Greetings, day two 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. To my left, we have Joydeep Goswami, who is the newly appointed permanent CFO, so congrats, and COO. We also have to his left, we have Salli Schwartz, who's lead IR at Illumina. First off, welcome, Joydeep and Salli.
Thank you, Dan.
Thank you.
Awesome. Maybe a high-level way to kinda kick this off here, you know, you know, on the one hand, you know, Illumina's at the very beginning stages of your latest high throughput product cycle, possibly, you know, the most impressive one technologically in your history. You have new markets for NGS opening up. Stock has lagged, hence the upside opportunity is significant. At the same time, competition's arguably never been more material. There's been notable pressure on your clinical customers, and it's not clear when that lifts. You're dealing with material uncertainty over GRAIL deal. Given you just took the CFO role, it'd be interesting to hear how you think of the current and future setup for Illumina, and 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 and, you know, as part of Illumina's leadership team, we're incredibly excited, and I'm personally incredibly excited of the opportunities, right? The reality is, you know, we are in a large TAM, you know, $120 billion by 2027, that's very under-penetrated, 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? 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.
Incredibly excited about that market. Incredibly excited about you talked about, you know, the new innovations that we're introducing that improve the utility of sequencing, but also drive down total cost of ownership, drive down, you know, drive up the simplicity, drive down complexity of workflows of post-sequencing analysis, pre-sequencing prep time, et cetera. And, you know, coupled with things like AmpliSeq. There's a lot of things that are opening up the market and further catalyze a lot of what you're already seeing, what's happening in the field, right? 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.
Really excited about that and the opportunities that it opens up in both research and clinical fields. You talk about competition. Look, you know, the reality is that we've always had competition, right? You know, at every point in our existence, whether it's arrays or sequencing. You know, a lot of the players, like BGI or Thermo Fisher, have existed. We've competed with them, especially outside the United States, as for BGI. We know how to do that. We have the playbooks. 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, you know, we had record sales of NextSeq 1K, 2K even in Q4, right?
That does indicate that customers believe in the value that Illumina brings to them, you know, again, beyond just the one thing that people highlight is around cost per GB, but that's only very small part of the equation. There's many others in terms of reliability, service and support, ability to move towards clinical diagnostics, ability to have that level of, you know, continued collaborative innovation. We feel good about that. We continue to invest in those, dimensions, and we'll continue going forward as well.
Great. Maybe thinking about the guidance, love some insight into the 7%-9% top-line guidance. You know, core Illumina, I think it's 6%-9%. You call that a COVID headwind of about two points, right? I guess if you normalize it's 9%-11% ex-COVID, I guess 8%-11% core. You have easy comps, you have the X launch, which I think most of us, you know, most of us expected something maybe stronger on the guide given, you know, your LRP was 15% and you have, you know, the benefit of the again, this big launch. Maybe give us a little color, you know, why we deviated, I can follow up on something there.
Sure. The guide was 7%-10% consolidated and 6%-9%, as you pointed out, on the core. Yes, that was, you know, somewhat lower than initially what we were expecting around 10%. There are a few reasons, and we can go through that. A lot of that is things that we had pointed out earlier. First, you know, 2023 is a transition year for us, and the transition year really comes from, you know, the introduction of the X, right? We will see at least in the first half of the year, a reduction in the number of 6000s, 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? X consumables don't really ramp up till the second half of the year once people have brought on the instruments and done their initial validation.That's one part of it. And also we have said, and as is normal with any large instrument introduction, that the first year we will be somewhat supply-constrained, right? 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.
We expect that number to, you know, end the year way ahead of the 300+ instruments that we expect to be able to supply this year. That's one 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? That this is a somewhat backloaded year as you come into it. For us, there are a few reasons for that. I mean, some of the macroeconomic headwinds will persist, we feel, at least through the first half of the year.
We, you know, 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 two percentage points. That is also more front-loaded than not. You know, China COVID is another one, right? Where we do expect that is more prevalent in the first part of the year as they move away from zero COVID tolerance to something that is more sustainable and they open up the market. That essentially says, along with the transition to the X, our second half of the year is going to be meaningfully stepped up from the first part of the year.
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.
Right. Typically you go back with the NovaSeq and, you know, year two is a lot stronger than year one to your point. Presumably we should be looking at the exit rate this year when we think about 2024. Fair to say, clearly at this point, 2024 should be, we would assume, a much stronger year than 2023, absent, you know, anything uncertain changing in the market.
Yes. That's I think a good way to think about 24 having, you know, completed the initial transition and placement of the X. You start to see pull-through in the X consumables. This is something we're working on in particular, you know, 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.
How do we think about the plus? You know, your guidance is 300+ placements for 2023. What are the key factors here dictating how many you place? Is it actual demand? Is it your ability to manufacture and install, or is it your interest to smooth out the launch or other?
It's definitely about the last one. It's really, you know, more in terms of scaling up manufacturing, right? We have said we gonna start off the year with, in Q1, about 40 to 50 instruments, and then, you know, we'll continue to step up manufacturing from there. In fourth quarter, we expect at this point to roughly be at steady state, right? As many orders come in, we should be able to get out the door, but it will take us, you know, into next year to clear all of the backlog of the orders that we get in 2023.
Mm-hmm. Manufacturing-wise, you guys feel pretty good at kind of where things were guided to and the ability to scale and kind of, you know, be on that ramp pace?
You know, we don't tend to announce a new instrument launch till we are confident that we can supply the instrument. There's a lot that goes into that in terms of, you know, both the instrument capabilities, the software capabilities, and the consumables capabilities. We are where we need to be on that path at this point. We've shipped out, as we announced at AGBT on our earnings call, that we've shipped the first instrument, and we've, you know, we continue to make shipments as the quarter goes on.
Yeah, Broad Institute said this morning, just for, you know, we hosted them, they said they have one, and they're waiting for the next four. They're waiting. They're ready to roll. Given grants take a while to move, what, you know, what early kinds of new projects are you hearing from customers that are being enabled by XLEAP chemistry? You know, what confidence does that give you in your outlook for 2024?
Yeah. Let me break that down into research and clinical and, you know, just to step back, right? I mean, the initial order book surprised us, of course, in the strength of it, right? Also in the makeup of it. 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, you know, we've seen about a 4x jump in the number of countries that have already placed orders at a similar timeframe from where NovaSeq 6000 was. We've seen about 15% of the orders that have come from new to sequencing or new to high throughput customers.
Again, that's a, you know, a little bit of a surprise and a larger percentage. They're all reasons that they have given us, and they're consistent with the innovations that have gone into the X. Let me come to the kinds of things that we are seeing, right? First, from the research side, from some of the population genomics customers, we are hearing a lot more into, "Hey, we want to go from we've done whole genome sequencing, we wanna go to whole transcriptome sequencing with samples that are already there, and increasingly look at proteomics on a much bigger scale than we have done before." Right?
The good news about some of these is, yes, they'll, you know, need to secure funding, but the funding becomes, you know, more cost-effective, if you, if it were to look at larger cohorts. You don't need to collect samples, right? Many of the samples exist in their biobanks already, so it's a little bit of a faster timescale there. Also on the research side, especially around single cell and spatial, a lot more interest in doing more, right? More cells going from, you know, thousands to tens of thousands to some talk even of millions of cells per run. That's exciting and that, you know, although it's the same sample, it's actually more samples because you're looking at individual cells at that point.
We've had very strong interest in, you know, in pharma, taking a much bigger look at genomics and multiomics and drug discovery, right? Part of it is things like Nashville Biosciences, where the cohort exists and, you know, they're using this opportunity to move more towards sequencing these and combining that information. As you can imagine, right, the first step is doing DNA sequencing on a whole genome. Very quickly after that, it will move as they get answers to diving deeper into proteomics or transcriptomics, as it were. 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.
The dynamics in clinical are, you know, the existing assays that have been validated, they will continue on the 6000s, right? We don't see an immediate switchover on that. In fact, there'll be some fleet additions on the 6000 on those. What we are seeing is, you know, 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 X on these. You know, obviously the economics for them are better, but they can also move faster on clinical studies and more broadly from that angle. That's encouraging, right?
we are seeing also, 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? 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 evidence generation get started.
On oncology, this dovetails really nicely with the whole discussion you're probably hearing around the conference on MRD now and liquid biopsy. There's a multitude of.
Yeah.
pieces that we're hearing.
Mm-hmm.
Just kind of related to clinical, since it kind of dovetails with the question on the, you know, kind of on the guide for 2023. Like, have you guys seen, like, this clinical destock? We heard it from, you know, some other players as well, but that's been a headwind for you guys in the back half of 2022, and presumably that was one of the factors that you baked into 2023, I would think. Just kind of how do we think about that clinical destock?
Yeah.
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?
Yeah. It's a good question. There were two things that happened on the clinical side last year, right? There was one which was related to capital push out and, you know, just conservatism in the market that delayed some projects at our customers' ends, right? Part of it, again, if you remember early in the year, it was that plus, you know, there was some issues with the supply chain, not related to NGS, but other things. That I think we have, we've been a little bit more cautious this year in not factoring in everything that customers are, have told us about, you know, we'll scale up to a certain extent.
You're right, some of that actually, as I mentioned earlier, has moved from the 6000 to the X. 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, you know, as we progress 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? The amount of destocking went down.
Mm-hmm.
I think that was a trend we had expected to see. Our best guess at this point is, you know, some bit of it continues into Q1, you know, as we get into Q2, especially latter part of Q2, that, you know, starts reflecting more of the underlying demand. Again, we get a good insight to that because we have connected instruments that, you know, represent at least in North America and Europe, more than 60% of the instruments out there, especially in high throughput and mid throughput. A pretty good idea of what the underlying utilization is. That has continued very strong on clinical. You know, we saw a little bit of a pickup again in towards the end of the year.
Great. Maybe just one 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?
The experience so far has been very encouraging actually. We, you know, as I mentioned earlier, we continued very strong sales of our mid-throughput portfolio, especially on the NextSeq 1K 2K, which were the newer instruments we introduced, I guess, in 2020. We continued to have record sales overall in the mid-throughput category in 2022. More specifically, we exited 2022 in Q4 with record sales again in the quarter for our NextSeq 1K 2K instruments. Despite all the noise about competition coming in, the reality is that, you know, customers are assessing this more holistically, right?
What value does Illumina bring, you know, in terms of total cost of ownership and the fact that, you know, NextSeq 1K 2K 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, you know, the longer cycles and the XLEAP-SBS chemistry on NextSeq 1K 2K, which, you know, is a just a transition of flow cells. It doesn't require any changes to the instruments. There's a lot of interest and continued interest and pent-up demand on the on the mid-throughput side.
You know, 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 one set 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 a 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. From our conversations at least, most of the investors we speak with would prefer to have GRAIL separated.
Yeah.
They'd love to get access to the core Illumina, raise a blade this product cycle without kind of the uncertainty in the near term, significant dilution and burn. Ultimately, GRAIL could be a home run opportunity. It just kind of, it really, you know, makes it difficult to get access to that core Illumina business.
Yeah.
Net-net, I'm just wondering, you know, the management team, you know, Francis has been significantly, you know, very positive, enthusiastic about the deal. Given the ongoing regulatory pressure, plus, you know, the margin cash solution, like where does management stand today?
Yeah.
on GRAIL?
Yeah. You're right. Right. GRAIL, you know, I wanna continue to express it's a good asset. It's proven itself out. A little thing, and I'll go to where do we go from here. I mean, GRAIL is still the only multi-cancer early detection test on the market, and the only one with any line of sight to, you know, introduction on a multi-cancer basis, right? More than 50 cancers detected, of which, you know, 45+ have no other screening test available at this point, right? It's a huge impact on patient lives and the potential to 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 one which actually pinpoints where in your body the cancer is, which is absolutely essential for any liquid biopsy test to be able to be actionable. All those are positives, right? At the same time, I think we have been fairly clear that, look, we did not anticipate the regulatory challenges that, you know, 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. How does that play out? You know, we expect the divestment order to come from the EU in Q2. When we get that provides the guardrails for, you know, how a divestiture is to be effective. We will immediately begin.
We'll immediately move towards divestiture at that point, right. That starts the clock on that. You know, we expect that to do this right, whatever the guidelines are, takes us, you know, towards the end of 2023 or early into 2024. That's one piece, right? Where we are committing to, you know, immediately move on the divestiture order. 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, A, did not have any revenues in Europe, never planned to have any revenues in Europe.
And, you know, 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 timeframe where we would continue the work on the divestiture. We're not waiting for the trial, it just happens that the timing of the trial happens to be in that. 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, there's no, you know, hurdles from the FTC in closing the deal or integrating the deal. We've already closed it.
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, you know, closing over them. That's one potential outcome, again, in that timeframe of end of the year or early next year. The other outcome is, you know, we lose the case and we lose the trial, and we just proceed with finishing off the divestiture as we have been planning, anyways, right? That's a, you know, again, there are obviously, you know, stays that give us more flexibility in when exactly and to make sure we get the best value for our shareholders.
There's no further elongation of at least the divestiture process, beyond that, you know, that timeframe that I just outlined.
Is there an expectation I was thinking Q1, but it's more Q2 now, that's what you're hearing on the directive? For the order?
The divestiture order?
Yeah.
Yeah. Again, this is out of our control.
Got it.
They need to process what they need to process at their end, right?
Got it.
That's what we're hearing.
Is it a six-month timetable they're gonna give you to do this or 12-month?
We don't know. You know, it's that'll depend on the order that comes out. You know, I think what they are trying to do is be reasonable in terms of whatever timeframe they give us.
Francis mentioned on the Q3 call that you would seek strategic partners to invest in GRAIL on a multi-step process to a potential IPO. Just maybe one comment on that, like, just any elaboration on kind of what that is?
No, that is one of the options as we have done some pre-work on this, right? That's one set of options. Again, I want to make sure you understand, right? It depends a lot on what the EU comes back with. 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? Give us the time to get you information rather than me speaking in hypotheticals about that.
Got it. Okay. Switching gears here to your margin guidance. Looking at your 2023 guidance, I believe it was for a 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 if, in fact, 2024 sees a nice step up in growth, kind of where the margins go-?
Yeah.
as we cycle past 2023?
Yeah. Look, let me start with that last part, right? We're absolutely committed, and at Investor Day, we said, "Hey, we do expect margin expansion, and actually operating profit growth to exceed revenue growth." We're absolutely committed to that, and you will see that happening, you know, as early as 2024, right? You're absolutely right about that, and we remain committed to that. 2023, you know, why are margins at 22%, right? There are a few factors which are transitionary and are very specific. First, we had expected a lot more growth in 2022 when we started the year and, you know, even looking at the first quarter and most of the second quarter, right?
We had been tooling up and investing in, you know, our key innovations to support that. Part of the 2023 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'd reduced our hiring. We actually had a reduction in force of about 5%. 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. In 2023, a few things happened, right?
First of all, the revenue growth because of the transitioning or the factors that I talked about earlier, you know, there, you know, there is a little bit of, you know, 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. Again, all of that is dictated by NovaSeq X, right? When you launch a new instrument and new consumables, the margins in that first year tend to be lower because, you know, you're investing and you're not fully at scale. As you move through the year, first scale just improves those margins.
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. The second part of it is, as you move on in 2024 and beyond, you'll see the normal productivity and COGS productivity that you would expect from us on any instrument, right? You'll see a lot of that come through. For 2023, the one thing on the operating margin side, and in fact, all of the increase in OpEx is really from a normalization of our variable comp, right? Last year, because we didn't hit our numbers, we didn't pay much variable comp to our employees.
This year, we expect to meet our targets, so we are accruing at 100% of, you know, the same, the same kind of pay policies. That puts in a one-year kind of comp that accounts for any of the, you know, the OpEx increase that we've seen in 2023. Again, going next year, we won't see that kind of a normalization.
Mm-hmm.
We're very confident that our operating margin will tend back into in the long term, getting into that 25%-30% range.
Particularly if you beat numbers this year and your comp goes up a lot, then the base will be. You'll have a. No. Okay. [audio distortion], with that.
That'd be a good outcome.
Thank you, Joydeep, Salli, for being here. Thanks everyone in the room, and have a good rest of the conference.
Thank you. Appreciate it.