Good day, ladies and gentlemen, and welcome to the Second Quarter 2022 Illumina Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's call is being recorded. I would now like to hand the call over to Salli Schwartz, Vice President of Investor Relations. Please go ahead.

Hello, everyone, and welcome to our earnings call for the second quarter of 2022. During the call today, we will review the financial results released after the close of the market and offer commentary on our commercial activity, after which we will host a question-and-answer session. If you have not had a chance to review these earnings releases, they can be found in the Investor Relations section of our website at illumina.com. Participating for Illumina today will be Francis deSouza, President & Chief Executive Officer; and Joydeep Goswami, Chief Strategy and Corporate Development Officer as well as Interim Chief Financial 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, pending the outcome of the European Commission's investigation into Illumina's acquisition of GRAIL, the commission has adopted an order requiring Illumina and GRAIL to be held and operated as distinct and separate entities for an interim period. Compliance with the order is monitored by an independent monitoring trustee. During this period, Illumina and GRAIL are not permitted to share confidential business information unless legally required, and GRAIL must be run independently exclusively in the best interest of GRAIL. Commercial interactions between the two companies must be undertaken at arm's length. This call is being recorded, and the audio portion will be archived in the Investors section of our website. It is our intent that all forward-looking statements regarding our financial results and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based upon current available information, and Illumina assumes no obligation to update these statements. To better understand the risks and uncertainties that could cause actual results to differ, we refer you to the documents that Illumina files with the Securities and Exchange Commission including Illumina's most recent Forms 10-Q and 10-K. With that, I will now turn the call over to Francis.

Thank you, Salli. Good afternoon, everyone. Illumina delivered revenues of $1.16 billion in the second quarter, up 3% year-over-year or 5% on a constant currency basis. While sequencing activity across our markets was robust in the second quarter, with sequencing runs on our connected high and mid-throughput platforms growing more than 15% year-over-year and clinical growing even faster, our second quarter results were impacted by macroeconomic challenges that we expect to play out over the next couple of quarters. Specifically, some customers experienced supply chain pressures that delayed their lab expansions and others managed inventory and capital more conservatively. We also saw adverse effects of foreign exchange and anticipated COVID-related shutdowns in China. The robust sequencing activity levels, underlying growth of our target markets and our conversations with customers across the globe indicate these dynamics are temporary. During the quarter, we also made terrific progress on our innovation roadmap and are poised to soon deliver the next generation of breakthrough technologies that will fuel the next era of genomics. Turning now to performance across our platforms. In high throughput, NovaSeq shipments in Q2 grew 23% year-over-year, our highest second quarter ever. Consistent with prior quarters, clinical customers, primarily in oncology testing, drove half of our NovaSeq shipments. In mid-throughput, NextSeq 1000, 2000 orders were up 20% year-over-year. Despite some shipments shifting from Q2 to Q3 due to supply delays, Q2 NextSeq 1000, 2000 shipments increased slightly year-over-year. Low throughput shipments were relatively flat year-over-year, even with the comparison to last year's COVID surveillance-driven volume. Turning to our markets. We continue to gain traction in clinical, with sequencing consumable shipments for the second quarter, up 11% year-over-year, and all of our clinical markets contributing to the increase. As I mentioned earlier, we have seen continued growth in our oncology markets. In Q2, oncology consumables grew almost 20% year-over-year. An area of note is our market-leading TruSight Oncology Assay. Shipments of TSO grew 45% year-over-year, and we now have delivered comprehensive genomic profiling tests to every major market in the world. We have worked closely with large evidence programs to facilitate clinical utility and drive market access. And we have more than 10 pharma partners developing CDx claims with us. Most recently, we expanded our portfolio by co-developing a new TSO 500 HRD test with Merck, that leverages Illumina's work with Myriad Genetics. We also co-developed a pan-cancer companion diagnostic for TSO comprehensive EU with Bayer. Also in oncology, June marks the one-year anniversary of GRAIL's launch of Galleri. In that time, Galleri delivered the fastest ever first-year revenue ramp of a cancer screening test. GRAIL continues to drive progress in clinical evidence generation and commercial use of their multi-cancer early detection test, Galleri. The number of U.S. health systems partnering with GRAIL to offer Galleri continues to grow, most recently with the addition of Mercy, one of the 25 largest U.S. health systems, and Ochsner Health, the largest Gulf South Health system. Also, GRAIL recently partnered with AstraZeneca to develop companion diagnostic tests that will identify patients with high-risk early-stage disease. AstraZeneca will use GRAIL technology to recruit patients with early-stage cancer for AstraZeneca's clinical studies, making cancer medicines available where there is greater potential to transform outcomes. More broadly, the trials currently underway for Galleri continue to progress. The NHS-Galleri trial in the UK, the largest multi-cancer early detection study, has enrolled 140,000 volunteers in just over 10 months, an unprecedented speed, especially for a trial of this size. The pending successful completion of the trial, the NHS plans to roll out Galleri to an additional 1 million people starting in 2024. This collaboration supports the NHS long-term plan to transform cancer care with three and four cancers diagnosed at an early stage by 2028. Additionally, GRAIL has completed a final analysis of its PATHFINDER study, with data to be presented at the European Society of Medical Oncology Congress September 9 through 13. GRAIL has made substantial progress building a network of partners that will support ongoing adoption of Galleri. The commercial progress is proceeding at a more measured pace as health systems ramp up. For these reasons, GRAIL has revised its revenue guidance for the full year 2022 to a range of $50 million to $70 million. Turning to infectious disease and microbiology, the genomic surveillance infrastructure built on Illumina instruments during the pandemic in more than 100 countries is now being used for other diseases like monkeypox. This network is enabling a quicker genetic assessment of this new disease as momentum continues to build for a robust global pathogen infrastructure. We're expanding our surveillance portfolio accordingly. In June, we provided select customers access to our novel viral surveillance panel, based on workflows implemented for COVID-19. The panel provides targeted sequencing for the 66 most critical viruses of global public health concern, including monkeypox and polio, and will be commercially available later this year. Our research and applied markets were relatively flat year-over-year, with growth in the Americas and APJ, offset by declines in EMEA and China. In the quarter, we announced our partnership with Precision Health Research Singapore or PRECISE, to sequence whole genomes of 100,000 Singaporean participants. Together, we will develop Southeast Asia's most comprehensive population study and gather deep insights into Asian genomic diversity and key genetic, social, environmental and other factors associated with disease.

Thanks, Francis. As a reminder, our second quarter financial results include the consolidated financial results for GRAIL. I'll start by reviewing our consolidated financial results, followed by segment results for core Illumina and GRAIL, then conclude with additional remarks on our current outlook for 2022. I'll 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 second quarter, consolidated revenue was $1.16 billion, up 3% year-over-year or 5% on a constant currency basis, net of the effects of hedging. Revenue was impacted by the macroeconomic factors that Francis referenced. As you know, we had anticipated the headwinds from the China shutdowns, the negative impact of FX and slowing COVID surveillance. Each of these were slightly worse than we expected, and collectively, they drove one-quarter of the variance between our expectations and actual results. The remainder of this variance was driven by the lab expansion delays encountered by a few of our large customers as a result of global supply chain constraints, as well as customer inventory and capital management. Nonetheless, overall sequencing activity on our connected instruments was strong in the second quarter, with sequencing runs in our high and mid-throughput instruments growing more than 15% year-over-year. We believe this is a useful reference that shows the general activity trend across our installed base and is directionally correlated with revenue over time. For the second quarter, GAAP net loss was $535 million or a loss of $3.40 per diluted share, which included $609 million in legal contingencies recorded in Q2 due to the potential fine that the European Commission may impose related to our GRAIL acquisition and settlement of our litigation with BGI. Non-GAAP earnings were $91 million or $0.57 per diluted share, including dilution from GRAIL's non-GAAP operating loss of $152 million for the quarter. Our non-GAAP tax rate was 25.8%, which increased 790 basis points year-over-year and 800 basis points from Q1 2022, primarily due to the increased impact of R&D expense capitalization requirements implemented by the Tax Cuts and Jobs Act of 2017. Our non-GAAP weighted average diluted share count for the quarter was approximately 159 million. Moving to segment results, I will start by discussing the financial results of core Illumina. Core Illumina revenue of $1.16 billion grew 3% year-over-year or 4% on a constant currency basis, net of the effects of hedging. Core Illumina sequencing consumables grew 6% year-over-year to $744 million, driven by almost 20% growth in oncology testing. Core consumables growth more than offset headwinds from lockdowns in China, the completion of the UK Biobank program in quarter three of 2021, reductions in COVID surveillance, and negative FX impacts. Sequencing instruments revenue for core Illumina grew 1% year-over-year to $119 million, driven by 23% growth in NovaSeq shipments, offset by a 14% decrease in mid-throughput shipments year-over-year. The decrease in mid-throughput shipments was primarily due to headwinds from COVID surveillance and COVID lockdowns in China with NextSeq 1000, 2000 growth more than offset by a decrease in NextSeq 550. NextSeq 1000, 2000 instruments continued to grow year-over-year and the growth would have been stronger had it not been for temporary supply constraints that delayed shipments into the third quarter. NextSeq 1000, 2000 orders were up 20% year-over-year, with continuing strong adoption of our newest platform. During the second quarter, COVID surveillance contributed approximately $25 million in sequencing consumables revenue and $2 million in incremental instruments revenue, representing a decline of 55% year-over-year. This decline was driven by lower than expected testing samples and the expected decline in instrument shipments, as COVID surveillance capacity was largely established in 2021. Core Illumina sequencing service and other revenue of $125 million was down 2% year-over-year, driven by $20 million of one-time revenue recognized in 2021 from NIPT royalties received related to a patent litigation settlement, partially offset by increased instrument service contracts and contributions from oncology co-development partnerships. Moving to regional results for core Illumina. Revenue for the Americas region was $633 million, up 7% year-over-year, primarily due to NovaSeq strength with continued demand from oncology testing customers driving instrument placements and consumables growth. Growth in the region was nonetheless lower than expected primarily due to customer lab expansion delays and inventory and capital management we have mentioned during the call. EMEA revenue of $308 million represented a 4% decrease year-over-year, but a 1% increase on a constant currency basis, net of the effect of hedges. Sequencing growth driven by clinical and large-scale research projects was more than offset by the UK Biobank program in 2021 and a decline in COVID surveillance revenue. Cumulatively, these significant headwinds and FX negatively impacted year-over-year revenue growth by 20 percentage points. Greater China revenue of $118 million represented an 11% decrease year-over-year and a 10% decrease on a constant currency basis. This was slightly more negative than the approximately $35 million headwind to guidance we provided last quarter. As expected, the region continued to be impacted by prolonged COVID-19 restrictions and shutdowns that began in March this year. Finally, APJ revenue of $97 million grew 14% year-over-year or 20% on a constant currency basis, net of the effects of hedges. Growth in the region was primarily due to increased NovaSeq shipments, which doubled year-over-year, driven by large-scale research project demand as well as strength in NIPT and oncology testing. Moving to the rest of core Illumina P&L. For Illumina non-GAAP gross margin of 69.8% decreased 200 basis points year-over-year, primarily due to less fixed cost leverage on lower manufacturing volumes, margin impact from one-time revenue from a patent litigation settlement in 2021, and increased freight costs attributable to broader global supply chain pressures. These factors were partially offset by a more favorable product mix, as well as a number of productivity initiatives we continue to execute. Core Illumina non-GAAP operating expenses of $519 million were up $48 million year-over-year, due primarily to headcount growth and investments we're making in R&D to support the continued advancements of our innovation roadmap. Despite the year-over-year increase, non-GAAP core Illumina operating expenses were lower than we originally planned, as a result of lower performance-based compensation expense, given our lower revenue outlook and cost containment initiatives focused on select hires and discretionary spend, including travel. Transitioning to the financial results for GRAIL. GRAIL revenue of $12 million for the quarter consisted primarily of Galleri test fees. GRAIL non-GAAP operating expenses totaled $156 million for the quarter and consisted primarily of expenses related to headcount and clinical trials. These expenses were lower than expected, as GRAIL managed its project spend in light of its lower quarterly outlook. Moving to consolidated cash flow and balance sheet items. Cash flow from operations was $125 million. DSO was 50 days compared to 46 days last quarter due to revenue linearity. Second quarter 2022 capital expenditures were $71 million and free cash flow was $54 million. We did not repurchase any common stock in the quarter. We ended the quarter with approximately $1.3 billion in cash, cash equivalents and short-term investments. Moving now to 2022 guidance. We have revised our outlook for the full year to represent the macroeconomic factors we observed through early August, and we assume will continue for the rest of the year. We now expect full-year 2022 consolidated revenue to grow in the range of 4% to 5%, including core Illumina revenue growth in the range of 3.5% to 4.5%, and GRAIL revenue of $50 million to $70 million. For the full year, at the midpoint of our revenue guidance range, we now expect core Illumina sequencing revenue to grow approximately 4.5%. This includes intercompany sales to GRAIL of approximately $25 million, which are eliminated in consolidation. Within core Illumina sequencing revenue, we now expect instrument growth of 1.5% and consumables growth of 5%, which reflects NovaSeq pull-through in the range of $1.1 million to $1.2 million for a system for 2022. We continue to expect pull-through for NextSeq 1000, 2000 in the range of $130,000 to $180,000 per system, and for the NextSeq 550 in the range of $100,000 to $150,000 per system. For MiSeq, we continue to expect pull-through in the range of $35,000 to $45,000 per system. And for MiniSeq, we continue to expect pull-through in the range of $20,000 to $25,000 per system. We now expect revenue from COVID surveillance in the range of $110 million to $130 million. While we anticipated a decline in COVID surveillance in 2022, the deceleration has occurred at a more rapid pace than we previously forecasted. As we navigate the macroeconomic factors we have mentioned, we're implementing multiple strategies, including prioritizing key innovation investments and critical hires, while pausing investments that can be made at later times. We've retained all critical investments in our innovation roadmap, including NovaSeqDx, Chemistry X, our Infinity long-read technology and our TSO portfolio. We now expect consolidated non-GAAP operating margin in the range of 11.5% to 12% and core Illumina non-GAAP operating margin in the range of 24.5% to 25%. We expect the consolidated non-GAAP tax rate of approximately 14%, which continues to assume that the R&D expense capitalization requirements implemented by the Tax Cuts and Jobs Act of 2017 will be repealed or deferred in Q4. And we now expect non-GAAP earnings per diluted share in the range of $2.75 to $2.90, which includes dilution from GRAIL non-GAAP operating loss of approximately $610 million, in line with previous expectations. Lastly, we continue to expect diluted shares outstanding of approximately 159 million shares for 2022. For the third quarter of 2022, we expect consolidated revenue to be flat to 1% higher year-over-year from the third quarter of 2021. We expect consolidated non-GAAP operating margin to be approximately 5%. We expect core Illumina non-GAAP operating margin to be approximately 20%. We expect consolidated non-GAAP tax rate to be approximately 22%, which continues to reflect the negative impact from the R&D capitalization requirements, which we expect will be repealed or deferred in the fourth quarter of this year. And lastly, we expect diluted shares outstanding to be in line with our full year 2022 guidance of approximately 159 million shares. I will now hand the call back over to Francis for his final remarks.

Thanks, Joydeep. Turning to our innovation roadmap, we have significant opportunities to reimagine the power and potential of genomics. Development and registration activities for NovaSeqDx, the first-ever high-throughput clinical sequencer are progressing as planned and on track for a Q4 launch. We continue to get good feedback from initial customers on our Infinity Long Read technology with many saying it has the potential to replace on-market long reads for a broad range of applications, including human rare diseases. Infinity is on track to be available later this year for early access customers. In Multiomics, our partnership with SomaLogic to accelerate NGS into proteomics is progressing, and we expect to deliver our ultra-high throughput ultra-high plexity assay in 2024. Turning now to Chemistry X. Our next-generation breakthrough SBS chemistry, we’ve made fantastic progress over the last quarter. We’re now producing flow cells using our new manufacturing process based on 300-millimeter wafers. We successfully tested Chemistry X on the new flow cells and the results exceed our expectations for quality, cost and speed. We're excited to showcase these breakthroughs and reveal how they come to life at the Illumina Genomics Forum. And we look forward to hosting you at our Investor Day on October 3rd, where we will discuss these technologies and our long-term growth strategies. If you haven't already registered, please be sure to do so soon. I'll now invite the operator to open the line for Q&A.

Thank you. We'll take our first question from Derik De Bruin at Bank of America. Please go ahead.

Hi. Good afternoon. So Francis, I’m a bit perplexed on the lab expansion comments, as channel checks and discussions at AGBT in June didn’t suggest that this was happening. So is this more of an issue with your clinical customers not expanding? And how do you know it wasn’t the impact of them evaluating competing products? And just exactly how much consumable inventory is there still in the channel? Thank you.

Hi, Derik. So in terms of the lab expansion, what we saw happen in Q2 was a few of our customers that had plans to launch new labs or expanded labs experienced some delays on their own because of their own supply chain issues; equipment that they were expecting to get for those expanded labs didn’t come in as they expected. And so we saw a few lab expansion plans delayed, some into Q2, into Q3, and then one into Q4 of next year. As you can imagine, we are very close to our customers. So we know the specifics of those lab expansions. And to be clear, those lab expansions are delayed, but still progressing. And so that’s what’s driving the number we talked about, both in Q2 and for the rest of the year. In terms of inventory, what’s playing out is some of our customers that are looking to manage their capital more closely are holding less inventory on their site. They have a lot of confidence in the resilience of our supply chain. And so they’re looking to trim back the inventory levels that they hold on their own site. And so from our perspective, we expect that to play out. It started to play out in Q2. It will play out a little bit in Q3 and 4 as well. But in the end, their demand activity levels are going to match what we are seeing from the data that we get from monitoring their instruments. And there, the activity and therefore, demand continues to be very robust. As we said in Q2, the activity levels that we’re monitoring on the high and mid-throughput instruments reflected a growth rate in runs that are greater than 15%. And so as we work through these transitory impacts, we fully expect both demand and therefore, orders to more closely match the activity levels that we’re seeing.

We'll take our next question from Dan Brennan with Cowen. Please go ahead.

Thank you for taking my questions. I would like to follow up on Derik’s question and ask a related one. Regarding the decline expected in the second half, the updated guidance for core Illumina growth indicates flat growth for the latter part of the year, compared to the high teens growth you initially projected. Could you provide more insight into this decline? Is there a significant level of conservatism in this guidance, or how should we understand the reasoning behind this reduction given that a few customers are holding back? Additionally, as a related question to Derik's point, are you noticing any delays, possibly due to the impending launch of Chemistry X, which might lead customers to pause? Or is there any impact from competitive pressures that could help clarify the situation? Thank you.

Yes. Thanks for that question, Dan. And maybe I’ll start with the second half, and then I’ll turn it over to Joydeep to sort of size the magnitude of the factors that we talked about. From what we are seeing and what we are hearing from our customers, the challenges that our customers are addressing are around their lab expansion delays, as I said, related to dealing with their own supply chain for the expansion of their labs. And again, tighter management of their inventory levels. And that really were some of the big drivers of the change in addition to a little bit of foreign exchange and so on. And so what they’re telling us is this isn’t really related to Chemistry X or any competitive issues. In fact, they’re excited to hear about Chemistry X, and they’re looking forward to learning more about it at the Illumina Genomics Forum. But really, what’s driving the change are the factors that we talked about. And maybe I’ll turn it over to you, Joydeep, to shed some more color on the size of that.

Thank you, Francis. Regarding your question about the forecast for the second half, we believe it is conservative but balanced based on current trends. There are always upsides and downsides to consider. The factors affecting our outlook from the second quarter are expected to persist through the rest of the year. Specifically, about 25% of the decline is attributed to foreign exchange impacts, a quicker-than-anticipated acceleration related to COVID, and some declines in China due to GDP-related effects on our research operations there. The remaining 75% is associated with lab expansion delays caused by broader supply chain issues, which are affecting our customers’ construction of labs and the introduction of new assays and instruments. Additionally, macroeconomic headwinds are temporarily reducing inventory levels and leading to some capital expenditure postponements among our customers.

We'll take our next question from Dan Arias with Stifel. Please go ahead.

Good afternoon, guys. Thanks. Francis, maybe just back on the consumable side. You’ve talked a lot about the fact that the outlook for sequencing there is good, because that work essentially has to be done in order to support patient assessment. So what’s slamming the brakes on purchasing so abruptly? Is it more development on the commercial side related to things like liquid biopsy work, or are you actually seeing lower spending at patient-facing institutions, clinical oncology institutions, etc.? And then just a follow-up, why no preannouncement when Sam left, only three weeks left in the quarter? So it seems like a miss was well on its way at that point. Thanks.

Sure. Let me address both parts of your question, Dan. First, on the consumables and demand issue, you’re correct that serving clinical customers has led to strong continued demand. Many of our clients are focusing on cancer patients who require tissue biopsies for sequencing or ctDNA tests. This demand was evident in the activity levels we observed in Q2. Even though our customers are tightening their inventory management, they are still heavily utilizing their machines. Overall, if we look at the activity on mid and high-throughput instruments across our customer base, we reported a 15% year-over-year increase in runs. In the clinical markets, particularly in areas like oncology therapy selection testing, which is our largest segment, demand remains robust, as reflected in their activity levels. However, our clients are looking to manage their cash more conservatively and have reduced the inventory held on-site. This adjustment can be seen as a temporary rebalancing. Ultimately, we believe their ordering levels will align with the actual activity on their instruments. Therefore, we expect this impact to be felt somewhat in Q2 and in the following quarters, but order rates should match the activity we’re observing. Now, regarding Sam, he departed for personal reasons and needed to relocate to the East Coast, which was communicated at the time of his departure. It’s important to note that our financial quarters tend to be more back-end loaded, so the impact I mentioned became clearer towards the end of the quarter, which is why there was no commentary when Sam left.

We'll take our next question from David Westenberg with Piper Sandler. Please go ahead.

Hi. Thank you for the question. I’d like to revisit the quantification of the guidance. If you exclude the guidance, it appears to be $400 million. The foreign exchange situation worsened; do you want to provide specifics on that? Also, what is the COVID surveillance number? I know GRAIL was $20 million, plus there's the lab expansion. Are there any other factors you can mention? Additionally, I’d like to discuss the instrument and the backlog. You seemed optimistic about the backlog at the end of the quarter, but it appears those orders didn’t materialize as expected. What’s happening with that? Thank you.

Thank you for the question, Dave. To clarify, about 25% of the shortfall was due to factors such as foreign exchange fluctuations, a quicker-than-anticipated drop in COVID surveillance, and macroeconomic challenges in the second half of the year, particularly relating to slower GDP growth in China. The remaining 75% can be attributed primarily to two issues: delays in lab expansion, which we believe will improve in 2023 based on customer feedback, and the slower recovery of inventory levels along with some capital delays from various customers. As Francis noted, we expect these challenges to be temporary. Regarding the backlog, we ended Q2 with a robust backlog of $1.1 billion, consistent with what we've observed over the past six quarters. While backlog can fluctuate from quarter to quarter, this figure aligns closely with our historical performance, which has been solid.

We'll take our next question from Julia Qin with JPMorgan. Please go ahead.

Hi. Thank you for the opportunity to ask a question. I have two follow-ups regarding the guidance. Firstly, I noticed that you have adjusted the pull-through guidance for NovaSeq to between $1.1 million and $1.2 million. Since you mentioned that volume utilization remains strong, are there any pricing factors contributing to this updated guidance? Secondly, regarding GRAIL, you've lowered the guidance by $20 million. Given that NHS appears to be making good progress, could you clarify the reasons behind this adjustment? Thank you.

Thank you, Julia, for your question. Let me address the NovaSeq pull-through first. This is not related to pricing pressures. The pull-through is influenced by several factors, including shipments in the quarter and the number of instruments activated at a specific time. This quarter, both of these factors played out in an unexpected way. While the number of runs was strong due to inventory adjustments, the actual shipments were slightly lower than anticipated. This was partly because some customers purchased many NovaSeqs in previous quarters, and there were delays in lab expansions that meant some instruments weren't activated. As a result, the pull-through calculation was skewed. We expect the pull-through number to be lower this quarter because of these two reasons. However, looking ahead, we believe that the strong growth in runs across our high throughput customers and the ongoing demand for sequencing in areas like MRD, oncology testing, and proteomics will lead to long-term growth in this metric. You also asked about GRAIL. GRAIL has demonstrated significant market acceptance and has the fastest revenue growth in its first year of any screening test available. Although GRAIL's numbers are somewhat below our initial expectations, it remains a strong test, and we are seeing solid adoption in various hospital systems nationwide. We are optimistic that the ordering from these committed systems will increase, and we maintain a positive outlook on the quality of the test and its future potential.

We'll take our next question from Tejas Savant with Morgan Stanley. Please go ahead.

Hey, guys. Good evening. Just a quick follow-up to kick things off there on the pricing, but from a more forward-looking perspective here. Francis, you mentioned some customers thinking harder about CapEx. Some of them are even undergoing restructuring as we've seen this quarter. I was curious as to how you're thinking about this weighing on growth in 2023 and perhaps more importantly, in the near term. How, if at all, does this change how you’re thinking about pricing for Chemistry X, backward compatibility options for Chemistry X and so on?

In response to the macro challenges our customers are facing, we continue to stay closely connected with them. They rely on us as a crucial supplier for their business and revenue, and we play a key role in their operations. Thanks to the strength and resilience of our supply chain, our customers feel more confident managing lower inventory levels, which aids their cash flow. However, they must still address the demand they are experiencing, as this demand drives their revenue and growth. We have not observed any decrease in activity levels from our customers, as our involvement remains central to their success. We're also closely monitoring their lab expansion plans and are attentive to when they will receive equipment for new labs. Regarding pricing, we believe there is a significant opportunity to expand the genomics market by lowering costs for high-quality and accurate sequencing. This belief holds true not only in research markets but also in emerging clinical markets. For instance, we are seeing encouraging developments in areas like cardiovascular and neurological diseases, which will require extensive research as well as potentially different pricing for clinical applications. Our goal remains to make genomics more accessible by reducing costs. Regarding Chemistry X and our instruments, we believe we can offer Chemistry X on existing market instruments, which provides us with an opportunity. We will be considerate of customers who have purchased newer instruments that may still be in their depreciation period, focusing on making Chemistry X available on those platforms. For older instruments that have completed their depreciation cycle, we see a chance to facilitate upgrades not just with Chemistry X innovations, but also with advancements in other technology components, such as optics and data pads, allowing us to deliver transformative new instruments. This is our current perspective moving forward.

We'll take our next question from Puneet Souda with SVB Securities. Please go ahead.

Yes, hi Francis. Thank you for addressing the questions. My first question is about the customer base. Can you provide some insight into who these customers are? I'm curious if they are primarily related to COVID, oncology, or genome centers, especially in terms of their lab expansion plans. It seems that's where the challenge lies. When we examine the life science tools companies in your peer group, many have achieved considerable growth despite facing supply chain issues in the first quarter, with those challenges being particularly severe. These labs have successfully received a significant number of instruments, which has contributed to the strong performance of the peer companies. So, I'm interested in understanding what sets Illumina instruments apart or what is distinctive about these customers. Additionally, regarding GRAIL, while you're highlighting it as the fastest adopted test, you're also revising your guidance downwards. I'm trying to grasp if there are any unique dynamics at play with specific customers in this context. Thank you.

Yes, let's address both points. Regarding the labs, I understand you're asking about those that are postponing their expansion plans. There are a few customers in this category, specifically those focused on genomics and operating genomics labs. While this trend might not be visible in the broader life sciences tools market, it's certainly evident in the sequencing sector. These customers are typically on a growth trajectory, having plans for expansion due to their success in markets with increasing demand, such as oncology. They are significant customers, growing rapidly, and facing notable demand for lab expansions. Most of these genomics labs primarily utilize Illumina's products, which is why these developments directly benefit us. As for GRAIL, their growth in the first year has been exceptional. They recently completed a 140,000-person trial for the NHS in just 10.5 months, a process that usually takes years. This rapid enrollment highlights market demand for their groundbreaking test that can detect 50 types of cancer at various stages. While we're optimistic about GRAIL's ongoing growth, the team has slightly adjusted their estimates for the remainder of the year based on the ramp-up in some health systems and employers that have come on board. Nonetheless, GRAIL remains the fastest-growing cancer screening test ever recorded.

We'll take our next question from Kyle Mikson with Canaccord. Please go ahead.

Hey, thanks for taking the question. Just a few on the guidance. So I was just curious about components of instrument revenue for ’22, 1.5% year-over-year. Maybe Joydeep, can you talk about expectations for placements versus orders versus pricing, maybe pricing is locked in or not locked in at this point? Just given the backlog commentary, it was a very strong kind of like entering the year and recently, just how is that trending recently and going forward? And kind of relatedly, the year-over-year decline in mid-throughput shipments in 2Q. I mean I hear you on China and the other factors, but any chance that’s partially due to the platform evaluation process as these new vendors into the market or at least make some noise because obviously, the large clinical labs already test driving these products, so it’s just worth asking? Thanks.

Yes. Thank you, Kyle. Let me begin by discussing the second quarter performance related to mid throughput. As I mentioned, we experienced very strong orders for the NextSeq 1000 and 2000, which are our latest platforms. There was a temporary supply chain issue on our side that delayed the delivery of these orders in the second quarter, but they have since been delivered in this quarter. We are very optimistic, and we see a robust demand for our mid-throughput platform from both research and clinical customers. Looking at the full year, starting with NovaSeq, we had a strong first half of the year, with orders up 30% year-over-year. In the second quarter, we saw a 23% growth. This platform has been on the market for six years, and we are witnessing unprecedented demand, building on a very strong year in 2021. It's important to note that most of these instruments have been deployed already. We anticipate that the demand for consumables associated with these instruments will continue to grow in the coming quarters and years. Overall, we are confident in our portfolio, both in the high-throughput and mid-throughput segments.

We'll take our next question from Patrick Donnelly with Citi. Please go ahead.

Hey guys, thanks for taking the question. Francis, maybe one for you just in terms of kind of the operational spend that you guys are doing. You obviously kind of talked about the op margin pull down in the back half. Can you talk about how you’re balancing some of the growth investments with also being mindful of kind of insulating the margins, protecting the bottom line? Obviously, you have Chemistry X and Infinity coming up. I would assume you’d want to invest in kind of the launches there. So maybe just talk about, again, kind of that balance of investing for growth and at the same time, kind of realizing with things slowing, you protect the bottom-line a bit and where you’re pulling back and where you’re pushing forward? Thanks.

Yes. Sure, Patrick. So obviously, with the revised revenue outlook for the year, we are taking a look at our spend and exactly as you said, doing that balance. On the one hand, we’re looking for areas where we can contain costs. That means pulling back on discretionary items, for example like travel and other discretionary spend. And we’re also prioritizing the hiring that we’re doing. And so, there are some hires that we will put off because we don’t think it’s essential to do right now. So, the team is absolutely doing that book. Having said that, we’re also protecting our innovation roadmap, as well as essential hires in other parts of the company as we scale the business. We have very ambitious product plans, as you know and we’re going to continue to protect that roadmap because that’s what drives the success of our customers and our long-term success and that’s what creates the long-term shareholder value in the company. So that’s the balance we’re doing. We’re protecting the innovation roadmaps. We’re protecting activities that drive that long-term shareholder growth, including things like capacity expansions, IVD capabilities commercial expansions in targeted markets and sort of maintaining that balance.

Yes, I would also add, we continue to have productivity improvements on our gross margin side as well, right? So that’s, of course, despite the reduced volume that we have seen this year. Some of those improvements are contributing to increased gross and operating margin as well.

We'll take our next question from Vijay Kumar with Evercore ISI. Please go ahead.

Hey guys. Thanks for taking my question. Francis, maybe a 2-part question for you. Your guidance for the back half, it implies 1% growth. You just did 3% in 2Q. Are you – is the guide assuming things to worsen from 2Q levels? Because if I understood you, some of these are temporal factors. If I look at your inventory on-hand, I don't think your customers stock up 12 months. So, shouldn't some of these factors were – how conservative is this guidance for the back half? And on Chemistry X, I think we've heard a 30% price cut 20%, 30%, somewhere in the ballpark. Does it have any implication to revenue growth for fiscal '23? Thank you.

Thank you. To address the first part of your question regarding Q3 guidance and the factors influencing that number, I will highlight several key points. When adjusting for the impacts I'm mentioning, the growth appears to be higher, and I will revisit that momentarily. Some of the influencing factors include the decline in COVID surveillance demand, which is affecting Q3. There's also a foreign exchange impact and a challenging comparison with the UK Biobank that ends in Q3. Additionally, we anticipate continued slower GDP growth in China, which will have effects on us. The issues surrounding inventory management and lab expansion are also significant factors we've considered while setting our Q3 guidance. If we adjust for these issues, the growth rate in Q3 would be considerably higher.

We'll take our last question from Jack Meehan with Nephron. Please go ahead.

Thank you. Good afternoon. Francis, I have a two-part question for you on GRAIL. So, the first is just given the prolonged regulatory uncertainty here, is there a point where you could choose to walk away? What's your conviction level on getting this done? And then second off, that obviously now isn't the most accommodating environment for capital markets activity. So, in a scenario where you might have to spin GRAIL out? How would you fund the ongoing operations? I look at your balance sheet after the BGI payment and that you define you have your marks through European Commission, you have roughly $550 million of unrestricted cash. So just talk about if you got to that, how would you finance a spin if it ends up there?

I’ll begin by stating that our ongoing priority is to focus on initiatives that enhance long-term shareholder value. As we pursue this strategy, we truly believe that merging GRAIL and Illumina will yield significant long-term benefits for shareholders. For instance, the GRAIL team has already achieved the quickest 12-month ramp of any cancer screening test in history, which shows their potential. I can only imagine the impact this could have with Illumina's support. Looking ahead, we see opportunities to take this test into markets in Europe, Asia, and Africa, building on GRAIL's existing plans. This perspective is what guides our strategy. That being said, we will continue to evaluate the best next steps as we navigate this process. There are various pathways we could take, including the possibility of spinning out GRAIL if regulatory challenges arise or considering alternative exit strategies. We'll keep this in mind as we proceed through the regulatory phase. Regarding your question about funding operations, this will be a key factor as we explore options for a potential spin-off. Our goal is to protect the asset value so GRAIL can remain focused on its mission, which requires ensuring it is well-capitalized and has access to future funding for its expansion plans. This capital could come from Illumina, existing shareholders, and possibly new investors during divestiture and beyond. These considerations will shape how we approach any potential divestment and establish a successful future for GRAIL. While we are not making immediate decisions, these factors are important in our ongoing discussions.

Thank you for joining us today. As a reminder, a replay of this call will be available in the Investors section of our website. This concludes our call, and we look forward to our next update with you at Investor Day on October 3.

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation. You may now disconnect.