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

Good morning, everyone. Thanks so much for joining us. My name is Eve Burstein. I cover U.S. life science tools and diagnostics here at Bernstein. And I'm delighted to be joined by our Illumina friends. So Ankur Dhingra, CFO; Salli Schwartz, Head of IR. Ankur joined Illumina as CFO just a couple of weeks ago. So we're glad to have you right out of the gate, who's formerly CFO at Summit Therapeutics and prior to that, CFO at CareDx and spent a number of years at Agilent as well. Salli has been, what, 2.5 years?

Almost.

Happy almost 2.5 anniversary as the VP of Investor Relations at Illumina. And before that, she was Head of Investor Relations and Treasurer at MSCI, and she also spent a number of years with Moody's. So I'm excited. I have a lot of questions. But a reminder to the audience, please feel free to submit questions via Pigeonhole. I'll be looking at it as we're doing the conversation, and I'll add them in. Great. With that, let's go ahead and get started. Ankur, do you want to kick us off? Anything you want to say right off the bat?

Yes. Let me just speak to a couple of things because we'll get into the details of the strategy, but here's 2 points that we've been talking about, mainly the priorities that I have as I'm walking into the company for -- this is now 1.5 months now. And we've -- Jacob and I have talked about the top 3 priorities here in the near term of getting back to growth as a company and that remains priority #1. The second one around driving operational excellence in the company. We'll talk a little bit about it during the Q&A potentially. But my focus coming in as the CFO is to think about profitable growth of the company going forward. We are in the process of setting up what does baseline core Illumina look like. You've seen it -- a lot of it in our disclosures. But as we get ready for laying out a strategy in the latter part of this year, our focus remains on driving both the growth as well as much higher levels of profitability, similar to what Illumina may have seen in the past. That remains my top area of focus. And then more short term is around GRAIL, and I'm going to make a couple of comments on that because everyone including us, wants to get to a quick resolution to that and start focusing on the core business. We continue to make -- take steps in both this -- for both the scenarios, whether it is a spin or it is a sales scenario. We're running them both in parallel. Our Board is considering and has given us the pathway to continue to run those. You may see filings that we will have to make to be able to run both the scenarios together, including things like filing an amended Form 10, including seeking approval from NASDAQ or SEC, while in parallel, we may also be talking to companies about the alternative scenario for sale as well. They will both run in parallel. Our intention is to get to a resolution here as we've stated within this quarter. And when we say quarter, I'm still thinking end of June. And we'll keep running both of those until we get to a point where it is a very clear decision that there is only one of them that is viable. And we will promptly communicate and then set the pathway so that we can pimply execute on that as well. both of the pathways require various regulatory approvals and it's not a really short process. And what we didn't want to do was to pursue a single path, get to a point where we feel it is not viable anymore and then start the second half. So both of them are running. We, as of now feel confident that we will get to a resolution here within Q2. And as soon as we do, we will communicate it. Okay. So let's get into the Q&A now.

Okay. Sounds good. Thank you. So you mentioned that you're going to be unveiling a strategy in the fall. And clearly, you're in the midst of examining that strategy and deciding what it's going to be. So we'll try to stay away from questions that we know you won't answer, but this is the Strategic Decisions Conference. So I've got to ask about strategy to some extent. Let's start there. Maybe let's start out with, can you help us understand what the bones are going to look like? Or sort of what sorts of components we can anticipate in a strategy? So for example, I don't imagine you're going to come out and say, we are going to give on price to keep market share or we're going to try to take on 10x, right? So what is it when you say that you're going to be articulating a strategy that you really plan to articulate?

Yes, sure. So yes, great question. And yes, I'm not going to lay out exactly what the strategy is going to be here. The way we are thinking about it right now, if you still step back and think about -- we're still thinking about the genomics ecosystem overall that Illumina has created over the last 2, 2.5 decades. We have made access to genomics much more broad as well as efficient. So several steps over the last 2 decades have been taken were now talking. But realistically, in a production environment, a $200 genome, which is being run now in the labs. That's a great feat of both technology as well as the science that this company has driven. Our strategy is built on that foundation. That is what we will further. It's not -- the way we are also thinking about it is thinking about the sequencer being used potentially as a detector. It might come from the life sciences tool sites of thinking about detector. But there is much more that the sequencer is being used for in the ecosystem today. As a player, what is it that Illumina can continue to do for developing that ecosystem? How do we make other parts of that sequencing run scientifically more progressive as well as cost-wise, more efficient? And that takes on many forms. You can talk about it in the terms of sample-to-answer. You can talk about it in terms of multiomics. You can talk about it in terms of what everyone calls elasticity. But in terms of how much higher resolutions of these new applications actually consume, but they've now been enabled because you can run that sequencing at a cost level which is much more efficient than it has ever been in the past, right? So there is an ecosystem that's being enabled and our strategy likely will talk and touch on all of those to say what role can Illumina play in these areas going forward, whether you think about sample answer, whether you think about multiomics and whatnot. And how do we believe that can both drive the ecosystem as well as Illumina's growth going forward. So that's the largest play. Second part as the CFO, I have to talk about the returns. And that's how I think about it, right? The company has been investing heavily in various aspects of this ecosystem at this point. We do want to talk about what our expectations of returns on some of these investments are. How do we measure them and what kind of pathway do we see over the next several years of what core Illumina excluding Grail could potentially look like, what kind of path we are besetting ourselves up on. So that's how we're kind of thinking about the strategy at this point.

So to your comment about returns, do you expect to offer long-term guidance on revenue growth or EPS?

In some form. I can't tell you exactly whether it will be an EPS growth number or whatnot. But I do intend to, at some point, set the expectations of where are we going? Where do we see leverage within our P&L. And I can tell you it is likely going to be across all of lines of the P&L. And then with the 20-ish percent core operating margin today, what kind of pathway from a profitable growth can we expect or what I'm driving for over the next several years. We'll give you some sort in regard to them. I don't know the answer exactly what it would look like. But yes, we do intend to get there.

Okay. Great. Could there be new product announcements?

Investor Day, new product announcements, lower probability. We still intend to stay focused more at the strategy level. But still thinking about it more like an Investor Day less in R&D day type of discussion at this point. Now don't hold me, I may change that later on, not because we have to make a product announcement, but this is still more a strategy conversation. This is more to say here's where we think we want to take Illumina, and what could that look like rather than a very specific product discussion.

Fair enough. Great. Thank you. So you talked a lot about how the discussion is going to touch on some of the different ways that you can grow beyond just sequencing as a platform, right, sample-to-answer, multiomics, different applications. But if we think just about your core business, just the sequencer and the consumables, just the platform. One of my favorite quotes about strategy for Michael Porter is it's saying what you're not going to do as well as what you are going to do. And it seems to me that for your core business, there's really a tension between investing at kind of industry or historical high levels in order to try to drive back to the top line growth that you've had historically, high singles, low doubles verse (sic) [ versus ] acknowledging that maybe that's not possible in the new world that we're in and cutting costs. So I guess my question to you is, do you agree that those 2 things are at odds? And do you -- are you and Jacob and the rest of the team ready to talk about what you're not going to do?

Yes. Great question. Are they at odds? The answer to that is where you are in the S curve of the technology development, right? It may not be at odds early on, where you have to make outsized investments, when you're making the market with the adoption of the technologies in the earlier cycles. At a stage where Illumina is now, I don't see it as much at odds. Now the way I'm thinking about it is the -- it still comes back down to, if you're running 20, 25 different programs, the technology has now -- you've built an ecosystem, people really know the value of what the sequencing is. Most of the changes that you will make now are more going to be -- are you pushing the envelope of the science, where people still know how the technology is being used? And as soon as you push the next envelope, they can very clearly articulate how it is going to affect them. Does it enable running new tests? Does it enable running tests much more efficiently, right? So you're lesser in the market-making mode, which means the returns expectations on your R&D, on your marketing investments is now different than it would be what Illumina was 15 years ago, right? Is the team internally thinking about it the same way? They're getting there. I've been here 6 weeks. And I think I've spoken about this to say some of the observations I've had coming into the company and some of the most positive ones as I talked to the leadership team, is that understanding to say, yes, we have a leading science position, but the size of investments that we need to make going forward, to continue to make the changes that are required may not be that outsized as they were in the past as a percentage of revenue. So coming back to your one question. Are they the odds? If you still set the right return expectations, if you still set the right prioritization of areas that we will work on, which by connotation means the areas that we will not work on, I think we can drive a good revenue growth in this market. We're still in early stages of adoption. But not in early stages of technology development, but still early stages adoption in this market.

Fair enough. You talked in Q4 quite a bit about strategic partnerships because you've had a lot of revenue from them, but they were also lower margin. And you just said we're still sort of in early stages of adoption. It kind of strikes me that for the last decade or more, you have been really investing to build this market. And that's great because it builds the market, but that's also expensive for you. So I guess, is there a point where that burden goes away and you don't have to continuously overinvest in order to build that market? And also now that you have, I would argue, credible competitors, they seem to also benefit from the investments that you make. How do you think about that free rider problem?

Yes. I think every new industry, every market maker goes through that cycle, right? The size of the investment made by the first entrant who creates the market is always much larger than the second or the third follower behind that, who ends up benefiting from the work that has been done by the other company. But at the same time, the second and the third player also helps expand the market a little bit in terms of making the technology more -- I don't know, is it available, more acceptable or many -- kind of plays out in many different ways. Now is there a point in time where the size of marketed making investments could go down? Yes, I see that. And I see that potentially happening within [ here in ] 2024. So I can say that within this decade, where I'm not going to say 2025. But certainly, within the time horizon that we're talking about, thinking about it from a strategy perspective where the size of the market-making investment potentially could go down. As we think about our evolution of Illumina's P&L as well, those are part of the things that we think about to say, does this still require that much of a push to the customers to adopt the technology? But most of our customers really know now what they're getting into. This is now more a conversation of -- because you can now do sequencing at a much, much lower cost. And hey, you can do a whole genome-based sequence, of a whole exon-based sequence and now you can run an MRD or a new kind of test, which is much more intensive from a sequencing perspective, but also gives you the level of resolution to enable that science. The conversation is more about that end consumer developing that test, right? It's not about the adoption of the technology itself. And that's the power of this ecosystem where we make one step change and what does it enable in the entire ecosystem. So definitely, the market making goes down. Do the second and the third player end up getting a free ride from that perspective? Yes, they do. What they don't have is a 25,000 instrument base in the world. What they also don't have is the stable, high-quality, highly reliable instrument, which is also going through significant technology upgrade, not just on a hardware basis, but also by adding DRAGEN, either in the new box or even available potentially as a cloud. You get the analytical capabilities at the back end. We enable new assays in the front end, and many of them are backwards compatible to 1 or 2 generations behind. So the value that you're getting out of that ecosystem is just dramatically different. It's taken a couple of decades to build up. And we don't intend to just back away from it. There is so much more that we can add into that ecosystem, not just by buying the latest X technology, but if you've been with us for 10, 15 years, a lot of this enablement goes into the entire ecosystem. So this -- the power of that is -- I think when I get into some of these discussions with some of the investors, I still feel that's kind of underappreciated a little bit right now. But part of it is we also have to lay out how does that fit within our strategic thinking, too.

Yes. And so maybe just to pick on that a little bit or put together some of the pieces that you mentioned. You said for the core sequencing business, maybe you can start spending less over time because you don't get the same return, you aren't going to have to spend as much to develop the market and the power is really in the ecosystem. Is it fair to say that at this point, that pure platform sequencing is commoditizing, if not commoditized, and really the value of Illumina or of any sequencing player going forward is in the ecosystem that they create?

Yes. Let me say that differently about how we think about it. If you get commoditized, if there are so many other companies who are able to replicate that same quality, capability and experience, that's when I would say it is commodity. I don't think we're anywhere near commoditized. Where we are, though, if you think about an end-to-end workflow and you think about the total sequencing cost, both at the research level as well as in a clinical environment, the cost of sequencing is getting to a point where that isn't the largest part of the cost system anymore, right? What Illumina has done is that it has made the technology available at a speed of execution as well as at a price point where that's not your largest component. There are companies -- and I come from KDx. So there is more time labor money spent on collecting the sample, bringing it into the lab, the number of people who are running the tests, how much does it take to prepare the libraries and the preparation work as well as subsequent analysis as well as the delivery of the results. If you look at the entire end-to-end cost structure, there are many more components that are ripe [ before ] taking a look at, right, and making them more potentially efficient or scientifically advanced both. We're not going to play in each and every one of those, that's not Illumina's play. But that there are areas where scientifically, Illumina can make a difference and make those pieces -- but take an example of whole-genome sequencing. There is a play Illumina could potentially make in that space to make that part of an assay much more easily available to the ecosystem, so that our customers can then build their diagnostics, their tests on top of us showing them what's possible, what can something be done? Something can be done in a 15-hour run at a low price point on whole genome, it does enable our ecosystem to think about tests in a different way, right? So...

That's great. That's a good lead-in into another topic that I want to touch on. So I'd like to spend time on the health of each of your end markets. And maybe let's start with academic. And I guess, a framing question first just about the money available there. So if I wanted, I think I could argue that NIH funding is at an all-time high, if you look at it on inflation-adjusted dollars and there's a lot of political risk to funding in academia, getting cut this year. So it just seems like there's a lot more downside risk than upside potential for that market overall. Do you agree with that statement? And what does it mean for Illumina?

Yes. I think I've personally -- even during the Agilent as we used to get that question in terms of our ability to predict where NIH or some the government funding would go, which is highly questionable. But at the same time -- and Salli, help me add on this one a little bit. But so far, what we've seen is that the funding has been stable to slight growth this year as well. To the extent we hear from our academia partners, with whom we are working as well as anything on The Street. We see good bipartisan support for the science, at least so far. We haven't seen a large discussion anywhere about -- especially not academia partners, who rely a lot on some of this funding. We haven't seen any discussion so far about saying our funding is being cut or there are questions being asked about what programs are we running, et cetera. Can at any point in time, the government take a different decision? That risk will always remain, right? Are we seeing signs in the market at this point? I wouldn't say so. Nowhere near. So...

I'd only add two things. One, we track a lot of different grants through our customers and trying to understand where they're headed and what they'll need in order to take advantage of those if they are awarded those grants. And those levels have persisted in terms of the number and dollar amounts represented by the various grants that we're tracking. That's one. And two, we're kind of talking about all this funding in one big bucket, but then there's the part that goes towards genomics specifically or things that could be relevant to our world. Maybe we'll broaden it out a little bit. And that's typically been holding up better and growing a little faster than the overall NIH budget, for example. So there's a -- that gives us some confidence as well. But back to Ankur's point, particularly in the future.

In the end, if you're in academia, you're running a program based on a grant and whether -- even if you're in, say, a single cell-based analysis in the end, it is still a sequencer being used in the back end, right? So there is a portion of that, that Illumina does enable in the amount of research that's going on. Now strategically within that space within, let's say, the academia research center space or otherwise, one thing that you will see it play out in more detail during the strategy, but what we been working through is Illumina's relationships with the KOLs, with the partnerships that we have with pharma. How have they been in the last few years, especially when GRAIL happened and whatever was going on in the company? Is there a play here in terms of how Illumina works with some of its largest customers. How many of the customers really have some views into what is in Illumina's pipeline, right? And how good -- what's in our pipeline enables some of the work that these customers are doing, can they partner with us? So the discussions with -- having about that to say, how do you evolve the ecosystem in a manner where some of your largest customers who are an equal partner with you in shaping the science, become more participative in where Illumina is going, right? So we've talked about the MRD partnership we have with BMS and J&J. We have internally been working with some of the largest KOLs in the industry and talking about -- so what's the next program you're doing? We can show you some of the things that could be coming from Illumina hailing the near term to enable that next level of science. And we're seeing excitement around that. The second connection I'm trying to make there is also from a grant and the funding perspective, is we see excitement in these KOLs to say, Oh, I am thinking about this large program that will require a different level of measurement. And if you have something in your pipeline, let's work on that. We may have access to funding for those kind of programs. So it's kind of going both ways. One is how much funding is available, but at the same time, we are enabling science that eventually does pull funding in that direction as well.

That makes sense. To that point, so this is not the case in every single workflow, but some of the workflows that are growing like single cell and spatial for example, they have their own costs for a researcher, right? They have their own instruments. They have their own consumables. And you even said earlier that the platform sequencing is really not the biggest portion of cost anymore. So if the -- if academic funding is relatively stable, maybe growing a touch above NIH funding in general. Are you still losing -- at this point with the products that you have now without the full ecosystem, are you losing share within that academic sphere? Because yes, single cell and spatial give volume to you. But at the same time, an investigator has a $2 million grant, some of that money has to go to someone else.

Yes. But in the end, the whole idea of making sequencing available at that point is exactly what you're talking about, which is a single cell or a spatial, if run does take whatever front end that they would take, but does enable much more sequencing than a typical traditional sample would have done. In the end, the consumption of the consumables within that space is much, much higher than what would have been in the past, which goes back to the core concept of elasticity to say, are we enabling science that is much more sequencing intensive? And there is a transition period. We've talked about [ a valley ] here a little bit as we transition with some of these newer technologies. But specifically in the examples that you're talking about, we do go back and see and actually measure to say the actual GP output is much, much higher. The actual consumable consumption in that space is much, much higher, which is the core tenet of what we're trying to drive.

Much higher than what? What are you comparing it to...

What has been in the past. So if a research -- if someone was running a research on core [ sequencing ] genomics workflow based on saying [ C and ] S4 cell and now they go into a single cell analysis, the actual output for that analysis could be significantly higher, could be 30%, 40%, 50% higher from a core sequencing basis that is required in that cell. Now it's hard for me to kind of articulate if you had a $2 million grant are you putting more money here or here. But if you are running a single cell analysis, you by design require more flow cell consumption to be able to run that test effectively. Said other ways, if the cost of sequencing hadn't moved the way we've moved it, to be able to run those tests at that volume probably would not have been possible or economically viable, right? So we still get a fair share there.

Okay. Fair enough. You talked about elasticity. Let's go there. So elasticity in the clinical end market comes up all the time. And you guys have talked about this in the past. And if I had to sort of say, what I've taken away as your view, and you should correct me if I'm wrong, it's two things. One, people are going to do more. They're going to do bigger panels. They're going to do more coverage. And then two, the clinical applications are still very underpenetrated, and that's where growth comes from. Is that fair? Anything you would add?

Generally, I think the only other thing I would say from a clinical market perspective is traditionally, and it's always been whether it was in the sequencing space or do you look at the other modalities within the clinical diagnostics space. It has always been a longer cycle market, right? When you get a test approved, when you actually get it into the clinic, changing that to a newer technology takes much, much longer. The technology you will see within a clinical lab generally tends to be [ orderly ]. It is used much more longer, just because of the cost of regulation in validating a new test on a new technology. So irrespective whether it is sequencing based or otherwise is a portion of that market that always is longer to transition to the new technologies here.

Okay. Great. So then I want to dig in on this a little bit across 2 time horizons. So you -- let's start longer term first, actually. So longer term, the new FDA LDT final rule to some extent, makes it harder for clinical players to evolve assays to do what you said, right, to add more bells and whistles. Like Guardant, for example, they have a CGP test and they have a CDx version and then they have an LDT version that is bigger and deeper and offers more. And with this new rule in place, is there a risk that companies are not going to be able to bring that innovation to patients as quickly? And so that elasticity of demand is going to take longer to play out than it would have otherwise.

Well, if they don't, somebody else will, right? If the science is enabled and it is cost effective, somebody will, whether it is Guardant or -- I wouldn't take any of the examples. Now the clinical -- the evolution of technology within the clinical space, as I said, always takes longer for the exact reasons that we talked about. When we think about elasticity within the clinical space, that it will come in 2 different ways. One is the actual development of the test themselves. So the examples you took at the companies, if they are developing, say, a new MRD test and start using the power of X to say, "I'm not going to -- now be able to build a test that can still make me money, and I can still run it in a certain time frame and can still give me the resolution that we need for this test to be really effective, they will go out and research and develop that test. The first elasticity would be in their test development lab. And I think if I'm right, roughly about 1/3 of our Xs got sold to the clinical customers, right? So -- and my thesis is that's largely still going into their research efforts to say, can I now develop a test that is much more viable both scientifically and economically. The second step then is to take it into the clinic through the approval, whether -- whatever the final form of FDA's LDT rules are going to be because you have a grandfather test potentially and then you have to go through a transition over a period of time. Is it going to take longer than what it would have before the LDT rules? It's going to be a year longer or whatever, we'll see where it eventually lands. But if you take a medium- to long-term view, in the end, if the science has been enabled and if the economics have been enabled, somebody will go develop that test, right? And it will be up to our entire ecosystem with all the players to go see, which part do they think they can bring fastest to the market and choose their investments accordingly. We're enabling an ecosystem so that whether you have a specialty lab or a core lab or an up and coming new lab, you can take advantage of the signs to develop these tests and Illumina is positioned to benefit either way in respect of which player takes that position.