Illumina, Inc.

Ladies and gentlemen, and welcome to the second quarter 2023 Illumina 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 second quarter of 2023. During the call today, we will review the financial results released after the close of the market and offer commentary on our commercial activity, after which we will host a question and answer session. If you 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 Charles Dadswell, Interim Chief Executive Officer and General Counsel, and Joydeep Goswami, Chief Financial Officer and Chief Strategy and Corporate Development Officer. Chuck 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 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 10Q and 10K. With that, I will now turn the call over to Chuck.

Thank you, Sally. Good afternoon, everyone, and thank you for joining today's call. As you know, I assumed the role of Illumina's interim CEO two months ago. Our search for a CEO is underway, and we look forward to updating you soon. Our board is pleased with the outstanding candidates they're seeing. Before going to our second quarter results, I wanted to take a moment to acknowledge and thank our former CEO, Francis D'Souza, and our former chairman of the board, John Thompson, for their thoughtfulness and commitment while at Illumina. I would also like to welcome our new board members, Stephen McMillan, our new chairman of the board, as well as Andrew Tenno and Scott Ullum. I also want to acknowledge changes in our executive leadership team, including the departures of our chief technology officer, Alex Aravenas, and our chief medical officer, Phil Febo. I speak for the whole company in wishing both of them every success for the future. We're also pleased to announce that Steve Bernard, a 25-year Illumina employee and distinguished scientist in our field, will drive Illumina's legacy of innovation forward as our next Chief Technology Officer. We'll be conducting a search for our next Chief Medical Officer. Turning to second quarter results, in Q2, Illumina delivered revenue of approximately $1.18 billion and diluted non-gap EPS of 32 cents. both ahead of guidance we provided in Q1. We shipped 109 NovaSeq X instruments in the quarter and have increased our expectations for our full year supply capacity to more than 390 instruments. However, as you saw from our earnings release, we are reducing our guidance and now expect Core Illumina full year 2023 revenue to be approximately flat with 2022, primarily as a result of three factors. First, a larger than expected temporary decline in high throughput consumables as we transition more than expected customers to the NovaSeq X. Second, many of our customers are remaining more cautious in their purchasing behaviors. And finally, in China, there's a more protracted economic recovery and an increasingly challenged competitive landscape, in contrast to the Americas and Europe, where we're still expecting year-over-year growth in 2023. Joy Deep will provide additional details on our revised guidance during his remarks. One area I'd like to touch on further is the rollout of NovaSeqX. This has been a more challenging process than we anticipated. NovaSeqX is the most sophisticated platform we have ever launched and includes the most comprehensive end-to-end software we have ever released. Also, the rollout of the X has occurred at an unprecedented magnitude and pace, and we have identified issues in the field that are typical in new product releases. To address these issues, we have taken actions, including a planned software update that was released in June after our first customer shipment in March. We have deployed Illumina technical teams worldwide to work with our customers to accelerate bringing their systems online. While the rollout of NovaSeq X will take longer than we originally expected, the continued strong interest and commitment of capital to purchase NovaSeq Xs remains encouraging. To date, 20% of customers who have purchased a NovaSeq X have ordered more than one instrument. This early demand for multiple instruments and the capacity they represent underscores our confidence that customers are planning to increase their sequencing activity. Customers have clear intentions to do more sequencing in the future. Our customers have commented that larger-scale single-cell and spatial analysis experiments have become more practical with Novaseq-X, and they are requesting funding for these applications. Customers engaged in large population genomics initiatives have stated they plan to run additional multi-omic programs for population-specific variants, which can be used to develop treatments for various demographics that will be more effective in those populations. And, as some of you have heard, several of our largest customers are using the X to accelerate the move from targeted panels and exomes to whole genome sequencing. We expect these types of projects to scale and ramp in the near future, and we'll be closely engaged with our customers to support their needs. We continue to consciously and actively reduce our expense base and have accelerated actions with $100 million-plus annual run rate expense reduction program we announced at our last earnings call. As you saw in our late June 8K filing, we have reduced our global headcount and are downsizing our global real estate footprint. We're also optimizing our third-party vendor spend and have reduced travel-related and other costs. For 2023, these steps are helping mitigate the impact of lower full-year revenue on our operating margin. Looking forward, these actions will continue to support our margins and create flexibility for further investment in high-growth areas. Let me give you an update on a couple of our platforms. We saw continued global interest in the NovaSeq X series in Q2, and we exited the quarter with more than 260 orders since launch. Our shipments of 109 NovaSeq X instruments in Q2 were above our expectation of 80 for the quarter and brought our total install base to 176 instruments. We now expect to be able to ship more than 390 NovaSeq X instruments this year, up from the 330 we had previously expected for the year. In mid-throughput, we shipped approximately 160 NexSeq 1K-2K units in the second quarter. an increase of 8% year-over-year as customers expanded their current fleets or migrated from the MySeq or NextSeq 550. More than 20% of NextSeq 1K, 2K units in Q2 were placed with new to Illumina customers. We continue to experience lengthened sales cycles, in some cases as customers take time to raise funding or prioritize their investment dollars, and in other cases as they run longer procurement processes. Our win rate across the mid-throughput segment outside of China increased from the first quarter. We believe there is a long runway of differentiation for the 1K2K, notably with XLEAP SBS chemistry coming available on these instruments next year. Moving to our markets. In Q2, clinical represented approximately 53% of our total sequencing consumables revenue. In oncology, progress continued for next-generation sequencing-based testing reimbursement. Anthem, the second largest commercial payer in the U.S., and Blue Cross Blue Shield of Michigan both added coverage for comprehensive genomic profiling for patients with advanced cancers, adding more than 30 million additional covered lives. We also saw coverage continue to progress in Europe, with Switzerland now reimbursing large next-generation sequencing panels, including comprehensive genomic profiling. Illumina's market-leading TruSight oncology assay TSO 500, remains on track to exceed more than $100 million in 2023 revenue. Growth continues to be driven by greater utilization and broader adoption of our assay. In Q2, we also completed our TSO comprehensive submission for IVD registration in the United States. Also in oncology, Grail continues to achieve solid progress in the adoption of its Gallery Multicancer Early Detection Test. In Q2, GRAIL achieved its 100,000th commercial gallery test milestone, and the test has now been prescribed by more than 7,500 providers in the U.S. and ordered in more than 80 health systems. As an update, on the NHS gallery study, in Q2, GRAIL completed second-year follow-up visits in which 130,000 participants returned, giving the trial a retention rate of 91.3%. Invitations for the third and final year visits have begun, And the first appointments for those visits are expected this fall. Evidence for gallery continues to grow. At the most recent annual meeting held by the American Society of Clinical Oncology, Grail announced results from the University of Oxford-sponsored SIMPLIFY study. Reporting high specificity, positive predictive value, and accuracy of the cancer signal detected and the cancer signal of origin prediction, as well as demonstrating the feasibility of using an MSED test to assist clinicians with decisions regarding referrals from primary care physicians. GRAIL is also making progress on its unique multi-cancer minimal residual disease test. At the American Association for Cancer Research annual meeting, GRAIL and AstraZeneca presented new data that supports the use of GRAIL's methylation platform to identify residual cancer in post-treatment settings. Grail's technology had a cancer detection rate of 92% in patients with relapsed or refractory disease across six hematological malignancies. These findings demonstrate that Grail's blood-based methylation approach offers additional options to clinicians as they evaluate patients in efforts to achieve remission and improve survival. Returning to cor alumina, in reproductive health in the U.S., five state Medicaid programs in Louisiana, Michigan, North Carolina, Rhode Island, and Tennessee updated their policies and are now covering non-invasive prenatal testing for all pregnancies. In Europe, NIPT is now available for all pregnancies in the Netherlands and has been approved for broader coverage in Italy. Turning to our research and applied markets, as we announced in mid-July, the Alliance for Genomic Discovery launched by Illumina and National Biosciences in 2022 now includes five founding members, AbbVie, Amgen, AstraZeneca, Bayer, and Merck. It now represents a novel industry-led collaboration to accelerate the development of therapeutics through the large-scale genomics. Members will co-fund whole genome sequencing of 250,000 samples and all have access to the resulting data for use in drug discovery and therapeutic development. The first phase in the alliance was announced in January and it involved whole genome sequencing for 35,000 samples. primarily made of DNA from individuals of African ancestry. Before we move to Joy Deep and then go to Q&A, I wanted to point out a couple of additional innovations that we recently announced. In June, our Primate AI 3D, an AI algorithm that predicts disease-causing genetic mutations in patients with unprecedented accuracy, was featured in articles as the cover story of Science Magazine's June issue. And in July, we announced the latest version of our Dragon software for analysis of next-generation sequencing data. Dragon 4.2 expands award-winning accuracy combined with the flexibility and scalability to enable efficient workflows and extract meaningful insights from genomic data. It improves identification of the causes of genetic disease and further aids in both drug discovery and population genomic analysis. While the year hasn't progressed the way we expected, We remain focused on execution, innovation, and supporting our customers as they ramp their NovaSeq X instruments. We continue to progress on margin improvement while prioritizing investment in proprietary technology that generates differentiated products that are valued by our customers and will drive growth. These include upcoming product launches, including the highly anticipated 25B flow cell for NovaSeq X, the Illumina Complete Long Reach enrichment assay, and ExLeap SBS Chemistry on NextSeq 1K2K, as well as future offerings for emerging markets like proteomics, multiomics, and spatial, where we see opportunities to address researchers' needs, deliver complete, integrated, and accessible workflows. In short, Illumina will continue to deliver impactful outcomes. We empower researchers and clinicians with the data and technology they need to make life-changing discoveries and decisions for patients. Our employees take pride in being part of Illumina's mission to improve human health by unlocking the power of the genome. And we are the global engine of genomics innovation, positioning us today and in the future to maximize shareholder value. With that, I'd like to turn the call over to Joy Deep to discuss additional details on our results and outlook. And from there, we'll go to Q&A. Joy Deep?

Thank you, Chuck. I'll start by reviewing our consolidated financial results, followed by segment results for Core Illumina and GRAIL, and then conclude with my remarks on our current outlook for 2023. I will be discussing non-GAAP results, which include stock-based compensation. I encourage you to view 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. As Chuck noted, in the second quarter, consolidated revenue was $1.18 billion, up 8% for the first quarter of 2023 and exceeding the high end of our guidance range on stronger-than-expected shipments of NovaSeq X. Consolidated revenue was up 1% year-over-year and up 3% on a constant currency basis. Non-GAAP net income was $50 million, or 32 cents per diluted share, which includes deletion from Grail's non-GAAP operating loss of $164 million for the quarter. Non-GAAP EPS exceeded our expectations primarily due to continued execution of expense reduction initiatives, gross margin favorability, and our higher revenue for the quarter. Our non-GAAP tax rate was 39.3% for the quarter, which increased from 25.8% in Q2 2022, with both quarters reflecting the impact of R&D capitalization requirements. Although the non-GAAP tax expense impact of R&D capitalization requirements in dollars was the same in both periods, the impact to our effective tax rate in Q2 2023 was more significant due to our lower earnings. Our non-GAAP weighted average diluted share count for the quarter was approximately 158 million. Moving to segment results. Core Illumina revenue of $1.16 billion was approximately flat year over year, or up 2% on a constant currency basis, which included an anticipated reduction from COVID surveillance of approximately 180 basis points. COVID surveillance contributed approximately $6 million in total revenue in Q2 2023, compared to $27 million in Q2 2022. Core Illumina sequencing consumables revenue of $739 million was down 1% year-over-year. Mid-teens growth in clinical led by continued momentum in oncology and genetic disease testing was offset by anticipated headwinds impacting research, including an approximately 260 basis point reduction from COVID surveillance, as well as sanctions in Russia, the impact of Novaseq 6K consumables as customers start to transition to, but before they're fully ramped up on Novaseq X. and constrained funding impacting many of our customers globally. Total sequencing activity on our connected high and mid throughput instruments grew 3% from Q1 2023 and 9% year over year. Research and applied was flat from Q1 and declined 1% year over year. Clinical sequencing activity growth remained strong, up 6% from Q1 and 23% year over year. As a reminder, we believe this data is a useful reference that shows the general activity trends across our install base and is directionally correlated with revenue over time. We have been providing this information on the basis of number of sequencing runs, but in the future, we will disclose these metrics in terms of gigabases sequenced to better reflect activity trends given the significant increase in output per run enabled by NovaSeq X and NexSeq 1K-2K. Sequencing Instruments revenue for Core Illumina of $193 million grew 2% year-over-year. Stronger-than-expected shipments of NovaSeq X more than offset the anticipated decline in NovaSeq 6000 shipments globally and NextSeq 550 placements in China, as well as a decrease in MySeq shipments as customers transition to NextSeq 1K, 2K. We continue to see strong demand for NextSeq 1K, 2K from new to Illumina customers, with shipments growing 8% year over year. Core Illumina sequencing service and other revenue of $134 million was up 7% year over year, driven primarily by higher instrument service contract revenue on a growing install base, partially offset by lower contributions from co-development partnerships. Moving to regional results for Core Illumina, All regions continue to be impacted by tighter funding and budget pressures that are affecting customers' project planning and purchasing behaviors. Additionally, all regions face the impact of high-throughput customers transitioning to Novosig X, where we saw customers reduce Novosig 6K consumables purchases before their fully wrapped-up activity on Novosig X. As Chuck mentioned, though anticipated, this effect was magnified by the larger-than-expected number of Novosig X deliveries and a slower-than-expected ramp of these instruments coming online in Q2. Continued global demand for Novaseq X instruments and a stronger-than-anticipated supply in Q2 helped offset these factors. Strong momentum in clinical also continued across the Americas, Europe, and AMIA, with consumable shipments to clinical customers in these regions growing just under 20% year-over-year. Europe also benefited from the NIPT reimbursement decision in Germany last year, and a national NIPT program in the Netherlands. America's revenue of $623 million was down 2% year over year, and Europe revenue of $303 million grew 11% year over year, or 14% on a constant currency basis. AMIA revenue of $118 million declined 10% year over year, or 6% on a constant currency basis, which included a 14 percentage point impact from sanctions affecting our ability to conduct business in Russia. As a reminder, these regions also continue to be impacted by the slowdown in COVID surveillance year over year. Greater China revenue of $115 million represented a 3% decrease year over year or a 1% increase in a constant currency basis. In addition to persistent macroeconomic and geopolitical challenges that are impacting this region, revenue was negatively impacted by the local competitive landscape, particularly in mid-throughput. Moving to the rest of core Illumina P&L. CoreLumina non-GAAP gross margin of 67% decreased 280 basis points year-over-year, primarily driven by lower instrument margins due to the NovaSeq X launch, which is typical in a launch year, as well as less fixed cost leverage on lower manufacturing volumes and higher field services and installation costs. CoreLumina non-GAAP operating expenses of $531 million were up $12 million year-over-year, primarily due to the full year impact of our headcount growth in 2022. Non-GAAP operating expenses were lower than expected due to the acceleration of our expense reduction initiative and lower performance-based compensation. As a result of the above, Core Illumina non-GAAP operating margin was 21.2% in Q2 2023 compared to 24.9% in Q2 2022. Transitioning to the financial results for GRAIL. Grail revenue of $22 million for the quarter grew 83% year over year, driven primarily by accelerating adoption of gallery. Grail non-GAAP operating expenses totaled $174 million and increased $18 million year over year, driven primarily by continued investments to scale Grail's commercial organization. Moving to consolidated cash flow and balance sheet items. Cash flow provided by operations was $105 million, Second quarter 2023 capital expenditures were $47 million and free cash flow was $58 million. We did not repurchase any common stock in the quarter. We ended the quarter with approximately $1.6 billion in cash, cash equivalents, and short-term investments. As you're aware, we have $750 million in convertible debt that matures this month. Additionally, on July 12, 2023, The European Commission imposed a 432 million euro fine on Illumina due to the completion of the GRAIL acquisition during the pendency of the European Commission's review. We plan to issue a guarantee and defer the payment of the fine pending the outcome of the appeal of the EU General Court's ruling that the European Commission has the jurisdiction to review the GRAIL acquisition. Moving now to 2023 guidance. We now expect full year 2023 consolidated revenue to grow approximately 1%. including core Illumina revenue that's approximately flat with 2022. As a reminder, these ranges include anticipated reductions from COVID surveillance of approximately 200 basis points, the impact on our business from sanctions on Russia of approximately 100 basis points, as well as a year over year negative impact from foreign exchange rates. GRAIL revenue is still expected to be in the range of $90 million to $110 million for 2023. For fiscal 2023, we now expect core Illumina sequencing instrument revenue growth of approximately 3% year-over-year, reflecting our higher Novosig X shipment expectation, partially offset by capital and cash flow constraints that have continued to impact our customers' purchasing behaviors, including in China, which also had an increased impact from local competition primarily affecting Mithub. We also expect Core Illumina sequencing consumables revenue to decline approximately 3% year-over-year, driven predominantly by, one, a more persistent impact of funding issues and cautious purchasing behaviors causing project delays, two, a more meaningful decrease in Novosig 6000 sequencing ahead of planned transitions to Novosig X, in part due to our higher shipment expectations for Novosig X, three, A delay in the expected ramp of consumables on NovaSeq X. And four, a slower than anticipated second half recovery in China. We now expect annual pull through for NovaSeq 6000 of approximately $800,000 to $900,000 per instrument in 2023. Next Seq 550 pull through in the range of $80,000 to $130,000 and pull through for MySeq in the range of $30,000 to $40,000. We still expect pull-through for NEC-Seq 1K, 2K to be within the historical guidance range of $120,000 to $170,000, and Mini-Seq pull-through is still expected to be within the historical range of $20,000 to $25,000 per instrument. With regard to core Illumina sequencing revenue, we expect it to be approximately flat year over year. This includes intercompany sales to grail of approximately $30 million, which are eliminated in consolidation. We now expect consolidated non-GAAP operating margin of approximately 5% and core alumina non-GAAP operating margin of approximately 20%. Our revised operating margins reflect our lower revenue expectations for the year and lower gross margins given lower manufacturing volumes and fixed cost leverage. These impacts are partially offset by acceleration of our $100 million plus annual run rate expense reduction initiatives, spanning headcount, real estate, and other costs that Chuck mentioned earlier. We now expect our non-GAAP tax rate to be approximately 41% for 2023, which continues to include an approximately $75 million tax expense impact from R&D capitalization requirements. Although the non-GAAP tax expense impact of R&D capitalization requirements in dollars hasn't changed, the impact to our effective tax rate in 2023 has increased as a result of our lower earnings. Lastly, we now expect non-GAAP earnings for diluted share in the range of 75 cents to 90 cents for 2023, which continues to include dilution from GRAIL's non-GAAP operating loss of approximately $670 million. Before we go to Q&A, I'd like to cover guidance for the third quarter of 2023. We expect consolidated Q3 2023 revenue to grow approximately 2% year-over-year to approximately $1.14 billion. This reflects a sequential decrease of approximately 320 basis points from Q2 2023, primarily driven by a sequential decrease in Novosig 6000 consumables as customers continue to transition to Novosig X. For the third quarter, we expect non-GAAP diluted EPS of approximately 10 to 15 cents, reflecting consolidated non-GAAP operating margin of approximately 4% and core alumina non-GAAP operating margin of approximately 19%. I will now invite the operator to open the line for Q&A. Thank you.

Thank you. If you would like to signal with questions, please press star 1 on your touchtone telephone. If you're joining us today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach 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 additional questions. And our first question will come from Puneet Satta with Learink Partners.

Yeah, hi, guys. Thanks for taking the question. The NovaSeq field challenges that you're having in the market, can you talk a little bit about that? You know, how soon can you fix these challenges? What is getting this recovery? And what does that mean for the installs in the third and fourth quarter and maybe even 2024? I mean, my question there is, does the market sort of freezes to see if these challenges are resolved before taking on more instruments? And then on the elastizer demand, clearly there is a, you know, significantly more higher dip this year. There's a decline in sequencing consumables versus when we look at the last product launch of Novaseq 6000. You mentioned a number of factors, but just trying to understand how much of that is due to the challenges that you're facing in the field. And look, the Novaseq is definitely selling despite these challenges. Maybe could you just update us on the CEO search as well? Thank you.

Yeah, Puneet, thanks for the question. I've been listening to you guys now for a long time, and it's nice to be able to be part of the conversation. So as far as the NovaSeq X, right, some of the positives of the launch of an instrument of this magnitude is, are, you know, that we've placed more instruments than we thought. It also has, you know, some of the biggest software placements that we've ever seen, and it's revolutionary from the ground up. What we did is we underestimated the amount of time it would ultimately take to bring these instruments online, but our technical teams are working with our customers to bring them up to speed as quickly as we can.

Yeah, and, Vineet, maybe I'll jump in. Nice to hear from you again. So a couple of things. First, as you know with any of these launches of this magnitude, as you go out into the field and as you start installing it, you find some bugs that you have to go resolve. So what we have seen in Q2 was nothing out of the ordinary. We have actually already have fixes for the issues that we have seen and are in the process of deploying these fixes. to our customers. So it has meant a little bit of delay in our original expectations of when these instruments would be fully up to speed. But it hasn't changed any of our or our customer expectations on NovaSeqX. And I will also really urge you to consider that it's not all customers that see this, right? So some customers are fully wrapped up while others, you know, as they've experienced these issues, we are really have all hands on deck to go fix these issues in the field. The other thing is you talked about elasticity and in terms of volume increase and sequencing volume increase. Look, we are not seeing any fundamental change to elasticity. The issues that you've seen are more related to transition to the X. So what we have seen is because of the larger number of Xs installed in the area, because we moved up some of the supply of Xs, we have seen that the decline in the 6K consumables has been faster and larger than we had expected. Again, this is the flip side of people really being excited about the X and our ability to deliver more Xs. So that's what has happened. It's a temporary decline. And we expect that, you know, as we ramp up fully on the Xs, that that volume will come back on in terms of X consumables. Well, what you're seeing now is this timing gap that we have between those two events. You know, and you said something about, I think it was, you know, whether these challenges on the X are continuing or they'll cause a stall in the market. Actually, they haven't caused a stall in the market. demand for the X and our late stage pipeline continue to ramp up. We are, as Chuck mentioned in his prepared remarks, that we have seen the X actually enable experiments and solutions that were not hitherto possible. So we do see continued interest in the X and the continued interest in doing things that were not possible before. And Chuck, I'll turn it back over to you for the CEO search.

Yeah, in regards to the CEO search, the board's actively searching for our new CEO. The search includes both internal and external candidates. They've been really encouraged about the outstanding quality of the candidates they're seeing. But, of course, you know that the details of the board's processes on this are confidential.

We'll be able to update you as soon as we can.

And our next question will come from Dan Brennan with TD Talent.

Thanks for taking the questions. So maybe a couple here packed into one, I guess. The $25 billion flow sale, is that still on track? When will that chip, given some of the issues that you've cited? Second part, China. China actually grew in the quarter, but I know you called out some pressure there. So kind of what's baked in now for China in the back half of the year? Third part would be you've referenced customer challenges throughout, which obviously the broader tool space is had a really challenging second quarter. But that said, the academic and government and market has actually been pretty robust outside of China. So I'm wondering if you can discuss a little bit where you're seeing these challenges. And then the final point would just be on the NovaSeq consumable pull-through cut, and you're mentioning customers are switching faster over to the X. I guess, how do we get comfortable that you're not seeing some either competitive impact or some dampening of utilization, I guess. You know, kind of what was different this time around, do you think, in terms of your forecasting versus you think how management forecasted during the last cycle? Thank you.

Yeah, Dan. So I think first, you know, we continue to prioritize our investments. They're proprietary and we still continue to focus on, you know, the differentiation of products. We probably have the biggest and the best proprietary pipeline in the industry. and we continue to, you know, lean on it. The 25B flow cell remains on track for launch in the second half of 23. We continue to push forward on the Illumina, the Illuminal CLR enrichment assay, particularly when, that's particularly compelling when you're using it with the 25B flow cell. We continue to move forward on the ExLeap SBS chemistry for NexSeq 1K, 2K, and we're going to have future offerings for emerging markets for things like proteomics, multiomics, and spatial.

Yeah, and maybe I'll jump in on China, right? So, yes, we did see, like other companies, you know, a slower than expected recovery in the second half of the year. Remember, we had expected China in the first half of the year to be, you know, somewhat soft in recovering from the COVID challenges, and then we had expected an acceleration in that recovery in the second half of the year. We do not currently see that happening, both because of some of the challenges that you've seen to the broader economy in China, but also for us from a increased competitive intensity that we are seeing in China on the mid throughput and low throughput segments. I think with respect to, sorry, your second part of the question was on the, oh yeah, everything extra China, right? So, you know, there, it's a, it's a little bit of a, you know, I don't think the situation is, you know, dire as it was in last year. It was more what we are seeing is a little bit of conservatives and given the economic uncertainty in the speed at which people are coming back online or purchasing. So we have seen a little bit of lengthening of cycles in terms of purchasing behavior, both on. Our instrument side were mid-throughput and low-throughput and also on some of the consumables pieces. Activity, as I indicated, remains strong, but it's just that, you know, any newer projects or new instruments that are coming in are slower than we had expected. Our win rate in, and we track this pretty closely, in terms of both mid-throughput and, of course, on the high-throughput side, remains high. In fact, it picked up slightly compared to Q1. in Q2. So again, I think it's more that it's more of a lengthening out of cycles and purchasing cycles rather than any, you know, anything related to competitive intensity on those fronts. And then, sorry, I just want to make sure I'm hitting your thing. So customer challenges. Yep. Yeah. And then on the X, the issue is not competition at all, right? We, as I indicated, I mean, we, are seeing continued strong interest and strong interest from, of course, their existing customers, but also, you know, newer customers or people that are moving up from mid throughput. We continue to see that our ability to actually deliver on the instruments is, you know, continues to maintain that interest. And then in terms of, as Chuck mentioned, right, in terms of what these instruments are enabling, there's a whole new set of experiments that are on a larger scale going forward. Again, this is a lead indicator for us. Obviously, people have not ramped up on the X fully, but it is a lot about transitioning to the X and being able to take advantage of the many capabilities that it's providing beyond just the price aspect of it, right? the dragon on board, the faster capabilities, the simplicity of the workflow, obviously the ambient ship reagents. So there's a lot that goes into that beyond just the focus on, oh, it's going to help us with the lower price per GB.

And our next question will come from Dan Arias with Stiefel.

Good afternoon, guys. Thanks for the questions. Joy Deep, obviously quite a few moving parts here on the top line and the OPEX line. And it looks like what you're doing in terms of cost reduction and expense management is part of a multi-year effort. So I guess given where this year is headed, how are you thinking about out margins next year for the core business relative to the 25% target that you talked about last quarter? Thanks.

Yeah, absolutely. Thanks, Sam, for the question. So a couple of things, right?

So one, you're right. We started off and as we committed to in our Q1 earnings call, we started off a broad look at cost structure and actually at the end of Q1, we proceeded with beginning a cost reset that we have executed on and actually have taken out on a run rate basis more than $100 million annually of cost. You know, during the second half of the year, just given, you know, some of the uncertainties in the broader economic space, we continue to keep a very close eye on managing expenses and being very careful about allocating expenses to the highest return areas, including, you know, the innovation areas that Chuck talked about. You know, given the challenges we are having this year, obviously we acknowledge that, you know, getting to margins next year is going to seem like a stretch, but we remain very committed to, you know, to planning for and delivering on those margins, and that's the way we're moving forward.

And we have a question from Vijay Kumar with Evercore ISI.

Hey, guys. Thanks for taking my question. I had a two-part question, mostly on the guidance here. I think for third quarter, you said 3%. Your comps for fourth quarter look pretty easy. Historically, when I've looked at your sequential revenue ramp from second quarter, it's always been up. Now, look at your second quarter trends. Sequentially, your instruments are up. Consumables are up. Your pull trooper box is up. China was up. Is there anything incremental headwinds that we should be thinking about for the back half? Why your back half shouldn't follow historical patterns? And I take a related question here. You mentioned $800,000 to $900,000 pull through on the NOAA 6K. I think there's been some concern the pull through on the NOAA Seek X perhaps might be lower because of the lower sample price point. Maybe can you just walk us through your assumptions around pull through for the NOAA X? Could we perhaps see a rebound because I'm assuming inventory levels here for customers are pretty low and they need to restock?

Wow, Vijay, good to hear from you.

And that was a long, multi-part question. So let me try to get to unpack some of that, right? So first of all, for the full year guidance, given that it has come down, the components roughly fall into three categories. About 25% of the reduction in guidance really comes from China. And as I mentioned earlier, for China, this is a two-part thing. We are seeing a slower than expected recovery in the larger economy, including some liquidity challenges for mainly our clinical customers. And we are seeing a higher competitive intensity that affects the mid-throughput and low-throughput segments. That's 25%. The other 75% is roughly equally split into two buckets. So one part is around the transition to the X and the gap we are seeing in terms of the high throughput consumables, right? And this is an issue of the 6K consumables going down pretty rapidly as people are planning to transition to the X and again, exacerbated somewhat by the larger number of Xs we are delivering. And the other part is a slightly slower than expected ramp up on the full utilization of the X. The other 50% of that 75% is coming from some of the customer conservatism that we are seeing in terms of longer sales cycles and slower than expected recovery across the board, right? But beyond China. So, now in third quarter versus second quarter, sorry, second quarter versus the first quarter, and then, you know, third quarter versus second quarter. So, we did see a ramp up from first quarter into second quarter across many dimensions. Obviously, we shipped more excess, so we saw a jump on the instrument side. We did see a healthy ramp up on our 6K consumables, primarily driven by the clinical segment. And you're right, we did actually see a jump from Q1 to Q2 in China, but that was expected given China was really depressed for us and other companies in Q1. Moving on to Q3, what you're seeing in some of the sequential ramp down, there are two big reasons for it, right? One, the aforementioned 6K consumable reduction is going to hit sort of a local maxima there. because of the larger transition expected to the X. We're shipping more Xs. That impact on the 6K consumables is going to ramp up. And we don't yet have a full ramp up on our X consumables yet, right? We expect that in Q4, and I'll come back to that. And the other piece is we do expect China to actually be down slightly from Q2, again, because of the expectation that the recovery is proceeding, unfortunately, more slowly than we had expected. And then the last piece around that is just, you know, we do expect Q4 to be up significantly and Q4 is the first quarter you actually start seeing the ex-consumables come in. You see your traditional end of the year ramp up in some of the spend from companies. So you are still seeing that and that's built into our guidance. The last thing you mentioned was about pull-through. And pull-through, by the way, we only, we have not given you pull-through on X. We, as with all new instruments, we'll only come out with that once the, you know, the instrument ramp up has stabilized. So, we do expect, given the interest in X and the kinds of, you know, cohort studies and experiments that our customers are telling us they want to do on X, we do expect that, you know, our initial assumptions on pull-through are still justified. On the NovaSeq 6000, which is probably what you were referring to, we have called down our pull-through numbers for this year, but that is really driven by the transition to the X and the larger than expected impact of that transition that I've talked about.

And we'll take a question from Tejas Savant with Morgan Stanley.

Hey, guys. Good evening. So one, Chuck, for you on the leadership changes here, perhaps, Joy, feel free to chime in as well. You know, Dan asked about sort of margins and your commitment to, you know, 25%, and you call that sort of stretchy, but something that you're certainly committed to. Would that sort of framing apply to your mid-teens growth that you had talked about at the analyst day as well for Core Illumina? And Chuck, for you on the leadership changes, I mean, beyond sort of the CEO seat, obviously the CTO and CMO search is underway as well. Any color you can share there on the thought process behind that? And then on the base business itself, on the NovaSeek, you know, placements here for the X clearly came in I think it was 28 to 30 units above at least where we were. But sequencing instrument revenue beat us by only about 5% to 6%, right? So the question really is, are you seeing more aggressive discounting? I mean, is that something Illumina is pushing through in response to the macro environment? You called out sort of BGI starting to be sort of competitive in China, but just any color and just the pricing dynamics on the instrument side would be helpful as well. Thank you.

Yeah, Tejas, thanks for the question. On the executive team and on the process here. So, you know, I think the first thing we want to do is just both thank Alex and Phil for all the things that they've done for Illumina. With Alex, what we know is that he's moving on to a new role. He'll be taking the CEO in another company. And I think that we should be really proud to see the kind of leadership that we grow out of Illumina. So Alex started with Illumina, he went over to Grail, he came back to Illumina, and now he's going to land as a CEO, and we're all looking forward to kind of where that's going to be. We have a really deep bench in our R&D program, and it's really heartening to see employee number four, Steve Bernard, who is the first scientist that the company ever hired, bringing him into that role. He knows the technology, he knows the team, and he'll be able to seamlessly pick up where Alex left off. On the chief medical officer, we're going to take some time and look at that organization. We're going to evaluate where we are on the clinical side and on the medical side. Our commitment to our clinical customers, our clinical markets, and our clinical programs continues, and we'll open up that search after we have some time to examine exactly where that organization fits and what we need.

Yeah, Tejas, thank you for picking up on your other questions.

First of all, in terms of margins and, you know, the implied long-term growth in mid-teens. So, look, the long-term growth in mid-teens, by the way, our expectations on that have not changed, right? And, you know, that was, as you know, underpinned on two things, right? a large and growing market that NGS is still under-penetrated in. And the ability then by, you know, through our innovations, addressing the core needs of that market for NGS and Illumina to take and have a growing share. And that then manifests itself in the sequencing volume growth along the three dimensions I had mentioned earlier. First, Ron, you know, ever increasing number of samples, again, more cohorts you know, things like spatial and single-cell really driving more of that. The increasing number of analyses per sample. So again, that's really being driven by NGS being able to handle more of the multi-omic side of the questions that our customers are asking. And lastly, just the higher sequencing intensity, right? So as you move towards larger panels, as you do more things in liquid biopsy or things like MRD, So all those remain intact. I think where, you know, we are really looking for in the next year or so, right, is as X kind of comes online and enables a lot of these moves into things that we talked about, you know, how quickly does that ramp take place? So, but in the long term, nothing of what we had guided to you know, really has changed in our mind and we are looking forward to seeing how the X kind of evolves us down that path. You had asked two other questions. So, one was around, oh, yeah, the X and the revenue growth on the instrument side not being that high. So, as I mentioned, right, so we are very pleased that we were able to deliver on the X and ramp up our supply much faster than expected. I think this is a good thing in the long run. What offset that higher number of Xs was twofold, two things that I mentioned earlier. So one, we did see on the China side that we did have a lower than expected number of mid throughput and high throughput, not mid throughput, and low throughput instruments. And in general, overall, given some of the lengthening of the purchasing cycles, we did see a lower than expected mid-throughput and low-throughput instrument sales across the world. Now, unlike as in China where competitive intensity was a factor, in the rest of the world, we actually did not see our win rate go down. We actually saw it climb a little bit in Q2. Also, with respect to pricing, we track this very closely, right? So in China, yes, we are being very surgical about when to use price and given the type of customer, but we did see a price decline overall in China. In the rest of the world, our price actually remains on track to where we expected it to be, and we're proceeding along what we wanted to do with using price as a means to encourage, you know, faster adoption of our technologies. And let's see, did I cover all your questions? Yeah, I think I covered them. Thank you.

And our next question is from Sung G. Nam with Scotia Bank.

Thanks for taking the question. Just a clarification question. In terms of the cautious purchasing behavior, is that more for your academic customers, or is it also across clinical as well? And then, sorry if I missed it, but kind of roughly what percentage, I guess, of that, you know, the consumable delay in purchase is attributable to the launch of the higher density, the 25B, and kind of waiting for, you know, the better economics in terms of sequencing? Thank you.

Thanks for the question.

So, no, the cautious purchasing behavior, again, broadly, except China, is across both academic and clinical segments, right? The reasons are slightly different. I think, you know, a lot of our clinical customers are not profit-making companies, right? So, they are managing their cash as you would expect them to. And while they're, you know, they continue to have sequencing at their core, we have seen that their purchasing intensity has come up less quickly than we had expected it to. In terms of your second question on how much of a delay is there for 25B, I don't think there's a delay in 25B. So what I was trying to articulate is off the reset and guidance for the whole year, You know, about 25% of that came from the impact from China. The other 75%, about 50% of that 75% really came down to this impact on high throughput consumables due to the transition on X, right? So, that includes, as I said, you know, more transition on the 6K faster, and then a little bit of a delay given some of the issues I mentioned in Q2 that we are, you know, already deploying solutions in the field. There's a little bit of delay that is flowing through in 2023.

And we have a question from Rachel Vensta with JP Morgan.

Great, thanks for taking the questions and good afternoon. So first up on guidance, you cut revenue growth by 750 basis points at the midpoint for the year. You've walked through a few of the moving pieces between more cautious CapEx environment, China, and then some of these lower consumables as customers are transitioning to the new platform. So can you just give us a more granular breakdown of from that 750 basis point cut, how is it really broken out across those three areas? And then as a follow-up, I just wanted to follow up on some of the earlier comments on China, just mainly relating to some of these stimulus packages. We've heard that there could potentially be another tranche of stimulus in 4Q. So what are you hearing regarding stimulus packages? I know you guys weren't seeing much of a benefit in 1Q, but did you see anything in 2Q? And then how is stimulus contemplated in guidance for the back half of the year? Thank you.

Yeah, so I'm going to go through. I mentioned the breakdowns earlier, so very quickly, Rachel, I think about 25% of that guidance reset is really coming from the impact from China. Of the remaining 75%, approximately 50% of that 75% really was coming from the impact on high throughput consumables related to the transition to the X. And then the other 50% is some of the cash conservatism that we are seeing with customers outside of China. So that's roughly how we see the math working out. In China, first of all, there is no stimulus built into our expectations for the second half of the year. There never was in our guidance as well. As far as we could see, the stimulus in the first half of the year benefited more of the industrial segments, which we don't play in. And there is no, you know, we didn't see any stimulus in the second half, sorry, the second quarter either, right? So it's consistent. We have not built it in, and we hadn't initially as well.

And our next question will come from John Sauerbeer with UBS.

Hi. Thanks for the question here. You know, maybe just a couple of clarifications. So I appreciate confirming the long-term guidance in the mid-teens. It does sound, though, that some of the China headwinds there could be structural with some of the competition increases there. I guess just have the long-term outlook for that market change at all. And then just, you know, follow up here just on the complete long reads, you know, any color there on what you've seen the demand for that launch.

Thanks. Yeah, let me take those in order, right? So...

I think for China in terms of the long-term outlook, I think China remains an important market for us and we are committed to serving our customers in China. Our brand in China actually is very positive and again, we remain committed to serving that market. Now again, given some of the changes we're seeing, we will continue to kind of refine our strategy in terms of how we go to market there, the kinds of partners we choose in order to reach the relevant segments, the highest growing segments of the market better and more efficiently. So none of that has changed, but we continue to observe how China is going to evolve from its current condition, as most other people in our space are. In terms of the Illumina Complete Long Reads side, so the interest on that has been very high. We have a large number of customers that have taken the current WGS product and are working on it. I think really we had always anticipated that the real jump into this technology would come from the enrichment product, which we are on track to delivering. But that also is coupled because of the economics involved in it. really coupled with the launch of the 25B flow cell, right? So we are, you know, that is still coming through towards the end of this year and really pick up, you know, as we go into 2024.

And that concludes our Q&A session. I will now hand the call back over to Sally Schwartz.

Thank you again 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.

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.