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

Hi I'm John Sourbeer, one of the Life Sciences analyst here at UBS. Final day of the 2023 UBS Life Sciences Conference here [indiscernible] the Life Science portion here with a fireside chat with Illumina. Joining us today is Sally Schwartz, VP of Investor Relations. Sally, thanks for joining us.

Thank you for having me.

So you guys recently reported 2Q earnings last week, but maybe just start off with a recap in the lower guidance. There's certainly been larger macro issues throughout the life sciences industry, but maybe some of the puts and takes on China slower-than-expected NovaSeq X ramp and some of the general budget pressures across customers.

Sure. And maybe just as a quick recap. We previously had guidance for core Illumina growing 6% to 9%, a range of 6% to 9% for 2023. And we lowered that guidance to flat -- approximately flat for the year. So obviously, meaningful takedown, which is frustrating, but temporary in a lot of the drivers. So you mentioned some of the drivers just to put some numbers around them, about 25% of the variance is related to China. And I'm sure you've seen other companies as well. We've had our own challenges there. We had anticipated a recovery in the back half of the year in China from a macro perspective, and that's just not happened. So certainly, that's been a negative to our growth for the year. In addition to that and something more specific to us, we've seen a more competitive landscape there, more steeply discounted pricing coming from our primary competitor. And that's also created a lower win rate on our part and that's been -- something else that's been a negative. So about 25% from China. The other 75%, it's roughly evenly split between the two other factors that you mentioned, John. So transition to NovaSeq X has been going really well, lots of demand, lots of placements that we've put in the market. On the flip side, that Slide 2, some of our customers bleeding down their 6,000 -- NovaSeq 6,000 consumables faster than we had anticipated. It's also allowed us to see earlier on some of the technical issues that you typically run into once you roll out a new instrument and getting out to all of our customers and fixing those issues, it's taken longer. So not a negative necessarily, but a push out of some of the consumables purchases than what we had originally anticipated, as well as a faster bleed down. And then the final piece is really very macro related. So despite some hopefully positive signs in macro data out there in the world, Walmart certainly doing better with what it's seen from its consumers. Some positive retail sales, some positives on inflation, some hopeful things around the Fed and other central banks. Our customers are being really careful and cautious with their purchasing. And we've seen that play out in terms of just longer time to get to purchases, more cautious spending, more disciplined expense management and that's certainly been a hit to what we thought would be a bit of a recovery in the second half of the year. So across those three take down this year, we are still very excited about what's ahead of us in terms of the ramp-up starting in the Fourth Quarter with consumables on the X in particular.

And I did want to mention, we do have an iPad here. If you have questions in the room, there's a QR code. We can take them up here on this. So thanks for the overview on the macro situation there in 2Q. Looking into the NovaSeq X launch, demand still remains strong there. Guidance was raised on placements for the year. Could you just provide a little color on the breakdown of the next cohort of orders you've seen come in, I guess, since 1Q or since 2Q? And just a breakdown of where those customers are coming from? Maybe how many of those are new to high throughput or to Illumina and how we think about that?

We said we would give updates on orders once a quarter. So the last update we gave was during the Second Quarter Earnings. We said we had received cumulatively about 260 orders. So that's roughly about 60 coming in the Second Quarter. And we've continued to see about 40% of the orders come from clinical customers, which is different than what we've seen in past rollouts, especially the NovaSeq 6000 on the high throughput side. So more early interest from that customer base, which is -- which is really exciting to see because their purchasing in X is not at this point to replace the work that they're doing, maybe on the 6000, but rather incremental to build a new test or a new process. And so that's additive to what we've already got going on with the 6000. In terms of new to high throughput or new to Illumina, we had tucked in the First Quarter about roughly 15% of the orders being customers, again, that are either new to Illumina or new to high throughput. And some of the new to Illumina come from the capabilities that DX has around ambient shipping. So we've been able to chip consumables now without all the dry eye and the packaging and the boxes and everything that we've historically had to use and while that may not seem like a big deal is a huge deal to our customers, and it's opened up some new geographies and new customers that we haven't been able to access before. So we've continued to see good uptake on some new names and also some customers taking this opportunity to move up the spectrum mid-throughput to high throughput.

I guess this one point that you mentioned there on [indiscernible] and shipping. So it sounds like that's opening up new geographies. Just additional color there and maybe what geographies are now coming online for sequencing.

Yes. So we've had -- I think we had last put some numbers out there 35 or so different countries that we're selling into and that's just early days so far. So we think of more far-flung regions the world more emerging markets where maybe cold chain is not a given and you had to be more careful about being able to not have consumables arrive that you immediately have to throw away, because they had expired. Those are the sort of markets that we're seeing come online, and we're seeing more discussions come from those countries as well. I think certainly, the process of COVID, if I could call it that we all went through has risen the visibility of genomics as an interesting opportunity for health care broadly.

And I think now it's been about 2 quarters, instruments in the field. Just what's been the initial feedback you've had from users? Any learnings, updates, what's been the feedback there?

Yes. And a very, very positive feedback and enthusiasm, which is exciting because we can all use some enthusiasm for what's possible. So we've had a number of open discussions. I mean, if you think back to our Illumina genomic forum in the fall, we tried to facilitate the gathering industry folks to really work with each other and then push things forward, not just for Illumina, but more broadly for the industry. That's continued, and we've continued to facilitate those conversations. So a lot of excitement for what's possible here. I would say, in terms of learnings, one thing that's been interesting in this rollout, I referenced a little bit earlier, we've rolled out more Xs faster and to more places than we've done any launch before. And that's great, except. It also means it's a lot more challenging. It takes a little bit more time to work through the support you need to provide your customers as they continue to bring these instruments online. So that's part of -- as we talked about why guidance is coming out a little bit. It's taking longer to get to everybody and make sure they're ready to plow ahead with their work. But feedback so far has been pretty phenomenal.

And that kind of leaves the next question, just maybe that slower rollout of the NovaSeq X was highlighted in the Earnings Call. Just any color on how -- who is tracking maybe even versus internal expectations? And it sounds how do you expect this to ramp as the instruments go online?

No, it's really early. So I know when we initially launched the X, we talked about, call it, 6 or 8 quarters to just get some stability because if you think of what pull-through is, it's consumables purchases as a numerator and the installed base of the denominator currently with the installed base growing very rapidly. Consumables purchases, we've had some so far, and we've had the 10B flow cell available, the 25B flow cell becomes available, we'll have more. We're starting to see the beginnings of this ramp here, especially as we get to the Fourth Quarter. But it's very early and so that number is moving around a lot. We'll give you an outlook on it as soon as we can get a little bit more stability there.

And just can you remind us on the 25B flow cell, when do you expect that to come online, start shipping there?

Yes. And so Fourth Quarter, so very highly anticipated by our customers and all eyes internally on getting out of the door and delivering on the full promise of what the NovaSeq X can do.

And it sounds like some of the NovaSeq X users still are using their NovaSeq 6000s. I guess how do we think about the replacement ratio and upgrade cycle for the 6,000 now that you're studying to place NovaSeq X?

Well, we have, call it 1,000 or so, NovaSeq 6000 customers and for that 1,000 customer base, about 750 of them only have one NovaSeq 6000. So for them, it's a binary choice. The they're going to buy an extra they won't. We think over time, everybody will replace their 6,000. But you can't buy half an instrument or 1/3 an instrument. So it's one or nothing or more. And then for the other 250 customers who have multiple instruments, we've already seen a number of multi-unit purchases. About 20% of the orders have been multiunit purchases, which is more or less keeping pace with the 25% of the customer base that has multiple units. And one other thing on that will -- we've started to see -- and this is part of why we have some confidence in the order book going forward some of those initial customers that got early instruments come back around again and place follow-on orders, which is great.

And I guess, similarly on the NovaSeq 6000 I think there's some pull through. There's macro headwinds here with pull-through over the near term, but how do we think about that tracking then as you start to see those replacements come in for the NovaSeq X?

Yes, it's going to come down. And the same that we've experienced with prior transitions from one instrument to the next. And like you said, we already brought down the average pull-through for the 6,000 to 800,000 to 900,000 range in this recent Earnings Call. So we've seen that come down faster than we expected to this year, which is one of the reasons we brought that down. And then also one of the reasons why guidance has come down a bit. So more on the research side, as customers look to really pick up work and move it over and then accelerate from there. Clinical side, we'll hold on longer with the 6,000. They have tests and processes that are already validated in those, let's take a lot more effort to move.

And just maybe one more here on the NovaSeq X question from the audience. But placements can has been strong. I guess you have the new flow cell hitting in the Fourth Quarter. Is there a simple there? I guess, when do you see this catalyst happening where the pull-through starts to increase, maybe even if you look at previous launch cycles, how this could play out?

Yes. We expect to start to see it in the Fourth Quarter. The availability of that flow cell. We've worked through instruments getting ready to come online, and we're really starting to see some take-off points. Now there's hopefully some little bit of budget flush, I mean I don't want to overstate that, but I think it's every little bit helps. So Fourth Quarter is -- when we expect to see and you can see that in our guidance as a start of a ramp.

And actually, one more here. Some of your customers on the liquid biopsy side or saying they're starting to switch to the NovaSeq X. I guess, how do you see this impacting adoption pull-through revenue on that as well?

Yes. There are some very exciting areas. And I think this is part of what I mentioned earlier with the customer excitement as you listen to a number of our peers and our customers, the mentions of liquid biopsy and all the things that could get done the promise there and just the ease of use relative to tissue samples to collecting on the collection front. So that's very exciting. MRD is another area that pops up in a lot of customer discussions around what they want to get done or what they're building into. You've seen this morning more news on the single-cell side, and there's a lot of movement broadly across the space. If we could get a better economic sentiment to support it, I think there's a ton of opportunity here.

Great. So let's move on to mid throughput, the NextSeq. I guess, are you seeing a lengthening in the cell cycle there on the mid throughput just given some of the budgets? And is any of this also due to some of the increased competition that could be coming to the market?

Yes, on both. So I think the mid-throughput side, I mentioned earlier, these cautious purchasing decisions. It's taking people longer to make commitments, and it's taking them longer internally to work through approvals and budget processes that they might have. I mean that's true even at Illumina. So it's -- that part makes sense on the macro side. Competition as well, I think procurement departments generally speaking, like to look at options if there are options and evaluate them. So we've been tracking very closely our win rate. And we mentioned during the Second Quarter Earnings Call, our win rate across this throughput actually accelerated in the Second Quarter versus the First Quarter of this year. So it might take longer, but ultimately, we're still doing quite well.

And I guess just can you also remind us, maybe even if you think about it just the NextSeq mid-throughput, some of the pressures there and how that's impacting customer budgets and consumables for the guidance for this year?

Yes. We've taken down our 550 pull-through figure, our average pull-through figure. It was 150 -- excuse me, $100,000 to $150,000 range, and we pulled it down to $80,000 to $130,000. So that has come down. Part of that China, part of it is just there's not the COVID surveillance driven demand that we had historically seen. On the 1K/2K, the NextSeq 1K/2K though, we held the pull-through range, it's $120,000 to $170,000. So that's continued to stand up well despite the fact that the increase -- despite the increases in the installed base. So the denominator continues to move up. We had 8% growth in the Second Quarter in NextSeq 1K/2K. Despite that, the pull-through is holding up nicely. We were toward the lower end of that range in the Second Quarter though.

Thanks, and the companies talked about bringing the XLEAP chemistry to the NextSeq next year. Just any thoughts or color on that and how that upgrade cycle could look.

Yes, that's -- so no need to buy a new instrument. So that's good. You can use your existing NextSeq 1K/2K, but you will have the ability to effectively download, I'll call it chemistry X and have some of the capabilities that the NovaSeq X offers customers. So there's a lot of excitement around that. I do think that's driven some of the sales that we've seen. But in addition to Chemistry X and some of the other offerings that NextSeq 1K/2K is unique in providing customers a dragon on board the informatics and the analytics capabilities is something that our customers have been looking for, and we're delivering on as part of our broader value proposition. So we expect to continue to see a nice backlog there and strong purchases and the rollout of Chemistry X on the NextSeq 1K/2K is first half of next year.

Thanks that you kind of touched on a little bit. But I guess if you go back to the NovaSeq X launch and the 6-K, you saw a little bit of change, maybe some pause in the ordering patterns there, but this is more of a upgrades and a brand new instrument. So it sounds like you're not anticipating any shift or changes in backlog from what you see right now?

No. Well, I mean we may see people bleed down or run down some of their consumables to be able to switch up to the new consumables but they don't have to switch the instruments. And so that's a more contained transition, I'll say.

And maybe switching now to margins. The company has announced some cost savings plans. And just how do we think about the different components there and maybe even an R&D run rate now with the cuts you're making.

Yes. So the expense cuts, I mean, we're doing the same thing a lot of our customers are doing. It's the sort of environment where you prudent to do such things. So the way we approach the expense cuts was to look at projects or initiatives that either could be downsized, could be delayed or just didn't perhaps make the cut to get done and then looked across the functions to be able to say, all right, well, what does that mean we don't have to spend. And that's translated to head count reductions in some case. And you saw us announce a few of those over the last year and other costs around vendor spend, travel and so forth that are associated with those initiatives. One big piece that we're still working through is on the real estate side. So we've relooked our global real estate footprint we've been rationalizing what we have, and we'll have more announcements there just in terms of amounts and the impact to the P&L as we get those things done. But it's been pretty broad-based, including R&D. R&D though, remains a key point of commitment for the company. We've -- we're an innovation-oriented company. I know a lot of companies say that, but that has been the hallmark of what we do and who we are, and we -- it has allowed us to drive the industry forward. So I think you will still see significant dollars going to R&D and growth in that budget, but we've got to be disciplined about the spend, which is something we're pushing hard to do as well.

And at the Investor Day last fall, you gave some targets on both margins and for core aluminum revenue growth. And on the Earnings Call, you reiterated that 25% margin target. I guess how do you view the achievability of that target? And then maybe long term, where are the opportunities, where you think you can see advantages on margins going forward?

Yes. So I know Joydeep mentioned -- referred to it as more of a stretch. And I think that I mean that makes sense by definition before we had 300 basis points of a gap from 22 to 25 to cover off. Now we've got 500. So purely from a numbers perspective, that's 100% true. We do have multiple levers to work at, and we're pulling on all of them. So on the OpEx side, we talked about that. And we see further opportunities to continue to fine-tune our OpEx spend. On the gross margin side, there are opportunities that should translate as revenue terms and then also proactive things we're doing to manage the gross margin. So on the first part, as we cover off more of our manufacturing cost base as we're ramping up the production of the X and all the consumables, that go along with it, we're able to cover more of that fixed cost base and that certainly helps the gross margin. And it's been one of the reasons why the gross margin is lighter this year. But then on top of that, as we ramp further into the consumables purchases, those are higher-margin revenue. And so we should see a mix shift back towards higher margin revenue, which will also benefit the gross margin. In addition to the actions that we're taking to continue to proactively manage down the cost that fit within our cost of goods sold. So lots of pieces there and lots of things to do to get that moved back up again. And then obviously, the top line I think we're going to need to work through the rest of this year, see how the ramp takes shape. See where we are as we go into next year with the broader macro environment and customer sentiment. But again, that's what we're working towards. Is the 25% for next year and then accelerating beyond that. As a company, we've been sort of in that 25% to 30% range historically. And we think structurally, that's a very reasonable place for us to be going forward.

And I guess, similarly, on the top line part of that guidance, the mid-teens growth. I think China is about 10% of your revenues. Obviously, there's macro issues there, but also there's been increased competition, maybe some pricing. I guess we put all these factors and the NovaSeq X launch, NextSeq mid-throughput. How do you think about then that ramp just on the core alumina to get to that mid-teens growth from where we are here?

Yes. I mean we -- the mid-teens still makes sense to us as the long-term structural growth of the company. And when you look at it, all the things we presented at Investor Day around the target addressable markets and the size of those giant markets that are largely unpenetrated or very lightly penetrated. There's opportunities to really accelerate into a number of different places. I seriously doubt it will be entirely linear, but we're certainly putting in place all of the pieces to enable continued reimbursement, continued adoption, continued awareness amongst physicians and patients alike to be able to understand what genomics could do for them and the sort of the power of sequencing generally. Then the analysis that Joydeep walked through it at Investor Day also for elasticity is another place that we see continued possibility where it's not just about we have to go find more samples. Sure, that will help. But we also are seeing increased interest in taking those samples through multiple different analyses, and you hear lots on multi -- different pieces of multi-omics from across our customer base and us. So lots of different analyses that can get done. And then data, we're seeing some of our customers start to say, "I'm not going to just do whole exomes, I'm going to do whole genomes or I'm going to expand these panels. We're doing bigger panels now or forget about panels, we're going to go straight to PGP. So there's -- or a liquid biopsy, you mentioned it's more intensive on the sequencing side. So all these things point to more elasticity, more use of the firepower that we've created more enablement by the lower price points.

And I guess just on that point, liquid biopsy in clinical markets, just any additional color you're going to see there on just how these markets are coming online and how these could add to the long-term growth there?

Yes. The clinical side has been hard to get prepped to serve. It's not something you just decide to do overnight and start calling on clinical customers, and you're good to go. The transformation that the company has had to undertake in order to be prepared to really service those customers is taking years and quite a bit of investment. But we are very well positioned to now to be accessing that whole customer base. And we see the clinical markets as bigger and faster growing than research and so for us, it made perfect sense over the long term to be able to have access to those broader markets and take advantage of the growth opportunities there. And there's a nice feedback loop between research and clinical that we're certainly trying to fuel as well.

And I guess, while we're talking on clinical -- just any updates or feedback on the NovaSeq DX launch, I think China might have been a big market for that. So any impact there and just color you can provide.

Yes. So the NovaSeq X DX has had a nice rollout. China was one piece, and certainly, that's at some point of success and then other challenges like we were discussing, Europe has actually been a really important market, just broadly lots of specific countries there that have rules or requirements that the DX helps serve. So we've had a pretty nice rollout on that front, and we'll continue to selectively pick spots where we have DX instruments for those customers who need those specifically.

And one area I just wanted to touch on. There was an SEC investigation listed in the 10-Q that came out post the earnings call is the company providing just any comment on that or just more broadly, any update on the various GRAIL investigations and timing on those?

Sure. On the SEC, it's not a whole lot to add to our disclosure in the 10-Q. It's very early. So we received a letter in July, requesting various documents. We're cooperating with the SEC to provide all the things that they've asked for. I think we would observe that given what we've been through as a company, a very public proxy fight, ongoing regulatory discussions, I'll say, going on in multiple different countries and then the departure of our CEO earlier this year. All of those things draw a lot of attention to what's going on with the company. And I think the SEC looking to understand all the moving parts. So we'll have more to say over time, but for right now, pretty early. And then on GRAIL, I won't call them investigations, but with regard to the ongoing GRAIL processes, we'll say, in the U.S., we have the appeal that we've now got in the Fifth Circuit Court in the U.S. We're expecting to get a decision from them by the end of this year. So we should know at that point whether we've been supported in progressing with the acquisition or whether we have to divest at least according to the U.S. In the EU, we have -- we're paying most attention to a jurisdictional appeal that we have underway at the EU Court of Justice like the Supreme Court in the EU. We're supposed to get a decision there, either later this year or early next year. And this is specifically on whether the EU has the jurisdiction to even review the transaction in the first place. So if we win that appeal, then the fine that you've probably read about that we recently had a sign to us that goes away. So that's EUR 432 million, which would go away, which is obviously something we're critically focused on. But also importantly, we wouldn't have to divest if we were going to, in accordance with any divestment order, we'll be able to do a bit more flexibility in terms of what we do from there. So in terms of a decision tree, if we lose one or both of these appeals, we'll be divesting. We're not going to pursue anything any further at that point in terms of further appeals on our part. If we win both of them, then we have a decision to make, either we are going to keep the asset in some form or fashion or we're going to divest even though we could keep it. And so our Board is committed as is our management team to relooking the asset if we get to that point and making a decision based on looking forward, what the business case is and the value that could be accrued. And if it's in the best interest of shareholders, we'll finish the deal. And if it isn't, then we won't, we'll divest. And one last piece on this. I know it's a lot of moving parts. We're waiting still on a divestment order from the European Commission. Hopefully, we'll receive it this quarter. We assume maybe September since August is more of a summer break. That will allow us to then start progressing with the divestment and start running down hopefully different paths to see what's possible in the markets and with potential buyers. So we're prepared to get moving as is we receive that.

And maybe back to Core Illumina here a couple more questions is, I guess, maybe start off long-read market. Just how does that come up in the conversation? How do you see the short-read long-read dynamics play out?

Not as often in the conversations, I would say, but an important part of the market. We see these two short-read and long-read that are complementary to one another. Short-read addresses most use cases and at a price point that's unparalleled by long-read by quite a bit, as you know, I'm sure. But long read is important as an offering, certainly in niche or certain areas where it just -- it makes sense to you. So what we're working on is a long reoffering of our own that would be available on our existing instruments. So you wouldn't need to go buy another instrument, you'd be able to use what we're rolling out on our instruments for what you need it for and obey that. So we had one offering that we rolled out and we announced in March of this year, we started to roll out in May. We'll have an enrichment assay that we're coming out with very soon. And that, coupled with the 25B flow cell on the NovaSeq X gets you to a $600 total genome with long-reads. That's very exciting for some of our customers. We've got more than 40 of them right now that are doing evaluations and initial work and so far, pretty encouraging on that front. And our aim is whatever our customers need, we want to be able to deliver it on our instruments. So whether it's front-end needs of use and easier sample prep, especially for clinical customers or whether it's back-end informatics, analytics, data storage, data losses compression and all the data management tools that we increasingly need, there's long read. We want to be able to -- you don't have to go buy new instruments or new tools for all these things, all built into our systems.

And I appreciate that on, I think, 40 customers. You said the [indiscernible] long-read. Just any additional feedback there from those customers that have started to receive the kits since May? And how do you think about just the broader opportunity of the end customer set that's out there for these products?

So early good feedback. Obviously, this initial product is not the full enrichment assay and the 25 B flow. So those are coming. So we expect the enthusiasm to ramp on this. I think it's an incremental offering. So we don't see, generally speaking, long-read is a replacement to short-read, but again, more as a complement. So it will be a nice revenue addition. But again, more of a complement than a replacement.

I guess there's quite a few population sequencing programs out there. I don't think it came up on the earnings call, but have you seen any of the macro headwinds impact these programs and just any new programs or other updates on this?

We continue to track. We've got a portfolio of 30-something different POPS programs, projects that are underway. And some finish, new ones get added. There's actually some very large programs. The X has enabled in certain countries that we hope to be adding very soon. So that will be exciting. No big, big ones to know. I know in the past, we've had some very large ones, but it's -- we've got a diversified set. There has been an impact of the macro to some of the -- both the purchasing as well as even inflation has stretched some of those budgets in terms of what can get done and sample gathering has been an issue at times. But we built that into the way we've looked at the year. And if it's intensified, we've reflected it in our revised guidance overall, they're the PopSeq programs as a whole portfolio are less than 5% of our revenue. So in and of itself, it's important but not a huge piece of the revenue base.

Great. Well, thanks for that. With that, we're right here at the time. Sally, I really appreciate you joining us today, and thanks for everyone in the audience and listening.

Yes. Thank you.