Joydeep Goswami: Yes. So, Vijay, thanks for the question, and good calculations, rapid calculation of the math. So, let me first hit the simple question on the Russia headwind. So, as we said in the call, it’s about $60 million for the full year and approximately $18 million in headwind year-over-year in Q2. You’re right, gross margins were down sequentially for us in Q1. Actually, we had signaled some of this as we gave our guide in February. There are two specific reasons. So one, of course, is the launch of the Xs. We told you, the X is just ramping up, so margins for the X tend to be low. And of course, we sold more Xs than we anticipated in Q1. The other reason, as you go from Q1 to Q — sorry, from Q4 to Q1, you typically have lower absorption in our factories, right?
So that tends to lead to a sequential decline in gross margin as you move from Q1 — Q4 to Q1. In terms of operating margin for Q2, there are a couple of factors there, right? So, we — as I mentioned in the call, there’s — we had our typical salary and promotional adjustments and equity adjustments. So, from — as you move from Q1 to Q2, there is a one-time jump in overall operating expense. But of course, that then stabilizes for the rest of the year. The second factor, of course, in Q2 in terms of margins is we have — because of the Russia issue, we have a shift again in a higher amount of instruments being sold, which has an impact on gross margin. So, those two combined offset some of the operating leverage that we are getting to keep margins at 17%.
Now, you’re absolutely right. We had indicated in our call that we expect margins to improve in the second half of the year. The two biggest reasons for that are really as we scale up and start to improve margins on the X, and of course, then consumables ramp up. So, we have a sequential step-up in each quarter. And because of that, absorption in our factories improves, leading to increased gross margin. And we do expect to exit the year with gross margins in the high 60%-s and operating margins close to the high 20% numbers that you indicated.
Operator: And our next question will come from Tejas Savant with Morgan Stanley.
Tejas Savant: Hey, guys, good evening, and thanks for the time here. So, Francis and Joydeep, maybe a couple on the Core and then a couple on GRAIL. So, on the Core business here, nice upside on the X shipments obviously versus what you indicated earlier in the year. But instrument revenues were essentially in line with our forecast. So, Joydeep, just the math there, was the offset essentially the EMEA weakness with the NextSeq 550 shipments in China? Or was there some sort of like greater-than-expected discounting or some such elsewhere in the portfolio? Second, for you, Francis, on the NextSeq, any updated thoughts on where you need to land on the per GB price point once you bring XLEAP to that platform next year? The competition is roughly at $2.00 a gig.
So, do you think $4.00 to $5.00 is sort of a fair assumption? Or could it even be higher than that given the inertia to switching here? And then, on GRAIL really, the question that we get a lot is how committed are you to divesting the asset? Should you win that jurisdictional appeal and claw back the European Commission fine? So, put another way, I mean, what color could you share on the scenarios under which you could decide to keep GRAIL instead? I mean, is it essentially premised on what you’d get for the asset via an IPO or a sale or some such? Or just walk us through that thought process. Thank you.
Joydeep Goswami: Yes. So, let me answer the instrument question first. So, yes, we were happy with our increased supply of NovaSeq X. And as we mentioned on the call, the primary offset was in terms of instruments, the offset in the mid-throughput instrument cycle. And that was again mostly due to the reduced 550 shipments, and that was primarily in China. In terms of pricing, I want to be very clear, we track pricing pretty carefully. We’re not seeing any differential with the expected prices nor a decrease in the prices that we track, both for instruments and our consumables. So, they are exactly at where we had expected them to be. And I think the next question was, was it out to GRAIL or…
Francis deSouza: The next question was about — maybe I’ll jump in, to talk about NextSeq and the — what the impact of XLEAP-SBS could be on NextSeq? And so, Tejas, as you know, when we put XLEAP-SBS on NextSeq, you’ll see a number of pretty dramatic improvements. One, you’ll see an improvement in the price points associated with NextSeq, and I’ll come back to that because that’s where your question was. But you’ll also see improvements in other capabilities, right? So the actual performance of the chemistry in terms of quality and so on. And then, you’ll obviously see the sustainability benefits, and that’s a big draw for our customers, because with XLEAP-SBS chemistry, you don’t need a cold chain when you are shipping the consumables.
And that’s a really big savings for our customers in terms of the sustainability value proposition of the product. Now in terms of how we think about the price, our perspective is — and we’re not enhancing the price right now, but our perspective is we want to price it such that we can maximize the market opportunity. And so clearly, we’re going to bring prices down. But our products also have, uniquely in the market, additional capabilities, not only the sustainability features that I just talked about, but we have the onboard compute associated with having the FPGAs built into the NextSeq. We also have the onboard storage optimization, which is also unique to Illumina’s NextSeq compared to any other mid-throughput instrument in the market.
And so, we’re going to bring the prices down, but we’re also going to recognize the additional value we provide in our instruments. And that will be part of the calculus that determines what the ultimate pricing is, and it will be around what opens up the market the most in the mid-throughput segment. In terms of GRAIL, so the pass-through divestiture is — to answer your question around what’s about the divestiture and then in what scenario do you keep GRAIL. So, the pass-through divestiture is, obviously, the divestiture order will come out shortly, that will lay out the process and the structure of the divestiture. We have a divestiture team, that’s already engaged with the team in the European Commission, and we’ll move forward with that process.
In parallel, we have the two appeals going. If we lose either of the appeals, we’ll divest promptly in the best interest of our shareholders. And we expect that to play out again in the late this year, early next year kind of timeframe in parallel with the appeals that are happening. Under what scenario would we keep it? If we win both the appeals and, at that time, we have a chance to sort of look at the asset and sort of make sure that the assumptions in the business case that we did hold in terms of us keeping it compared towards divesting it. And so that would be the scenario under which we would keep the asset and integrate.
Operator: And shortly, I’ll be turning the call back over to Francis for closing remarks. The next question comes from Julia Qin with J.P. Morgan.
Julia Qin: Hi, good afternoon. Thanks for taking the question. First off, regarding your operating margin targets, can you help us think about the upside/downside scenario? And in those numbers, do you assume that your in-house NovaSeq X manufacturing reaches full efficiency by the end of ’24 or by the end of ’25? And for the R&D efficiency, I wondering if you could elaborate on how to think about the magnitude of improvement in new product before and after you implement that new R&D structure? And then, lastly, I wonder if you can comment more on China. Are you seeing any offset from the government stimulus? And are you seeing any signs of recovery here? Thank you.
Joydeep Goswami: Okay. So, let me — Julia, let me take the operating margin target question. So, I think there are probably two steps there. For 2022, I want to reaffirm that we are still at our operating margin guidance of 22% for the year for Core. We see a couple of offsets there. So, of course, we are seeing more instruments in the number for the year, again, due to some of the offset from Russia about $60 million for the year. So for that, we do expect a slight gross margin hit, which will be offset by further productivity efforts on our manufacturing, and of course, some of the impact from the further cost reductions that we have introduced. In terms of your instrument or X manufacturing efficiencies, we do expect that by the end of the year, we will have achieved the efficiencies that we had initially outlined.
We don’t think the efficiencies will stop there. As we have done with all of our instruments, we continue to have further efficiencies as we go into subsequent years. So, you will see that those efficiencies continue to progress as we get into year two, three of manufacture. In terms of the R&D efficiencies that we talked about, so this is really coming from a couple of areas, and it’s R&D and beyond, right? So, from the R&D side, we have spent a lot of effort in modularizing our innovations as part of the X and of course, even part of the NextSeq 1k/2k. And innovations like the new flow cell technology and XLEAP-SBS really allow us to radically reduce the spend per platform and for subsequent platforms and accelerate their time to market. So, you won’t see this in 2023, but you’ll see this in ’24 and beyond.
And then, we’re also streamlining where we are doing some of our R&D, so leveraging our global footprint in more cost-effective hubs. So, this is for R&D, but also for other functions. And then that — those kinds of activities also lead to further streamlining our organization and our processes allow us to rationalize our global real estate portfolio, spend and our IT infrastructure as well. So, again, you’ll see that coming through starting towards the end of this year, but really kicking into place as we go into 2024 and beyond. And finally, in China, we are not seeing the benefits of any stimulus in China, at least for our business. We are monitoring China closely in terms of looking at some of the funding challenges our customers are facing and taking steps to mitigate some of these challenges.
Operator: And we have a question from David Westenberg with Piper Sandler.
