Illumina, Inc. (NASDAQ:ILMN) Q3 2023 Earnings Call Transcript

Illumina, Inc. (NASDAQ:ILMN) Q3 2023 Earnings Call Transcript November 9, 2023

Illumina, Inc. beats earnings expectations. Reported EPS is $0.33, expectations were $0.13.

Operator: Good day, ladies and gentlemen, and welcome to the Third Quarter 2023 Illumina Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Salli Schwartz, Vice President of Investor Relations.

Salli Schwartz: Hello, everyone and welcome to our earnings call for the third quarter of 2023. During the call today, we will review the financial results we released after the close of the market, and offer commentary on our commercial and regulatory activity, after which we will host a question-and-answer session. Our earnings release can be found in the Investor Relations section of our website at Illumina.com. Participating for Illumina today will be Jacob Thaysen, Chief Executive Officer and Joydeep Goswami, Chief Financial Officer and Chief Strategy and Corporate Development Officer. Jacob 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 transitional 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 10-Q and 10-K.

With that, I’ll now turn the call over to Jacob.

Jacob Thaysen: Thank you, Sally. Good day everyone and thank you for joining today’s call. As you know, I assumed the role as Illumina’s CEO a little over six weeks ago. It is an honor to lead this company. I joined Illumina after more than a decade at Agilent, where I ran both the Diagnostic and Genomics Group, and more recently, Agilent’s largest business, the Life Science and Applied Markets Group. I have long admired Illumina for its role in building the genomics market, and I’m incredibly excited to be here. During my first weeks, I prioritized getting to know our employees and meeting with several of our customers. Illumina has a highly capable team, and I have been impressed with their level of passion and commitment to our work.

Both our employees and our customers are driven to move genomics forward. Like our team, I’m passionate about genomics and the role that this field can play in healthcare and personalized medicine, particularly in the oncology space. This is a massive opportunity, and Illumina will remain the key player, even as others enter the market. Illumina’s infrastructure that we have built over two and a half decades, our compelling offerings that set the global standard, and our deep commitment to innovation for the future will continue to drive the use of genomics and multiomics around the world. Turning to our third quarter results; in Q3, Illumina delivered revenue of approximately $1.12 billion, flat year-over-year, or up 1% on a constant currency basis.

This was a disappointing result. The macroeconomic environment remains challenging for our industry and for our customers, with customers increasingly cautious and constrained in their purchasing decisions. Despite a lower gross margin year-over-year, tight management of our operating expenses allowed us to deliver diluted non-GAAP EPS of $0.33, also approximately flat year-over-year. While we cannot control external environment, Illumina’s management team and I remain focused on supporting our customers and our own operational execution. Part of my comprehensive review of the business includes reexamining our strategic initiatives and our targets for long-term revenue growth and operating margins. We will lay out our new targets for you later next year.

A key priority for me is to get clarity on the GRAIL situation. Therefore, I have requested and the Board has established a special committee to expedite decisions on GRAIL. Furthermore, we have retained advices and are preparing for sale and capital markets transactions. We expect to file a Form-10 on a confidential basis with the SEC. Hereafter, we will contact third parties as investment capital sources or as potential purchasers as our appeals are ongoing. I know there have been questions regarding our appeals. These appeals are not just about GRAIL. They provide Illumina with flexibility for any divestiture of GRAIL and also for future transactions. The appeals will not impact our ability to move swiftly. Make no mistake, I’m here to focus on the core business, which I will talk more about after Joydeep’s remarks.

Joydeep?

Joydeep Goswami: Thank you, Jacob. 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 review the GAAP reconciliation of these non-GAAP measures, which can be found in today’s release, and in the supplementary data available on our website. As Jacob noted, in the third quarter, consolidated revenue of $1.12 billion was flat year-over-year and up 1% on a constant currency basis. Consolidated revenue was down 5% from the second quarter of 2023. Although we correctly anticipated a sequential decrease in high-throughput consumables revenue due to the NovaSeq X transition, we placed fewer NovaSeq X instruments than we expected in the quarter, as customers’ purchase constraints led to lengthened sales cycles.

Non-GAAP net income was $52 million, or $0.33 per diluted share, which included dilution from GRAIL’s non-GAAP operating loss of $155 million for the quarter. Despite our lower revenue, non-GAAP EPS exceeded our expectations primarily due to continued execution of expense reduction initiatives and a higher gross margin than we forecast. GAAP net loss was $754 million, or $4.77 per diluted share, which included goodwill and intangible impairments of $821 million related to the GRAIL segment. These impairments were primarily the result of a decrease in Illumina’s consolidated market capitalization and a higher discount rate used for the fair value cancellation of the GRAIL segment. Our non-GAAP tax rate was 39.7% for the quarter, which decreased from 43.2% in Q3 2022, with both quarters reflecting the impact of R&D capitalization requirements.

The year-over-year decrease was primarily due to a decrease in the non-GAAP tax expense, impact of R&D capitalization requirements, given increased amortization of capitalized R&D expenses. Our non-GAAP weighted average diluted share count for the quarter was approximately 158 million. Moving to segment results; Core Illumina revenue of $1.11 billion was flat year-over-year on both the reported and constant currency basis, and included anticipated reductions of approximately seven percentage points from two primary categories. One, the decrease in COVID surveillance and the effect of sanctions in Russia that together represent approximately 3.5 percentage points and two, the year-over-year reduction in China revenue that also is approximately 3.5 percentage points.

COVID surveillance contributed approximately $4 million in total revenue in Q3 2023, compared to $28 million in Q3 2022. Core Illumina sequencing consumables revenue of $695 million was down 4% year-over-year. The decrease was primarily driven by a 12% decline in sales research customers. These customers were impacted by the NovaSeq X transition and are reducing NovaSeq 6000 consumables purchases before they have fully ramped up activity on NovaSeq X. Total sequencing consumables revenue was also impacted by the COVID, Russia and China factors I noted previously, as well as the impact of macroeconomic conditions on customer’s purchasing power and project planning. Strength in sales to clinical customers partially offset the decline in research, with clinical sequencing consumables growing 10% year-over-year, led by continued momentum in oncology and genetic disease testing.

Turning to sequencing activity, total sequencing gigabase output on connected high and mid-throughput instruments grew 5% from Q2 2023 and 29% year-over-year. We are encouraged by the trends we’re seeing across both research and clinical high-throughput customers that have a NovaSeq X installed. As expected, these customers show higher overall growth in sequencing output than high-throughput customers that have not yet adopted the NovaSeq X, both on a quarter-over-quarter and a year-over-year basis. As a reminder, we believe this data is a useful reference that shows the general activity trends across our installed base and is directionally correlated with revenue over time. Sequencing instruments revenue for Core Illumina of $179 million grew 10% year-over-year, driven primarily by NovaSeq X, which more than offset the decline in NovaSeq 6000 shipments.

Growth in high-throughput instruments was partially offset by the expected decline in mid-throughput due to increasing capital purchase and cash flow constraints that continue to impact our customers’ purchasing behaviors globally, as well as by local competition in China. For NovaSeq X, we exited Q3 with more than 310 orders since launch. Our shipments of 97 NovaSeq X instruments in Q3 brought our total installed base to 273 instruments. Core Illumina sequencing service and other revenue of $142 million was up 15% year-over-year, driven primarily by higher instrument service contract revenue on a growing installed base, as well as an increase in lab services revenue. Moving to regional results for Core Illumina, all regions continue to be impacted by two key issues.

One, tighter funding and budget pressures that are impacting customer purchasing power and project planning and two, the impact of high-throughput customers transitioning to NovaSeq X as customers continue to reduce NovaSeq 6000 consumables purchases before they have fully ramped up activity on NovaSeq X. America’s revenue of $650 million grew 10% year-over-year, attributed to NovaSeq X placements, as well as clinical testing volume driving greater consumables revenue. Clinical sequencing consumables shipments grew more than 20% year-over-year. Europe revenue of $260 million was flat year-over-year or up 1% on a constant currency basis. Growth in sequencing consumables was driven by mid-teens growth in clinical and strength in mid-throughput consumables offset by the decline in COVID surveillance and the negative impact of exchange rates.

For sequencing instruments, growth in high throughput due to NovaSeq X placements was more than offset by a decline in mid-throughput instruments. India revenue of $98 million declined 22% year-over-year or 19% on a constant currency basis, which included an 11 percentage point impact from sanctions in Russia. The year-over-year decrease was also driven by softness in Japan due to the macroeconomic factors I mentioned earlier as well as the expected slowdown in COVID surveillance. Greater China revenue of $98 million represented a 26% decrease year-over-year or 25% on a constant currency basis, reflecting continued macroeconomic and geopolitical challenges as well as local competition in mid-throughput. Moving to the rest of Core Illumina P&L.

Core Illumina non-GAAP gross margin of 66% decreased 290 basis points year-over-year, primarily driven by product mix and less fixed cost leverage on lower manufacturing volumes as well as lower instrument margins and higher field service and installation cost due to the NovaSeq X launch, which is typical in a launch year. Core Illumina non-GAAP operating expenses of $481 million were down $33 million year-over-year and were lower than expected primarily due to continued expense reduction initiatives. As a result of these factors, Core Illumina non-GAAP operating margin was 22.5% in Q3 2023 compared to 22.6% in Q3 2022. Despite our lower gross margin, operating margin was approximately flat year-over-year due to our proactive cost management initiatives.

Transitioning to financial results for GRAIL; GRAIL revenue of $21 million for the quarter grew 110% year-over-year, driven primarily by adoption of Galleri. GRAIL non-GAAP operating expenses total $161 million and increased $12 million year-over-year driven primarily by efforts to scale GRAIL’s commercial and R&D organizations. Moving to consolidated cash flow and balance sheet items; cash flow provided by operations was $139 million. Third quarter 2023 capital expenditures were $45 million and free cash flow was $94 million. We did not repurchase any common stock in the quarter. We ended the quarter with approximately $933 million in cash, cash equivalents and short-term investments. During the third quarter of 2023, the company used $750 million in cash to repay the outstanding principle of convertible notes that matured in August 2023.

Moving now to 2023 guidance; we now expect full year 2023 consolidated revenue to decline 2% to 3% from 2022, including Core Illumina revenue that is down 3% to 4% year-over-year. As a reminder, these ranges include anticipated reductions from COVID surveillance of approximately 200 basis points, the impact on our business from sanctions in Russia of approximately 100 basis points, reductions in our business in China, as well as a year-over-year negative impact from foreign exchange rates. GRAIL revenue is now expected to be at the low end of the range of $90 million to $110 million for 2023. For fiscal 2023, we now expect Core Illumina sequencing instrument revenue to decline 5% to 6% year-over-year driven by capital and cash flow constraints that have continued to impact our customers’ purchasing behaviors globally, as well as the decline in our business in China.

The decrease from our prior guidance is primarily driven by our lower NovaSeq X shipment expectations for 2023. We now expect to ship between 330 NovaSeq X to 340 NovaSeq X instruments for the year as customers’ purchasing constraints lead to lengthened sale cycles. We also now expect Core Illumina sequencing consumables revenue to decline 5% to 6% year-over-year, driven primarily by the decrease in NovaSeq 6000 consumables as customers transition to NovaSeq X. The impact of macroeconomic conditions on customer project planning and budgets, the effect of sanctions in Russia, the slowdown in COVID surveillance, and the decline in our business in China. The decrease from our prior guidance primarily reflects a slower ramp in NovaSeq X consumables, in part due to our lower placement expectations, as well as the increasing impacts of macroeconomic constraints.

We now expect Core Illumina total sequencing revenue to decline 3% to 4% year-over-year. This continues to include intercompany sales to GRAIL of approximately $30 million, which are eliminated in consolidation. We now expect consolidated non-GAAP operating margin of 4% to 4.5%, and Core Illumina non-GAAP operating margin of 19% to 19.5%. Our revised operating margins reflect our lower revenue expectations for the year, partially offset by continued expense reduction initiatives. We now expect our non-GAAP tax rate to be approximately 39% for 2023, due to discrete tax benefit recognized in Q3 2023 related to prior year return adjustments. Lastly, we now expect non-GAAP earnings per diluted share in the range of $0.60 to $0.70 for 2023, reflecting non-GAAP diluted shares outstanding of approximately 159 million shares.

Dilution from GRAIL’s non-GAAP operating loss is now expected to be approximately $660 million, as GRAIL continues to manage its expense base in line of its latest revenue outlook. I will now turn it back over to Jacob for his closing remarks. Thank you.

Jacob Thaysen: Before we go to Q&A, I wanted to reiterate Illumina’s commitment to supporting our customers in this difficult macroeconomic environment. While we cannot control for external factors, we can optimize our own actions to successfully navigate through this period and position the company for a return to accelerated growth on the other side. I know you’re interested to hear our views for 2024. With the caveat that we haven’t finished 2023, we’re still looking at our budget for 2024. Our initial views is that 2024 results will look very similar to 2023. We don’t expect near-term improvement to the macroeconomic environment, and geopolitical issues have been persistent. We are encouraged with the early signs we’re seeing for NovaSeq X utilization and the continued rollout of the X position us very well for the ramp in consumables and overall growth with the market conditions improve.

This is clearly a dynamic situation, and we want to be able to develop our views in depth. Therefore, for 2024, we will not provide guidance before our Q4 earnings call in February. The main reason that I joined Illumina was my strong conviction about the future of the Core Illumina business. While over the coming month, I’ll continue to listen and learn, I will also be focused on several key priorities. First, we need to drive our top line as much as possible in this environment. This means continuous placements of the NovaSeq X and all of our instruments, laying the groundwork for increased consumables demand. We’ll continue working closely with our customers around the world, whether they’re integrating new instruments into their workflows, starting new projects, or building new tests or assays.

Second, we need to keep driving innovation that is highly focused on our customers’ priorities. These innovations include automation and sample-to-answer solutions, serve to strengthen our leadership position around the world. At the same time, we need to manage our R&D investments with discipline and rigor. We most recently launched our 25B Rating Kit. This was highly anticipated by our customers, and it will unleash the full power of the NovaSeq X. Third, we need to focus our own operational excellence across geographies, functions, and processes. Earlier this year, we announced a plan to reduce our analyzed run rate expenses. Our team has executed well and has been able to reduce analyzed run rate expenses by approximately $175 million, ahead of our original projection of more than $100 million.

These savings will continue to support flexibility in further investment in high-growth areas and our margins. I’m committed to executing against all of these priorities with a strong sense of urgency. We are focused on delivering tangible improvements that support profitable long-term growth for Illumina and for our shareholders. I will now invite the operator to open for the line of Q&A.

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Q&A Session

Operator: [Operator instructions] And our first question comes from Vijay Kumar with Evercore ISI.

Vijay Kumar: Hey guys, thanks for taking my question and Jacob, welcome to Illumina. My, maybe one question is on GRAIL, maybe a two-parter here. I think the EC’s divestiture order asked for 2.5 years of cash outlay. What does that mean given GRAIL’s current OpEx spending? Is that $1.75 billion of cash outlay? And I think related to that; I saw you announced a special committee. Who is on the special committee? What is the focus for this committee? Is there any more details? And it sounded something different, I just want to understand what is different, what has changed?

Jacob Thaysen: Yeah, Vijay, thank you very much and I’m really excited to be here at Illumina and let me start with your second question and then I’ll have Joydeep step in also on talking about what those 2.5 years means, but as I discussed here, coming into the company, I felt it was very important to get clarity on GRAIL and it was very important for me to have the support for the board and to make swift decisions to move forward and thereby, we started a special committee with three of the board members, including, and then besides me, that is the chairing of that committee. So I have three board members and plus me that will work with the management team and to really walk through all the elements around the divestiture order to make sure we can make some fast decisions.

We need to make decisions which path we’re going to follow. Is it going to be a trade sale, the spin, the split, without a sponsor and of course, there’s a lot of considerations related to that. That’s really what the special committee is helping me and the rest of the management team to do. Joydeep.

Joydeep Goswami: Yeah, Vijay. Hey, so on the 2.5 years of cash support or to GRAIL, we’re still working with the European Commission on exactly what that means in terms of a numerical number. So I’m not at liberty to disclose those details. We will come back with that once we have alignment, but I think as Jacob alluded to, this is not something that we have to provide all on our own. We have several options now that we have worked with the EC to come out with a, or to have a divestiture order that is in line with our expectations of flexibility to use even in the case of a spin or a split decision, we can get in a sponsor that can support all or a part of the requirement for the 2.5 years of cash support or we can go to the markets and raise that money as well. So stay tuned on that one.

Operator: And our next question will come from Dan Brennan with TD Cowen.

Dan Brennan: Hey, thanks for taking the questions here. Jacob, Welcome. Maybe just a last one, obviously, it’s all we have, but maybe a couple of parter. So maybe Jacob, obviously you left a great job at Agilent before coming here and certainly we’ll be interested to get your view on the growth rate and outlook from for Illumina when you’re ready to give that. But to be interested to get your view on kind of the overall NGS market and taking the job, like thoughts on what type of growth characteristics you think are reasonable in that market because given the price cuts, there’s just a lot of question on demand elasticity. So I guess first one is on the NGS overall market, if you had a view there and then B, I just had a question on the X specifically.

I understand, obviously, as a lowering the placement number given customer constraints, but can you give any color on the orders or the backlog that you have as of right now? And then the final part would just be on guidance. Illumina’s had a series of kind of guidance reductions. A lot of peers are facing the same issue, but you guys have had a more elongated period of this. I’m just wondering kind of what changes can be made in order to hopefully better set guidance so that the risk of these reductions is eliminated going forward, thanks.

Jacob Thaysen: No, thanks, Dan. And I think I would have Joydeep also jumping in on some of those elements here, but let me just start by coming here into Illumina and my observation both from when I was outside Illumina, but also coming in, I think that the core business has a tremendous opportunity. I think there’s a lot of opportunities in the NGS markets and I think we are definitely through a tough period right now. I think the whole life science tools industry is seeing it and certainly here at Illumina, we’re not immune for that, but the growth rates, even though I will spend time here over the next period of time still learning the business and really understand the organization. So at this point of time, I don’t have a final opinion about what I think is the right growth rates for the business and what we’re committing to, but I will certainly come back later in ’24 and share all of that with you when I’m ready for it.

But in the meantime, I think that the overall market is very healthy and there will be a lot of growth opportunities for Illumina going forward and I can then say that some of the findings coming into the company and really digging deep into our innovation engine and what our roadmaps look like. I’m very excited for the future of this company. I think we will continue to pioneer in this area. So I think on guidance and Joydeep joining here also, but in the end, we wanted to make sure when we signal also from, especially ’24 here that, that at this point, we want to be prudent in how we set our, it’s not a guidance yet, but at least how we view ’24, as we simply don’t see any change, short-term change in the economical environment and therefore we felt it was important for, to go out now and then share our observations, but Joydeep, do you want to?

Joydeep Goswami: No, I think, I think Jacob, that’s right. On the guidance piece, look, we made a commitment to you to come back to you with any read on the macroeconomics we see, and I think we’re held up to that commitment. In fact, we may have been a little bit canary in the coal mine signaling some of this earlier to you, especially this year than others, right? One of the things, of course, you did bring up with the elongated, sort of lack of growth or the reduced growth that we have had. That is true. I think, part of what hit us at the same time as the macroeconomics going down is the transition, major transition on our platform, which has hit us as customers move from the 6,000 to the X, but there’s a gap between when they run down some of their inventory on the X and then wait to fully ramp up on the X.