Q1 2023 Illumina Inc Earnings Call
Please standby.
Good day, ladies and gentlemen, and welcome to the first quarter 2023 Alumina earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session.
Please be advised that today's conference is being recorded.
I would now like to hand, the conference over to Sally Schwartz, Vice President of Investor Relations.
Hello, everyone and welcome to our earnings call for the first quarter of 2023.
During the call today, we will review the financial results released after the close of the market and offer commentary on our commercial activity.
After which we will host a question and answer session.
If you had not had the chance to review the earnings release. It can be found in the Investor Relations section of our website at Illumina dotcom.
Participating for Illumina today will be Francis Desouza, President and Chief Executive Officer enjoy deep Goswami, Chief Financial Officer, and Chief strategy and corporate development Officer.
Francis will provide an update on the state of aluminum business enjoyed eat will review our financial results which include grill.
As a reminder, grill must be held and operated separately and independently from alumina pursuant to the interim measures ordered by the European Commission, which prohibited our acquisition of grill under the EU merger regulation.
This call is being recorded and the audio portion will be archived in the investors section of our website.
It is our intent that all forward looking statements regarding our financial results and commercial activity made during today's call will be protected under the private Securities Litigation Reform Act of 1995.
Forward looking statements are subject to risks and uncertainties actual events or results may differ materially from those projected or discussed.
All forward looking statements are based upon current available information and Illumina assumes no obligation to update these statements.
I understand the risks and uncertainties that could cause actual results to differ we refer you to the documents that Illumina files with the Securities and Exchange Commission, including alumina. That's most recent forms 10-Q and 10-K.
With that I'll now turn the call over to Francis.
Thank you Sally.
Good afternoon, everyone.
Illumina delivered revenue of approximately $1.09 billion and diluted non-GAAP EPS of eight cents in Q1.
Both ahead of the guidance, we provided at the beginning of the year, but down year over year as expected.
J D will take you through more detail later in the call.
Our focus for the rest of the year is to deliver sequential growth primarily by scaling the production and distribution of Nova seek ex driving elasticity on the back of its increased capabilities and improving margins we.
We will share more on each well.
We achieved key product milestones in Q1, including shipping the first Nova seek X systems.
We also launched Illumina complete long read technology and Illumina connected insights are cloud based tertiary analysis tool that addresses a key barrier to adoption and will enable more labs to perform comprehensive genomic profiling for advanced tumors.
Turning to our performance across platforms, beginning with high throughput.
The Nova seek X launch further strengthen illuminates competitive position and high throughput sequencing.
Our strong global interest for the Nova seek X series continued in Q1, and we exited the quarter with over 200 orders received for more than 30 countries.
Clinical demand continued to be stronger than expected generating approximately 40% of orders with some customers planning to leverage the nova seek ex to launch new clinical offerings.
About 15% of orders are from new to high throughput customers like the clinical genomics lab that is leveraging novus seek X is ease of use and cost benefits to perform high throughput whole genome single cell RNA sequencing.
Our manufacturing capabilities for Nova seek X instruments and consumables are scaling nicely.
We shipped 67, Nova seek X instruments in Q1.
Initial expectations of 40 to 50, and now expect to deliver more than 330, <unk> X instruments. This year up from 300.
Customers initial runs are showing robust data output and sequencing quality with some customers reporting output is greater than seven tera basis, and more than 95% of basis above Q30, well ahead of public specifications.
As customers take delivery, if their nova seek xs and plan their deployments, they're sharing examples of how nervous he gets unlocked demand elasticity in the sequencing market.
Customers are planning to leverage the X is greater output and lower price per sample to sequence more samples before more analyses per sample and obtain more data or analysis.
For example, a leading European Life Science Research Institute will use Nova seek acts to scale up its data intensive research programs, specifically in multi omics spatial and single cell, enabling them to deliver Atlas scale projects.
Within our clinical base customers are using the greater output and cost savings of Novus seek extra launched new sequencing intensive offerings.
Some customers are planning to move from targeted panels to exome and genome to achieve higher diagnostic yield in health care efficiency.
And I apology customers planning to use the axe to launch liquid biopsy testing, which requires 12 to 15 times more sequencing than solid tumor testing.
Some customers are using the cost in turnaround time benefits to enter deeper sequencing applications like minimal residual disease or MLR D to build datasets at scale.
We also saw continued demand for Nova C 6000, primarily for fleet expansions of existing workflows and reshaped 17 Novo seek six thousands in Q1.
More than 80% of <unk> 6000 shipments were to clinical customers and approximately 25% of shipments to oncology testing.
And mid throughput next week, one K two K unit shipments increased 6% year over year.
As customers expand their existing fleets.
We continue to shift projects from the mice. He can next week 550.
More than 20% of next week, one K two K units in Q1 were placed with new to Illumina customers.
Our win rate in the mid throughput segment remains strong, but we're seeing some sales cycles lengthen.
Our low throughput platforms continued to provide an entry point to sequencing approximately 30% of these shipments in the first quarter were to new to Illumina customers further increasing our installed base and enabling adoption of sequencing across a broad customer network.
Looking now at our clinical markets.
Q1 marked an important milestone for illumina with clinical sequencing consumables revenue, representing 50% of our total sequencing consumables revenue for the first time.
In Q1 oncology testing consumables declined 3% year over year, but increased 21% sequentially driven by growing clinical testing volumes and increased product development in areas like liquid biopsy and M D.
Some customers in this segment are facing pressures to improve profitability, which may in turn slow down their ability to develop new tests and scale.
Revenue from our market, leading two-sided oncology assay G. S. O 500 was greater than $25 million in the quarter up 26% year over year across more than 540 accounts driven by increased utilization and pull through particularly in Europe .
In March we announced the expansion of our partnership with myriad genetics to broaden access to homologous recombination deficiency or HRD testing.
H R. D is an important biomarker identifying tumors with a specific type of DNA damage like those in ovarian breast prostate and pancreatic cancers.
Our T S O 500, HR D. A research use only test is now available in the U S with early customers like Florida cancer specialists and research Institute, one of the largest independent medical oncology and Hematological practices in the United States.
The expanded partnership also establishes a unique alliance to develop HRD as a companion diagnostic for novel agents targeting these tumors.
There was significant progress for N G S based oncology testing reimbursement this quarter in Europe , expanding the accessible market.
Seven regions in Italy committed 10 million euros for next generation sequencing in lung cancer.
In Germany health insurers commenced reimbursement for whole genome sequencing and pediatric cancer patients with relapse.
And in the Czech Republic funding for comprehensive genomic profiling was added to the national fee schedule effective January 1st.
Also in oncology grill, so accelerating demand in Q1 for its gallery multi cancer early detection blood test and delivered revenue of $20 million exceeding plan and representing 100% growth year over year.
non-GAAP operating expenses increased to $173 million, driven primarily by investments in clinical trials and scaling grills commercial organization.
Since launch Grail has received more than 85000 Gallery test orders with about 20000 delivered in Q1 alone.
The 140000 participant NHS Gallery trial, which completed enrollment in July 2022, and just over 10 months is progressing well with more than half of study participants have in return for their second annual blood draw.
The trial recently achieved its halfway point and is currently on track to meet retention targets.
Gray Oak continued to expand its partner relationships. Following a successful pilot last year, John Hancock, one of the largest life insurance companies in the U S and a unit of Manulife announced that it would expand access to gallery to eligible life insurance customers.
And Providence Health system, serving the Western U S expanded its partnership with Grail to offer gallery to eligible individuals across its 52 hospitals and 900 clinics across seven states.
In reproductive health consumable shipments declined 4% year over year, primarily due to FX, but increased 14% sequentially due to continued coverage progress.
In the U S, Virginia, and Michigan initiated state Medicaid coverage for N P T and all pregnancies, adding.
Adding about $4 3 million additional covered lives and more than 70000 pregnancies per year.
Genetic disease testing or G. D. T had a record quarter in Q1 G. D. T consumable shipments grew 7% year over year and 6% sequentially.
Coverage continues to grow for whole genome sequencing and patients with the rare and undiagnosed genetic diseases.
During the quarter one of the largest U S health insurance companies updated their policy to include managed Medicaid lives in 16 states, adding another approximately $3 8 million covered lives for whole genome sequencing.
Also in G. D. T earlier this month, we announced a partnership with Henry Ford Health.
Health care organization in the Detroit Metro area, and a leading U S academic medical center to assess how whole genome sequencing can improve cardiovascular disease management with a particular interest in diverse and underserved populations.
Turning to our research and applied markets sequencing consumable shipments were down 19% year over year, primarily due to the slowdown in Covid surveillance.
Looking at the whole year, we are on track to deliver on our financial commitments for 2023 as well as some important releases in the coming quarters.
Specifically, we will ship the ICL, our enrichment assay and affordable high throughput targeted long read solution in Q3 and X sleep SBS chemistry next week, one K two K in the first half of 2024, delivering step change cost speed and sustainability benefits on that platform.
Finally, as we navigate through this dynamic environment, we are focused on delivering durable success for our shareholders through a balance of investing in breakthrough innovations for future growth, while delivering operating leverage through disciplined expense management across the organization.
Does that end, we announced earlier today, our commitment to deliver core Illumina non-GAAP operating margins of 25% in 2024 and 27% in 2025, while maintaining investment in the key elements of our innovation roadmap.
Building on the cost reduction actions announced last November we're taking additional steps to reduce our annualized run rate expenses by more than $100 million. Beginning later in 2023, this will accelerate progress towards higher margins as well as free up capital to increase investment in high growth areas.
I'll now turn the call over to J D to discuss additional details on our results and outlook as well as provide more detail on the steps we are taking to deliver on the cost reduction I mentioned.
J D.
Thank you Francis.
I'll start by reviewing our consolidated financial results followed by segment results for core Illumina and Grill, and then conclude with additional remarks on our current outlook for 2023 I.
I will be discussing non-GAAP results, which includes stock based compensation our.
I encourage you to review the GAAP reconciliation of these non-GAAP measures, which can be found in today's release and the supplementary data available on our website.
In the first quarter consolidated revenue was $1.09 billion up 1% from the fourth quarter of 2022 exceeding the high end of our guidance range on.
Stronger than expected shipments of <unk> consolidated revenue was down 11% year over year or down 9% on a constant currency basis net of the effects of hedging.
This was primarily driven by an expected year over year slowdown in corporate surveillance.
Covid related disruptions in China, the transition of some of our high throughput customers and oversee X.
And customers managing constrained capital markets globally.
non-GAAP net income was $13 million or eight cents per diluted share, which included dilution from grilles non-GAAP operating loss of $164 million for the quarter.
Our non-GAAP tax rate was 27, 3% for the quarter, which increased from 17, 8% in Q1 2022 with both quarters, reflecting the impact of R&D capitalization requirements.
Although the non-GAAP tax expense impact of R&D capitalization requirements. In dollar terms was the same in both periods the impact to our effective tax rate in quarter. One 2023 was more significant due to our lower earnings.
Our non-GAAP weighted average diluted share count for the quarter was approximately $158 million.
Moving to segment results.
Core alumina revenue of $1.08 billion was down 12% year over year, which included an anticipated headwind from Covid surveillance of approximately 400 basis points.
Surveillance contributed approximately $11 million in total revenue in Q1, 2023 compared to $60 million in Q1, 2022, reflecting a $49 million headwind on a constant currency basis core Illumina revenue was down 10% net of the effects of hedging.
Oral immuno sequencing consumables revenue of $692 million was up 1% sequentially, but down 12% year over year, which included an approximately 500 basis point headwind from Covid surveillance. In addition to the slowdown in corporate surveillance the year over year decrease was primarily attributable to.
Lower and overseeing 6000 consumables pull through euro headwinds I mentioned earlier.
Covid related disruptions in China, the transition of some of our high throughput customers, and obviously X and customers managing constrained capital markets globally total sequencing activity on our connected high and mid throughput instruments grew 6% from Q4, 2022, and 3% year over year.
Research and applied grew 7% from Q4, 2022 and declined 4% year over year clinical sequencing activity growth remained robust up 7% from Q4 2022.
And 15% year over year.
As a reminder, we believe this data is a useful reference that shows the general activity trends across our installed base and it's directionally correlated with revenue overtime.
Sequencing instrument revenue for core <unk> of $154 million declined 27% year over year, including a 300 basis point headwind from Covid surveillance as expected the year over year decrease was primarily driven by lower nervously at 6000 shipments compared to our record Q1 2002.
22.
Any decrease in mid throughput shipments.
Due primarily to fewer next week 550 placements in China.
Stronger than expected shipments of Nova seek ex helped partially offset this impact although we remain supply constrained in the first year of launch.
We continued to see strong demand for next week, one K two K from neuro alumina customers.
Core Illumina sequencing service and other revenue of $119 million was up 7% year over year, driven primarily by higher instrument service contract revenue on a growing installed base.
Before moving to the regional results for core Illumina I'd like to highlight that we have implemented a new global commercial structure.
Improved operating efficiencies and better align with local markets we are in.
Integrated APG with emerging markets across Middle East Africa, Turkey, and C. I S.
Going forward, we'll report regional results for the falling regions Americas, Europe , Greater China, and EMEA or Asia Pacific Middle East and Africa.
America's revenue of $605 million grew 5% sequentially from Q4, 2022 and exceeded our expectations due to stronger than anticipated and overseas X shipments revenue.
Revenue for the region was down 6% year over year due to the expected decline in research driven by the slowdown in Covid surveillance and delayed the recruitment for some large research projects. We continue to see strong demand for <unk> in the Americas with instrument shipments up over 20%.
Year over year.
Europe revenue of $261 million represented a 9% decrease year over year or a 4% decrease on a constant currency basis net of the effects of hedges.
Growth in clinical led by oncology testing was more than offset by the expected decline in Colby surveillance revenue as well as lower high throughput instrument shipments due to supply constraints on <unk> in the first quarter.
Greater China revenue of $91 million represented a 28% decrease year over year or a 23% decrease on a constant currency basis net of the effect of hedges.
The year over year decline was primarily driven by persistent COVID-19 disruptions and liquidity and funding constraints at our customers. This resulted in lower sequencing consumables revenue.
And a decrease in mid throughput shipments compared to last year.
We will continue to closely monitor and mitigate market headwinds in China through the rest of the year. Finally, EMEA revenue of $119 million declined 27% year over year or 23% on a constant currency basis net of the effects of hedges.
As expected year over year decline was primarily caused by the completion of a large research project in Japan, lower covert surveillance revenue and a decrease in overseeing 6000 instrument shipments only partially offset by normally seek X shipments as demand in the region outpaced supply EMEA revenue was also impacted by sanctions affecting.
Our ability to conduct business in Russia.
We expect the impact of sanctions to persist through 2023 and have reflected approximately $60 million and lower sequencing consumables revenue expectations for the region and our outlook for 2023.
Moving to the rest of core Illumina P&L.
Core alumina and non-GAAP gross margin of 65, 2% decreased 500 basis points year over year, primarily driven by a less fixed cost leverage and a lower manufacturing volumes and lower instrument margins due to an overseas X launch, which is typical with a new platform introduction.
We expect gross margins to improve sequentially through the year as we scale <unk> manufacturing and continue to drive operating efficiencies.
Core Illumina non-GAAP operating expenses of $514 million were up $9 million year over year, primarily due to the full year impact of our head count growth in 2022, non-GAAP operating expenses were lower than expected as a result of cost containment initiatives.
Transitioning to the financial results for Grill.
Rail revenue of $20 million for the quarter grew 100% year over year, driven primarily by accelerating adoption of gallery.
As expected rail revenue decreased sequentially due to a milestone payment in Q4 2022 related to <unk> pharma partnerships rail non-GAAP operating expenses totaled $173 million and increased $34 million year over year, driven primarily by continued investments in <unk>.
Clinical trials and a scaled grills commercial organization.
Moving to consolidated cash flow and balance sheet items.
Cash flow provided by operations was $10 million.
First quarter 2023 capital expenditures.
$52 million and free cash flow was negative $42 million, we did not repurchase any common stock in the quarter.
We ended the quarter with approximately $1 $5 billion in cash cash equivalents and short term investments.
During the first quarter, we used $500 million repaid the outstanding principal of our 2023 term notes that mature in March.
Moving now to 2023 guidance.
We still expect full year 2023, consolidated revenue to grow 7% to 10%, including core Illumina revenue growth of six 9%.
As a reminder.
These ranges included an anticipated headwind from Covid surveillance of approximately 200 basis points as.
As well as a year over year headwind from foreign exchange rates.
Rail revenue is still expected to be in the range of $90 million to $110 million for 2023.
Our revenue outlook for 2023 now reflects the following offsetting factors one lower revenue in EMEA due to the impact of sanctions affecting our ability to conduct business in Russia.
<unk> and.
An increase in our Nova seek ex shipment expectations to more than 330 instruments.
And three higher contributions from our strategic partnerships related to drug discovery.
As we have previously stated we expect quarterly core Illumina, our revenue to ramp sequentially through 2023 with linearity trends similar to 2017, when we launched in over 6000.
Where we've delivered approximately 54% of our total revenue in the second half of the year, including approximately 26% in Q3 and the remainder in Q4.
Our revenue ramp for 2023 reflects the following assumptions one quarterly ramp in <unk> X shipments as the matter of factoring capacity improves each quarter two <unk>.
Sequencing consumables revenue increases and obviously X customers kickoff projects in the second half of 2023, and three certain macroeconomic headwinds lessen in the second half of 2023, including a recovery from Covid disruptions in China.
For fiscal 2023 at the midpoint of our revenue guidance.
We now expect core Illumina sequencing instrument revenue growth of approximately 13% year over year, reflecting our higher nervously at shipment expectations.
Now expect core Illumina sequencing consumables revenue growth of approximately five 5% year over year, driven predominantly by our lower revenue outlook for EMEA due to the impact of sanctions affecting our ability to conduct business in Russia.
We continue to expect core alumina sequencing revenue to grow approximately 8% year over year. This now includes a higher contribution from sequencing service and other revenue primarily due to higher contributions from strategic pharma partnerships.
We continue to expect non-GAAP earnings per diluted share in the range of $1 25 to $1 50 for 2023.
Including our consolidated non-GAAP operating margin.
Approximately 8% and core Illumina non-GAAP operating margin of approximately 22%.
We are reaffirming.
All other financial guidance for fiscal 2023 that we provided on February seven 2023, moving to the second quarter of 2023, we expect consolidated revenue in the range of 1.15 billion to 1.1 dollars 7 billion.
For Q2 2023.
Reflecting a sequential increase of approximately 670 basis points from Q1, 2023 at the midpoint or approximately $70 million.
Primarily driven by.
A sequential increase in <unk> X instrument shipments as manufacturing capacity continues to ramp.
Sequential growth in sequencing consumables and service revenue as new instruments continue to come online.
The sequential increase in rail revenue driven by accelerating gallery adoption.
Partially offset by a sequential decrease in micro arrays revenue due to historical seasonality.
For the second quarter at the midpoint of our revenue guidance range, we expect non-GAAP diluted EPS of approximately <unk>, reflecting consolidated non-GAAP operating margin of approximately 1% and core Illumina non-GAAP operating margin of approximately 17%.
These margins reflect a sequential increase in core illumina operating expenses driven by an increase in compensation related expense due to our typical annual equity grant and merit adjustment in March.
We continue to expect operating margins to improve in the second half of 2023 as revenue ramps and we scale our production of Adobe C X and leverage the fixed cost of the manufacturing base.
Looking forward, we are committing to achieve core illumina non-GAAP operating margins of 25% in 2024 and 27% in 2025.
Loopnet will reduce its annualized run rate expenses by more than $100 million beginning.
Beginning later in 2023.
These cost savings will accelerate progress towards higher margins as well as free up capital to increase investment in high growth areas.
Illumina will achieve these savings through a combination of several actions.
We will leverage the recent Modularized nation of R&D innovation created as part of the <unk> X development, including ex leap SBS, new flow cell technology, lower the cost and accelerate time to market for future platforms.
We will achieve additional savings through leveraging our global footprint, enabling activities at more cost effective hubs.
We are also streamlining our organization and processes, including rationalization of the Companys Global real estate portfolio and third party vendor spend as well as accelerating it optimization efforts.
The company will continue to prioritize innovations that generate highly differentiated products that are valued by alumina as customers.
I will now invite the operator to open the line for Q&A. Thank you.
Thank you if you would like to signal with questions. Please press star one on your Touchtone telephone.
If you are joining us today use a speaker phone. Please make sure mute function is turned off to allow your signal to reach our equipment again star. One if you would like to signal with questions and as a reminder, please limit yourself to one question. So that we can accommodate as many analysts as possible you are welcome to reenter.
The queue, if you have additional questions.
And our first question will come from Puneet <unk> with SBB Securities.
Yeah, Hi, Francis Julien Thanks for taking the questions. So first one on the order book, it's good to see the increase there, but just wanted to get your expectations in terms of the overall.
Funnel youre seeing could that.
330 number.
You know continue to increase as you go through the year and could you just help us understand your ability to.
Ramp the production delivered through the year, what sort of cadence should we be assuming per quarter in terms of installs.
And then if I may ask on sort of Grail question.
More operational and execution questions I mean historically.
Product cycle that alumina has taken preference above everything, but theyre just a number of distractions in terms of in terms of legal front.
European Commission FTC and now you have an activist campaign as well so I'm wondering if.
Any of that.
Risks the product cycle and the execution that you have here or how separate are these efforts.
We shared the responses on those and then if I could ask also about biotech funding there've been questions around that from a peer today I'm just wondering if youre seeing impact from any of the emerging biotechs.
And is that contemplated in tier guys. Thanks for taking the questions.
Great. Thanks, Puneet you had a few questions. There. So let me let me work our way through it. So first question was around the X and the order book of the acts in the pipeline that we're seeing for Dx.
And your question was about $3 30 could it actually go up and I think here. The reality is that $3 30 is going to be more manufacturing bound than demand bound I think it's the feeling we're getting right now that there's a huge amount of interest.
And getting the customers hands on the X across our customer base.
As you know, we always expected research customers to be among the most aggressive early adopters and we thought clinical with lag a little bit, but we're not seeing that this time, we are seeing strong demand from clinical customers do as they are looking to launch new offerings on the X and expand into more sequencing intensive.
Offerings and you heard also that we're seeing strong demand from new to Illumina, new to high throughput customers and so our expectation is that we will continue to sort of build.
Build the demand and there'll be a little bit gated by how many xs, we can ship out the door.
Over the course of this year.
We were very encouraged by the scaling up of our manufacturing and operations teams in Q1 and as you saw we were able to ship 67 instruments are comfortably ahead of the guide we had a 40 to 50 instruments in Q1, and so manufacturing and scaling nicely. The teams are doing a terrific job.
We are scaling that up to 80 in Q2, and so a nice little step up.
From Q1, and you know, we'll take sort of a gradual steps over the course of the year to get us to that 330, and so to the extent that we're able to scale manufacturing.
Better than that we will certainly update keep you guys updated.
In terms of you know there's a lot going on as you said, obviously all eyes are on the X for US is the story of this year is the <unk> and this is what this is illumina doing what we love to do what we do best launching a high throughput instrument and so while it seems like Theres a lot going on in terms of the regulatory process and so on the reality is.
It's a very small part of the company.
<unk> involved in that and the vast vast vast majority of our time and attention at Illumina is spent on <unk>.
Getting our products out in really.
Most of the focus is on the <unk> right now.
Okay.
The other question I'm, sorry, you had a question one last besides just remind me do you have a question about biotech funding.
From our perspective, our direct exposure to small and mid cap biotech funding companies is very small and so we don't expect that to have any kind of material impact on our revenue over the course of this year.
And our next question will come from Dan Brennan with TD Cowen.
Great. Thank you thanks for the questions guys.
Congrats on the strong start to the year.
Maybe on the <unk> could you give a little color on the idea of the replacement ratio. This early on from the order book, Thus far how is that shaping up in terms of existing mill to see customers in terms of ordering the X.
Kind of related to that you have another question, we get frequently is the ex dramatically expands capacity.
So just wondering early on obviously, we're going to see what the volume looks like as we get through this year next year, but kind of how are you viewing kind of customers as they look to buy the <unk> and fill it.
Having any.
Is that a gating factor it doesn't appear to be and then the final one just on Grail franchise.
Well you know how should we think you've got three different regulatory.
No decisions pending and Youre in the middle of those with the EU directive coming likely sure what what's the most likely outcome in your mind for grill that investors should be anticipating.
And kind of when would we get clarity on that thank you.
Great. Thank you Dan for the question. So let's start with Dx, Yeah, very strong start to the year really excited about that and we spent a lot of time modeling you know what what to expect in terms of the number of <unk> that that could be absorbed by the market over the next few years and there are a number of ways to think about it if I had one.
To take the static view today and say, okay. If we just have a conversion from an upgrade cycle from the six thousands to the X what could that mean.
Now you have to add to that the number of customers that are coming into the <unk> as new to illumina or new to high throughput, but so let me start with that and just again, assuming and I'll come to elasticity in a moment, but lets elasticity side aside for a moment and so.
You May remember we went through this discussion also with the 6000 to say well how should we think about the upgrade cycle and how many units it would take two to satisfy the upgrade cycle in a couple of ways you could do it you could start with capacity back and think about what the ratio is for each.
For each ask how many six thousands of you, replacing but really we think the better way to think about it is to go customer out and what I mean by that is we have roughly maybe 1000 customers that are high throughput customers of ours about 750 of them have only $1 6000, and so you know for those 750 <unk>.
By less than a single apps and so you can think about those 750 needing to purchase it acts and so again, even if their demand for sequencing doesn't expand beyond today, which of course, it will and we will tap into elasticity you can see that they will require a 750 right off the bat to serve that customer base and then.
The $2 50 that have multiple <unk>.
<unk> thousands will apply their own sort of conversion ratio.
And then of course, the elasticity, we're tapping into right and as we shared on the call.
The majority of the customers that are purchasing the <unk> are purchasing the <unk> because they want to tap into the elasticity associated with the lower price per sequencing and so the clinical customers are talking about new applications that they want to get into that are fundamentally enabled by the lower price for sequencing, it's the solid tumor oncology testing customers.
Now looking to get into a liquid biopsy and knowing that they can access. It takes 12 to 15 times more sequencing, but they can access the price point of the X to enable to do that under the reimbursement limits. They have with the customers that are looking to do the larger.
Larger research experiments around single cell or spatial and so that'll be that'll be on top of the base case of the numbers I just talked about with people just straight up upgrading.
In terms of the Grail regulatory process.
So there.
They were thinking about it is that you know.
The whole process of comes to a head towards the end of this year. The beginning of next year, because we expect to get decisions around the two most important.
Appeals in that timeframe.
In Europe , we expect to get a decision around the jurisdiction appeal in that timeframe and in the U S. You might've seen within the last week, we had granted expedited review by the U S. Fifth Circuit Court of Appeals for our appeal against the FTC and so that gives us even more confidence that a decision will come even maybe a little earlier than had been.
Initially anticipated, but certainly in the timeframe of later this year early next year and so our expectation is that the whole sort of legal process winds up.
In that timeframe overall at the same time, we are we've got a divestiture work stream that we started a while ago that work stream is all set to continue marching down the divestiture path. We're waiting for the divestiture order from the European Commission, which we expect to come out shortly and so that path will be run in.
In parallel in the same timeframe as the appeals that are happening.
France is I'll just add to your elasticity comment on clinical right. So it's you're absolutely right. These are new applications.
Typically these are fairly complex signatures that require high levels of sequencing and illumina because its a supplier of.
Tools and reagents starts making money as those clinical trials kick off even before the tests are available in the public market right. So our elasticity actually begins even before the test reaches the market.
And our next question comes from Dan <unk> with Stifel.
Afternoon, guys. Thanks for the questions Francis J D, but can I just follow up on the comments there on elasticity I mean.
Is that something you expect to materialize meaningfully in the back half of the year just in the sense of that.
It can contribute to consumables growth for the year I know in January when you gave your outlook one of the explicit drivers.
Of the 8% consumables growth was elasticity so.
I'm, just trying to understand where things sit when it comes time to think about installation timing and ramp it John you're ramping on usage that allows you to actually see that in the in the second half of the year and that you can count on it contributing to the overall target for the year.
Yeah, Dan that's exactly right as we have stated rate we expect the.
<unk> and the initial work that our customers do to bring up their workflows to happen as we get into.
Q2, and Q3 and Q4, we start.
Starting to see some of these are these projects ramp up and end customers to build inventory in stock.
Honestly moving to the excess there a world class platform.
And moving on to our next Oh I'm sorry go ahead.
No. That's good I think the question was about the extra hopefully that answers that.
Thank you. Our next question will come from Vijay Kumar with Evercore ISI.
Hey, guys. Thanks for taking my question I.
I had a couple on the guidance here.
John you would add.
I guess can you quantify the Russia headwind, which is incremental.
Then related to guidance gross margins were down sequentially, we're looking at a sub 65.
Can you talk about what changed sequentially from the Q4 number of up to 66 and change its down a couple of hundred basis points.
If you look at the operating margin guidance for two Q, let's first half being at 17.
The back half you need to hit 26, 27% for core alumina.
To hit the annual guide.
What drives that 17% step up to like 27 in the back half. Thank you.
Yeah. So vijay thanks for the question and good calculations rapid calculations on the Mat. So let me let me first hit the <unk>.
Simple question on the the Russia headwind so as we said in the call it's about $60 million for the full year and approximately.
Proximately $18 million in it.
Headwind year over year in Q2.
You're right gross margins were down sequentially for us in Q1.
We had signaled.
Some of this as we gave our guidance in February .
For two specific reasons. So one of course is the launch of the X. As we told you. The extra is just ramping up some margins for the X tend to be low and of course, we sold more access than we anticipated in Q1. The other reason is you go from Q1 to Q2, I'm sorry from Q4 to Q1.
You typically have lower absorption in our factories right. So that tends to lead to a sequential decline in.
Gross margin as you move from Q1 Q4 to Q1.
In terms of operating margin for Q2.
There are a couple of factors there right. So are we.
As you mentioned on the call.
We had our typical.
Salary and promotional adjustments and equity.
Adjustments so from as you move from Q1 to Q2.
There is a one time jump in overall operating expense, but of course that then stabilize us for the rest of the year.
The second factor of course in Q2 and in terms of margins as we have because of the Russia issue, we have a shift again and in a higher amount of instruments being sold which has an impact on gross margin. So those two combined.
<unk> offset some of the operating.
The leverage that we're getting.
To keep margins at 17% now you're absolutely right. We had indicated in our call that we expect margins to.
To improve in the second half of the year.
Two biggest reasons for that are really as we are.
We scale up and start to improve margins on the X and of course, then consumables.
<unk> ramped up so we have a sequential step up in each quarter and because of that absorption in our factories improves leading to increased gross margin and we do expect to exit the year with gross margins in the in the high <unk> and operating margins close to the high 20 numbers that you indicated.
And our next question will come from Josh <unk> with Morgan Stanley .
Hey, guys. Good evening and thanks for the time here, So Francis and J D. Maybe a couple on the core and then a couple on Grail. So on the on the core business. Your nice upside on the on the AG shipments obviously versus what you had indicated earlier in the year, but instrument revenues.
Essentially in line with our forecast so do I think just on the math that it was the offset essentially the EMEA weakness with the next week 550 shipments in China or was there some sort of like greater than expected discounting or some such elsewhere in the portfolio.
Second for you Francis on the next seek any updated thoughts on where you need to land on the poor GB price point once you bring ex leap.
To that platform next year. The competition is roughly $2 a gig. So do you think four to five is sort of a fair assumption or could it even be higher than that given the the inertia to switching yard and then on Grail really.
The question that we get a lot is how committed are you to divesting the asset should you win that jurisdictional appeal and claw back the European Commission fine. So put another way I mean, what color could you share on the scenarios under which you could decide to keep grille. Instead I mean is it essentially premised on what you would get for the asset via an eye.
Or a sale or some such or just walk us through that thought process. Thank you.
Yeah. So let me answer the instrument question first.
So yes, we were happy.
Happy with our you know our increased supply of off and obviously kicks in as we mentioned on the call.
The primary offset was in terms of.
Instruments, the offset in.
The mid throughput instrument cycle and that was again, mostly due to the reduced.
550 shipments and that was primarily in China in terms of pricing you're going to be very clear every track pricing pretty carefully we're not seeing any any differential with the expected prices Lori <unk>.
Decrease in AR and the prices that we track both for instruments <unk>.
And our consumables. So they are exactly where we had expected them to be.
And I think the next question was was it at the grille and or the next question was about maybe I'll jump in Yeah talk about next week and the you know what the impact of X sleep SBS can be wrong next week and.
So as you know when we put <unk> on next week, you'll see a number of pretty dramatic improvements. One you will see an improvement in the price points associated with next week and I'll come back to that because that's where your question was but you'll also see improvements in other capabilities right. So the actual performance of the chemistry in terms of quality and.
So on and then you'll obviously see the sustainability benefits and that's a big draw for our customers because with equity if SBS chemistry, you don't need a cold chain. When you are shipping the consumables and that's a really big savings.
For for our customers in terms of the sustainability value proposition of the product.
Now in terms of how we think about the price our perspective, and whatnot and hence the price right now, but our perspective is we want to price it such that we can.
Maximize the market opportunity and so clearly we're going to bring prices down but our products also have uniquely in the market additional capabilities not only the sustainability features that I just talked about but we have the onboard compute associated.
With having the the FPGA is built into the next week. We also have the onboard storage optimization, which is also unique to illuminate <unk> compared to any other mid throughput instrument on the market and so we're going to bring the prices down but we're also going to recognize the additional value that we provide in our instruments and that'll be part of the <unk>.
<unk> that determines what the ultimate pricing is it'll be around what opens up the market. The most.
Mid throughput segment.
A grill so the pass through divestiture.
It is.
But to answer your question on what's about to divestiture in what scenario do you keep so the path to divestitures as you know obviously the divestiture order will come out shortly that will lay out the process and the structure of the divestiture. We have a divestiture team that's already engaged with the team and the European Commission and we'll move forward with that process.
In parallel we have the two appeals going if we lose either of the appeals, we will divest promptly in the best interest of our shareholders and we expect that to play out again in the.
Late this year early next year kind of timeframe in parallel with the appeals that are happening.
Under what scenario would you keep it if we win both the appeals.
And at that chance at that time, we have a chance to sort of look at the asset.
And so.
Make sure that the assumptions in the you know the.
The business case that we did holds in terms of us keeping it compared towards divesting it and so that would be the scenario.
Under which we would keep the asset and integrate.
And shortly I'll be turning the call back over to Francis for closing remarks. Once again, if you would like to signal with questions. Please press star one.
Star One if you would like to ask questions. The next question comes from Julia Cohen with J P. Morgan.
Hi, good afternoon, Thanks for taking the question first.
First off regarding your operating margin targets can you help us think about the upside downside scenario and in those numbers do you assume that your in house manufacturing.
Manufacturing reach its full efficiency by the end of 'twenty four by the end of 'twenty five I'm, sorry, the R&D efficiency.
I'm wondering if you could elaborate on how we think about the magnitude of improvement in that new product.
After you implement that new R&D structure.
And then lastly, I wonder if you can comment more on China are you seeing any of that from the government stimulus.
Any signs of labor.
All recovery here. Thank you.
Okay.
Okay. So let me Julian let me take the operating margin target question, so anything there.
Probably to two steps there for 2022 I want to reaffirm that we are still at our operating margin.
Guidance of 22% for the year for core.
We are.
We see a couple of offsets there so of course, we are seeing.
More instruments in the number for the year again due to some of the.
The offset from Russia about $60 million for the year.
So for that we do expect a slight gross margin.
Hit which will be offset by further productivity efforts on our manufacturing and of course.
Some of the some of the impact from the.
Further cost reductions that we have introduced.
In terms of your instrument or ex manufacturing efficiencies.
We do expect that by the end of the year, we will have.
Achieve the efficiencies that we had initially outlined that we don't think the efficiencies we'll stop there we as we have done with all of our instruments. We continue to have further efficiencies as we go into subsequent years. So you will you will see that those efficiencies continue to.
Progress as we get into your true three of manufacturer.
In terms of the R&D efficiencies that we talked about so this is really coming from a couple of areas in its R&D and beyond right. So from the R&D side, we are.
Have spent a lot of effort in modular rising our innovations.
Part of the <unk> and of course, even part of the next week <unk> and innovations like the new flow cell technology, and ex leap SBS really allow us to radically reduce the.
The spend per platform and for subsequent platforms and accelerate their time to market. So you won't see this in 2023, but you will see this in 'twenty four.
Beyond and then we're also streamlining where we're doing some of our R&D leveraging our our global footprint and more cost effective hub. So this is for R&D, but also for other functions and then that those kinds of activities also lead to further streamlining our organization and our processes are.
Allow us to to rationalize our global real estate portfolio our spend.
Spend and our.
Our infrastructure as well, so again, you'll see that coming through starting towards the end of this year, but really kicking into place.
As we go into 2024 and beyond and finally in China.
We are not seeing.
The benefits of <unk>.
Off any stimulus in China at least for our.
For our business.
We are monitoring China closely in terms of looking at some of the funding challenges are our customers are facing.
And are taking steps to mitigate some of these challenges.
Okay.
And we have a question from David Western Berg with Piper Sandler.
Alright, Thank you for taking the questions and congrats on the one the big.
Obviously X placements, so I want to stick on that on those 67 placements have any of those customers started decommissioning any of their six thousands traditionally you've had customers finish their old projects before starting on the Ax now you have really good consistency between platforms.
Of that behavior might have changed have you seen any maybe subsequent orders on 6000, even though they are already switched to act just trying to get really get a sense on <unk>.
On on kind of this.
This dynamic thank you very much.
Yes so.
David.
For the question I think on the North Sea.
Xs rates, so you're right a majority of our customers. They are they will transition their projects.
Overtime and.
They are not intending, especially on the clinical side not intending to decommission their there and obviously six thousands.
For the initial set of.
Set of customers that we are tracking into from Q1 into Q2.
We expect just about a about a 10 to 12 decommission.
As a as those excess come online, but again decommissioned and replacements will be a smaller fraction and as we get into the year, we'll provide more updates in terms of.
How the 6000 inventory or 6000 on inventory, but instead of installed base.
You know continues to evolve.
And we'll take our next question from Kyle Nixon with Canaccord.
Great. Thanks, guys. Thanks for taking my questions and congrats on the launch for the next year.
Just one question for me historically, the company's revenue growth has been kind of elevated in a year or two following one of us meaningful sequence or launches.
118 that was those were strong with 6019. It was a setback than $14 15 were solid with the Hiseq X within 16 growth with single digit. So is there anything about the <unk> launch that would lead to a different outcome.
Or could it be stuck in this kind of perennial fecal independents, how new products driving near term growth because now you have more headwinds than <unk> had in the past.
Be helpful to understand thanks.
Yeah. Thanks for that question, Kyle I'll say, maybe a couple of points I'll make one product cycles are important in our market.
From a couple of perspectives, one obviously, there's an upgrade cycle that they catalyze and that's typically.
More more quick in the research market. So historically, it's been very important in terms of driving near term revenue growth because our market was primarily a research market, but now.
As we pointed out last quarter, 50% of our consumables revenue coming from the clinical market I'd say that one of the drivers of growth, but but big driver of growth is just going to be.
The growth in the clinical use cases, and so we talked about the fact that we're seeing in the clinical markets from our proactive runs that we monitor continued strong growth of our clinical customers just because we're seeing more uptake of tests like the genetic disease testing.
Segment, that's continuing to grow or more coverage associated with oncology therapy selection or increased at ITT coverage and so as you look forward a significant driver of growth is going to come more from adoption of sequencing in the clinical markets.
More so necessary than just a straight upgrade cycle.
I think just one more thing to add right you will see a little bit of what we traditionally see is as customers cut over from one system to the other there will be a little bit of a transition from consumables from one system to the other so I don't think that can totally be avoided but Francis is right you see that much more with research customers that clinical.
Customers right, so that will tend to mitigate.
Thank you.
That concludes our Q&A session I will now hand, the call back over to Francis Desouza.
Thank you for joining us as.
As we close the call today is DNA day celebrating the 70 <unk> anniversary of the discovery of the double helix structure of DNA.
This month is also illumina its 20 <unk> anniversary over our history. Our team has played an important role in the genomic revolution by delivering breakthrough innovations that dramatically reduced sequencing cost and broaden access to genomics unlocking new frontiers in biology and health care.
And yet today with only 4 million genomes ever sequenced, representing only 0.07% of the population we are still at the beginning of the genome era.
That concludes our call today, we look forward to seeing you at upcoming conferences and other events.
Thank you that does conclude today's conference. We do thank you for your participation have an excellent day.
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