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

Greetings, Day 2 of TD Cowen Healthcare Conference. I'm Dan Brennan. One of the tools analysts here. Really pleased to be joined with me on stage senior management team of Illumina. So to my left, we have Joydeep Goswami, who is the newly appointed permanent CFO. So congrats -- and COO. And we also have to his left, we have Salli Schwartz, who's lead IR at Illumina. So first off, I'll welcome Joydeep and Salli.

Thank you, Dan.

Thank you.

Awesome. So maybe a high-level way to kind of kick this off here. On the 1 hand, Illumina is at the very beginning stages of your latest high throughput product cycle, possibly the most impressive 1 technologically in your history. You have new markets for NGS are opening up, stock has lagged, hence the upside opportunity is significant. At the same time, competition has arguably never been more material, there's been notable pressure on your clinical customers and it's not clear when that lifts, and you're dealing with material uncertainty of the GRAIL deal. So given you just took the CFO role, I would be interested to hear how you think of the current and future setup for Illumina, should investors be worried about some of these headwinds or rather more excited for the opportunity?

It's a long question, but let me try to parse that down. Look, when I look out and stepping into the role as part of Illumina's leadership team, we're incredibly excited, and I'm personally incredibly excited of the opportunities, right? So the reality is we are in a large TAM $120 billion by 2027. That's very underpenetrated, give or take, about 7% penetration. NGS uniquely offers the opportunity to enhance the understanding of biology at a scale and at a speed that no other technology in the history of this field allows, right? And it isn't just about DNA anymore. It's about DNA and RNA and increasingly proteomics, coupled with things like single cell and spatial that really allow you to understand biology at scale and in context. So incredibly excited about that market. Incredibly excited about -- you talked about the new innovations that we are introducing that make -- that improved the utility of sequencing, but also drive down total cost of ownership, drive down -- drive of the simplicity, drive down complexity of workflows of post sequencing analysis, pre-sequencing prep time, et cetera. So -- and coupled with things like Ambient shipped. So there's a lot of things that are opening up the market and further catalyzed a lot of what you're already seeing was happening in the field, right? So single cell spatial liquid biopsy, multiomics are not new things, but what NGS and our innovations do is they accelerate the adoption of that both from a cost standpoint, but also from a workflow and analytics, bioinformatics point of view. So really excited about that and the opportunities that it opens up both research and clinical fields. Thing you talk about competition. Look, the reality is that we've always had competition, right? At every point in our existence, whether it's arrays or sequencing, and a lot of the players like BGI or Thermo Fisher have existed. We have competed with them especially outside the United States as for BGI. So we know how to do that. We have the playbooks. And even after the announcements of all the players from last year, we continue to have record interest in our platforms, record sales of our mid-throughput portfolio into the second half of the year. In fact, we had record sales of NextSeq 1000, 2000 even in Q4, right? So that does indicate that customers believe in the value that Illumina brings to them, again, beyond just the 1 thing that people highlighted is around cost per GB, but that's only very small part of the equation. There's many others in terms of reliability, service support, ability to move towards clinical diagnostics, ability to have that level of continued and collaborative innovation. So we feel good about that. We continue to invest in those dimensions and will continue going forward as well.

Great. Maybe thinking about the guidance, I love some insight into the 7 to 9 top line guidance. Core Illumina, I think it's 6 to 9, you called out a COVID headwind of about 2 points, right? So I guess, if you normalize it 9 to 11x COVID. So I guess, 8 to 11 core. Do you have easy comps. You have the X launch, which I think most of us most of us expected something maybe stronger on the guide, given your LRP was 15% and you have the benefit of, again, this big one. So maybe give us a little color why we deviated and then I can follow up on something there.

Sure. So the guide was 7 to 10 consolidated and 6 to 9, as you pointed out on the core. Yes, that was somewhat lower than initially what we were expecting around 10, but there are a few reasons, and we go through that. A lot of that is things that we had pointed out earlier. So first, 2023 is a transition year for us and the transition year really comes from the introduction of the X, right? So we do -- we will see, at least in the first half of the year, a reduction in the number of 6000 -- NovaSeq 6000 sold as people transition towards the X. You see that both in terms of the instrument sales, but also in terms of some of the consumable sales, right, ex-consumer don't really ramp up until the second half of the year once people have brought on the instruments and done there initial validation. So that's 1 part of it. And also we have said and is normal with any large instrument introduction. The first year, we will be somewhat supply constrained, right? So we had -- already had as of the Q1 earnings call. We had about 155 orders, right? And then about 250 late-stage pipeline opportunities, which really means that customers have definitive interest and have funding lined up to buy the instrument in 2023. And we expect that number to end the year way ahead of the 300-plus instruments that we expect to be able to supply this year. So that's 1 part of the transition. The other part of the transition is a little bit of a story that you're hearing from a lot of players in the life sciences field, right? But this is a somewhat backloaded year as you come into it. And for us, there are a few reasons for that. In some of the macroeconomic headwinds will persist, we feel, at least through the first half of the year. We -- that includes some of the FX headwinds, which are more severe in the first half of the year, the COVID surveillance impact, which is about $100 million or 2 percentage points. That is also more front-loaded than not. And then China COVID is another one, right, where we do expect that, that is more prevalent in the first part of the year as they move away from 0 COVID tolerance to something that is more sustainable and they open up the market. So that essentially says along with the transition of the X, our second half of the year is going to be meaningfully stepped up from the first part of the year. And you do see a step-up in each quarter both in terms of revenue and in terms of overall profitability, both from a gross margin standpoint and of course, from an operating margin standpoint.

All right. So typically, you go back with the NovaSeq and year 2 was a lot stronger than year 1 to your point. So presumably, we should be looking at the exit rate this year when we think about '24. But fair to say, clearly, at this point, '24 should be, we would assume a much stronger year than '23 absent anything uncertain changing in the market.

Yes, that's, I think, a good way to think about '24 having completed the initial transition and placement of the Xs. You start to see pull-through in the X consumables. And -- and this is something we're working on, in particular. It is a lot about demand elasticity and catalyzing some of the newer applications, the increased pull-through on some of the newer applications that people are talking about, both in terms of the research and the clinical side of things.

So how do we think about the plus? Your guidance is 300-plus placements for '23. What are the key factors here dictating how many you place? Is it actual demand? Is your ability to manufacture and install? Or is your interest to smooth out the launch or other?

It's definitely about the last one. It's really more in terms of scaling up manufacturing, right? So we have said we -- we're going to start off the year with in Q1, about 40 to 50 instruments and then we'll continue to step up manufacturing from there. So at the -- in fourth quarter, we expect at this point to roughly be at steady state, right? So as many orders come in, we should be able to get out the door. But it will take us into next year to clear all of the backlog of the orders that we get in 2023.

And manufacturing wise, you guys feel pretty good kind of where things were guided to and the ability to scale and kind of be on that ramp pace?

Yes. We don't tend to announce new instrument launch, we are confident that we can supply the instrument. There's a lot that goes into that in terms of both the instrument capabilities, the software capabilities and the consumables capabilities. So we are -- where we need to be on that path at this point. We have shipped out as we announced at HVTN on our earnings call that we shipped the first instrument -- and we've -- we continue to make shipments as the quarter goes on.

Yes, the broad said this morning, just -- we host them. They said they have one, and they're waiting for the next 4. So they're waiting. They're ready to roll. So given grants take a while to move, what early kinds of new projects you're hearing from customers that are being enabled by XLEAP chemistry? And what confidence does that give you in your outlook for '24?

Yes. So let me break that down into research and clinical. And just to step back, right? I mean we -- the initial order book surprised us, of course, in the strength of it, right, but also in the makeup of it. So what we've said previously about 35% of the orders have come from clinical customers, which is a little bit higher than where we had expected it from a percentage basis at this point. About -- we've seen about a 4x jump in the number of countries that have already placed orders with a similar time frame from where NovaSeq 6000 was. And we've seen about 15% of the orders that have come from new to sequencing or new to high-throughput customers. So again, that's a little bit of a surprise and a larger percentage. They are all reasons that they have given us, and they're consistent with the innovations that have gone into the X. But let me come to the kinds of things that we are seeing, right? So first, from the research side, from some of the PopGen customers, we are hearing a lot more into, hey, we want to go from -- we've done whole genome sequencing. We want to go to whole transcriptome sequencing and the samples that are already there and increasingly look at proteomics on a much bigger scale than we have done before, right? So the good news about some of these is, yes, they'll need to secure funding, but the funding becomes more cost effective, if were to look at larger cohorts. But you don't need to collect samples, right? I mean you have samples insist in they're biobanks already. So it's a little bit of a faster time scale there. We are hearing also on the research side, especially around single cell and spatial a lot more interest in doing more, right? So more cells going from thousands to tens of thousands to some talk even of millions of cells per run. So that's exciting and that -- although it's the same sample, it's actually more samples because you're looking at individual sales at that point. And we have had very strong interest in pharma taking a much bigger look at genomics and multiomics and drug discovery, right? So part of it is things like NASH Bio, where the cohort exists and they're using this opportunity to move more towards sequencing these and combining that information. And as you can imagine, right, the first step is doing DNA sequencing on a whole genome basis. But very quickly after that, it will move as they get answers to diving deeper into proteomics or transcriptomics as it were. So that's on the research side of things. On the clinical side, again, as I mentioned, this was surprising to see this level of interest. And the dynamics in clinical are -- with the existing assays that have been validated, they will continue on the 6000, right? We don't see an immediate switch over on that. In fact, there will be some fleet additions on the 6000 on those. What we are seeing is the next generation of assays that require either bigger panels or deeper analysis or both, right? Moving to the X directly. And they'll start with the XMDs. Obviously, the economics for them are better, but they can also move faster on clinical studies and more broadly from that angle. So that's encouraging, right? And we are seeing also so that there's, of course, a huge amount of interest on the oncology side. But we are also seeing some early kind of interest in having more holistic and deeper panels, larger panels, maybe all the way towards whole genome sequencing on things like cardiovascular and very early on the neuro side, right? So encouraged by that, encouraged by the conversations getting accelerated. But some of these -- especially on the non-oncology thing, they will take time, but I think it's interesting to see some of the clinical activity and the average generation we had started.

On oncology, this Dovetail really nicely with the whole discussion you're probably hearing around the conference on MRD and liquid biopsy. So there's a multitude of pieces that we're hearing.

Just kind of related to clinical since it kind of Dovetail with the question on the -- kind of on the guide for '23. So like have you guys seen like this clinical destock and kind of it's -- we heard it from some other players as well, but that's been a headwind for you guys in the back half of '22, and presumably, that was 1 of the factors that you baked in to '23, I would think. But just kind of how do we think about that clinical destock and maybe some of it's due to belt tightening, some of it's due to the X coming out? Just kind of where do we stand there?

Yes. So it's a good question. So there were 2 things that happened on the clinical side last year, right? So there was 1 which was related to capital pushout and just conservatives in the market, conservatism in the market that delayed some projects at our customers' ends, right? And part of it, again, if you remember early in the year, it was that plus there were some issues with supply chain, not related to NGS, but other things. So that I think we've been a little bit more cautious this year and not factoring in everything that customers are have told us about we'll scale up to a certain extent. And you're right. Some of that actually, as I mentioned earlier, has moved from the 6000 of the [excess]. And I think that's a good thing. It's more sustainable. They actually ramp up the amount of sequencing they're doing. What we did see towards the -- as we progress towards through the second half of 2022 is the amount of inventory destocking that happened with both research and clinical customers, was slowing down towards the end of the year, right? So the amount of destocking went down. And I think that was a trend we had expected to see. Our best guess at this point is some bit of it continues into Q1. And as we get into Q2, especially latter part of Q2, that starts reflecting more of the underlying demand, which we get a good insight to that because we have connected instruments that represent recent North America and Europe, more than 60% of the instruments out there, especially in high throughput and the throughput. So we've a pretty good idea of what the underlying utilization is, and that has continued very strong on clinical -- and we saw a little bit of a pick up again towards the end of the year.

Great. Maybe just 1 on competition. There's a lot of attention on the high throughput part of the market. But from a commercial perspective, the mid-throughput is where there's more viable competition today with singular Element, BGI, MGI. What does your guide assume for the mid-throughput part of the market in terms of market growth and share loss? And what's been your experience so far?

So the experience so far has been very encouraging, actually. We -- as I mentioned earlier, we continued very strong sales of our mid-throughput portfolio, especially on the NextSeq 1000, 2000, which were the newer instruments we introduced, I guess, in 2020. But we continue to have record sales overall in the mid-throughput category in 2022. And more specifically, we exited 2022 in Q4 with record sales again in the quarter for our NextSeq 1000, 2000 instruments. So despite all the noise about competition coming in, the reality is that customers are assessing this more holistically, right? So what value does Illumina bring in terms of total cost of ownership in fact, that NextSeq 1000, 2000 continue to be the only instruments with DRAGEN on board, so the analytics gets a lot easier and a lot more cost effective again. The workflows are easier and with the introduction of the longer cycles and the actual chemistry on the NextSeq 1000, 2000, which is just a transition of flow cells. It doesn't require any changes to the instruments. There's a lot of interest and continued interest in pent-up demand on the mid-throughput side. I think people always overlook the fact that reliability of supply, reliability to support our instruments over the long run regardless of which continent you're on is a big deal for customers, right? They're not getting into the technology for 1 of experiments and getting out, that reliability and the fact that we are by far, the only company that has the kind of infrastructure, both from a supply chain and the service and support capability, whether you're in research or in clinical is an important part of why people continue to choose Illumina over other instruments that are out there.

Great. Okay. Maybe switching over to GRAIL. So from our conversations at least, most of the investors we speak with would prefer to have GRAIL separated. They'd love to get access to the core Illumina and as ratably, this product cycle without kind of the uncertainty in the near term significant dilution and burn, although ultimately GRAIL could be a home run opportunity. It just kind of really makes it difficult to get access to that core Illumina business. So net-net, I'm just wondering, the management team, Francis has been significantly very positive, enthusiastic about the deal. But given the ongoing regulatory pleasure plus the margin cash solution, like where does management stand today on GRAIL?

Yes. So you're right, right, GRAIL, I want to continued expressing. It's a good asset. It's proven and sell-out. So a little thing, and I'll go to where do we go from here. And GRAIL is still the only multi-cancer early detection test on the market and the only 1 with any line of sight to introduction on a multi-cancer basis, right? More than 50 cancers detected of which 45 plus have no other screening tests available at this point, right? So it's a huge, huge impact on patient lives and the potential of the save lives. It's the only test where real-world data with this point, more than 40,000 patients absolutely corroborate the clinical trial data, which was already extensive to begin with. The only 1 which actually pinpoints where in your body to cancer is, which is absolutely essential for any liquid biopsy test to be able to be actionable. So all those are positives, right? But at the same time, I think we have been fairly clear that look, we did not anticipate the regulatory challenges that this vertical merger is facing. We will be pragmatic in terms of our next steps going forward, right, regardless of how good the asset is and how much we believe in it. So how does that play out? We expect the divestment order to come from the EU in Q2 and when we get that, that provides the guardrails for how a divestiture is to be affected. And we will immediately begin the -- we'll immediately move towards divestiture at that point, right? So that starts the clock on that. Now we expect that to do this right, whatever the guidelines are takes us towards the end of 2023 or early into 2024. So that's 1 piece, right, where we are committing to begin -- to immediately move on the divestiture order. Now at the end of this year or early next year, we also expect to have the jurisdictional trial that really looks at the ability for the European Union or European Commission to really stop a merger of a company that did not have any revenues in Europe never plan to have any revenues in Europe and application of Article 22, which was retroactively applied despite them clearly saying that they wouldn't do so, right? The reason I'm bringing it up is this trial plays out in a time frame where we would continue to work on the divestiture. So we're not waiting for the trial. It just happens that the timing of the trial happens to be in that. Now the trial is important because it's a binary result, right? There is no appeals to it, either for us nor for the European Commission. If we win the trial, then we immediately get to integrate GRAIL. There is no -- as you know, the FTC removed its injunction. So there's no hurdles from the FTC in closing the deal or integrating the deal. We've already closed it. So that then allows us to begin realizing the revenue and cost synergies that we knew we had in GRAIL and it reverses any fines that are paid to the European Commission as a result of closing open. So that's 1 potential outcome. Again, in that time frame of end of the year or early next year. The other outcome is we lose the case, and we lose the trial. Let me just proceed with finishing off the divestiture as we have been planning anyways, right? So that's a -- again, there are obviously stays that give us more flexibility and when exactly and to make sure we get the best value for our shareholders. But there's no further elongation of at least divestiture process beyond that time frame that I just don't want.

And is there an expectation, I was thinking 1Q, but it's more Q2 now. That's what you're hearing on the director divestiture.

Yes, that's what they have. And again, this is out of our control. They need to process, what they need to do process at their right? But that's what we are hearing.

And is it a 6-month time table they're going to give you to do this for 12 months?

We don't know. It's -- that will depend on the order that comes out. And I think what they are trying to do is be reasonable in terms of whatever time frame they give us.

So Francis mentioned on the 3Q call that you would seek strategic partners to invest in GRAIL on a multistep process to a potential IPO. So just maybe 1 comment on that? Like just any elaboration on kind of what that is?

No. That is 1 of the options as we have done some prework on this, that's 1 set of options. Again, I want to make sure you understand, right? It depends a lot on what the EU comes back with. And as we outlined in our Q1 earnings call, right, we will come back to you right after the order with more clarity on what's in the order, what we expect to do moving forward, right? So give us the time to get you information rather than me speaking and hypotheticals about that.

Got it. Okay. So switching gears here to your margin guidance. Looking at your '23 guidance, we were 22% core Illumina EBIT, right, even with high 60s gross margin. Just kind of I think that surprised some people, just the degradation in that margin, you kind of explained some of the factors there. But maybe can you just elaborate a bit on the step down in margins and kind of what supports that margin degradation and kind of as we think through, in fact, '24 season nice step-up in growth kind of where the margins go as we cycle past '23.

Yes. So look, let me start with that last part, right? So we're absolutely committed. I mean, at Investor Day, we said, "Hey, we do expect margin expansion and actually operating profit growth to exceed revenue growth. So we're absolutely committed to that. And you will see that happening as early as 2024, right? So you're absolutely right about that, and we remain committed to that. So 2023, why are margins at 22%, right? So there are a few factors which are transitionary and are very specific. And so first, we had expected a lot more growth in 2022 when we started the year and even looking at the first quarter and most of the second quarter, right? We had been tooling up and investing to -- in our key innovations to support that. So part of the '23 margin you see is an overhang on some of that investment that we have provided. We had taken action again in the second half of the year. We reduced our hiring. We actually had a reduction in force of about 5%. So all of that is already in there, and we had taken action to slow down some of that OpEx increase when it didn't match our growth expectations weren't met. Now '23, a few things happen, right? First of all, the revenue growth because of the transition or the factors that I talked about earlier, there -- there is a little bit of -- the margins will improve in the second half of the year, but not in the first half because of some of the headwinds. Gross margin, while it's still within our range is towards the lower end of the range. And again, all of that is dictated by X, right? When you launch a new instrument and new consumables, the margins in that first year tend to be lower because you're investing and you're not fully at scale. As you move through the year, first scale just improves those margins, again, you should expect margins in the second half of the year to be better than -- much better actually than the first half of the year. And then the second part of it is, as you move on into '24 and beyond, you'll see the normal productivity on COGS product that you would expect from us on any instrument, right, but you'll see a lot of that come through. And then for '23, the 1 thing on the operating margin side. And in fact, all of the -- the increase in operating expense is really from a normalization of our variable comp, right? So last year, because we didn't hit our numbers, we didn't pay much where it will come to our employees. This year, we expect to meet our targets. So we are accruing at 100% of the same kind of pay policies. And so that puts in a 1-year kind of comp that accounts for any of the OpEx increase that we have seen in 2023. So again, going next year, we won't see that kind of a normalization. So we're very confident that our operating margin will turn back into -- in the long term, getting into that 25% to 30% range.

Particularly if you beat numbers this year and your comp goes up a lot and the base will be -- then you'll have no. Okay. So with that -- thank you. Joydeep, Salli for being here. Thank you for 1 in the room, and have to give rest at the conference.

Thank you. Appreciate it.