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

Hello, everyone, and welcome to our earnings call for the third quarter of 2023. During the call today, we will review the financial results we released after the close of the market and offer commentary on our commercial and regulatory activity, after which we will host a question-and-answer session. Our earnings release can be found in the Investor Relations section of our website at Illumina.com. Participating for Illumina today will be Jacob Thaysen, Chief Executive Officer, and Joydeep Goswami, Chief Financial Officer and Chief Strategy and Corporate Development Officer. Jacob will provide an update on the state of Illumina's business, and Joydeep will review our financial results, which include GRAIL. As a reminder, GRAIL must be held and operated separately and independently from Illumina pursuant to the transitional measures ordered by the European Commission, which prohibited our acquisition of GRAIL under the EU merger regulation. This call is being recorded and the audio portion will be archived in the Investor section of our website. It is our intent that all forward-looking statements regarding our financial results and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based upon current available information, and Illumina assumes no obligation to update these statements. To better understand the risks and uncertainties that could cause actual results to differ, we refer you to the documents that Illumina files with the Securities and Exchange Commission, including Illumina's most recent Forms 10-Q and 10-K. With that, I'll now turn the call over to Jacob.

Thank you, Salli. Good day everyone, and thank you for joining today's call. As you know, I assumed the role as Illumina's CEO a little over six weeks ago. It is an honor to lead this company. I joined Illumina after more than a decade at Agilent, where I ran both the Diagnostic and Genomics Group, and more recently, Agilent's largest business, the Life Science and Applied Markets Group. I have long admired Illumina for its role in building the genomics market, and I'm incredibly excited to be here. During my first weeks, I prioritized getting to know our employees and meeting with several of our customers. Illumina has a highly capable team, and I have been impressed with their level of passion and commitment to our work. Both our employees and our customers are driven to move genomics forward. Like our team, I'm passionate about genomics and the role that this field can play in healthcare and personalized medicine, particularly in the oncology space. This is a massive opportunity, and Illumina will remain the key player, even as others enter the market. Illumina's infrastructure that we have built over two and a half decades, our compelling offerings that set the global standard, and our deep commitment to innovation for the future will continue to drive the use of genomics and multiomics around the world. Turning to our third quarter results; in Q3, Illumina delivered revenue of approximately $1.12 billion, flat year-over-year, or up 1% on a constant currency basis. This was a disappointing result. The macroeconomic environment remains challenging for our industry and for our customers, with customers increasingly cautious and constrained in their purchasing decisions. Despite a lower gross margin year-over-year, tight management of our operating expenses allowed us to deliver diluted non-GAAP EPS of $0.33, also approximately flat year-over-year. While we cannot control the external environment, Illumina's management team and I remain focused on supporting our customers and our own operational execution. Part of my comprehensive review of the business includes reexamining our strategic initiatives and our targets for long-term revenue growth and operating margins. We will lay out our new targets for you later next year. A key priority for me is to get clarity on the GRAIL situation. Therefore, I have requested and the Board has established a special committee to expedite decisions on GRAIL. Furthermore, we have retained advisors and are preparing for sale and capital markets transactions. We expect to file a Form-10 on a confidential basis with the SEC. Hereafter, we will contact third parties as investment capital sources or as potential purchasers as our appeals are ongoing. I know there have been questions regarding our appeals. These appeals are not just about GRAIL. They provide Illumina with flexibility for any divestiture of GRAIL and also for future transactions. The appeals will not impact our ability to move swiftly. Make no mistake, I am here to focus on the core business, which I will talk more about after Joydeep's remarks.

Thank you, Jacob. I'll start by reviewing our consolidated financial results, followed by segment results for Core Illumina and GRAIL, and then conclude with my remarks on our current outlook for 2023. I will be discussing non-GAAP results, which include stock-based compensation. I encourage you to review the GAAP reconciliation of these non-GAAP measures, which can be found in today's release and in the supplementary data available on our website. As Jacob noted, in the third quarter, consolidated revenue of $1.12 billion was flat year-over-year and up 1% on a constant currency basis. Consolidated revenue was down 5% from the second quarter of 2023. Although we correctly anticipated a sequential decrease in high-throughput consumables revenue due to the NovaSeq X transition, we placed fewer NovaSeq X instruments than we expected in the quarter, as customers' purchase constraints led to lengthened sales cycles. Non-GAAP net income was $52 million, or $0.33 per diluted share, which included dilution from GRAIL's non-GAAP operating loss of $155 million for the quarter. Despite our lower revenue, non-GAAP EPS exceeded our expectations primarily due to continued execution of expense reduction initiatives and a higher gross margin than we forecast. GAAP net loss was $754 million, or $4.77 per diluted share, which included goodwill and intangible impairments of $821 million related to the GRAIL segment. These impairments were primarily the result of a decrease in Illumina's consolidated market capitalization and a higher discount rate used for the fair value cancellation of the GRAIL segment. Our non-GAAP tax rate was 39.7% for the quarter, which decreased from 43.2% in Q3 2022, with both quarters reflecting the impact of R&D capitalization requirements. The year-over-year decrease was primarily due to a decrease in the non-GAAP tax expense, impact of R&D capitalization requirements, given the increased amortization of capitalized R&D expenses. Our non-GAAP weighted average diluted share count for the quarter was approximately 158 million. Moving to segment results; Core Illumina revenue of $1.11 billion was flat year-over-year on both the reported and constant currency basis and included anticipated reductions of approximately seven percentage points from two primary categories. One, the decrease in COVID surveillance and the effect of sanctions in Russia that together represent approximately 3.5 percentage points and two, the year-over-year reduction in China revenue that also is approximately 3.5 percentage points. COVID surveillance contributed approximately $4 million in total revenue in Q3 2023, compared to $28 million in Q3 2022. Core Illumina sequencing consumables revenue of $695 million was down 4% year-over-year. The decrease was primarily driven by a 12% decline in sales to research customers. These customers were impacted by the NovaSeq X transition and are reducing NovaSeq 6000 consumables purchases before they have fully ramped up activity on NovaSeq X. Total sequencing consumables revenue was also impacted by the COVID, Russia, and China factors I noted previously, as well as the impact of macroeconomic conditions on customers' purchasing power and project planning. Strength in sales to clinical customers partially offset the decline in research, with clinical sequencing consumables growing 10% year-over-year, led by continued momentum in oncology and genetic disease testing. Turning to sequencing activity, total sequencing gigabase output on connected high and mid-throughput instruments grew 5% from Q2 2023 and 29% year-over-year. We are encouraged by the trends we're seeing across both research and clinical high-throughput customers that have a NovaSeq X installed. As expected, these customers show higher overall growth in sequencing output than high-throughput customers that have not yet adopted the NovaSeq X, both on a quarter-over-quarter and a year-over-year basis. As a reminder, we believe this data is a useful reference that shows the general activity trends across our installed base and is directionally correlated with revenue over time. Sequencing instruments revenue for Core Illumina of $179 million grew 10% year-over-year, driven primarily by NovaSeq X, which more than offset the decline in NovaSeq 6000 shipments. Growth in high-throughput instruments was partially offset by the expected decline in mid-throughput due to increasing capital purchase and cash flow constraints that continue to impact our customers' purchasing behaviors globally, as well as by local competition in China. For NovaSeq X, we exited Q3 with more than 310 orders since launch. Our shipments of 97 NovaSeq X instruments in Q3 brought our total installed base to 273 instruments. Core Illumina sequencing service and other revenue of $142 million was up 15% year-over-year, driven primarily by higher instrument service contract revenue on a growing installed base, as well as an increase in lab services revenue. Moving to regional results for Core Illumina, all regions continue to be impacted by two key issues. One, tighter funding and budget pressures that are impacting customer purchasing power and project planning and two, the impact of high-throughput customers transitioning to NovaSeq X as customers continue to reduce NovaSeq 6000 consumables purchases before they have fully ramped up activity on NovaSeq X. America's revenue of $650 million grew 10% year-over-year, attributed to NovaSeq X placements, as well as clinical testing volume driving greater consumables revenue. Clinical sequencing consumables shipments grew more than 20% year-over-year. Europe revenue of $260 million was flat year-over-year or up 1% on a constant currency basis. Growth in sequencing consumables was driven by mid-teens growth in clinical and strength in mid-throughput consumables offset by the decline in COVID surveillance and the negative impact of exchange rates. For sequencing instruments, growth in high throughput due to NovaSeq X placements was more than offset by a decline in mid-throughput instruments. India revenue of $98 million declined 22% year-over-year or 19% on a constant currency basis, which included an 11 percentage point impact from sanctions in Russia. The year-over-year decrease was also driven by softness in Japan due to the macroeconomic factors I mentioned earlier as well as the expected slowdown in COVID surveillance. Greater China revenue of $98 million represented a 26% decrease year-over-year or 25% on a constant currency basis, reflecting continued macroeconomic and geopolitical challenges as well as local competition in mid-throughput. Moving to the rest of Core Illumina P&L. Core Illumina non-GAAP gross margin of 66% decreased 290 basis points year-over-year, primarily driven by product mix and less fixed cost leverage on lower manufacturing volumes as well as lower instrument margins and higher field service and installation costs due to the NovaSeq X launch, which is typical in a launch year. Core Illumina non-GAAP operating expenses of $481 million were down $33 million year-over-year and were lower than expected primarily due to continued expense reduction initiatives. As a result of these factors, Core Illumina non-GAAP operating margin was 22.5% in Q3 2023 compared to 22.6% in Q3 2022. Despite our lower gross margin, operating margin was approximately flat year-over-year due to our proactive cost management initiatives. Transitioning to financial results for GRAIL; GRAIL revenue of $21 million for the quarter grew 110% year-over-year, driven primarily by the adoption of Galleri. GRAIL non-GAAP operating expenses total $161 million and increased $12 million year-over-year driven primarily by efforts to scale GRAIL's commercial and R&D organizations. Moving to consolidated cash flow and balance sheet items; cash flow provided by operations was $139 million. Third quarter 2023 capital expenditures were $45 million and free cash flow was $94 million. We did not repurchase any common stock in the quarter. We ended the quarter with approximately $933 million in cash, cash equivalents, and short-term investments. During the third quarter of 2023, the company used $750 million in cash to repay the outstanding principal of convertible notes that matured in August 2023. Moving now to 2023 guidance; we now expect full year 2023 consolidated revenue to decline 2% to 3% from 2022, including Core Illumina revenue that is down 3% to 4% year-over-year. As a reminder, these ranges include anticipated reductions from COVID surveillance of approximately 200 basis points, the impact on our business from sanctions in Russia of approximately 100 basis points, reductions in our business in China, as well as a year-over-year negative impact from foreign exchange rates. GRAIL revenue is now expected to be at the low end of the range of $90 million to $110 million for 2023. For fiscal 2023, we now expect Core Illumina sequencing instrument revenue to decline 5% to 6% year-over-year driven by capital and cash flow constraints that have continued to impact our customers' purchasing behaviors globally, as well as the decline in our business in China. The decrease from our prior guidance is primarily driven by our lower NovaSeq X shipment expectations for 2023. We now expect to ship between 330 NovaSeq X to 340 NovaSeq X instruments for the year as customers' purchasing constraints lead to lengthened sales cycles. We also now expect Core Illumina sequencing consumables revenue to decline 5% to 6% year-over-year, driven primarily by the decrease in NovaSeq 6000 consumables as customers transition to NovaSeq X. The impact of macroeconomic conditions on customer project planning and budgets, the effect of sanctions in Russia, the slowdown in COVID surveillance, and the decline in our business in China. The decrease from our prior guidance primarily reflects a slower ramp in NovaSeq X consumables, in part due to our lower placement expectations, as well as the increasing impacts of macroeconomic constraints. We now expect Core Illumina total sequencing revenue to decline 3% to 4% year-over-year. This continues to include intercompany sales to GRAIL of approximately $30 million, which are eliminated in consolidation. We now expect consolidated non-GAAP operating margin of 4% to 4.5%, and Core Illumina non-GAAP operating margin of 19% to 19.5%. Our revised operating margins reflect our lower revenue expectations for the year, partially offset by continued expense reduction initiatives. We now expect our non-GAAP tax rate to be approximately 39% for 2023, due to discrete tax benefits recognized in Q3 2023 related to prior year return adjustments. Lastly, we now expect non-GAAP earnings per diluted share in the range of $0.60 to $0.70 for 2023, reflecting non-GAAP diluted shares outstanding of approximately 159 million shares. Dilution from GRAIL's non-GAAP operating loss is now expected to be approximately $660 million, as GRAIL continues to manage its expense base in line with its latest revenue outlook. I will now turn it back over to Jacob for his closing remarks. Thank you.

Before we go to Q&A, I wanted to reiterate Illumina's commitment to supporting our customers in this difficult macroeconomic environment. While we cannot control external factors, we can optimize our own actions to successfully navigate through this period and position the company for a return to accelerated growth on the other side. I know you're interested to hear our views for 2024. With the caveat that we haven't finished 2023, we're still looking at our budget for 2024. Our initial view is that 2024 results will look very similar to 2023. We don't expect near-term improvement to the macroeconomic environment, and geopolitical issues have been persistent. We are encouraged by the early signs we're seeing for NovaSeq X utilization and the continued rollout of the X position us very well for the ramp in consumables and overall growth when market conditions improve. This is clearly a dynamic situation, and we want to be able to develop our views in depth. Therefore, for 2024, we will not provide guidance before our Q4 earnings call in February. The main reason that I joined Illumina was my strong conviction about the future of the Core Illumina business. While over the coming months, I'll continue to listen and learn, I will also be focused on several key priorities. First, we need to drive our top line as much as possible in this environment. This means continuous placements of the NovaSeq X and all of our instruments, laying the groundwork for increased consumables demand. We'll continue working closely with our customers around the world, whether they're integrating new instruments into their workflows, starting new projects, or building new tests or assays. Second, we need to keep driving innovation that is highly focused on our customers' priorities. These innovations include automation and sample-to-answer solutions, serving to strengthen our leadership position around the world. At the same time, we need to manage our R&D investments with discipline and rigor. We most recently launched our 25B Rating Kit. This was highly anticipated by our customers, and it will unleash the full power of the NovaSeq X. Third, we need to focus on our operational excellence across geographies, functions, and processes. Earlier this year, we announced a plan to reduce our analyzed run rate expenses. Our team has executed well and has been able to reduce analyzed run rate expenses by approximately $175 million, ahead of our original projection of more than $100 million. These savings will continue to support flexibility in further investment in high-growth areas and our margins. I'm committed to executing against all of these priorities with a strong sense of urgency. We are focused on delivering tangible improvements that support profitable long-term growth for Illumina and for our shareholders. I will now invite the operator to open the line for Q&A.

And our first question comes from Vijay Kumar with Evercore ISI.

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

Yeah, Vijay, thank you very much and I'm really excited to be here at Illumina. Let me start with your second question, and then I'll have Joydeep step in also on talking about what those 2.5 years mean, but as I discussed here, coming into the company, I felt it was very important to get clarity on GRAIL. It was also very important for me to have the support of the board to make swift decisions to move forward. Thereby, we started a special committee with three of the board members, including me as the chair of that committee. So I have three board members, plus me, that will work with the management team and really walk through all the elements around the divestiture order to make sure we can make some fast decisions. We need to make decisions about which path we're going to follow: is it going to be a trade sale, the spin, or the split without a sponsor, and of course, there's a lot of considerations related to that. That's really what the special committee is helping me and the rest of the management team to do. Joydeep?

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

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

Hey, thanks for taking the questions here. Jacob, welcome. Maybe just a last one, obviously, it's all we have, but maybe a couple of parter. So maybe Jacob, obviously you left a great job at Agilent before coming here, and certainly, we'll be interested to get your view on the growth rate and outlook for Illumina when you're ready to give that. But I'd be interested to get your view on kind of the overall NGS market and your thoughts on what type of growth characteristics you think are reasonable in that market because given the price cuts, there's just a lot of questions on demand elasticity. So, I guess the first one is on the NGS overall market, if you had a view there, and then B, I just had a question on the X specifically. I understand, obviously, a lowering of the placement number given customer constraints, but can you give any color on the orders or the backlog that you have as of right now? And then the final part would just be on guidance. Illumina's had a series of kind of guidance reductions. A lot of peers are facing the same issue, but you guys have had a more elongated period of this. I'm just wondering kind of what changes can be made in order to hopefully better set guidance so that the risk of these reductions is eliminated going forward. Thanks.

No, thanks, Dan. And I think I would have Joydeep also jump in on some of those elements here, but let me just start by coming here into Illumina and my observations, both from when I was outside Illumina and also coming in, I think that the core business has a tremendous opportunity. I think there are a lot of opportunities in the NGS markets, and I think we are definitely going through a tough period right now. I think the whole life science tools industry is seeing it, and certainly here at Illumina, we're not immune to that. But the growth rates, even though I will spend time here over the next period of time still learning the business and really understanding the organization, so at this point, I don't have a final opinion about what I think is the right growth rates for the business and what we're committing to, but I will certainly come back later in '24 and share all of that with you when I'm ready for it. But in the meantime, I think that the overall market is very healthy and there will be a lot of growth opportunities for Illumina going forward, and I can then say that from some of the findings coming into the company and really digging deep into our innovation engine and what our roadmaps look like. I'm very excited for the future of this company. I think we will continue to pioneer in this area. So I think on guidance and Joydeep joining here also, but in the end, we wanted to make sure when we signal, especially for '24, that at this point, we want to be prudent in how we set our, it's not a guidance yet, but at least how we view '24, as we simply don't see any change, or short-term change, in the economic environment. And therefore, we felt it was important to go out now and then share our observations, but Joydeep, do you want to?

No, I think that's right. On the guidance piece, look, we made a commitment to you to come back to you with any read on the macroeconomics we see, and I think we're held up to that commitment. In fact, we may have been a little bit of a canary in the coal mine signaling some of this earlier to you, especially this year than others, right? One of the things, of course, you did bring up with the elongated, sort of lack of growth, or the reduced growth that we have had. That is true. I think part of what hit us at the same time as the macroeconomics going down is the transition, major transition on our platform, which has hit us as customers move from the 6,000 to the X, but there's a gap between when they run down some of their inventory on the X and then wait to fully ramp up on the X. So you will see that balance out over time. We don't have any doubts on that. And then, on the X, I want to reemphasize, and I think you will have seen this from your channel checks as well, demand and interest in the innovation and the capabilities that the X brings remain strong. I think we are very excited about the launch of the 25B and I think those of you who attended ASHE would have seen our customers' interest in that and the data that's coming out of the other 25B and the improvements that we continue to make on the software really resonate with our customers. So we remain very interested in that.

And our next question will come from Puneet Souda with Leerink Partners.

Yeah, hi, Jacob. Good to have you on board here. So if I could ask two-part questions, with the 25B launch, can you talk a little bit about how, and maybe Joydeep can chime in and talk about how the transformation is going to be sort of over the next couple of months? You obviously get a price uptick with the 25B, but not all customers are going to be able to essentially fill up that flow cell. So there's going to be a bit of an ebb and flow. So maybe if you could talk a little bit about that, at least qualitatively in the near term. And then a bigger competition question. Jacob, you've seen the LCMS businesses and other businesses in China. What do you imagine for Illumina with one of the bigger competitors over there? How do you see Illumina's position in China, longer term? And if I may just ask, again, on competition, one of your diagnostic customers, NIPT and MRD customer, pointed out that they're validating different platforms. So again, what's your view on competition? Thank you.

No, thank you very much, Puneet, and again, I'm very pleased to be here. Let me start with the China question. As you're right, I have certainly some experience of running businesses in China. I'm very familiar with China itself and how to operate businesses there. So what is, of course, more unique for Illumina than some of the other life science tools companies is that Illumina has a Chinese competitor that has at least good enough sequencing capabilities here. But China continues to be an extremely important country for us and we are right now working through a China for China strategy to really be much better positioned in China going forward, and we are committing to China, and I think we can actually do really well in China. Many of our customers in China prefer to work with Illumina for what we stand for, both quality, but also that we are the number one brand out there. So we will continue to be very strong in China. Generally speaking on competition, yes, you're right. There is competition out there. As you also know, I'm very familiar with being in a very competitive environment, and I think that with what Illumina has, which I think will serve us extremely well, is that we have a very strong brand. We have a very strong installed base. Almost all papers coming out are based on our technology, and also, of course, what I see internally with the roadmap we have for the pipeline of new products coming out, our innovation capabilities will continue to position us very competitively in this environment. But of course, I understand and I'm fully aware that we will be in a very competitive situation going forward. In the end, I think that just keeps us really focused on our customers, and we'll do our best for our customers. So I'm here, and I'm ready to fight for it.

Yeah, maybe I'll tag on there. Let me start with the competition. We obviously, as Jacob said, take it seriously, but we also monitor it very carefully across the globe through what we're seeing out in the field. So I will say outside of China, we have seen the competition and share have been what we had expected. Obviously, with new market entrants, you will see a little bit of a decline in share, but it has been outside of China, very much according to expectations. On the 25B, Puneet, so let me start by saying what we have seen in this; early indicators that when we look at sequencing activity growth, and we measured it by gigabase, we are seeing that customers who have adopted DX have seen a faster growth rate in output and sequencing output than customers who have not adopted DX. So this is an encouraging sign that X is actually spurring more sequencing activity at these customers. And again, it's still very early days. They're ramping up, they're validating fully on their particular workflows. With 25B, I think you're right. It will spur even more capacity and experiments. We've heard customers that want to run very large single-cell experiments, for example, be very excited about this 25B and the capabilities that it brings. So we expect that to play out. I think when you get into the dynamics of whether you're running full flow cells or not, there is a very complex interaction of things that will lead to higher prices per gigabase until you fully load your flow cells. So we can get into that offline, but we do expect those dynamics to be very similar to what you saw when you brought on NovaSeq 6000 and some of the other S4 flow cells, etc.

But I think also, Joydeep, just to finish on the opportunity that we have seen, at least the customers that I've met here in the clinical space are very excited with the new flow cell as this opens up for new assays, new products, offerings that they haven't had before. So while it will take them a little while to validate and get up and running, we see many of them right now rushing to be first to market with this.

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

Yeah, hi guys, thanks for the question here. Jacob, just to follow up on the special committee that will look at GRAIL, what's the general timeline that they're expected to be on with respect to reaching a decision? And then can you update us on when the GRAIL team is expecting to see a readout for the NHS Galleri study at this point? Thanks.

Yeah, so I can tell you that we are working as quickly as we can under the framework to look at the options here. And I can tell you, I'm as frustrated as all of you, and I look forward to getting this behind us. So we are working on very tight timelines. At this point, I don't want to commit to anything because I want to make sure that I can deliver on my commitments on any timeline here. By the way, I also want to share with you that this morning we got the feedback from the ECGA that they have now put in a date for the hearing, oral hearing, which would be mid-December. So it's good news in the way that things now are moving forward. Just on that, that the appeals are important to us, obviously for the reason of GRAIL, but probably as important for ensuring that we have the flexibility for future transactions that we will look into and obviously also to get rid of the finance and so on. So that's why the appeals continue to be important.

NHS' GRAIL readout timing, I think that's as GRAIL had stated before, that's the final expectation on that is some point in 2024, and they will have a fully readout as well, or preliminary readout before that.

And we have a question from Michael Ryskin with Bank of America.

Great, thanks for taking the question and welcome aboard. I guess I want to follow up on the earlier question about sort of underlying demand in the market and what gives you confidence in some of the longer-term view. And I guess I'll phrase it in terms of your update to the guide here in the third quarter. You're citing some of the same macro headwinds that others are in terms of what's going on in China and broader funding concerns and budget tightness, and you're saying that that's weighing on consumables purchases. But at the same time, you're not getting the switch over to the Nova X because if you're looking at the order book, the orders have barely grown between Q2 and Q3. You went from 260 to 310. So orders were up 50 units in the quarter, and you placed 97. So it's not like there's a ton of demand growing for Nova X, and yet the Nova 6000 consumable seems to be really slowing. So I'm just trying to reconcile that if people aren't sequencing on the Nova 6000 because they're gearing up for the Nova X, then you would only see those orders grow. So how can you confidently state that some of this is that transition between instruments and not just less underlying demand in the market?

Yeah, so let me just start again and address that we do see the demand in the market space. We also mentioned this overall, that we see more gigabase growth rates. So we see definitely that there's a lot of activities out there, and again, there's no doubt that the long-term perspective in this market is very healthy. I think what you're seeing is that we're running through a very challenging environment that everybody else is seeing. And I think everybody also last year when they were providing guidance, they were probably optimistic that things would shrink back in the second half, and everybody got surprised or at least that it didn't. So therefore, we are right now a little more prudent in how we look out into the future. So I think that's one element to it, but if you look into the specifics, I think Joydeep can provide a little more insights.

There are a couple of factors affecting the slowdown related to the transition. While there is certainly a broader macroeconomic slowdown at play, we have observed that high-throughput customers who purchased the X are experiencing a more significant slowdown in 6K consumables compared to those who did not. This provides us a valuable way to distinguish the effects of the transition from general economic trends. It's important to consider that these early adopters are still ramping up their use of the X, and for many of them, particularly those with higher usage rates for the NovaSeq X, the 25B will lead to increased consumption of X consumables. However, it will take some time for them to reach their full capacity after they validate their workflows.

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

Good evening, Jacob, and welcome to Illumina. I have a couple of questions for you. First, regarding GRAIL, it seems you're anticipating the ECJ decision in mid-2024. Can you explain the implications of that and what actions the committee can take before that time? Additionally, aside from the ongoing court cases and considerations about divesting this asset, how are you planning to leverage the data value within GRAIL? Is that topic actively discussed at the board level? Lastly, I’d like to ask about the leadership within Core Illumina. How do you feel about the current key leadership positions? Have you settled on a team, or should we expect significant changes in the upcoming months? Thank you.

Let me begin by discussing the GRAIL situation. As I mentioned earlier, we've established a special committee due to the European divestiture order. While we continue with our appeals, we are committed to acting as swiftly as possible within the existing framework. Once we have submitted the Form 10, we will reach out to potential buyers and initiate conversations regarding the spin-off. We are making every effort to progress quickly. The appeals process runs concurrently, so there are no obstacles hindering our pace. Joydeep, do you have any insights on the monetization of GRAIL?

I think primarily we are discussing GRAIL data here. This is one of the options that the committee will obviously consider, and we will evaluate as a team. However, it really hinges on the divestiture option chosen and what we negotiate with the European Commission. Thus, it is certainly something that we are considering among the various options that Jacob mentioned, which the committee will address.

Yeah, and then the last question, I think was on the leadership team. I will put it more broadly, saying that I will be performing a comprehensive business review over the next period of time. Again, I've been here 40 days and I'm really impressed with the team and the talented people we have in the organization. But I'll, of course, keep you updated on what my thinking is while we move forward here in '24.

And we have a question from Dan Leonard with UBS.

Thank you and hello, Jacob. Now that you're sort of transitioning to maybe a bit more of a hand-to-mouth demand cycle for the X, given that you don't have much backlog left, I was hoping you could elaborate on what the pipeline looks like, any metrics you could offer. And is it possible you could quantify how much is the sales cycle lengthening? Is it double what it used to be? Is it some different multiple? Just anything you could help us contextualize that.

I think, Dan, again, I would like to invite Joydeep to provide a little more insights on where we are, but I can say generally speaking, the sales cycle is extended quite a lot from what we used to. Not only does it take time to make the decision, but also to get it through all the levels that there's much more scrutiny on all levels in the decision-making, and we've seen that. We see that in Illumina, but I think that's a general thing that is happening in the industry right now. But Joydeep, you want to go a little closer?

I want to confirm what you mentioned, Jacob. We still see strong interest in the X, and the launch of the 25D has increased that interest even further. Our pipeline remains robust with hundreds of opportunities, so we're not experiencing a decline. We are consistently adding new opportunities. However, due to the macroeconomic conditions, converting that pipeline into orders is proving to be more challenging and is taking longer than we anticipated. This extended sales cycle you referred to is likely to persist for us, as well as for others, until macroeconomic conditions improve. Nevertheless, it's important to note that demand has not shifted to other technologies; it remains focused on the X. We are actively engaging with our customers to help them ramp up their operations and utilize the consumables as quickly as possible.

And again, as Joydeep was saying, we have a healthy pipeline, and just as evidence that this is moving, we just here over the last few days, we received 10 pieces of what is it, 10 instrument orders on our X from one of our biggest customers. So we are definitely seeing that there are really customers who really like the X and can really see that it can be utilized very nicely.

And we have a question from Sung Ji Nam with Scotia Bank.

Hi, thanks for taking the questions and welcome to Jacob. Just a quick one on GRAIL, what's the key driver of the guidance, updated guidance being at the low end of the prior range? Thanks.

I can handle it. So again, it's mostly two things. They did have this particular year some challenges with their PDX revenue. This is the pharma services revenue, and then Galleri sales are, while they're growing nicely, have been lower than their initial expectations, right? So both those have impacted it.

But still a healthy growth.

So very healthy growth. We're seeing that at 100%-ish.

And our next question comes from Kyle Mikson with Canaccord.

Hey, thanks. Welcome, Jacob. Two-part question. First on GRAIL, second on Core. On the GRAIL funding in conjunction with the divestiture, if it is a capital market transaction, the company's going to need 2.5 years cash. I think that was touched on earlier. You could provide that via equity raise or debt issuance. Could you just walk through what your exact options are to produce that capital if you don't do equity or debt offering? And then on the Core business, you guys mentioned the initial view on 2024. Is that a little similar to 2023? Does that mean that revenue is going to be flat year-over-year for the third year in a row, and then maybe you could just comment on orders and placements for next year? Could placements grow in 2024? Thank you.

Let me address the second question. We will provide full guidance in our Q4 '23 call in February, but I want to share our initial perspective on 2024. Given the current macroeconomic environment, we don’t anticipate any changes at this moment. If things shift during 2024, we could see more momentum in the business, but I thought it was important to let you know how we are viewing the year. We are still finalizing the budget for 2024, so it’s too early to go into details. However, I can tell you that we maintain a strong pipeline, especially in X, and while we are noticing that the sales cycle is longer than anticipated, we do expect to see an increase in consumables in 2024.

And on the GRAIL, I think I've mentioned this earlier. Look, there are several options now on the table that we could help pay for the 2.5 years of funding requirements. So for example, if you went for a spin, there are options around a sponsored spin where a sponsor could put in a fair chunk of the money, or some or all of the money that is required for that funding. The other one, which is more of a capital markets transaction, which is more of a split kind of option where you could go and raise money in the capital markets for GRAIL and IPO market for GRAIL. So we're looking through and working through those various options. They're, of course, dependent on specific market conditions and interest in GRAIL from private placement. So we'll keep you posted on that as we go out to the market and consider those options.

And we'll take a question from Catherine Schulte with Baird.

Hey guys, thanks for the questions and welcome, Jacob. I guess just on your comments on '24, when you say results might look similar to '23, in that case, I guess, how do you view Core Illumina op margins? Would those also look similar to '23 or given some of the cost reductions that you guys have talked about, do you think there's room for improvement there?

Thank you for that. Currently, Illumina has a strong model with impressive operating gross margins. While growth can significantly benefit our bottom line, we're finding the current flat environment quite challenging. As it stands, we anticipate being flat in both our top line and bottom line.

Yeah, and I think you're right. We do expect to see an improvement in gross margins next year, obviously with more zeroables mixed in there. Off the cost reductions that we have made this year, I just want to remind you that some of that, a substantial portion of that has already been recognized this year. So they won't be incremental to next year as we go through. And then offsetting those two positives is, we do expect that the variable compensation and rationalization and year-over-year comp on that will eat away into that goodness that you've had, coupled with merit increases in inflation, right? So, and again, we did not pay executives the stock-based compensation and variable compensation this year as our performance has not been up to par. So we do expect that that will come back into next year as we correct some of that.

But I think on that, I think everything I see here, as I mentioned, also the gross margins are strong in the company, but there's a lot we can do to continue to improve that. So I don't see anything that is, for me at least coming in here, that sees there's any difference in the thesis about Illumina going back to what has been historically margins. And we will work on that. I think historically we have been, the logic has been, this will come through growth, and clearly we need growth to drive some of that, but we will also focus on operational excellence to build that going forward.

And our next question will come from Conor McNamara with RBC Capital Markets.

Hi guys, thanks for taking the question, and Jacob, welcome to San Diego. Just, if I look at kind of what you've said about 2024, from pre-pandemic levels from 2019 to 2024, that would imply an annual growth rate on the core business of about 5%, which is roughly in line with the overall life science tools market, despite the fact that you guys have consistently spent about 20% of sales in R&D. So if I'm an investor looking at Illumina, should I think of this as an EBIT margin expansion story from here where you bring R&D down in line with peers, or do you think that you guys can drive a return to growth above historic life science tools growth levels?

Yeah, that again, I want to be careful on coming with too many comments right now. I'm 40 days into my work here, to my job here, but I think I still believe that Illumina has a better growth opportunity than many of the other life science tools companies, and I will come back and give you more insights when I'm ready for it later in 2024. But I don't think that Illumina is in a place where it's in the level of many of the other companies right now, but it's too early for me to give you a clear guidance, but yeah, so wait and see.

And our next question will come from Rachel Vatnsdal with JP Morgan.

Great, thanks for taking the questions and welcome to Illumina, Jacob. So first up, I just wanted to ask on Core Illumina margins, follow up on some of the earlier questions. Specifically, it looks like that implied 4Q margin stepped down for Core Illumina, but also given the lower placement number, your mix should be more skewed towards consumables than typical in 4Q. So is there anything else that we should look at from a one-time perspective or anything else on the puts and takes on that margin implied for 4Q?

Yeah, so Rachel, a couple of things, right? So you will see margins and operating margins decline. We are seeing a step down in revenue from Q3 into Q4. So that's one element of that. The second element is gross margins are impacted for several reasons, right? One, that we do see every time you see a reduction in volume, you have less absorption of fixed costs, so you have that flowing into it. The second piece is around, yes, we are seeing some shift from instruments into consumables, but we are seeing a reduction because of the transition effects of NovaSeq 6000 consumables, which are highly profitable, and so you're seeing a little bit of gross margin decline because of that. And then the third is we have some components of strategic deal revenue that we have coming in, in Q4 versus Q3, and that is also pulling down our gross margin. So those three components are really what are impacting the gross margin component. And in the operating margin side, I think we obviously are getting some of the benefits of the cost action that we saw, but we did have some movement of R&D specific timing investments that moved from Q3 into Q4. So that is taking up our Q4 operating expense a little bit compared to what we had in Q3.

Thank you. And that does conclude our question-and-answer session. I will now hand the call back over to Jacob Thaysen for closing remarks.

Thank you, everyone. As we finish the year and move into 2024, I want to reiterate the great foundation that we have here, both in the infrastructure that we have built and in the significant markets that we serve. It is clear to me that there's a tremendous opportunity to create value for our customers and our partners worldwide, and of course, for our shareholders. Thank you again. We're looking forward to seeing you at upcoming conferences and other events. Thank you.

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