Illumina, Inc.

We're about to begin. Good day, ladies and gentlemen, and welcome to the fourth quarter 2022 alumna 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 fourth quarter and year-end 2022. During the call today, we will review the financial results released after the close of the market and offer commentary on our commercial activities, after which we will host a question-and-answer session. If you have not had a chance to review the earnings released, it can be found in the investor relations section of our website at Illumina.com. Participating for Illumina today will be Francis D'Souza, President and Chief Executive Officer, and Joydeep Goswami, Chief Financial Officer and Chief Strategy and Corporate Development Officer. Francis will provide an update on the state of Illumina's business, and Joydeep will review our financial results, which include GRAIL. As a reminder, GRAIL must be held and operated separately and independently from Illumina pursuant to the interim measures ordered by the European Commission which prohibited our acquisition of GRAIL under the EU merger regulation. This call is being recorded and the audio portion will be archived in the investor 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 those 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 10Q and 10K. With that, I'll now turn the call over to Francis.

Thank you, Sally. Good afternoon, everyone. 2023 is off to an exciting start for Illumina and for Genomics, and I'm pleased to announce that we've started shipping the first NovaSeqX Plus systems to customers. Later in my remarks, I'll share how we're scaling our manufacturing and distribution infrastructure to ship 40 to 50 units in Q1 and over 300 units for the year. First, I'll cover our financial results for both the fourth quarter and full year 2022. Illumina delivered fourth quarter revenue of approximately $1.1 billion and full year 2022 revenue of approximately $4.6 billion. in line with the upper end of our revised guidance range. We placed more than 3,200 instruments in 2022, increasing our installed base to approximately 23,000 instruments worldwide. Delving now into each of our platforms, starting with high throughput. We've had a fantastic customer response to the NovaSeq X series launch. Both orders and the advanced pipeline continue to grow. There's strong global interest. with orders from more than 25 countries, four times more than in the first quarter of the NovaSeq 6000 launch. We're also seeing stronger-than-expected clinical adoption and orders from new to high-throughput customers who are bringing sequencing in-house due to NovaSeq X's ease of use and cost benefits. The NovaSeq X has had the strongest pre-order book of any Illumina instrument launch. and this demand will catalyze a multi-year upgrade cycle. We also shipped more than 340 NovaSeq 6000s in 2022, with more than one-third of those instruments for oncology testing, and nearly half to new to high throughput or new to Illumina customers. Placements were strong in the first half of 2022, even after a record 2021. Second-half placements were tempered by growing customer excitement, for the NovaSeq X series. Across 2022, average consumable pull through for the NovaSeq 6000 was approximately $1 million per instrument. Moving to mid throughput. In 2022, we shipped a record 1,215 instruments and saw the fourth consecutive record year for NextSeq shipments. The fourth quarter of 2022 was also the highest quarter on record for NexSeq 1K-2K shipments. Customers appreciate NexSeq 1K-2K's unique capabilities as the only mid-throughput sequencer with built-in analysis and the first mid-throughput instrument to include the 2x300 kits. Close to 25% of NexSeq 1K-2K units in 2022 were placed with new to Illumina customers. For low throughput, in 2022, we shipped approximately 1,670 instruments, bringing nearly 700 new customers to Illumina. Our low throughput instruments consistently open new geographies and applications, while serving as an effective entry point to sequencing. Shifting to our markets. Our clinical markets currently include testing for oncology, reproductive health, and genetic disease. In 2022, shipments to clinical customers represented 45% of core Illumina consumables. For 2022, oncology testing consumables grew 7% year over year from utilization of NGS-based molecular profiling across early detection, therapy selection, and minimal residual disease. We see expanding opportunities for our oncology products globally. For our TruSight Oncology 500 Distributed Therapy Selection Assay, sample volume grew approximately 60% year-over-year across more than 500 accounts. And for 2023, we expect more than $100 million in revenue for TSO500. Also in oncology, Grail continues to have strong demand from consumers, physicians, health systems, and payers. in a $40-plus billion market, and it had the fastest first-year revenue ramp in cancer screening test history. Grail has established over 60 partnerships with leading health systems, self-insured employers, and other healthcare stakeholders. In 2022 alone, more than 4,500 providers ordered the test, contributing to the more than 60,000 gallery test orders that have been received to date. The gallery test has received FDA breakthrough designation and was recognized by Time as one of the best inventions of 2022, by The Atlantic as one of the breakthroughs of the year, and by Fast Company as one of the world-changing ideas of 2022. The gallery was also featured in an AARP health story on game-changing medical breakthroughs improving lives today. Grail expects this exciting momentum to continue and to translate into an expected revenue CAGR of 60 to 90% over the next five years. Beyond oncology, genetic disease testing had a record quarter in Q4 and another strong year in 2022. For 2022, GDT consumable shipments grew 11% year over year, driven by broader adoption of whole genome sequencing globally and increased demand for rare disease treatment. We also saw additional evidence generation, with the European Society of Human Genetics updating its guidelines to recommend increased adoption of whole genome sequencing in diagnostics, as well as increased coverage for rare and undiagnosed genetic diseases. Recently, two of the largest health insurance companies in the U.S., based on the number of patients served, announced that whole genome sequencing will be covered for patients with rare and undiagnosed genetic diseases starting this quarter. And AIM Specialty Health, which provides lab benefits management services for more than a dozen regional health plans in the U.S., now considers comprehensive genomic profiling medically necessary for appropriate patients with advanced cancers. Tens of millions more Americans will be covered. a huge win for patients and our customers and for Illumina. Turning to our research and applied markets, consumable shipments represented 55% of core Illumina consumables in 2022. Boosting the diversity in genetic databases is a significant need for our customers as they work to understand the underlying cause of disease. Genomics, combined with clinical information, can increase drug discovery success by up to 150% and reduce costs by up to 50%. To achieve this, we need more samples over time and for more diverse populations. We recently announced an agreement with Amgen and its subsidiary DecoGenetics to sequence the first 35,000 genomes in our collaboration with Nashville Biosciences. This sample cohort will represent the largest data set of African Americans to date, as we aim to accelerate equitable access to precision health therapies, and they've already begun sequencing the first samples. Moving now to 2023, we're excited for this launch year and have now started shipping NovaSeqX Plus systems to our first customers. We're on track to ship 40 to 50 NovaSeq X instruments in Q1 and more than 300 instruments in 2023. To accomplish this, we've boosted our operational capabilities. We've built state-of-the-art consumable manufacturing facilities in the UK, Singapore, and San Diego, adding nine new production lines. At launch, we already have two to three months of inventory for each of the six core consumable SKUs. In our instrument manufacturing facility in Hayward, we are fully staffed in ramping up production and capacity. Right now, there are more than 60 NovaSeq X instruments in various stages of the production process. All primary and secondary sequencing metrics are meeting or exceeding specifications. In addition, we've taken steps to ensure our supply chain is strong. We began adding and onboarding new suppliers to the material and component supply fueling NovaSeq X production. We're also equipping our global commercial team to guide our customers as they receive the first NovaSeq X shipments. In January, we brought together more than 800 sales team members in a three-day training session, giving them new tools and insights to support customers as they accelerate genomics worldwide, with this powerful new instrument. The team is energized to bring these new capabilities to market and excited to see the outcome of years of preparation. We are confident that our organization's scale, reach, and experience will enable our customers to sequence more samples, run more analyses, and obtain more data than ever before. And NovaSeq X unlocks greater elasticity we expect average pull-through for the X to comfortably exceed NovaSeq 6000 over time. Illumina will remain focused on supporting our valued customers with transformative innovations and continue to advance our roadmap to accelerate the genome era. Customers' interest worldwide continues to be very strong, and they are eager to harness the capabilities of the X, the most powerful, most sustainable, and most cost-effective sequencer ever developed to further unlock the power of the genome. You'll hear more about the customer experience and data at AGBT this week. Now, before I turn the call over to Joydeep, I'd like to thank him and welcome him to the role as Illumina's Chief Financial Officer. With over two decades' experience in the industry, Joydeep brings strategic expertise, deep industry knowledge, and extensive global business experience to the role. He is a proven and disciplined leader with a strong track record of creating value and an ideal partner to help drive the next phase of Illumina's growth. I'll now turn the call over to Joy Deak for more detail on the quarter and our full year outlook.

Thanks, Francis, and thanks for the kind introduction. I'm excited to step into the role on a permanent basis and continue to work with all of you. I'll start by reviewing our consolidated financial results, followed by segment results for Core, Illumina, and GWAIL, and conclude with additional remarks on our current outlook for 2023. I will be discussing non-GAAP results, which include 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 supplementary data available on our website in the fourth quarter consolidated revenue was 1.08 billion down 10 year over year or down seven percent on a constant currency basis net of the effects of hedging non-gap earnings were 22 million or 14 cents per diluted share including dilution from grail's non-gap operating loss of 159 million dollars for the quarter Non-GAAP earnings per share were lower than expected due to approximately $87 million in incremental tax expense from the R&D capitalization requirements that were not repealed in Q4 2022, despite broad bipartisan support. The incremental tax expense includes approximately $80 million recorded in Q1 through Q3 that was ultimately not reversed in Q4. Our non-GAAP tax rate was 29.3% for the quarter and 26% for the full year 2022, which increased from 15.6% in Q4 2021 and 17.3% in fiscal year 2021, primarily due to the impact of R&D capitalization requirements. Our non-GAAP weighted average diluted share count for the quarter was approximately 158 million. Moving to segment results. I'll start by discussing the financial results of Core Illumina. Core Illumina revenue was $1.07 billion, down 11% year-over-year or down 8% on a constant currency basis, net of the effects of hedging. Core Illumina sequencing consumables revenue of $687 million was down 13% year-over-year. As expected, growth driven by pull-through on the increased installed base was offset by delayed recruitment for some large research projects in the Americas and Europe, the ongoing impact of COVID disruptions in China, the year-over-year impact of customer inventory management, the anticipated decrease in COVID surveillance revenue, and headwinds from foreign exchange rates. Sequencing Instruments revenue for Core Illumina declined 24% year-over-year to $146 million, driven primarily by the lower Novosig 6000 shipments in advance of the availability of NovaSeq X. The decline was partially offset by another quarter of record NexSeq 1K, 2K shipments, which grew 31% year over year, as we continue to see strong adoption by new to Illumina customers and demand for our new 2x300 kits that bring longer read capabilities to our mid-throughput platform for the first time. During the fourth quarter, COVID surveillance contributed approximately $20 million in total revenue, comprised of $19 million in sequencing consumables and $1 million in sequencing instruments. This was in line with our expectations and down $30 million year over year, driven primarily by lower sample volumes. Core Illumina sequencing service and other revenue of $131 million was up 24% year over year. driven primarily by higher instrument service contract revenue on a growing installed base, as well as an increase in oncology and IBD partnership revenue. Moving to regional results for Core Illumina. Revenue for the Americas was $577 million, down 7% year-over-year, and a mere revenue of $301 million represented a 14% decrease year-over-year or a 10% decrease on a constant currency basis. As expected, the base business in both regions was impacted by an anticipation for NovaSeq X and the slowdown in COVID surveillance and research I mentioned earlier. We continue to see strong demand for NextSeq 1K, 2K, with record shipments in the Americas up nearly 50% year over year, driven by strength across both research and clinical. In addition, NovaSeq DX shipments exceeded expectations in the first quarter of launch, with strong early demand by clinical customers in Europe. Greater China revenue of $94 million represented a 22% decrease year over year or a 14% decrease on a constant currency basis. The region continued to be impacted by COVID lockdowns that resulted in lower sample volumes year over year. We continue to expect our business in China to be impacted by headwinds from COVID-related disruptions, exchange rates, and slowing GDP growth in the region, at least through the first half of 2023. Finally, APGA revenue of $93 million declined 10% year-over-year, or 4% on a constant currency basis, net of the effects of hedges. Strong growth across clinical markets was more than offset by the conclusion of a large research project in Japan and delayed high-throughput instrument purchases due to the introduction of NovaSeq X. Moving to the rest of Core Illumina P&L. Core Illumina non-GAAP gross margin of 67.3% decreased 430 basis points year over year, primarily due to less fixed cost leverage on lower manufacturing volumes. Core Illumina non-GAAP operating expenses of $528 million were down $52 million year over year, primarily due to cost containment initiatives, lower performance-based compensation expense, and a one-time partnership-related expense in Q4 2021. Transitioning to the financial results for GRAIL. GRAIL revenue of $23 million for the quarter grew 130% year-over-year, driven primarily by accelerating adoption of Gallery, as well as higher contributions from MRD-Pharma partnerships due to a milestone payment in Q4 2022 that GRAIL does not expect to repeat in Q1 2023. GRAIL non-GAAP operating expenses totaled $166 million and increased $35 million year-over-year driven primarily by continued investments in clinical trials and to scale GRAIL's commercial organization. Moving to consolidated cash flow and balance sheet items. Cash flow provided by operations was $147 million. Fourth quarter 2022 capital expenditures were $88 million and free cash flow was $59 million. We did not repurchase any common stock in the quarter. We ended the quarter with approximately $2 billion in cash, cash equivalents, and short-term investments. Cash as of the close of the quarter included $991 million in net proceeds from the term notes issued on December 13, 2022, which will be used to repay upcoming debt maturities in 2023. Moving now to 2023 guidance. We expect full year consolidated revenue to grow 7 to 10% to approximately $4.9 to $5.03 billion. We expect full year 2023 core Illumina revenue to grow 6 to 9% to approximately $4.83 to $4.96 billion. These ranges include an anticipated headwind from COVID surveillance of approximately 200 basis points as well as a year-over-year headwind from foreign exchange rates. We expect quarterly revenue to ramp sequentially through 2023, with linearity trends similar to what we saw in 2017 when we launched the NovaSeek 6000. GRAIL is expected to deliver revenue in the range of $90 million to $110 million for 2023, reflecting year-over-year growth of 82% at the midpoint, driven by accelerating adoption of the gallery test. For fiscal 2023, at the midpoint of our revenue guidance range, we expect Core Illumina sequencing revenue to grow approximately 8% year-over-year. This includes intercompany sales to GRAIL of approximately $35 million, which are eliminated in consolidation. We expect Core Illumina sequencing instrument growth of approximately 9% year-over-year, driven by the NovoSeqX upgrade cycle and continued momentum in mid-throughput. We expect core Illumina sequencing consumables growth of approximately 8% year-over-year, primarily driven by the NovaSeq X launch, as customers build consumables inventory and ramp utilization, as well as continued growth in our mid-throughput consumables due to the growing install base. This growth will be partially offset by further reduced COVID surveillance revenues. We expect annual pull through for NovaSeq 6000 approximately $900,000 to a million dollars per system in 2023 as customers transition to NovaSeq X. We expect pull through for next week 1K, 2K in the range of $120,000 to $170,000 per system in 2023 as the record instrument placements in 22 and continued strong placements in 2023 are brought fully online. We expect the remainder of our pull-through ranges to be in line with historical guidance. We also expect revenue from COVID surveillance of approximately $30 million in 2023, which reflects a year-over-year headwind of $105 million, or approximately two percentage points. We expect consolidated non-GAAP operating margin of approximately 8% and core Illumina non-GAAP operating margin of approximately 22% for 2023. These margins reflect, one, an increase in core Illumina operating expenses from 2022, primarily driven by normalization of our performance-based compensation. Two, a temporary decrease in gross margins as we launch the Novosig X, consistent with what we saw in 2017 when we launched Novosig 6000. And three, an increase in GRAIL operating expenses due to the ongoing investments to support the FDA application NHS trial, and to continue to scale GRAIL's commercial organization. We also expect a consolidated non-GAAP tax rate of approximately 36%, which includes an approximately $75 million impact from the R&D capitalization requirements. If these requirements are repealed in 2023, we expect our 2023 non-GAAP tax rate to be approximately 15%. We expect consolidated non-GAAP earnings per diluted share in the range of $1.25 to $1.50, which includes dilution from GRAIL's non-GAAP operating loss of approximately $670 million. And finally, we expect non-GAAP diluted shares outstanding for fiscal 2023 to be approximately 160 million shares. For the first quarter of 2023, We expect consolidated revenue in the range of $1.05 billion to $1.07 billion for Q1 2023, reflecting a sequential decrease of 212 basis points from Q4 2022 at the midpoint, primarily driven by historical seasonality of our core business due to year-end budget flushes not repeating in the first quarter, partially offset by an increase in high-throughput instrument shipments due to the launch of NovaSeqX in Q1. and a decrease in GRAIL revenue of approximately $5 million due to a milestone payment in Q4 2022. We expect quarterly revenue to grow sequentially through 2023, driven by a ramp in Novosig X shipments and utilization, recovery from COVID disruptions in China, accelerating adoption of Gallery, and an expected mitigation of macroeconomic headwinds in the second half of 2023. For the first quarter, we expect consolidated non-GAAP operating margin of approximately 1% and core aluminum non-GAAP operating margin of approximately 17%. We expect operating margins to improve throughout 2023 as revenue ramps and we scale our production of NovaSeq X and leverage the fixed cost of the manufacturing base. We expect net other expense of approximately $9 million, primarily due to the interest expense on our new bond issuances. Lastly, we expect non-GAAP diluted shares outstanding of approximately 160 million shares in line with fiscal 2023. I'll now hand the call back over to Francis for his final remarks.

Thanks, Jaydeep. Illumina continues to prioritize innovation. We know our customers invest in our roadmap, not just our instruments. I talked about the NovaSeq X series earlier. The X is a powerful catalyst for 2023 and beyond. We also prioritize sustainability. NovaSeq X features a 90% reduction in packaging waste and weight and a 50% reduction in plastic usage compared to the NovaSeq 6000. The enablement of ambient temperature shipping of reagents will result in nearly 500 tons of dry ice savings per year while significantly reducing waste streams for our customers. These improvements are game changers for our industry. We're also excited to bring long read capabilities to market through two upcoming products in our Illumina Complete long reads offering. Our long read human whole genome assay will be available in the first half of this year while the enrichment panel will be available in the second half of this year. We recently announced that our enrichment panel will enable a comprehensive, high-accuracy long-read view for as low as $600 per genome. More than a dozen customers have evaluated data from their own samples using Illumina Complete Long Reads, and their feedback has been strongly positive. They find Illumina Complete Long Reads more convenient than other long-read technologies and more straightforward with flexible input requirements. They're impressed with the data accuracy, along with the read lengths and phase blocks that can be generated on Illumina sequencers. Illumina complete long reads, and NovaSeqX will continue to evolve the genomics industry. This year, we will celebrate Illumina's 25th anniversary. Over this quarter century, Illumina has remained at the forefront of a global genomics movement, and we're even more optimistic about the road ahead. We're honored to be driving a global health transformation with our customers, and together we will seize the potential of the genome era. I'll now invite the operator to open up the line for Q&A. Thank you.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. If you're using a speaker phone, please pick up your handset and make sure your mute function is turned off so that your signal reaches our equipment. As a reminder, please limit yourself to one question so that we can accommodate as many analysts as possible. You are welcome to re-enter the queue if you have any additional questions. And we'll go ahead and take our first question from Puneet Sawada with SCB Securities. Please go ahead.

Yeah, hi, Frances. Joydeep, thanks for taking the questions, and congrats on the permanent role, Joydeep. So my first question is, you know, at AGBT, we saw that you had 150 orders as of this morning, and that's 10 more than what you had at, you know, the start of this year. So just wanted to clarify sort of the number, you know, increase was only 10 versus what are the advanced pipeline prospects? Maybe if you can provide that number specifically, You know, again, I appreciate that you're providing the full year 300 plus number, but last time advanced pipeline prospects, I believe, were 200 plus. So if you could clarify how much that increased by, because the number increase here within a month was somewhat lower than what we had expected. And then I just wanted to clarify, Francis, on You know, what are you hearing from customers in those advanced pipeline prospects? What are they looking for at this point? What are they waiting for in order to convert their, you know, interest into orders? Are they looking for validation for customers' data or anything else? That would be super helpful. Thank you.

Sure. Thanks, Puneet. So let me start with the numbers, as you asked. So, you know, as we said, the customer demand for the X-Series has been very strong, exceeding our expectations. And you know that we recently shared, as you pointed out, that we had 340 instruments spoken for between 140 in pre-orders and 200 in advanced pipeline. Now, this momentum continued over the last few weeks in January, and we're currently at over 155 instruments in pre-orders, and over 250 in advanced pipeline. So you've seen the progression as we work through January. Now going forward, we plan to update you quarterly as usual, both on how we're doing with orders, but now as we've started shipping, obviously we'll update you on shipments as well. You know, what we're hearing from customers as we go through the pipeline is that they're incredibly excited about some of the things we expected them to be excited about. So they're excited about the power of the X series in terms of being able to run many more samples concurrently than they could before. They're very excited about the economics associated with running the X. And they're equally excited about the sustainability features that we put into the X. So the reduction in plastic and waste but also the elimination of the need for dry ice as part of the shipping. All of these combined with the ease of use that they're seeing. So, you know, when we described the specs to them at IGF, you know, they got a sense of the power and the performance and the faster turnaround time. But one of the things that people have been, I think, pleasantly surprised about as they get to interact with DX is the investments we've made around ease of use of the workflow. So this is even a significant step forward than the state of the art with the 6,000 before. And what that opens up is the ability for the sequencers to be used by a technical team that is not as, you know, doesn't necessarily require a degree in genomics, for example. And so that opens up workforce capabilities for them. Now, what we're hearing from research customers is increasingly they're starting to see the X as a must-have. In terms of being able to remain competitive for grants and grant dollars. And so we're starting to see people cost that into thinking about how they will apply for brands on the clinical side. What we're hearing is that because of the superior workflow performance and cost associated with the X clinical customers. are designing their new assays and their new tests on the X with the anticipation that that's how they'll roll out new testing. At the same time, they're starting to want to get familiar with the workflow so that they can plan a transition over on their existing test, but that'll take longer. So the first demand from clinical customers is about new testing that they want to do on the X. So that's some of the feedback we're getting from our customers.

Yeah, and maybe, Puneet, thank you, first of all, for your kind words there. I think the other question you asked is, you know, what are customers waiting to convert from the funnel to the orders, right? And this is, remember, this is late stage funnel, so we have confirmed interest. They like what they see, as Francis mentioned, and they have line of sight to budget, right? So, usually it's the, when are they going to get the budget? Maybe it's, you know, finishing up or confirming some of the grants. which then tips them over into orders. And we fully expect that, as we have seen in other years, to happen as we go through the year.

And we'll go ahead and move on to our next question from Dan Brennan with Callen. Please go ahead.

Great. Thanks. Thanks for digging the questions. Joydeep, congrats. Maybe first on the guidance, I believe at J.P. Morgan, you guys talked about the 23 Guide reflected a conservative approach I'm just wondering, just given, you know, the history in the back half of 22, have you learned anything? Has the process changed in terms of how you're guiding? Could you just walk through a little bit about the conservatism or, you know, however you want to quantify it that's within the 23 guide? I know, Francis, you know, you guys quantified a fair number of kind of headwinds. Just wondering how much maybe you baked in cumulatively for those headwinds or however you would kind of discuss the process and the conservatism. And then just be just on grail. Would love an update. Assuming that the EC directive comes back here during Q1, I know you guys are going to apply for a stay, but if you can kind of walk us through the process as you see it. If you don't get a stay, then kind of what happens? And related to that, the GRAIL balance, just wondering, ultimately, if GRAIL has to be divested, how do we think about the capital that aluminum may have to commit to that? Thank you.

Yeah, Dan, first of all, thank you. So, I, you know, in terms of 23 guidance, we have, as we mentioned earlier, right, pulled in a few things that were visible, of course, is one, the transition to Novosig X. We have mentioned that this is, you know, demand is going to outstrip supply. And we're also told you about linearity that we do expect the second half to be you know, for revenue to step up in each quarter as the NovaSeq X gets out to market and people start, you know, bringing up the instrument and ordering NovaSeq X consumables. We also expect that, you know, we've placed a large number of mid throughput instruments late in 2022 and continue to expect to place additional NextSeq 1K, 2K instruments in, throughout 23. So as those come, um come online right then you you would expect a an increase in the in the consumables uh ramp up as we get through the year um also in uh 2023 we have uh talked a little bit about the uh the recovery in china in the second half of the year so we we had seen china going into the end of 22 and then you know even the first quarter of 2023 with some covid uh hangover and rollover from last year so Right now, we believe that, you know, those should abate and, you know, we also have a lower impact of effects from from from 1st half from obviously from 1st half in the 2nd half of the year. So, for all those reasons, we do expect, even after taking into account some of the, you know, the slowdown and in recruitment that we have seen in large projects that we will see linearity and revenue step up throughout. 2023 and I'll hand it over to to Francis for the 2nd, part of the question.

Sure. So, Dan, in terms of the grail process, we are expecting the divestiture order to come out at the end of Q1. so, maybe beginning of Q2 and we are going to apply if there isn't to stay associated with it pending the appeals and we're going to ask for one and then we're going to pursue the dual track and we'll be pragmatic as we go down both paths on the 1 hand. We're going to have a divestiture track where we work with the European Commission, GRAIL, and go down the path on the divestiture process. And we expect that to play out over the course of this year going into next year. And in parallel, we have our appeals and we have two appeals underway. One is around the jurisdiction. And we expect a decision probably towards the end of this year. And another one is on the prohibition order. And we expect a decision maybe towards the end of this year, maybe sometime into next year. And so those are the two paths. In terms of the capitalization, part of the divestiture track is going to be around making sure that GRAIL is capitalized going forward. And that could be through a combination of strategic partners that invest in GRAIL that could be you know, a path. It could be a multi-step path that includes initially investment into Grail from strategic partners heading towards an IPO. But all of that, you know, is dependent on what comes out in the divestiture order. And that's something we're still in conversations with. So we'll keep you updated as that makes progress.

Our next question that comes from Dan Arias with Staple. Please go ahead.

Good afternoon, guys. Thanks for the questions. I wanted to touch on Grail too, if I may. Joy deep on the dilution for 2023, the 670 million. I'm just curious how much flexibility you have to work with in that number and the investment associated with that number. Just with the point being that obviously the forecaster gallery is tough to call at this stage in the game. So, you know, to the extent that the revenue picture were to start to look different down the road, I'm wondering just, you know, how much of what you might have to spend there might be variable in one way or another. And then, Francis, on the GRAIL NHS project and part one of that study, the 140,000 asymptomatic population assessment, the documents from the NHS, if I remember correctly, stated that the initial results were expected to be available in late 2023. Is that still the timeline we should be thinking about? I mean, I'm just, I'm thinking about your comment on potential IPO and just outcomes there and what might be important to that process. Thanks.

All right. Hey, Dan, thanks for the question. So, you know, in terms of the GRAIL dilution of about $670 million this year, right, a couple of points there. So, you know, a lot of that is going towards, you know, continuing to accelerate some of the clinical trials in advance of completion of the NHS trials, the submission to the FDA. for their gallery product. And, of course, to ramp up the sales and marketing that is required as the product, you know, continues its successful commercial launch, right? They've had a really successful commercial launch. The way we have projected revenues into next year and, you know, based on, is really based on the run rate that we have seen with gallery as they have exited 2022 and, you know, some of what they had in the funnel into 2023 and certain assumptions of repeat testing around that. So given that, I will point out, and again, I will say that Grail is held separate. So Illumina and Francis and I don't really control how they spend their money and how they operate the company. But I will point out that in 2022, they have been very good with how they've managed to to adjust operating expenses as the revenues have, you know, have been different from what some of their original expectations were. So, we have faith in Grail's management that they are, you know, they're good managers, they're good with how they allocate their money and to the right places that, you know, really prioritize the clinical trials and the commercialization of the product.

And then, Dan, I'll respond about the NHS contract. As you pointed out, the GRAIL team has a contract with the NHS that covers the 140,000 person clinical trial that is underway, but also covers the next phase pending performance of the trial. And so they've already got an agreement with the NHS that if the trial meets its performance criteria, that the NHS will roll this test out to a million participants in the UK over 2024 and 2025, and that will be paid for by the NHS. The timeframe for that readout is, you know, the end of this year, maybe the beginning of next year. So it's still the timeframe that was contemplated in the contract.

And we'll move on to our next question with Vijay Kumar with Evercore ISI. Please go ahead.

Hey, guys. Thanks for taking my question. And I had a three-part question here. Francis, one on revenues. You look at Q1, I think the implied guidance, you know, teens declined. So I think the back half implied is north of 20% year-on-year revenue growth. to hit the high single to low doubles for the annual. What gives you that back half ramp here when I look at this on a year-on-year basis? I know you mentioned the historical launch here as a comp. Can you just walk us through on the visibility you have on those numbers? One on margins here for you. Why did gross margin declines sequentially Q and Q when I look at Q4 versus Q3? And if you start in Q1 at 17% off margins for core alumina, is the implied exit rate for core alumina in the high 20s when we look at Q4, high 20s?

Listen, let me start and I'll give you some piece in terms of back half ramp on revenues, right? You know, let me start with the first half, the first quarter and first half, right? We had very strong quarters in 2021 for the first half. We had record shipments of NovaSeq, 6,000, if you remember, at the beginning of the year, you know, still ramping COVID surveillance revenues. So this year, because in Q1, we are, you know, we've said we're going to ship about 40 to 50 which is far short of, you know, what our demand is for that, you would expect that the first half of the year growth rates are constrained as, you know, we ramp up Novosig X and we ramp up consumables purchases related to that. In the second half of the year, the story kind of flips a little bit, right? So, you have much more kind of, you know, approaching full throttle of Novosig X shipments. You have the, you know, the incremental benefit of people bringing on NovaSeqx consumables. You also have some of the effects which were headwinds this year in terms of, you know, China COVID, in terms of overall COVID surveillance going down in the back half of the year. So you're right, the percentage growth rates in the latter part of the year and the actual revenue both start to step up in the second part of the year. So hopefully that part is clear. In terms of margins, so let me talk about gross margin first. Gross margin declines quarter over quarter, and of course, you know, this being a launch year, primarily due to the impact of, especially if you look at quarter on quarter, is really due to the impact of launching NovaSeq X in Q1, which, as we had told you, would start off this year with a lower margin. We expect that margin to continue to improve. as we go into, you know, the latter part of 2023 as we have much more, you know, utilization of the factories and, of course, we start squeezing out efficiencies in the process as is normal. And, you know, I think the same thing with operating margin. I think your question there was, you know, you start off with a fairly low operating margin for us. So as both gross margin and the revenue profile improves, operating margin should improve as we go into the second half of the year. And that's mostly just math in terms of much better revenue profile to cover operating expense, which remains relatively flat as we go through the year. So hopefully that helps you understand a little bit of how we've talked through the year.

And our next question comes from Taha Savant. with Morgan Stanley. Please go ahead.

Hey, guys. Good evening and thanks for the time here. So a two-parter here. First on GRAIL, Francis, just going back to Dan's question there, can you talk a little bit about how much of that $70 million in OPEX this year is specifically related to that NHS clinical trial that presumably drops out starting in 24. And is there the possibility of a delay or a period of evaluation as the results come in from that before that 1 million paid pilot launches? And then second, on Novaseq X pull-through assumptions, if I look back to the 6,000 launch, you guys were approaching almost a million in pull-through about six quarters into the launch. So is there any reason why you couldn't sort of easily exceed that, say, six quarters into the X launch here, the back half of 24, should that number be sort of 1.3, 1.4 plus? Is that fair?

So thanks for the question, Tej. Just let me take Tim and then Joydeep will chime in if he has anything to add. Let me start with the Grail question and, you know, around how much of that 670Million is associated with the NHS trial and is there a chance that the readout is delayed or the next phase is delayed? So, a portion of it is, we haven't actually broken out, you know, that 670Million. A portion of it is, but it's not the majority. So, there are a number of things going on at Grail in addition to the NHS trial. There is also, you know, the studies they're doing for the FDA submission, and, you know, they're looking to have the final submission done towards the end of next year. And so they're sort of in the thick of things with the FDA. However, there is a part associated with that NHS trial, and as you point out, that moves from being a pure cost to Braille right now for this 140,000-person trial to next year being a paid rollout, starting next year over two years to a million people, so a pretty significant shift in economics positively for GRAIL next year. In terms of the timeframe, you know, the NHS did a very thorough sort of diligent job with GRAIL in terms of planning out this trial. And because GRAIL has done so many studies of such significant size before, they really had a good handle on how to analyze the data coming in and sort of what you would need to get to get to the decision that they're looking for. we don't expect and we haven't seen at this point any delays associated with the analysis that's happening of the data. And so we fully expect, you know, them to be, you know, getting to that readout at the end of this year, beginning of next year. And then similarly, you know, because of the power of this test and the NHS being so keen to really use this test as a core component in their war on cancer, you know, their intent is to get through the readout as responsibly and quickly as possible. And once they demonstrate and meet the performance criteria, to get to that rollout as quickly as possible. And so there's a huge motivation on the side of the NHS, again, because of the potential lifesaving benefits of this test. And obviously, there's motivation on the GRAIL side too. And so I don't expect there to be any delays that pop up between, you know, the readout and them rolling out the test. In terms of the 6,000 pull-through then, you know, what we have said, and you've seen this before, is really we expect sometime likely between the first and second year for us to get to, you know, a stable point in terms of pull-through. And you pointed that out, that we got there, you know, on the 6,000 in that kind of timeframe. And so, one, we do expect that to be the timeframe, and we'll keep you updated as we work through the process. And as you know, but for everyone else, before that, you know, the numbers are still too volatile. for it to be a useful modeling metric. Because if you put out a whole bunch of new instruments and people start to ramp up, the pull through can move pretty significantly, you know, from one week to the next, one quarter to the next. And so it takes that year for you to get enough instruments out there for the number to be, you know, to be significant. Now, also as you pointed out, as we get to a stable number for the X, we feel, you know, we feel really confident that the, ultimate pull-through number on the X will be comfortably above what we had with the 6000s because of the power of the X and the quick turnaround time and the ability to run just so much more on an X over a year.

And we'll go ahead and move on to our next question with Sungji Nam with Scotiabank. Please go ahead.

Hi, thanks for taking the question. Another one on GRAIL, would love to get your thoughts, Frances, in terms of you talked about the FDA breaks the designation for the gallery test. Kind of, I know it's, but it's still kind of an uncharted territory going through the FDA process and also maybe, you know, gaining broader reimbursement from Medicare. So, could you kind of talk about kind of what efforts are being made in order to move, you know, move forward with those in that direction?

Yeah, sure. So, let me talk about a few things. 1, as you pointed out, you know, grail has been able to get breakthrough designation from the FDA, and they have been working now with the FDA for a number of years on designing the studies. That'll be part of the ultimate submission. And so they've been working collaboratively with the FDA and although they've been working with them, they've already submitted some of the modules associated with the FDA submission. and they are planning to do the final module submission at the end of next year, maybe extending into the beginning of the year after. So they're making good progress. The other big step with the FDA, which really breaks new ground is that they've been talking to the FDA about submitting data from the NHS trial as part of the FDA submission. Now that's really powerful because that's a very large trial. And so that continues to add to the bolus of evidence that GRAIL is able to get and submit into the FDA. And so I think we're starting to see the benefits of that good working relationship between GRAIL and the FDA. And as you know, when you have the FDA approval, that's a pretty significant step forward in terms of getting broad reimbursement in the United States, which is a really, really big value creation point from a GRAIL perspective. So you'll see both things play out in the next couple of years. You'll see the big Now, NHS move from going from a trial to a roll out a population roll out, starting with the 1M people and then going population wide after the 1M people roll out in the 1st, 2 years. And at the same time, you'll see the progress in the US with the final FDA submission at the end of next year. And then, you know, the, the path towards broad reimbursement in the US.

We'll go ahead and hear from David Westenberg with Piper Sandler. Please go ahead.

Hi. Thank you for taking the question, and congrats again to Joy Deeb. So to all the staff up front, many of the lab companies that we cover are talking about reduced cash burn, and they're really excited about NovaSeqX, and even some of them are kind of excited about going from NovaSeq from NextSeq. So can you help us reconcile their desire to reduce cash burn and your expectation of increased spend with you. And then just my second one is just continuing on some of the price stuff. Why should we not be concerned about the new $99 Complete Genomics thing today? Okay, thank you.

Thank you for the question, Dave. So, let me go through them in order. We're hearing just like you're hearing from lab companies that are really excited about the again, it's the power, the performance, the turnaround time, but also the economics associated with the X. And I talked about the fact that increasingly people are going to see those economics as table stakes for applying for and winning new grants. But for lab companies too, especially in this environment, as they are looking to squeeze the most out of their operations, they see the X as a path to get there. And the superior economics, you know, will help them as they lower cash burn and reduce their capital needs going forward. And so we fully expect that to be part of the conversation, you know, with our customers. Similarly, you know, we're seeing that on the next week side, right? So we're seeing customers that are seeing more demand come in. And the question for them is do they buy the next, next week or do they fundamentally transform their cost structure and move to the X and that's part of the reason why we're seeing a higher than expected demand from two segments one from the clinical segment and we talked about you know the the pre-orders coming in represent a higher percentage of clinical customers than we expected and two from new to Illumina and new to high throughput customers and so that dynamic is already showing up in the pre-order number In terms of the competitive dynamics, one of the things that we're really excited about is that when we talk to customers, they get very quickly that when they're comparing what system to buy, they need to look at the total cost of ownership in terms of running these sequencers. One of the unique things about the Illumina portfolio around the started with the NexSeq 1K, 2K, but now with the NovaSeq X, is that we have built in capabilities like the compute associated with the primary, secondary, and in some cases, even parts of the tertiary pipelines that are baked into and built into the instrument, that we've built into the instrument capabilities like lossless data compression. when they start to compare prices, it's not just the cost of sequencing that they need to look at, but it's also the associated compute cost, the storage cost that they would need if they had any other sequencer in the market. And one of the things that I talked about when we talk about the X is that just the compute savings you get associated with the NovaSeq X will save you over a million dollars over a four or five year period. And so that's really exciting for them. know forget about the real estate requirements you know forget about the time it would take to post process your your your data all of those you know are important but they also see that the total cost of ownership of the x is so much superior because of those built-in capabilities yeah i think france is just a dovetail on that right you know david you'd asked about yes there are you know cash constraints with uh people trying to reduce cash burn

But it's important to understand that, A, sequencing is at the very heart of the value that these companies are generating and even academic institutions are generating, right? So they want to do more sequencing because sequencing gives them answers that other technologies are not giving them and at scale. I think the second point that Francis mentioned is really important, right? That when they look at their cash flow and something like the X or an XE, 1K, 2K actually allows them to reduce their expenditure elsewhere, like things that are on storage or compute or other things, right? And, you know, allows them to redirect their investments more positively into areas that add value. And that's a really important point as you think through. And then the third thing is just, you know, what they're doing and elasticity, demand elasticity or new applications that Francis and Susan and others have pointed out earlier. which is moving to things that they have not done with the NoviSeq 6000s or any other instruments before, which really then pulls through the elasticity that we are expecting to see starting in 2023, but really, you know, picking up in 2024 and beyond as the Xs become fully entrenched.

And with that, that is all the time we have for our question and answer session. I would now like to turn the call back over to Sally Schwartz for any additional or closing remarks.

Well, thank you for joining us today. As a reminder, a replay of this call will be available in the investor section of our website. This concludes our call, and we look forward to seeing you at upcoming conferences and other events. And this concludes today's call. You may disconnect.