Illumina Inc

NASDAQ:ILMN

Earnings Call Transcript 2022-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to the First Quarter 2022 Illumina Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' 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 Salli Schwartz, Vice President of Investor Relations. Please go ahead, ma'am.

[Salli Schwartz, Vice President, Investor Relations]

Good afternoon, everyone, and welcome to our earnings call for the first quarter of 2022. 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 have not had a chance to review the earnings release, it can be found in the Investor Relations section of our website at illumina.com.

Participating for Illumina today will be Francis deSouza, President and Chief Executive Officer; and Sam Samad, Chief Financial Officer. Francis will provide an update on the state of Illumina's business and Sam will review our financial results, which include GRAIL.

As a reminder, pending the outcome of the European Commission's investigation into Illumina's acquisition of GRAIL, the commission has adopted an order requiring Illumina and GRAIL to be held and operated as distinct and separate entities for an interim period.

Compliance with the order is monitored by an independent monitoring trustee. During this period, Illumina and GRAIL are not permitted to share confidential business information unless legally required, and GRAIL must be run independently exclusively in the best interest of GRAIL. Commercial interactions between the two companies must be undertaken at arm's length.

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.

To better 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 Illumina's most recent Forms 10-Q and 10-K.

With that, I will now turn the call over to Francis.

[Francis deSouza, President & Chief Executive Officer]

Thank you, Salli. Good afternoon, everyone. We maintained strong momentum across regions and markets in the first quarter. We saw particular strength in oncology, genetic disease testing and infectious disease and achieved record quarterly performance in the Americas and APJ. I'll share an overview of our results as well as our progress across our portfolio and markets before turning it over to Sam for additional detail.

Before I begin, I'd like to extend my thoughts to everyone dealing with the war in the Ukraine, and we will continue to support humanitarian efforts to help the affected communities.

Starting with our financial results. First quarter revenue of approximately $1.22 billion increased 12% year-over-year. We received record orders in the quarter with sequencing consumables orders surpassing $1 billion for the first time and we exited the quarter with record total backlog, a great leading indicator for upcoming quarters.

Turning now to performance across our platforms. Sequencing instrument shipments grew more than 20% year-over-year in the first quarter. We shipped a record number of NovaSeqs and received record NovaSeq consumables orders, demonstrating both strong demand in the instruments sixth year since launch and addition to our substantial installed base for future consumables revenue.

More than half of NovaSeq shipments were to clinical customers and we saw particular strength in oncology testing as high throughput sequencing and comprehensive genomic profiling become increasingly critical to cancer patient care.

In mid-throughput, the installed base of NextSeq 1000 2000 instruments has now exceeded 1,000. Additionally, Q1 shipments for the P1 flow cell that we launched in the fourth quarter of 2021 nearly doubled our expectations.

We're seeing strong adoption of the P1 flow cell from both new customers and customers moving up the throughput spectrum as well as broad kit utilization from existing NextSeq 1000, 2000 users due to the P1 flow cell's efficiency and cost effectiveness.

Our low throughput platforms also continued to perform well and provide a great entry point to sequencing. More than one-third of 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 markets. Oncology testing sequencing consumables grew almost 20% year-over-year, as we continue to help democratize sequencing in this critical area of health care. In March, we received CE IVD approval for TruSight Oncology comprehensive in Europe. This new in vitro diagnostic comprehensive genomic profiling kit, is the first distributed IVD for both DNA and RNA. TSO Comp IVD, covers a range of mutations and biomarkers associated with the European Society for Medical Oncology guidelines, maximizing opportunities to find actionable information from each patient's biopsy.

We're pleased with the early reception and excitement from customers across the EU. And we look forward to introducing TSO Comp IVD in other markets, including Japan, where we recently applied for regulatory approval. The TSO Comp IVD offering will build upon the incredible expansion we're seeing globally for TSO 500, which grew nearly 120% year-over-year in Q1.

Also in oncology, customer and provider interest for Galleri, GRAIL's groundbreaking multi-cancer early detection blood test is growing. To date, Galleri has been prescribed by more than 2,400 prescribing physicians and GRAIL has entered into 34 partnerships with health systems, employers and insurers who are investing in multi-cancer early detection to improve outcomes. This includes GRAIL's recent partnership with Point32Health, the combined organization of Harvard Pilgrim Health Care and Tufts Health Plan. Point32Health's 2-phased pilot of Galleri marks GRAIL first collaboration with a commercial health plan in the US.

Last week, GRAIL also announced a multiyear partnership with Munich Re Life US to provide Galleri as part of Munich Re's commitment to advancing cancer early detection and treatment. Munich Re and GRAIL will collaborate to enable carriers and distributors to offer Galleri to existing policyholders who are at high risk of cancer such as those aged 50 and older.

Also, the NHS Galleri trial continues to progress, with more than 90,000 of the planned 140,000 participants enrolled. To support the increasing interest around Galleri and to further their R&D efforts, the GRAIL team has almost doubled in the last 8 months to more than 850 employees, with another almost 250 job openings. Looking ahead, GRAIL plans to expand its existing sales force for Galleri to reinforce launch traction and drive continued market adoption.

Turning to our other markets. Genetic disease testing had another record quarter as we enable expanding coverage and utilization of whole genome sequencing or WGS globally. In the US, critically ill infants are now eligible for WGS in California, Oregon and Maryland through Medicaid, providing coverage for an additional 17 million lives. And last week, we announced an agreement with Germany's Hannover Medical School to implement the use of WGS for critically ill children suspected of having a genetic or rare disease.

This project, like our collaborations with other children's hospitals around the world helps demonstrate how WGS can support earlier diagnosis and treatment for children in neonatal and pediatric intensive care. In reproductive health, coverage, reimbursement and evidence generation continue to increase, particularly in Europe. Both Spain and Italy have expanded coverage for noninvasive prenatal testing, or NIPT, with Germany likely doing so as well later this year.

In infectious disease and microbiology, we saw a record quarter with incremental global investments in pathogen identification monitoring and resistance. While this was driven by COVID surveillance, we are also seeing traction for other pathogens, including tuberculosis. In March, the Milken Institute called for a network of multisector stakeholders to collaborate on data, insights and responses for early disease outbreaks. In the same month, the World Health Organization announced a 10-year strategy to use the power of genomics for global pan pathogen surveillance, demonstrating the growing trend for broader pathogen monitoring.

For example, FIND, a Geneva-based Global Alliance for Diagnostics, established Seq&Treat, a global initiative using sequencing for drug-resistant tuberculosis which affects nearly 0.5 million people globally each year. We're providing instruments to help Seq&Treat accelerate discovery for the half of patients with drug-resistant tuberculosis who are not currently successfully treated.

In our research and applied markets, we continue to see genomic research expanding across applications and disease states. Lab budgets, specifically for NGS are increasing, including for both academic labs growing approximately 9.5% and pharmaceutical and industry labs growing at approximately 14%. As part of our efforts to support growth in genomic research, we recently partnered with Allelica to provide cutting-edge polygenic risk score digital tools to our customers.

With Allelica's software, researchers can better identify individuals with high genetic susceptibility for developing life-threatening diseases. Also in research, increasing utilization and demand for multi-omics, particularly proteomics is driving sequencing growth and opportunities. Our partnership with SomaLogic to codevelop a high plexity, high sensitivity and high specificity proteomics assay is progressing well. Together, we look forward to empowering the next generation of novel insights.

Another fast developing area is the integration of multiomic and genomic data into drug development and clinical trials. Drug development R&D spend is more than $123 billion annually, yet more than 90% of drugs that enter Phase I clinical trials fail to reach clinical approval, with fewer than 70 entering the market each year. A main contributor to this high failure rate is target selection, where genomic-based methods can more than double success rates and dramatically improve cost and speed to market.

Because more than 85% of the human proteome cannot currently be targeted pharmacologically, we are excited to support genetic lead discovery and emerging drug modalities that could significantly expand the total number of potential therapeutic targets.

In addition to our partnership with Nashville Biosciences, today, we announced a partnership with Deerfield Management. This first of its kind collaboration will combine Illumina's genetic and AI-led approach to discovery with Deerfield's expertise in preclinical and clinical development. Together, we plan to translate genetic insights into new therapies across diseases with unmet medical needs and drive a step change in the pace and efficiency of drug development.

This will ultimately help more patients access potentially life-changing therapies. We also recently announced a collaboration with Janssen to accelerate development of precision medicines. This includes developing companion diagnostics across our new TSO Comp IVD and exploring discovery and research initiatives for drug and biomarker targets across disease states. These collaborations are a few of what we expect will be many pharmaceutical strategic partnerships, leveraging the power of Illumina to create precision medicine at scale.

Overall, we were pleased with our first quarter performance, including 20% sequencing instruments growth and sequencing consumables orders surpassing $1 billion for the first time. The significant ongoing growth in our installed base as well as our record backlog exiting the quarter lay the groundwork for continued acceleration of our business in the coming quarters. I'm also really excited about the work we're doing with our collaboration partners. These efforts underpin our ongoing progress in driving sequencing trends to improve human health.

I'll now turn the call over to Sam to discuss additional details on our results and outlook. Sam?

[Sam Samad, Chief Financial Officer]

Thanks, Francis. As a reminder, our first quarter financial results include the consolidated financial results for GRAIL. I'll start by reviewing our consolidated financial results, followed by segment results for core Illumina and GRAIL then conclude with our current outlook for 2022.

I will be highlighting non-GAAP results, which includes stock-based compensation. I encourage you to review the GAAP reconciliation of these non-GAAP measures, which can be found in today's release and in the supplementary data available on our website.

Our record first quarter revenue of $1.223 billion grew 12% year-over-year, with core Illumina sequencing instruments growing at 20% and sequencing consumables growing at 13%. Sequencing consumables growth was solid across both clinical and research, with both market segments growing in double-digits.

For the first quarter, GAAP net income was $86 million or $0.55 per diluted share and non-GAAP net income was $169 million, or $1.07 per diluted share, which included dilution from GRAIL's non-GAAP operating loss of $134 million for the quarter.

Our non-GAAP tax rate was 17.8%, which decreased 250 basis points year-over-year, primarily due to tax expense recognized in Q1 2021 on certain foreign subsidiary earnings that are no longer indefinitely reinvested.

The increase in the non-GAAP tax rate from Q4 2021 was primarily due to the impact of R&D expense capitalization requirements implemented by the Tax Cuts and Jobs Act of 2017. Our weighted average diluted share count for the quarter was approximately 159 million.

Moving to segment results, I will start by highlighting the financial results of core Illumina. Core Illumina revenue grew 12% year-over-year to $1.221 billion. Core Illumina sequencing consumables revenue grew 13% year-over-year to $784 million, driven by the growing NovaSeq installed base across clinical and research markets.

Sequencing instruments revenue for core Illumina reached a new high, growing 20% year-over-year to $212 million. This was driven by another record quarter of NovaSeq system shipments, resulting from accelerating demand in oncology testing, which accounted for almost 40% of the NovaSeq shipments for the quarter.

We also continued to see strong demand for NextSeq 1000, 2000 from new to Illumina customers, who represented more than a third of the shipments for the quarter.

During the first quarter, COVID-19 surveillance contributed approximately $53 million in sequencing consumables revenue and $7 million in incremental instruments revenue, driven by the sustained focus on pathogen surveillance. Core Illumina sequencing service and other revenue of $111 million was up slightly year-over-year, driven by growth in instrument service contracts.

Moving to regional results for core Illumina. Revenue for the Americas region was $646 million, growing 15% compared to the prior year period. Growth in the region was primarily driven by strength in three key areas: first, continued sample growth in oncology therapy selection; second, emerging applications such as single cell and proteomics; and third, pathogen surveillance initiatives.

EMEA delivered revenue of $316 million, representing 4% growth year-over-year, driven by strength across both clinical end markets and emerging markets, partially offset by the conclusion of the UK Biobank program in the third quarter of 2021 as expected. EMEA growth was modestly impacted by lower shipments to Russia as a result of the war in Ukraine.

Greater China revenue of $127 million was flat year-over-year as the region's robust clinical demand in hospitals was offset by COVID-19 restrictions that began in March. Finally, APJ revenue of $132 million grew 33% year-over-year with stronger than expected growth from large-scale research projects, oncology and genetic disease testing and pathogen surveillance initiatives.

Moving to the rest of the core Illumina P&L. Core Illumina non-GAAP gross margin of 70.2% decreased 30 basis points year-over-year due primarily to increased freight costs attributable to broader global supply chain pressures.

Core Illumina non-GAAP operating expenses of $505 million were up $85 million year-over-year due primarily to headcount growth and investments we are making in R&D and operations to support the growth and scale of our business. Despite the year-over-year increase, non-GAAP core Illumina operating expenses for the first quarter were roughly $15 million lower than we expected as a result of the slower hiring and timing of project spend shifting into the second quarter.

Transitioning to the financial results for GRAIL. GRAIL revenue of $10 million for the quarter consisted primarily of Galleri test fees. GRAIL's non-GAAP operating expenses totaled $139 million for the quarter, which consisted primarily of expenses related to headcount and clinical trials. GRAIL non-GAAP operating expenses were approximately $15 million lower than we expected due to timing of spend shifting to the second quarter.

Moving to consolidated cash flow and balance sheet items. Cash flow from operations was $172 million. DSO was 46 days compared to 49 days last quarter. First quarter 2022 capital expenditures were $61 million and free cash flow was $111 million and we did not repurchase any common stock in the quarter. We ended the quarter with approximately $1.4 billion in cash, cash equivalents and short-term investments.

Moving now to 2022 guidance. We continue to expect consolidated revenue growth of 14% to 16% for 2022, including core Illumina revenue growth of 13% to 15% and GRAIL revenue of $70 million to $90 million. And we continue to expect non-GAAP earnings per diluted share in the range of $4 to $4.20, which includes dilution from GRAIL of $3.75 in line with previous expectations. We are reaffirming all other financial guidance for full year 2022, we provided in February, with the exception of our consolidated non-GAAP tax rate, which we now expect to be approximately 18%.

Our outlook for 2022 assumes the lockdowns in China eased by June and our business in China recovers in the second half of 2022. For the second quarter of 2022, we expect consolidated revenue to increase 7% to 9% year-over-year from the second quarter of 2021, including an approximately 300 basis point headwind on overall revenue growth related to current COVID-related shutdowns in China. We expect consolidated non-GAAP gross margin to be roughly flat sequentially from the first quarter of 2022.

We expect consolidated non-GAAP operating margin to be approximately 10%, with the sequential decrease from Q1 2022, driven primarily by a $60 million increase in core Illumina operating expenses and the $25 million increase in GRAIL operating expenses. The expected increase in operating expenses are driven primarily by our typical ramp in compensation-related expenses, including our merit increase cycle, the timing of hiring and project spend shifting into Q2 from Q1 and the ramp in GRAIL's operating expenses.

We expect core Illumina non-GAAP operating margin to be approximately 23% in the second quarter. We expect the second quarter consolidated non-GAAP tax rate to be in line with our full year 2022 guidance of approximately 18%. And lastly, we expect diluted shares outstanding to be in line with our full year 2022 guidance of approximately 159 million shares.

I will now hand the call back over to Francis for his final remarks.

[Francis deSouza, President & Chief Executive Officer]

Thanks, Sam. As we look ahead, our business fundamentals remain very strong. The continued growth in our installed base, our record backlog exiting Q1 and the increasing volumes we're seeing as customers pursue higher intensity sequencing applications all bode well for future growth, especially in the second half of this year.

We also continue to drive increased access and deliver breakthrough genomic innovations. We're making progress across our innovation pipeline with data and excitement building around our breakthrough Chemistry X, our infinity Long Read technology and our NovaSeq Dx platform. We will provide additional updates on these technologies in the coming months and we look forward to welcoming thousands of customers from around the world to the Illumina Genomics Forum in late September.

Also, we are pleased to invite you to join us this fall for our Investor Day which will be held Monday, October 3 in San Diego, following the Illumina Genomics Forum. We will be announcing additional details in the coming days. Across our global business, we are at the forefront of genomics in health care. We're excited to deliver new technologies, collaborate with pioneering partners, Champion patient access and support incredible researchers and clinicians around the world, as we collectively unleash the power of genomics for the betterment of human health.

I'll now invite the operator, to open for Q&A.

[Operator]

Thank you. [Operator Instructions] We'll take our first question from the line of Dan Brennan. Please go ahead. Your line is now open.

[Dan Brennan, Cowen & Company]

Great. Thank you. Thanks for taking my questions. Maybe I have a couple parter, just to kick it off, Francis and Sam. First part is on China, 10% of your revenues, you talked about the headwind in Q2.

Can you just give us a sense of how it played out for you in Q1? It was flat, obviously, a pretty big deceleration. Just wondering, how much China really took away from what you expected in kind of 1Q.

Second part of the question is on instruments and consumables for NGS. You're kind of maintaining all your guidance numbers. I believe, you were kind of thinking about 10% instrument growth, and I believe 18% consumable growth for the year.

You obviously trended above that on instruments in Q1. And you were below that on consumables. So just walk us through, particularly in consumables, kind of how the year is going to play out and was 1Q impacted, whether it be by China by anything else.

And then, the final part of the question is just AGBT. Presumably, we're going to get the update on Infinity there. Are we going to learn anything on Chemistry X or that's going to have to wait for the fall. Thank you.

[Sam Samad, Chief Financial Officer]

Yeah. Hi Dan. Thanks for the question. So this is Sam. I'll start with the first two questions, and then, I'll turn it over to Francis on the AGBT question. So with regards to China, China was approximately $10 million lower than our expectations in Q1, and that was really all driven by the restrictions that we saw in March.

So as you know, in March, we saw really large significant restrictions in Shanghai, basically shutting the whole city down. But also, we saw restrictions in a number of other cities as well, and that got reflected with about a $10 million downside in Q1.

As we said in Q2, we expect a 300 basis points headwind on overall company growth in China. So all in all, I would say in the first half, it's about a $45 million headwind for China on our results.

But we are expecting that by June, the restrictions start to ease. We're already seeing promising things in Shanghai. Beijing, I think there's mass testing going on. And so we're keeping obviously close to that situation.

But we're optimistic that as we get into June and beyond, this will start to ease. The underlying fundamentals of demand in China are really strong. Our backlog is up as we enter into Q2. It's higher than the last two quarters.

We've added new hospitals, almost 38 hospitals that we've added into our installed base. We're increasing our penetration in hospitals. The question is really just about restrictions and the ability to get products to customers just given the fact that there's, shutdowns.

With regards to your second question on instruments and consumables, yeah, we had a very strong start to the year with regards to instruments, over 20% growth. We said going into the year that this is going to be a more, I would say, less back-end loaded year for instruments.

We're going to have a strong start. It's going to be more, I would say, sequentially even in terms of instruments. So we are still reiterating our guide for 10% growth. We had a very strong backlog. And we still do going into Q1. And so we are basically shipping and delivering on that backlog as you saw in Q1 with our strong results.

And with regards to consumables, consumables actually were better than expectations in Q1. So they grew by 13% and they were better than what we expected in Q1, even with the impact of China. As you think about Q1, think about some of the impacts in Q1 of last year that actually muted some of the growth of 13%.

If you normalize for those, things like the U.K. Biobank, in Q1 of 2021, which was a $20 million benefit, we had some stocking in Q1 of 2021, which was also about a $20 million one-time impact. If you normalize for those, consumables would have grown in the high-teens. So we still have a lot of confidence in terms of our guide of 18% in consumables for the full year. I'll turn to Francis.

[Francis deSouza, President & Chief Executive Officer]

Yeah, Dan, let me take the questions about Chemistry X and Infinity. The teams are making really good progress in both. Our strategy is going to be on Infinity to have more customer data come out over the course of the rest of the year as we get closer to launching Infinity.

And then with Chemistry X, you will absolutely have a lot more information at the customer event and then at the investor event as well. And then between now and then to the extent that there is some new material data to show, we will bring it out.

[Operator]

Thank you. We'll take our next question from the line of Dan Arias. Please go ahead. Your line is now open.

[Dan Arias, Stifel, Nicolaus]

Yeah. Hi, guys, thanks for question. Francis, maybe just on a similar vein -- in a similar vein. You mentioned last quarter that the backlog was 2x the prior year, and you're saying now here that it's record levels. So presumably, the backlog grew in the quarter. Is that fair?

And then on the pull-through rate for the NovaSeq, I'm just curious whether you came in, in the range that you were looking for, for the year? Or did things that took place in March kind of take you a little bit below, and it's just a matter of getting back to that range later in the year.

And then if I could, just on GRAIL, anything new on the European Commission and the timing related to the news around that process? Thanks.

[Sam Samad, Chief Financial Officer]

Yeah. Maybe I can jump in, Dan, and take the first question on backlog. So we have talked about the fact that instrument backlog was a record going into Q1. It was double the backlog that we saw starting last year. With regards to overall backlog, it also is a record in Q1. So let's be clear on what the components are. So we had record overall backlog in Q1 or exiting Q1. So definitely, the overall backlog grew, but I think the double was really more relating to the instrument backlog.

So with regards to NovaSeq pull-through, let me continue with that. So we are still expecting pull-through to be in the range of 1.2% to 1.3%. So we are expecting that as we get -- first of all, we've had incredibly strong placements for NovaSeq. We had Q1 was a record shipment quarter for NovaSeq.

As we get more and more installed base expansion and we get more shipments into NovaSeq, as you know, it's going to take -- usually, it takes about a quarter or two for those customers to ramp up to their usual pull-through, but we have every confidence that we're still going to be in the -- in that 1.2 to 1.3 pull-through range for the year.

[Francis deSouza, President & Chief Executive Officer]

And then let me pick up on the question around GRAIL and timing with the European Commission. As you know, we're engaged in two processes in Europe. One is with the European Commission around their phase two review. We continue to be engaged with them. The clock is paused as we are working with them to see if there are remedies that could get this deal approved and we expect a decision on that to come either later in Q2 or in Q3. We are also engaged with the EU General Court as we work through the jurisdiction of the European Commission to review this deal, and we expect a decision on that similarly to come either later in Q2 or early Q3.

[Operator]

Thank you. We'll take our next question from the line of Derik De Bruin. Please go ahead. Your line is now open.

[Mike Ryskin, Bank of America]

Great. Thanks for taking the question. This is Mike Ryskin on for Derik. I want to follow-up on the instrument strength in the quarter. Again, another really good result after a strong run in 2021. I'm sure you know, there's increasingly more product launches coming in the space from a number of competitors. Some have already launched and we're in the process of launching more or less as we speak. I'm just wondering, has that shown up in any of your conversations with prospective customers? Are you competing more with any of these head-to-head? Is it coming in when you're having pricing conversations with them or any committed contract or anything like that? I'm just wondering if that's shown up on the margin, especially in the mid-throughput part of the portfolio.

[Francis deSouza, President & Chief Executive Officer]

Yeah. I'll start by saying that overall, we believe that the genomics market is a large and growing market that we're in the very early stages of penetrating. And so as we've seen before, and we'll continue to see, there's room for growth of multiple players in this market. And we expect that to be true for a long time going forward. The customers we sell to are among best and brightest in the world. They're obviously aware of the options that are out there, and we do have those conversations. And so all our customers, I think, are very well informed about what the genomics landscape looks like, who's available, what's coming and what to expect from the different vendors. So they're absolutely part of those conversations.

You see the strength, though, in the numbers we put up, right? You saw the 20% growth in Q1. You saw the strong orders, strong shipments, you especially see the strength in areas like NovaSeq, for example, where we had a record year last year. We had a record Q1 in terms of shipments. And that continues to be because whether it's at the high end of the portfolio or in the next seat line or even at the smaller end of the portfolio, we continue to provide a superior value proposition that is meeting the needs of customers in terms of total cost of ownership, in terms of performance, in terms of price points. And that's, frankly, the job we have to continue to do, continue to earn our customers' business by making sure that, that continues to hold true.

[Operator]

Thank you. We'll take our next question from the line of Tejas Savant. Please go ahead. your line is now open.

[Tejas Savant, Morgan Stanley]

Hey, guys. Good evening, and thanks for the time. Francis, I'll ask a two-parter, one on GRAIL and one on competitive dynamics similar to the prior question there. So you did about $10 million in revenue. You're still expecting about $80 million from GRAIL at the midpoint, so a fairly steep ramp through the rest of the year. Can you share some light on what sort of the uptake rate within the patient population here that you're assuming for Galleri in terms of your current health system and employer partners. And then on the competition, you've had some of the emerging competitors.

Your talk of mid-single-digit price per GB sort of price points on their medium throughput instruments, do you see yourselves as having sort of enough flexibility to go lower perhaps at the high end of the portfolio, $100 to $200 genome? Or do you see enough delight in terms of other specs that you'd still be very competitive and stay the preferred vendor for your customers?

[Francis deSouza, President & Chief Executive Officer]

Yes. So let's take – thanks for those questions. Let's take them one at a time. We are pleased with the way GRAIL is performing. So if we look at the traction that they got in Q1, not just the $10 million in revenue. But if you look at the traction they've made also with increasing the number of prescribing physicians to 2,400, increasing the number of partners across health systems, employers and insurers and up to 34. They continue to be on track to meet the revenue outlook that we laid out at the beginning of the year, the $70 million to $90 million.

The other thing that they've put into place that we know will pay off over the course of this year and then certainly going forward, signing up the first commercial insurance provider here in the US with Point32Health. That's going to be exciting both as an employer customer of theirs because they're going to roll it out internally and then obviously, as they roll it out to their customers.

The other exciting development was them signing up their first life insurance company. And that, we think, with Munich Re that we think is a good start in a segment that we think has a lot of potential for GRAIL going forward and so good traction there.

And then maybe a little bit longer term, we're also excited with the progress that GRAIL is making with the NHS trial that they have. They're now up to 90,000 enrolled participants. You will recall that had a target of 140,000 and so they're making good progress. which then brings us one step closer to the next phase of the NHS, which would be expanding this to a million people in the UK. So good progress all around, I feel like we're on track to meet the plan that we laid out at the beginning of the year.

In terms of competition, we still feel like we have headroom in a number of ways. One, when we talk to our customers, they look at the total cost of ownership of a system. And so the price per G is one part of the equation, but then you have to look at things like the compute infrastructure. And if you look at what we've got in the NextSeq, for example, or the NovaSeqs, that extends well beyond just core sequencing.

You've got advanced compute on board with the instruments with the FPGA arrays, which for other sequencers, you'd have to go out and buy that type of compute. In addition, we have things like the lossless data compression algorithms built in. Some customers can achieve a 5x reduction in the amount of data that's required to be stored. And so that's another part of the TCO equation that customers look at when they compare our systems with comparator systems.

And so price per G is 1 part of the equation. You add all of those other things and you start to – it starts to add up just how good that the value you're getting from Illumina is. Having said all that, we also have a lot of headroom in terms of continuing to drive the price per G down. As you've heard us talk a lot about the innovations that we've got in the pipeline and the kind of headroom that gives us as we look forward, both on new instruments and potentially on existing product lines, too. So we definitely have a lot of gas in both of those tanks, right? One is on the end-to-end TCO comparison, where we have a very strong proposition, but then also taking each of the components and continuing to drive the price down because of the technological innovation that puts us on dramatically in the [indiscernible].

[Operator]

Thank you. We'll take our next question from the line of Kyle Mikson. Please go ahead. Your line is now open.

[Kyle Mikson, Canaccord Genuity]

Great. Hi guys. Thanks for taking the questions and congrats on the quarters. I appreciate that we'll be hearing and seeing more about the new products in the near term. But specifically, when should we expect to hear some commentary around the Chemistry X economics? And maybe just to establish a benchmark, would 20% to 25% lower pricing to our original expectation, that's 20% to 25%? The second question about GRAIL. I understand the biopharma and MRD collaboration revenue represents a portion of the GRAIL revenue guidance.

But with respect to the Galleri revenue specifically, does the guidance assume most of the clinical trial revenue, like you were kind of mentioning Francis NHS Summit drive, et cetera, or actual diagnostic revenue like Intermountain, Alignment, et cetera?

[Francis deSouza, President & Chief Executive Officer]

All right. So let me take the questions one at a time. So Chemistry X will continue to give you technical updates as they become available. And the economics update will really depend on the instrument that we put Chemistry X into because it will be different, because ultimately, the economics of an instrument depend on the new chemistry but also every other part of the instrument, right? The optics that we put in there, the flow cells that you put in there, the compute infrastructure.

And so Chemistry X will be definitely a heavy contributor to superior economics in an instrument, but to tell you the overall economics, we'd have to lay out the entire configuration of an instrument, and then we'll share with you what that instrument would give you.

I can tell you right now that, frankly, 20% to 25% would be low. If you think about the road map of the new Chemistry, right? If you look at look at what we got with the last generation of Chemistry, right? So when Solexa came out in 2007, the project we got from them is $150,000 to launch -- to do a genome. Today, it's less than 600, right? So that chemistry, if you look at the lifetime of that chemistry. Now, I don't want to give all the credit just to the chemistry because obviously, there were innovations again, in optics and data paths and compute and everything associated with that.

But very, very significant road map in terms of price reductions that were enabled. So this is the most significant update we've done in Chemistry since the original SBS was invented. And so you should think about the lifetime of this Chemistry is giving us a lot of headroom in terms of performance, but also in terms of price reduction. So I would be personally disappointed if over the lifetime of this Chemistry, you were just thinking about a 20% to 25% reduction.

Secondly, let's talk about GRAIL. So the grow revenue for the year, what we said and reaffirm is that, the majority of the GRAIL revenue for this year will come from testing. There will be a component that comes from their pharma partnerships, but it won't be the majority of their revenue. And that's what they're working towards on the plan they're on.

[Operator]

We'll take our next question from the line of David Westenberg. Please go ahead. Your lime is now open.

[David Westenberg, Piper Sandler]

I hit that mute button. Hi. With the point of the cost per G in competition, I realize maybe just getting a little bit old, but it didn't get my specific like thought or thought process or a specific question. And that would be the mid-throughput is definitely crowded. You've gone on in length about the competitive levers you have to pull in that. When we're talking about the high throughput market, somebody who's catching you in price per G or even higher than that, how comfortable do you feel that in the high throughput range of competitive launch would not be that detrimental to you? And should we use BGI as an example. And hopefully, this is a quick question for my follow-up here for Sam. And that is a lot of the cash flow generating. Cancer labs are in cost-cutting mode. Has the conversation around investment in sequencing instruments came up as part of that cost reduction? Thank you.

[Francis deSouza, President & Chief Executive Officer]

So thanks for that question. Let me start with the first one, which is -- we have always had to compete in the high throughput environment, and we expect to continue to. And I'll start by saying that the genomics market as a whole, as I said earlier, is a large and growing market that's in the early stages of penetration.

And so we expect there will be vendors to emerge, there'll be vendors that -- some that go away. But we expect that there will be competition in that space, and that's what we've built into our plans. Having said that, I'm also very confident in our competitive posture in that market today and extraordinarily excited by the road map that we have in terms of enhancing that competitive posture.

And I'll start again, what I said a little bit earlier, which is when you think about even just the cost element, it's really important that you think about the total cost of ownership, especially on the high throughput side. When you're generating so much data, the compute costs, the storage costs, the end-to-end workflow costs, all of that become very important.

And so when you look at the levers of innovation that we have, not just to continue to drive the performance and price points associated with the core sequencing. But the levers we have around the end-to-end workflow, we have a terrific ability to offer a very strong value proposition in that high throughput market. And then the second question is on cost cutting.

[Sam Samad, Chief Financial Officer]

Yes. So Dave, thanks for the question. The short answer is no, but I'll explain why that's not the case that we're seeing any cost cutting on sequencing. So when you think about our customer universe, we've got about 8,000 customers, incredibly diversified customer base.

But if you think about the commercial labs, clinical customers, I mean, sequencing is part of what drives revenue for them. So really, all the demand is driven by the end markets. And it's really driven by the need for testing and the fact that we're seeing very robust demand driven by robust reimbursement, market access and utilization in markets in oncology or genetic disease testing. So no, we're not seeing any slowdown driven by cost cutting because I think it's really driven by end demand.

On the research side, we're still seeing very strong funding to the research market whether it's, again, into research in oncology, research and genetic disease or research in pathogen surveillance and other initiatives. So I think the short answer would be no, but hopefully, this gives you a bit of color why.

[Operator]

Thank you. We'll take our next question from the line of Puneet Souda. Please go ahead. Your line is now open.

[Puneet Souda, SVB Leerink]

Yes, hi, Francis and Sam, thanks for taking the question. So Francis, based on what you're saying about Chemistry X and what potentially the new instrument can extract from Chemistry X, I mean, this should take you to $100 genome and well beyond that. So can you talk about what applications will start to open with the reduction that is well above 25% type of reductions that you're talking about? And what does it do to the -- maybe what does it do to the diagnostic mix of the customers for you longer term as well? I think they're trending around nearly 50% of the sequencing consumables.

So maybe just help us understand on the applications and where the diagnostic customers can go in? Just a quick follow-up on the Sam. How much was pricing contribution in the quarter -- how much did pricing contribute in the quarter? And what should we expect it to do for the year in the guidance? Thank you.

[Francis deSouza, President & Chief Executive Officer]

Yes, Puneet. There's a lot that can open up as we continue to drive the price of sequencing down because the reality today is that we're still at the very early stages of understanding how a genome translates into human health and human disease. We've unlocked the first clinical applications. NIPT cancer therapy selection. There are many, many, many, many more that we know will emerge once we're able to do the experiments of the size that we need to do.

For example, if you look at complex diseases like neurological conditions, whether it's autism or schizophrenia or Alzheimer's or Parkinson's, what we're hearing from the research community is that if you look at schizophrenia, for example, in families, it's clear that there is a genomic component to it, but there's complex causality there. And the only way you can unravel the biology is by running cohorts that are not measured in the thousands or even tens of thousands, but are much bigger than that.

And so there's a huge amount of promise to uncover and address some of the genomic underpinnings of neurological conditions. We need cohorts much, much bigger than we've seen historically. And that's -- those are the kinds of experiments. Similarly, when you think about what we need to understand about single cells and the heterogeneity of expression across the cells, across the human body, there are tens of trillions of cells in the body. So if you want to do even just a representative -- statistically representative experiment, you don't need just thousands of cells like people are doing today. You need sizes in the millions or tens of millions, and we need to understand that.

And so those are the kinds of experiments that we're getting pushed on and say, okay, if you can just keep driving the prices down, it just opens up the large research areas which then will translate into a future area of new diagnostics, new screening modalities as well as new therapeutics. And so that's -- those are the kinds of big, big markets that get opened up.

Today, if you look at the top 10 causes of death for mankind, genomics helps address cancer, one of those top 10. The reality is that if you play this out a decade, maybe longer, genomics is going to help us address all 10. But to really understand the biology, we need an enormous amount of research to be done. And then we need an entire new set of diagnostic screens and therapeutics. And so that's what gets enabled.

[Sam Samad, Chief Financial Officer]

Yes. And Puneet, thanks for the question on pricing. So maybe just to walk you through what we do typically, which is -- and this is what we did in Q1, which is very consistent with what we've done in past years, we usually take, I would say, a low single-digit price increase on some of our products, not all of our products. It's mostly on the reagent side and also on library prep.

And as I said, it's in the low single-digit. This is very consistent with what we do every year. So it has some impact on the full year. It's embedded within the guidance that we've given. But it's nothing unusual compared to past years. We have not done anything that's a significant inflationary price increase that we passed on to our customers. We have not done any freight increases at this point. So we've done our typical price increase that we do in Q1.

[Operator]

Thank you. We'll take our next question from the line of Patrick Donnelly. Please go ahead. Your line is now open.

[Patrick Donnelly, Citi]

Hi, guys. Thanks for taking the question. Francis, maybe one on the clinical market. Obviously, the momentum there continues to build for really strong numbers. Can you just talk about where you're seeing the most strength underlying there? And then obviously, you talked a little bit about the competition. How confident you are and kind of your positioning there as maybe some more people come after the clinical side?

[Francis deSouza, President & Chief Executive Officer]

Yes. The -- we are seeing real strength across the board in the clinical market. So if you look across regions, we're seeing a huge amount of strength, obviously, in Americas and so on. But even in China, where we talked about the COVID restrictions, we still had strong momentum in the clinical market and signed up, as Sam pointed out, 38 new hospitals as well.

So what's driving that? One of the biggest drivers of that is oncology testing for therapy selection. The coverage that's been put in place for that, the move from smaller panels to comprehensive genomic profiling that requires larger panels. Now people looking at clinical exomes, that's driving a huge amount of strength. And if you look at a number of our metrics, whether it's the consumables that are being pulled into that market or even the NovaSeq, we saw, for example, I think it was about 40% of our NovaSeqs that were shipped in Q1 went to oncology testing customers.

And so I'd start by saying that oncology testing for therapy selection is a juggernaut that drove a lot of our growth in the clinical markets last year. It's continuing to play out this year because a lot of the -- a lot of the underlying demand drivers are still strong. We also saw, though, strong demand in genetic disease testing, and that had another strong quarter in Q1.

And some of the similar dynamics are playing out there. The dramatic expansion in coverage over the last couple of years is really helping fuel that demand. In addition, that -- those applications are sequencing intensive applications. So you're talking about clinical genome, you're talking about trios where those are available. And so that is continuing to fuel some of the demand in the clinical markets that we are seeing. And that has a lot of headroom in front of it in both of those markets.

The clinical market actually is a one market is a market where I think we have a special strength, right? Because we have established over the last decade a number of things that customers really like. So for example, we have cleared boxes both the MiSeqDx, which got clearance in 2013, but also now we have the NextSeqDx that's available to customers, and we are marching down the path to deliver a NovaSeqDx. That puts us in a unique position at this point is that if you want to develop on a cleared box, we are a really great choice for you.

In addition, we have some end-to-end workflows that are really exciting to our customers. TSO 500 is a fantastic product. And we talked about the fact that if you look at Q1, TSO 500 had really, really strong growth, growing over 100% from the previous year Q1. And then we're also continuing to see demand for our VeriSeq NIPT end-to-end workflow. So again, that positions us especially well against anyone else who's looking for -- in terms of customers looking for cleared workflows that they can buy and use.

And then even customers that are running in LDT mode, they have spent a long time developing their own validated workflows on our instruments, even if they're using our non-DX instruments, but it's taken them a long time to build up their validated workflows and to bring those to scale. And so from their perspective, it's a better thing in terms of running their labs to just continue to expand the relationship with Illumina. And so those are some of the dynamics in that space.

[Operator]

Thank you. We'll take our next question from the line of Vijay Kumar. Please go ahead. Your line is now open.

[Vijay Kumar, Evercore]

Hi. Thanks for taking my question. Just one, Sam, on the guidance here for 2Q. I think at the midpoint, even backing out the 300 basis points impact from China lockdown, I think it's $1.25 billion that's below Street models. Maybe talk about any cadence issues. Is that a comp issue or street modeling issue? Talk about the 2Q guide? And then a related question on supply chain in Q1, earnings was -- came in, I think, 19% of our Street models. Any cadence issue of expenses, your incremental supply chain pressures that the guide is baking in given the strength of Q1 view? Thank you.

[Sam Samad, Chief Financial Officer]

Yeah. So with regards to Q2, Vijay, and thanks for the question. I mean, I think the main thing is, yes, there is a 300 basis point impact on growth from China. There is an additional impact on growth in Q2 year-over-year as well, which I don't think you're factoring in, which is that back in Q2 of 2021 we had a onetime benefit from an NIPT settlement. It was $20 million. So that's an impact on growth as well. Now that's a year-over-year impact, not a sequential impact, which I think was your other question in terms of sequentially, whether there's anything there. I wouldn't say there's anything specific other than the fact, sequentially, obviously, that China is a $35 million negative impact in Q2. We are very -- still very confident with the guide that we have with the second half momentum that we expect to see and again I would say if you look at Q2 there is also the U.K. Biobank noise which we will lap at the end of Q3.

With regards to your question around supply chain and any impact of that. I mean look supply chain is pressured I think for most companies its reflected in our guide in terms of operating margin. There isn’t anything incremental that we are expecting to see in the second half versus the first half. We are expecting now, if you look at our operating maring profile first half, second half, our operating margins are roughly about 14%. This is consolidated in the first half, roughly around 17% in the second half. Some of that is driven by the fact that our revenues scale up in the second half. But despite the supply chain pressures that I think we're managing really effectively to make sure that there's no disruption and really offsetting some of the additional costs, I'd say our -- we are still very confident about our operating margin guidance for the year and the sequential growth that we see in the second half.

[Operator]

Thank you. We'll take our next question from the line of Luke Sergott [ph]. Please go ahead. Your line is now open.

[Unidentified Analyst]

Hey, guys. Thanks for squeezing me in. Can you talk about the GRAIL adoption? I know you've talked about this a little bit. But outside of concierge and the executive health plans kind of the demand that you're seeing there from just the regular normal customer?

[Francis deSouza, President & Chief Executive Officer]

Yeah, sure. Outside of the things you talked about, we are seeing adoption from groups like employers. And it was really -- it's unexpected and it's exciting to see the range of industries where employers are signing up. The thesis that said you expect some of the early adopter industries like maybe tech, maybe financial services where they are -- they tend to be earlier adopters of benefit. So you expected to see some of those employers. But the range of industries represented was an upside surprise. So, for example, logistics and transport companies, media companies, it's a broader list than you would expect, and that continued in Q1 as well.

They're also signing up beyond concierge systems. They're signing up health systems that like Point32Health that we pointed out, life insurance companies like Munich Re. And then there's certainly a retail element to what they're getting to and off their website through their partnership with Genomic Health. And that continues to grow as well. And that's also driving the -- their interest in wanting to continue to expand their profile in front of consumers. And so you should expect them to see more in terms of getting the GRAIL brand and the Galleri brand in front of consumers.

They're also expanding their reach directly to oncologists, and we talked about the fact that they're expanding their staff. A part of that was expanding their commercial staff, their sales staff that actually calls on doctors. And so that will continue to expand demand, both in terms of bringing new prescribing doctors into the fold, but also continuing to expand the number of tests that a prescribing doctor orders.

[Operator]

Thank you. We'll take our next question from the line of John Sourbeer. Please go ahead. Your line is now open.

[John Sourbeer, UBS]

Thanks for taking the questions. Just two parter here. On the GRAIL MRD assay. Any updates there on potential studies or milestones on the way as we look into the 2023 launch? And then on Chemistry X, details have been limited. But what has been the initial customer feedback there given the record NovaSeq backlog and potential for the new platforms in the horizon, just what a customer said within the initial feedback there? Thanks.

[Francis deSouza, President & Chief Executive Officer]

Sure. The GRAIL team continues to make progress in their MRD. We are excited about what that would bring to the market, using their sort of hypothesis-free tumor-naive approach into the market. We think that's a valuable assay for customers and allows them to get tested more quickly than an approach that requires a tissue sample, for example. So we think it will be a valuable add into the market. At this point, we don't have any additional updates other than the team is continuing to work on it and making progress. But as soon as we have some, we will make sure to share it.

The initial reaction from customers on Chemistry X has been very positive, just building excitement around what it could do. Obviously, at this point, it's not tied to a specific instrument and sort of curiosity around when and through what form factor, they'll get access to Chemistry X, but there's general enthusiasm around the promise of the new era of chemistry for SBS.

And they've all seen what SBS has done over the last 17 years. And so a huge amount of enthusiasm for the next leg of this journey. Sorry, that I will say though, having said all that, it hasn't really muted as you've seen the demand for our existing instrument, the NextSeq 1000, 2000, the NovaSeqs, we continue to see really strong demand for those instruments. And that's because our customers know we have a history of looking after our customers as we launch new products, right, by providing them very robust upgrade paths and looking at what they've ordered in the backlog and making sure they are happy about how we can move orders to new instruments, if that's what they choose.

And so we've established, I think, a good track record of carrying people through an upgrade process and whether it's trade in policies. And so that track record over the last decade, I think, is helping in terms of customers feeling confident about moving forward with instruments, knowing that to the extent that we launch an instrument that upgrades any part of our portfolio, we will have very robust upgrade programs for them.

[Operator]

Thank you. We'll take our next question from Jack Meehan. Please go ahead. Your line is now open.

[Jack Meehan, Nephron Research]

Thank you. Good afternoon. I had three questions on GRAIL. First, NCI recently had a blood-based [indiscernible] of multi-cancer testing, in that they talked about detecting cancer itself not being enough, the MCED test need to improve survival. So Francis, I was curious to get what your responses to that.

Second, just latest thoughts on time line for FDA approval of Galleri. And then finally, just your level of confidence that the study is underway, the enrollment is large enough to get FDA approved. Thank you.

[Francis deSouza, President & Chief Executive Officer]

Yes. So let's go through all three. I'll start by talking about the NCI commentary? And frankly, just the idea that, look, ultimately, you do want to see the impact on survival rates. And so, that's going to be important and that's something we're going to be tracking over the next few years. Obviously, it will take a long time to get that kind of data. But we will get it, of course.

Now, having said that, we do know that survival rates for cancer are very different depending on the stage you catch cancers. But even for a deadly cancer like a pancreatic cancer, survival rates are higher, if you catch the pancreatic cancer early versus catching a cancer late. And the disease burden of cancer is so high. 10 million people a year die of cancer, 600,000 in the US here alone. And because the fact that you have a higher survival rate, when you catch it early, we know that 71% of the people who die from cancer die from cancers that have no screens, because you can't catch those type of cancers early.

And so those are -- that the facts, the facts that we know that are fueling doctors to prescribe this test to their patients. And now they're up to 2,400 doctors that prescribe -- remember that this test was only launched in June. So we went from zero doctors a year ago to now 2,400 doctors that are confident and comfortable prescribing this test to their patients.

And so, I think that's going to continue to build. And while it's continuing to build, we'll continue to build the data set to ultimately track this to survival rates. And so you'll get that data eventually. But in the meantime, we believe a lot of lives will be saved on the way.

The team has continued to make progress in terms of engaging with the FDA. There is no new time lines to be announced. I don't think the size of the study is going to be the problem, and it'll just take time. I think they've powered the studies they need sufficiently, and the dialogue has been constructive with the FDA.

[Operator]

That concludes our Q&A session. I'll now hand the call back over to Sally Swartz.

[Salli Schwartz, Vice President, Investor Relations]

Great. Thank you for joining us today. As a reminder, a replay of this call will be available in the Investors section of our website. This concludes our call, and we look forward to our next update with you and in the close of our second fiscal quarter of 2022.

[Operator]

This concludes today's call. You may now disconnect.