in the Federal Court of Appeals, might go all the way to the Supreme Court. So that's a process that will play out, but it won't have any bearing on our ability to integrate as long as we get 1 of 2 positive decisions in the 2 European processes that are going on. With regards to the clinical trial data, Derik, I won't comment on time frame because right now, that's -- we're respecting the whole separate. That's more GRAIL -- those are GRAIL details for them to announce right now. But I can tell you a couple of things about that. One, this is the most studied product, probably the most studied diagnostic ever. I mean there's been 325,000 patients that have gone through clinical trials and been studied. So nothing here is -- points to anything new that you're going to find out given the number of patients that have gone through clinical trials. And then I would point you to one other important pilots that's going on in the NHS, which is their NHS -- the program that's going there, which is 140,000 patients, they've already enrolled more than 90,000 patients towards that. So that's another data point to look forward to because that's getting a lot of traction, making a lot of progress in terms of enrollment.

Got it. And that's '23, '24?

Potentially '23 when they get data out on that one. And it could lead to wide-scale adoption in the NHS in '24.

Got it. And we've got like 5 minutes left, so let's hit some of the competitive landscapes of a lot of noise in the space, short reads, new potential ultrahigh-throughput numbers coming through, just a lot of stuff going on. So how do you sort of think about the competitive landscape right now? And once again, just your thoughts on how Chemistry X sort of addresses some of these issues?

Yes, you'll find out more in Chemistry X when we announce it and we announce the specs, and we have more data on it. But we watch competition. We're monitoring competition. We're not concerned about competition. We have a very significant lead in terms of innovation, in terms of the product that we release with Chemistry X and where Chemistry X is -- and you'll find out more about that. But let's talk a little bit about the players in this space. I mean I think there's a lot of -- there's a few announcements about these, what we call [ me too ] SBS companies that are going to come out. This is a growing market. The first thing to know is this is a significantly growing market, not just in the applications that we know today, whether it's oncology, genetic disease, research, obviously, and clinical. But there will be other markets that are going to be fast-growing in this space, like potentially infectious disease, which is starting to evolve, cardiovascular and other applications within clinical that we think are very important. So it's inevitable that you'll see some small players come up. Will they get a few customers here and there? Sure. But it will be a growing market, and we believe that we're going to be, given our innovation, in a very strong position in that market. The other thing is you have to look at -- I mean I know there's been a lot of talk about pricing and pricing per gigabase and what's the dollars per G, et cetera. I think you have to look at the total cost to operate here and look at the end-to-end workflow and not just the cost per genome or the dollars per gigabase themselves. But look at the compression, storage, compute, interpretation, things that we offer on the NextSeq 2000, potentially offer on future sequencers, that our competitors right now are not talking as much about. But they talk more in a very, I would say, myopic way about the dollars per gigabase. So given our scale, 8,000 customers, 20,000 installed base, I think it's going to be very hard for anybody to meaningfully displace Illumina. Will they get a few price-sensitive customers here and there that only focus on that dollar per gigabase? Potentially. But in a growing market, that's fine.

Great. Any questions from the audience? Nope. Bye.