Good day, ladies and gentlemen, and welcome to the First 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.

Hello everyone, and welcome to our earnings call for the first 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 Francis deSouza, President and Chief Executive Officer; and Joydeep Goswami, Chief Financial Officer and Chief Strategy and Corporate Development Officer. Francis will provide an update on the state of Illumina's business and Joydeep will review our financial results which include GRAIL. As a reminder, GRAIL must be held and operated separately and independently from Illumina pursuant to the interim measures ordered by the European Commission, which prohibited our acquisition of GRAIL under the EU Merger Regulation. This call is being recorded and the audio portion will be archived in the Investor section of our website. It is our intent that all forward-looking statements regarding our financial results and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based upon current available information, and Illumina assumes no obligation to update 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 revenue of approximately $1.09 billion and diluted non-GAAP EPS of $0.08 in Q1, both ahead of the guidance we provided at the beginning of the year but down year-over-year, as expected. Joydeep will take you through more detail later in the call. Our focus for the rest of the year is to deliver sequential growth primarily by scaling the production and distribution of NovaSeq X, driving elasticity on the back of its increased capabilities, and improving margins. We will share more on each. We achieved key product milestones in Q1, including shipping the first NovaSeq X systems. We also launched Illumina Complete Long Read technology and Illumina Connected Insights, a cloud-based tertiary analysis tool that addresses a key barrier to adoption, and will enable more labs to perform comprehensive genomic profiling for advanced tumors. Turning to our performance across platforms, beginning with high-throughput. The NovaSeq X launch further strengthened Illumina's competitive position in high-throughput sequencing. The strong global interest for the NovaSeq X series continued in Q1 and we exited the quarter with over 200 orders received from more than 30 countries. Clinical demand continued to be stronger than expected, generating approximately 40% of orders, with some customers planning to leverage the NovaSeq X to launch new clinical offerings. About 15% of orders are from new-to-high throughput customers, like the clinical genomics lab that is leveraging NovaSeq X's ease of use and cost benefits to perform high-throughput whole genome, single cell, and RNA sequencing. Our manufacturing capabilities for NovaSeq X instruments and consumables are scaling nicely. We shipped 67 NovaSeq X instruments in Q1, above initial expectations of 40 to 50, and now expect to deliver more than 330 NovaSeq X instruments this year, up from 300. Customers' initial runs are showing robust data output and sequencing quality, with some customers reporting outputs greater than 7 terabases and more than 95% of bases above Q30, well ahead of published specifications. As customers take delivery of their NovaSeq Xs and plan their deployments, they are sharing examples about how NovaSeq X will unlock demand elasticity in the sequencing market. Customers are planning to leverage the X's greater output and lower price per sample to sequence more samples, perform more analyses per sample, and obtain more data per analysis. For example, a leading European life science research institute will use NovaSeq X to scale up its data-intensive research programs, specifically in multi-omics, spatial, and single cell, enabling them to deliver 'atlas-scale' projects. Within our clinical base, customers are using the greater output and cost savings of NovaSeq X to launch new sequencing-intensive offerings. Some customers are planning to move from targeted panels to exomes and genomes to achieve higher diagnostic yield and healthcare efficiency. An oncology customer is planning to use the X to launch liquid biopsy testing, which requires 12 to 15 times more sequencing than solid tumor testing. Some customers are using the cost and turnaround time benefits to enter deeper sequencing applications like minimal residual disease, or MRD, to build datasets at scale. We also saw continued demand for NovaSeq 6000, primarily for fleet expansions of existing workflows, and we shipped 17 NovaSeq 6000s in Q1. More than 80% of NovaSeq 6000 shipments were to clinical customers, and approximately 25% of shipments went to oncology testing. In mid-throughput, NextSeq 1k/2k unit shipments increased 6% year-over-year, as customers expand their existing fleets or continue to shift projects from the MiSeq and NextSeq 550. More than 20% of NextSeq 1k/2k units in Q1 were placed with new-to-Illumina customers. Our win rate in the mid-throughput segment remains strong, but we are seeing some sales cycles lengthen. Our low-throughput platforms continue to provide an entry point to sequencing. Approximately 30% of these shipments in the first quarter were to new-to-Illumina customers, further increasing our installed base and enabling adoption of sequencing across a broad customer network. Looking now at our clinical markets, Q1 marked an important milestone for Illumina, with clinical sequencing consumables revenue representing 50% of our total sequencing consumables revenue for the first time. In Q1, oncology testing consumables declined 3% year-over-year but increased 21% sequentially, driven by growing clinical testing volumes and increased product development in areas like liquid biopsy and MRD. Some customers in this segment are facing pressures to improve profitability, which may in turn slow down their ability to develop new tests and scale. Revenue from our market-leading TruSight Oncology assay, TSO 500, was greater than $25 million in the quarter, up 26% year-over-year across more than 540 accounts, driven by increased utilization and pull-through, particularly in Europe. In March, we announced the expansion of our partnership with Myriad Genetics to broaden access to homologous recombination deficiency, or HRD, testing. HRD is an important biomarker identifying tumors with a specific type of DNA damage, like those in ovarian, breast, prostate, and pancreatic cancers. Our TSO 500 HRD, a research-use-only test, is now available in the US, with early customers like Florida Cancer Specialists & Research Institute, one of the largest independent medical oncology and hematological practices in the United States. The expanded partnership also establishes a unique alliance to develop HRD as a companion diagnostic for novel agents targeting these tumors. There was significant progress for NGS-based oncology testing reimbursement this quarter in Europe, expanding the accessible market. Seven regions in Italy committed €10 million for next-generation sequencing in lung cancer. In Germany, health insurers commenced reimbursement for whole genome sequencing in pediatric cancer patients with relapse. And in the Czech Republic, funding for comprehensive genomic profiling was added to the national fee schedule, effective January 1st. Also in oncology, GRAIL saw accelerating demand in Q1 for its Galleri multi-cancer early detection blood test and delivered revenue of $20 million, exceeding plan, and representing 100% growth year-over-year. GRAIL non-GAAP operating expenses increased to $173 million, driven primarily by investments in clinical trials and scaling GRAIL's commercial organization. Since launch, GRAIL has received more than 85,000 Galleri test orders, with about 20,000 delivered in Q1 alone. The 140,000-participant NHS-Galleri trial, which completed enrollment in July 2022 in just over ten months, is progressing well, with more than half of study participants having returned for their second annual blood draw. The trial recently achieved its halfway point and is currently on track to meet retention targets. GRAIL continued to expand its partner relationships. Following a successful pilot last year, John Hancock, one of the largest life insurance companies in the US and a unit of Manulife, announced that it would expand access to Galleri to eligible life insurance customers. And Providence, a health system serving the Western US, expanded its partnership with GRAIL to offer Galleri to eligible individuals across its 52 hospitals and 900 clinics across seven states. In reproductive health, consumables shipments declined 4% year-over-year, primarily due to foreign exchange, but increased 14% sequentially due to continued coverage progress. In the US, Virginia and Michigan initiated state Medicaid coverage for NIPT in all pregnancies, adding about 4.3 million additional covered lives and more than 70,000 pregnancies per year. Genetic Disease Testing, or GDT, had a record quarter. In Q1, GDT consumables shipments grew 7% year-over-year and 6% sequentially. Coverage continues to grow for whole genome sequencing in patients with rare and undiagnosed genetic diseases. During the quarter, one of the largest US health insurance companies updated their policy to include Managed Medicaid lives in 16 states, adding approximately 3.8 million covered lives for whole genome sequencing. Also in GDT, earlier this month we announced a partnership with Henry Ford Health, a healthcare organization in the Detroit metro area and a leading US academic medical center, to assess how whole-genome sequencing can improve cardiovascular disease management, with a particular interest in diverse and underserved populations. Turning to our Research and Applied markets, sequencing consumables shipments were down 19% year-over-year, primarily due to the slowdown in COVID surveillance. Looking at the whole year, we are on track to deliver on our financial commitments for 2023 as well as some important releases in the coming quarters. Specifically, we will ship the ICLR enrichment assay, an affordable, high throughput, targeted long-read solution, in Q3 and XLEAP-SBS chemistry on NextSeq 1k/2k in the first half of 2024, delivering step-change cost, speed, and sustainability benefits on that platform. Finally, as we navigate through this dynamic environment, we are focused on delivering durable success for our shareholders through a balance of investing in breakthrough innovations for future growth, while delivering operating leverage through disciplined expense management across the organization. To that end, we announced earlier today our commitment to deliver Core Illumina non-GAAP operating margins of 25% in 2024 and 27% in 2025, while maintaining investment in the key elements of our innovation roadmap. Building on the cost reduction actions announced last November, we are taking additional steps to reduce our annualized run rate expenses by more than $100 million beginning later in 2023. This will accelerate progress toward higher margins as well as free up capital to increase investment in high-growth areas. I'll now turn the call over to Joydeep to discuss additional details on our results and outlook, as well as provide more detail on the steps we are taking to deliver on the cost reduction I mentioned.

Thank you, Francis. I'll start by reviewing our consolidated financial results, followed by segment results for Core Illumina and GRAIL, and then conclude with additional remarks on our current outlook for 2023. I will be discussing non-GAAP results, which include stock-based compensation. I encourage you to review the GAAP reconciliation of these non-GAAP measures which can be found in today's release and in supplementary data available on our website. In the first quarter, consolidated revenue was $1.09 billion, up 1% from the fourth quarter of 2022, exceeding the high end of our guidance range on stronger-than-expected shipments of NovaSeq X. Consolidated revenue was down 11% year-over-year, or down 9% on a constant currency basis, net of the effects of hedging. This was primarily driven by an expected year-over-year slowdown in COVID surveillance, COVID-related disruptions in China, the transition of some of our high-throughput customers to NovaSeq X, and customers managing constrained capital markets globally. Non-GAAP net income was $13 million, or $0.08 per diluted share, which included dilution from GRAIL's non-GAAP operating loss of $164 million for the quarter. Our non-GAAP tax rate was 27.3% for the quarter, which increased from 17.8% in Q1 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 dollar terms was the same in both periods, the impact to our effective tax rate in quarter one 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 $1.08 billion was down 12% year-over-year, which included an anticipated headwind from COVID surveillance of approximately 400 basis points. COVID surveillance contributed approximately $11 million in total revenue in Q1 2023 compared to $60 million in Q1 2022, reflecting a $49 million headwind. On a constant currency basis, Core Illumina revenue was down 10%, net of the effects of hedging. Core Illumina sequencing consumables revenue of $692 million was up 1% sequentially, but down 12% year-over-year, which included an approximately 500 basis point headwind from COVID surveillance. In addition to the slowdown in COVID surveillance, the year-over-year decrease was primarily attributable to lower NovaSeq 6000 consumables pull-through due to the headwinds I mentioned earlier, COVID-related disruptions in China, the transition of some of our high-throughput customers to NovaSeq X, and customers managing constrained capital markets globally. Total sequencing activity on our connected high- and mid-throughput instruments grew 6% from Q4 2022 and 3% year-over-year. Research & Applied grew 7% from Q4 2022 and declined 4% year-over-year. Clinical sequencing activity growth remained robust, up 7% from Q4 2022 and 15% year-over-year. 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 $154 million declined 27% year-over-year, including a 300 basis point headwind from COVID surveillance. As expected, the year-over-year decrease was primarily driven by lower NovaSeq 6000 shipments compared to a record Q1 2022, and a decrease in mid-throughput shipments due primarily to fewer NextSeq 550 placements in China. Stronger-than-expected shipments of NovaSeq X helped partially offset this impact, although we remain supply constrained in the first year of launch. We continued to see strong demand for NextSeq 1K/2K from new-to-Illumina customers. Core Illumina sequencing service and other revenue of $119 million was up 7% year-over-year, driven primarily by higher instrument service contract revenue on a growing installed base. Before moving to regional results for Core Illumina, I'd like to highlight that we've implemented a new global commercial structure to improve operating efficiencies and better align with local markets. We've integrated APJ with emerging markets across Middle East, Africa, Turkey, and CIS. Going forward, we will report regional results for the following regions: Americas, Europe, Greater China and AMEA, or Asia Pacific, Middle East, and Africa. Americas revenue of $605 million grew 5% sequentially from Q4 2022 and exceeded our expectations due to stronger-than-anticipated NovaSeq X shipments. Revenue for the region was down 6% year-over-year due to the expected decline in Research, driven by the slowdown in COVID surveillance and delayed recruitment for some large research projects. We continued to see strong demand for NextSeq 1k/2k in the Americas, with instrument shipments up over 20% year-over-year. Europe revenue of $261 million represented a 9% decrease year-over-year, or a 4% decrease on a constant currency basis, net of the effects of hedges. Growth in Clinical, led by oncology testing, was more than offset by the expected decline in COVID surveillance revenue as well as lower high-throughput instrument shipments due to supply constraints on NovaSeq X in the first quarter. Greater China revenue of $91 million represented a 28% decrease year-over-year, or a 23% decrease on a constant currency basis, net of the effect of hedges. The year-over-year decline was primarily driven by persistent COVID disruptions and liquidity and funding constraints at our customers. This resulted in lower sequencing consumables revenue and a decrease in mid-throughput instrument shipments compared to last year. We will continue to closely monitor and mitigate market headwinds in China through the rest of the year. Finally, AMEA revenue of $119 million declined 27% year-over-year, or 23% on a constant currency basis, net of the effects of hedges. As expected, the year-over-year decline was primarily caused by the completion of a large research project in Japan, lower COVID surveillance revenue and a decrease in NovaSeq 6000 instrument shipments, only partially offset by NovaSeq X shipments as demand in the region outpaced supply. AMEA revenue was also impacted by sanctions affecting our ability to conduct business in Russia. We expect the impact of sanctions to persist through 2023 and have reflected approximately $60 million in lower sequencing consumables revenue expectations for the region in our outlook for 2023. Moving to the rest of the Core Illumina P&L: Core Illumina non-GAAP gross margin of 65.2% decreased 500 basis points year-over-year, primarily driven by less fixed cost leverage on lower manufacturing volumes, and lower instrument margins due to the NovaSeq X launch, which is typical with a new platform introduction. We expect gross margins to improve sequentially through the year as we scale NovaSeq X manufacturing and continue to drive operating efficiencies. Core Illumina non-GAAP operating expenses of $514 million were up $9 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 as a result of cost containment initiatives. Transitioning to the financial results for GRAIL: GRAIL revenue of $20 million for the quarter grew 100% year-over-year, driven primarily by accelerating adoption of Galleri. As expected, GRAIL revenue decreased sequentially due to a milestone payment in Q4 2022 related to MRD pharma partnerships. GRAIL non-GAAP operating expenses totaled $173 million and increased $34 million year-over-year, driven primarily by continued investments in clinical trials and to scale GRAIL's commercial organization. Moving to consolidated cash flow and balance sheet items. Cash flow provided by operations was $10 million. First quarter 2023 capital expenditures were $52 million, and free cash flow was negative $42 million. We did not repurchase any common stock in the quarter. We ended the quarter with approximately $1.5 billion in cash, cash equivalents, and short-term investments. During the first quarter, we used $500 million to repay the outstanding principal of our 2023 term notes that matured in March. Moving now to 2023 guidance. We still expect full year 2023 consolidated revenue to grow 7% to 10%, including Core Illumina revenue growth of 6% to 9%. As a reminder, these ranges include an anticipated headwind from COVID surveillance of approximately 200 basis points as well as a year-over-year headwind from foreign exchange rates. GRAIL revenue is still expected to be in the range of $90 million to $110 million for 2023. Our revenue outlook for 2023 now reflects the following offsetting factors: one, lower revenue in AMEA due to the impact of sanctions affecting our ability to conduct business in Russia; two, an increase in our NovaSeq X shipment expectations to more than 330 instruments; and three, higher contributions from our strategic partnerships related to drug discovery. As we have previously stated, we expect quarterly Core Illumina revenue to ramp sequentially throughout 2023, with linearity trends similar to 2017 when we launched the NovaSeq 6000, where we delivered approximately 54% of our total revenue in the second half of the year, including approximately 26% in Q3 and the remainder in Q4. Our revenue ramp for 2023 reflects the following assumptions: one, a quarterly ramp in NovaSeq X instrument shipments as the manufacturing capacity improves each quarter; two, sequencing consumables revenue increases as NovaSeq X customers kick off projects in the second half of 2023; and three, certain macroeconomic headwinds lessen in the second half of 2023, including a recovery from COVID disruptions in China. For fiscal 2023, at the midpoint of our revenue guidance: we now expect Core Illumina sequencing instrument revenue growth of approximately 13% year-over-year, reflecting our higher NovaSeq X shipment expectations; we now expect Core Illumina sequencing consumables revenue growth of approximately 5.5% year-over-year driven predominately by our lower revenue outlook for AMEA due to the impact of sanctions affecting our ability to conduct business in Russia; we continue to expect Core Illumina sequencing revenue to grow approximately 8% year-over-year. This now includes a higher contribution from sequencing service and other revenue primarily due to higher contributions from strategic pharma partnerships. We continue to expect non-GAAP earnings per diluted share in the range of $1.25 to $1.50 for 2023, including a consolidated non-GAAP operating margin of approximately 8% and Core Illumina non-GAAP operating margin of approximately 22%. We are reaffirming all other financial guidance for fiscal 2023 that we provided on February 7, 2023. Moving to the second quarter of 2023. We expect consolidated revenue in the range of $1.15 billion to $1.17 billion for Q2 2023, reflecting a sequential increase of approximately 670 basis points from Q1 2023 at the midpoint or approximately $70 million, primarily driven by: a sequential increase in NovaSeq X instrument shipments as manufacturing capacity continues to ramp; continued sequential growth in sequencing consumables and service revenue as new instruments continue to come online; a sequential increase in GRAIL revenue driven by accelerating Galleri adoption; partially offset by a sequential decrease in microarrays revenue due to historical seasonality. For the second quarter, at the midpoint of our revenue guidance range, we expect non-GAAP diluted EPS of approximately $0.01, reflecting consolidated non-GAAP operating margin of approximately 1% and Core Illumina non-GAAP operating margin of approximately 17%. These margins reflect a sequential increase in Core Illumina operating expenses driven by an increase in compensation-related expense due to our typical annual equity grant and merit adjustment in March. We continue to expect operating margins to improve in the second half of 2023 as revenue ramps and we scale our production of NovaSeq X and leverage the fixed cost of the manufacturing base. Looking forward, we are committing to achieve Core Illumina non-GAAP operating margins of 25% in 2024 and 27% in 2025. Illumina will reduce its annualized run rate expenses by more than $100 million beginning later in 2023. These cost savings will accelerate progress toward higher margins as well as free up capital to increase investment in high-growth areas. Illumina will achieve these savings through a combination of several actions. We will leverage the recent modularization of R&D innovation created as part of the NovaSeq X development, including XLEAP-SBS and new flow cell technology, to lower the cost and accelerate time to market for future platforms. We will achieve additional savings through leveraging our global footprint enabling activities at more cost-effective hubs. We are also streamlining our organization and processes, including rationalization of the company's global real estate portfolio and third-party vendor spend, as well as accelerating IT optimization efforts. The company will continue to prioritize innovations that generate highly differentiated products that are valued by Illumina's customers. I will now invite the operator to open the line for Q&A. Thank you.

Thank you. Our first question will come from Puneet Souda with SVB Securities.

Yeah, hi, Francis, Joydeep, thanks for taking the question. So, first one on the order book. It's good to see the increase there, but just wanted to get your expectations in terms of the overall funnel you're seeing? Could that 330 number continue to increase as you go through the year? And could you just help us understand your ability to ramp the production to deliver through the year? What sort of cadence should we be assuming per quarter in terms of installs? And then, if I may ask on sort of a GRAIL question, more operational and execution questions. I mean, historically, product cycle at Illumina has taken preference above everything, but there are just a number of distractions in terms of legal front with the European Commission, FDC and now you have an activist campaign as well. So, wondering if any of that risks the product cycle and the execution that you have here, or how separate are these efforts? Appreciate the responses on those. And then, if I could ask also about biotech funding. There have been questions around that from a peer today. Just wondering if you're seeing impact from any of the emerging biotechs and is that contemplated into your guide? Thanks for taking the questions.

Thank you, Puneet, for your questions. Let's address them one by one. The first question was regarding the X, its order book, and the current pipeline. You asked if the figure of 330 could potentially increase. The reality is that production capacity will be more of a constraint than demand. We are currently observing significant interest from our customer base in obtaining the X. Historically, we expected Research customers to be the earliest adopters, with Clinical customers lagging behind. However, this time, Clinical customers are showing strong demand as they seek to introduce new offerings on the X and delve into more sequencing-intensive options. We are also seeing considerable interest from first-time Illumina customers and those new to high-throughput sequencing. We believe that demand will continue to grow, but our shipping capacity will limit us this year. We are pleased with the progress our manufacturing and operations teams made in the first quarter, as we successfully shipped 67 instruments, surpassing our guidance of 40 to 50. Manufacturing is ramping up well, and we plan to ship 80 instruments in the second quarter, marking a significant increase from the first quarter. As we make gradual progress throughout the year, we aim to reach the target of 330. If our manufacturing capabilities improve beyond expectations, we will provide updates accordingly. Regarding the regulatory processes, while they are receiving attention, they involve a small portion of our company. The majority of our focus remains on launching the X, which is where we excel. Finally, in response to your question about biotech funding, our direct exposure to small and mid-cap biotech funding is minimal, so we do not foresee it having a significant impact on our revenue this year.

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

Thank you for the questions and congratulations on a strong start to the year. Regarding the X, could you provide some insights on the replacement ratio based on the current order book? How are existing NovaSeq customers approaching orders for the X? Additionally, we often hear about the X's ability to significantly expand capacity. As we progress through this year and next, how are you viewing customer interest in purchasing the X and utilizing its capacity? Does this pose any challenges? Also, regarding GRAIL, with three regulatory decisions pending and the EU directive anticipated soon, what do you believe is the likely outcome for GRAIL that investors should be aware of, and when can we expect more clarity on this? Thank you.

Thank you, Dan, for your questions. Let's begin with the X. We've seen a very strong start to the year, and we're quite excited about it. We've spent considerable time modeling what to expect regarding the market's absorption of Xs in the coming years. There are various perspectives to consider. One approach is to take a static view and think about the conversion from the 6000 to the X. We also need to factor in the number of new customers entering the market with the X. Let’s start by assuming this for now, and I will address elasticity shortly. As you may recall from our previous discussions regarding the 6000, we considered how to evaluate the upgrade cycle and the number of units needed to satisfy that cycle. There are a couple of ways to approach this. You could examine capacity and the ratio of how many 6000 units are being replaced by each X. However, we believe a more effective approach is to consider it from the customer perspective. Currently, we have about 1,000 high-throughput customers, and roughly 750 of them own only one 6000. For these 750 customers, acquiring less than one X is not an option. Therefore, you can estimate that these 750 will need to purchase an X. Even if their demand for sequencing doesn't grow beyond what it is today, which we anticipate will change when we factor in elasticity, it’s clear that they will require 750 units initially to serve that customer base. The remaining 250 customers with multiple 6000s will have their own conversion ratios. Additionally, many customers purchasing the X are motivated by the desire to benefit from the lower sequencing prices. Clinical customers are exploring new applications made feasible by the reduced sequencing costs. For instance, solid tumor oncology testing customers are now interested in liquid biopsies, understanding that it might require 12 to 15 times more sequencing, but the X’s price point allows them to do so within their reimbursement limits. There are also customers interested in conducting larger research experiments involving single-cell or spatial projects. In terms of the GRAIL regulatory process, so the way we're thinking about it is that the whole process comes to a head towards the end of this year, at the beginning of next year, because we expect to get decisions around two of the most important appeals in that timeframe. In Europe, we expect to get a decision around the jurisdiction appeal in that timeframe. And in the US, you might have seen that in the last week, we got granted expedited review by the US Fifth Circuit Court of Appeals for our appeal against the FTC. And so, that gives us even more confidence the decision will come even maybe a little earlier than had been initially anticipated, but certainly in the timeframe of later this year, early next year. And so, our expectation is that the whole sort of legal process winds up in that timeframe. Overall, at the same time, we got a divestiture work stream that we started a while ago, that work stream is all set to continue marching down the divestiture path. We're waiting for the divestiture order from the European Commission, which we expect to come out shortly. And so that path will be run in parallel in the same timeframe as the appeals are happening.

Francis, I want to expand on your comment regarding clinical elasticity. You are correct that these are new applications and often involve complex signatures that need advanced sequencing. As a supplier of tools and reagents, Illumina begins to generate revenue from these clinical trials even before the tests become publicly available. Therefore, our elasticity starts even prior to the market launch of the tests.

And our next question comes from Dan Arias with Stifel.

Good afternoon, guys. Thanks for the questions. Francis, Joydeep, can I just follow up on the comments there on elasticity? I mean, is that something you expect to materialize meaningfully in the back half of the year just in the sense that it can contribute to consumables growth for the year? I know in January, when you gave the outlook, one of the explicit drivers of the 8% consumables growth was elasticity. So, just trying to understand where things sit when it comes time to think about installation timing and ramping on usage that allows you to actually see that in the second half of the year and that you can count on it contributing to the overall target for the year?

Yes, Dan, that's exactly right. As we had stated, right, we expect the installations and the initial work that customers to bring up their workflow to happen as we get into Q2 and Q3. And in Q4, we started to see some of these projects ramp up and customers to build inventory and start earnestly moving to the Xs their world-class platform.

And moving on to our next point, I'm sorry, please continue.

No, that's good. I think the question was about the X, hopefully, that answers that.

Thank you. Our next question will come from Vijay Kumar with Evercore ISI.

Thank you for taking my question. I have a couple of inquiries regarding the guidance. Joydeep, can you quantify the incremental headwind we’re facing in Russia? Additionally, related to guidance, gross margins have decreased sequentially, and we are looking at below 65%. Can you explain what changed from the Q4 number of over 66%? It has fallen by a couple of hundred basis points. Regarding the operating margin guidance for the second quarter, the first half is expected to be at 17%, but for the second half, you mentioned needing to achieve 26% to 27% for Core Illumina to meet the annual target. What factors contribute to that increase from 17% to around 27% in the second half? Thank you.

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 Q2, is you typically have lower absorption in our factories. So that tends to lead to a sequential decline in gross margin as you move from Q1 to Q4. In terms of operating margin for Q2, there are a couple of factors to consider. As mentioned in the call, we experienced our usual salary and promotional adjustments along with equity adjustments. Consequently, as we transitioned from Q1 to Q2, there was a one-time increase in overall operating expenses. However, this stabilizes for the remainder of the year. The second factor affecting margins in Q2 is due to the situation in Russia, which led to an increase in the number of instruments sold, impacting gross margin. These two factors combined somewhat counterbalanced the operating leverage we are achieving to maintain margins at 17%. You are correct that we indicated expectations for margin improvement in the second half of the year. The primary reasons for this are the scaling up of production and an improvement in margins for the X, along with a ramp-up in consumables. This will result in a step-up in each quarter, which will improve absorption in our factories and lead to increased gross margin. We anticipate ending the year with gross margins in the high 60s and operating margins close to the high 20s.

And our next question will come from Tejas Savant with Morgan Stanley.

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.

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...

The next question was about the potential impact of XLEAP-SBS on NextSeq. As you know, implementing XLEAP-SBS on NextSeq will lead to several significant enhancements. Firstly, there will be improvements in the pricing associated with NextSeq, which I'll address in a moment. Additionally, there will be advancements in performance, particularly regarding the quality of the chemistry. Sustainability benefits are another key aspect, as XLEAP-SBS chemistry eliminates the need for a cold chain during the shipment of consumables, resulting in substantial savings for our customers in terms of sustainability. Regarding pricing, we are not raising prices at the moment; however, our aim is to set prices that will maximize market opportunities. We plan to lower prices, but our products uniquely offer additional capabilities in the market. These include sustainability features and built-in FPGAs for onboard computing, as well as onboard storage optimization, which is exclusive to Illumina's NextSeq among mid-throughput instruments. Therefore, while we intend to reduce prices, we will also consider the added value we provide in our instruments, which will influence the final pricing strategy aimed at expanding our market share in the mid-throughput segment. Regarding GRAIL, to address your question about the divestiture, we will soon receive the divestiture order that will outline the process and structure of the divestiture. Our divestiture team is already engaged with the European Commission and will proceed with the process. Concurrently, we have two appeals in progress. If either appeal is unsuccessful, we will divest quickly to act in the best interest of our shareholders. We anticipate this situation to develop late this year or early next year, alongside the ongoing appeals. So, under what circumstances would we retain the asset? If we win both appeals, we would then have the opportunity to reassess the asset and evaluate whether the assumptions in our business case for keeping it are still valid compared to divesting it. This would be the scenario in which we would choose to retain and integrate the asset.

I will soon hand the call back to Francis for closing remarks. The next question comes from Julia Qin with J.P. Morgan.

Hi, good afternoon. Thank you for taking my question. First, regarding your operating margin targets, could you help us understand the potential upside and downside scenarios? In your projections, do you expect that your in-house NovaSeq X manufacturing will reach full efficiency by the end of 2024 or by the end of 2025? Additionally, could you provide more details on the expected improvements in new product development efficiency before and after the new R&D structure is implemented? Finally, could you offer insights on the situation in China? Are you experiencing any benefits from government stimulus, and do you see any signs of recovery there? Thank you.

Let me address the question about our operating margin target. For 2022, I want to reaffirm that we are maintaining our operating margin guidance of 22% for Core. There are a couple of factors to consider. We are expecting a larger number of instruments for the year, particularly influenced by around $60 million in offsets from Russia, which we believe will slightly impact our gross margin. However, we anticipate that this will be balanced out by enhanced productivity in our manufacturing as well as additional cost reductions we are implementing. Regarding our instrument or X manufacturing efficiencies, we expect to achieve the targeted efficiencies by the end of the year, but we believe these improvements will extend beyond that timeframe. Just like with our other instruments, we will continue to find additional efficiencies in the following years, so you can expect to see ongoing improvements as we progress into the second and third years of manufacturing. 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. 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. 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. We are streamlining our R&D operations by utilizing our global presence in more cost-effective locations. This initiative applies not only to R&D but also to other functions. These activities will contribute to further optimizing our organization and processes, enabling us to rationalize our global real estate portfolio, expenditures, and IT infrastructure. You can expect to see the impact of these changes starting at the end of this year, with a more significant effect in 2024 and beyond. Additionally, we are not currently observing any benefits from stimulus measures in China for our business. We are closely monitoring the situation in China regarding the funding difficulties our customers are encountering and are taking steps to address these challenges.

And we have a question from David Westenberg with Piper Sandler.

Hi. Thank you for taking the questions, and congrats on the big NovaSeq X placement. So, I want to stick on those 67 placements. Have any of those customers started decommissioning any of their 6000s? Traditionally, you had customers kind of finish their old projects before starting on the X. Now you have really good consistency between platforms. Has any of that behavior might have changed? Have you seen any maybe subsequent orders on 6000 even though they've already switched to X? Just trying to really get a sense on kind of this dynamic. Thank you very much.

Thank you for the question, Dave. Regarding the NovaSeq Xs, you are correct that most of our customers will transition their projects over time and do not plan to decommission their NovaSeq 6000s, particularly on the clinical side. For the initial group of customers we are tracking from Q1 to Q2, we anticipate about 10 to 12 decommissions as the Xs are implemented. However, decommissions and replacements will represent a smaller portion. As we progress through the year, we will offer more updates on how the 6000 installed base continues to evolve.

And we will take our next question from Kyle Mikson with Canaccord.

Great. Thanks guys. Thanks for taking the questions and congrats on the launch of the X here. Just one question for me. Historically, the company's revenue growth has been kind of elevated in the year or two following one of the meaningful signature launches. '17, '18 those were strong with 6000. '19 was a setback, and '14, '15 were solid with the HiSeq X. But in '16, growth was single digit. So, is there anything about the NovaSeq X launch that would lead to a different outcome? Or could Illumina be stuck in this kind of perennial cycle and dependence on new products driving near-term growth? Because now you have kind of more headwinds than you had in the past. I think it would be helpful to understand. Thanks.

Yes, thank you for the question, Kyle. I have a couple of points to address. First, product cycles are crucial in our market for several reasons. There is an upgrade cycle that they initiate, which tends to happen more quickly in the research market. Historically, this has been vital for driving short-term revenue growth since our market was mainly research-focused. However, as we mentioned last quarter, 50% of our consumables now come from the clinical market. This shift is one of the growth drivers, but a significant factor is the increasing number of clinical use cases. We've noted that our proactive monitoring shows continued robust growth among our clinical customers, due to more adoption of tests like genetic disease testing, expanding coverage for oncology therapy selection, and increased coverage for non-invasive prenatal testing. Looking ahead, a major growth engine will stem more from the adoption of sequencing in the clinical market rather than just relying on upgrade cycles.

I think just one more thing to add, right? Kyle, you will see a little bit of what we traditionally see as customers cut over from one system to the other, right? There will be a little bit of a transition from consumables from one system to the other. So, I don't think that can totally be avoided. But Francis is right. You see that much more with research customers than clinical customers, right? So that will tend to mitigate.

Thank you. And that concludes our Q&A session. I will now hand the call back over to Francis deSouza.

Thank you for joining us. As we close the call, today is DNA Day, celebrating the 70th anniversary of the discovery of the double helix structure of DNA. This month is also Illumina's 25th anniversary. Over our history, our team has played an important role in the genomic revolution by delivering breakthrough innovations that dramatically reduce sequencing costs and broaden access to genomics, unlocking new frontiers in biology and healthcare. And yet today, with only 4 million genomes ever sequenced, representing only 0.07% of the population, we are still at the beginning of the genome era. That concludes our call today. 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.