Illumina, Inc. Q2 FY2024 Earnings Call

Hello everyone and welcome to our earnings call for the second quarter of 2024. During the call today, we will review the financial results we released after the close of 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. Providing prepared remarks for Illumina today will be Jacob Thaysen, Chief Executive Officer; and Ankur Dhingra, Chief Financial Officer. Jacob will provide an update on the state of Illumina's business and Ankur will review our financial results for Core Illumina. As a reminder, we divested GRAIL in June of this year. For a review of second quarter financial results for GRAIL and consolidated Illumina, please see our earnings release and our SEC filings. This call is being recorded and the audio portion will be archived in the Investors section of our website. It is our intent that all forward-looking statements regarding our financial results and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based upon current available information and Illumina assumes no obligation to update these statements. To better understand the risks and uncertainties that could cause actual results to differ, we refer you to the documents that Illumina files with the Securities and Exchange Commission, including Illumina's most recent Forms 10-Q and 10-K. With that, I will now turn the call over to Jacob.

Thank you, Salli. Good afternoon, everyone. Throughout the second quarter, I continue to meet with our customers and partners around the world. I've been hearing about all of the opportunities they're excited for and discussing the issues we're facing together in this environment. Most importantly, it has been encouraging to see our customers and partners launch the next generation of their products. Illumina is uniquely positioned to support our customers' aspirations. Ongoing progress in science and technology allows our customers to envision large-scale discovery programs that are now possible using multiomics and customers are more empowered to move whole genome sequencing that provides significantly more insights. Furthermore, there's an opportunity to integrate genomics throughout the health care system to improve patient outcomes but we also have to help our customers navigate their current realities. There are still many moving elements in the global economy and we are taking a more measured view. I'm regularly hearing that our customers feel constrained to make significant capital outlays. We also see it in delays in our sales cycle and in orders being pushed out. For Illumina, this means we balance two important jobs. Job one is to stabilize our own base. We're doing that through continued rollout of the NovaSeq X Series to lay the groundwork for everything our customers and we want to pursue in the future. We are also highly focused on operational excellence and optimizing the ways in which we run our business. And job two is accelerating growth. Our strategy update next week will address Illumina's vision for the future and our strategy to execute new dimensions of technology from our R&D vault and our financial outlook for the next several years. For purposes of today's call, we'll focus on our second quarter results. In Q2, Illumina again delivered results ahead of expectations, with Core Illumina revenue of $1.1 billion and non-GAAP operating margins of 22.2%, driven by continued execution against our strategic priorities. The ongoing transition of sequencing activity to the NovaSeq X Plus led to a significant step-up in consumables in the quarter. We also placed another 62 NovaSeq X Plus instruments. With that said, we continue to see our customers actively managing their capital spend. As a result, for the remainder of the year, we are adding caution to our guidance. We have taken a more prudent view on the instrument business to reflect the further extension of sales cycles. But at the same time, we have a slightly stronger view on consumables. Ankur will provide further details on our adjusted guidance shortly. Turning to our regions' performance in the second quarter. Americas revenue was relatively flat year-over-year. Europe revenue was down 5%, given the significant backlog we worked through early last year following the X launch. AMEA revenue was down 8% and Greater China was down 35%. I've been talking with you about our three key priorities. I'd like to highlight the progress made by Illumina's management team during the second quarter towards those priorities. I'll start with driving our top line which has been focused on expanding our installed base and helping our customers maximize the potential of instruments. As I mentioned earlier, in Q2, we see up 62 NovaSeq X Plus instruments, bringing our total X Plus installed base to 469 instruments. Customers continue to transition their projects onto the NovaSeq X Plus and we are encouraged by the corresponding increase in sequencing activity. NovaSeq X Plus average annual pull-through has topped $1 million per instrument, a milestone achievement. Moving to mid-throughput. In Q2, we introduced the XLEAP-SBS chemistry to our NextSeq 1k/2k, P1, P2 and P3 flow cells, complementing the P4 flow cell we launched earlier this year. The XLEAP launch has exceeded our expectations. More than 60% of the 1k/2k installed base now has upgraded software, a leading indicator for adoption. SBS chemistry delivers improved quality, greater usable reads and lower turnaround times in addition to an attractive pricing. While customers' interest in XLEAP is encouraging, translation to additional instrument uptake has been less than we expected. Our mid-throughput segment remains the most sensitive to the macroeconomic environment. And we have seen our sales cycles continue to lengthen. This is clearly driven by constrained capital spending. Our win rates have remained stable and our pipeline has grown. We will continue to support our mid-throughput customers through this environment and are confident that bringing XLEAP to NextSeq 1k/2k is further strengthening our leadership position around the world. Turning to our second priority, delivering operational excellence. We are thrilled to have Everett Cunningham on board as Chief Commercial Officer. Everett is already driving a sharp customer focus across the business, with an essential underpinning of operational excellence. As I've shared, it has been my goal to align our organization in a way that will make our customers heroes by delivering the products, services and solutions that address their most pressing needs. Following our move to combine our marketing and commercial functions, we've implemented a new commercial organizational design. We are positioning our teams to more effectively serve our customers as their partners for innovation. Teams are equipped with a go-to-market expertise to accelerate our multiomics capabilities and commercialize and scale our software stack across research and clinical customers. This new structure will provide the alignment needed to deliver long-term results for our customers and for the business. Additionally, earlier this year, we shared that we are implementing a portfolio optimization strategy to drive productivity improvements across our supply chain. As one recent example, we have identified a number of products that we will rationalize in an effort to increase our focus on higher profitable offerings. We will, of course, work with our customers to provide a seamless transition to other offerings in our portfolio. We continue to make good progress towards achieving greater operating leverage this year. Moving on to my third priority which has been working to resolve GRAIL as quickly as possible. As you know, in June, we completed the spin-off of GRAIL and GRAIL is now an independent public company. Illumina has maintained a minority 14.5% stake. GRAIL plays a critical role in the fight against cancer. And while it's no longer part of Illumina, we remain confident in its future. We will continue to support GRAIL with our sequencing technology and suite of services. As we're continuing to deliver our process in activating our new strategy, I know we will be well positioned to move forward and lead the next era of genomics growth and discovery. Now, I'll ask Ankur to share more detail on our second quarter results and outlook.

Thank you, Jacob and hello, everyone. 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, as well as our consolidated financials that include GRAIL which can be found in today's release and in the supplementary data available on our website. In the last 3 months, I've had a chance to spend time with Illumina teams across all functions. I continue to be impressed with how mission-driven this team is and also how transformation is taking hold at Illumina. I've also heard from several of our investors as part of a listening tour. As I focus my commentary on the financial results and current outlook, I will include some additional color in my remarks. Core Illumina second quarter revenue of $1.1 billion was down 6% year-over-year on both reported and constant currency basis and up 3% from the first quarter of 2024. These results exceeded our guidance. This above-expectations performance was driven primarily by continued increase in high-throughput sequencing consumables revenue as our customers further ramp activity on NovaSeq X Plus. This strength in consumables was partially offset by fewer-than-expected shipments of our mid-throughput instruments, as capital and cash flow constraints continue to impact our customers' purchasing decisions. Total Core Illumina sequencing consumables revenue of $737 million was flat against last year's second quarter which was the highest sequencing consumables revenue quarter of the year 2023. High throughput was a particularly bright spot in this year's second quarter, with consumable shipments growing both year-over-year and sequentially. Ex-consumables revenue grew 35% from the first quarter of 2024, accelerating from the double-digit sequential growth we saw in the first quarter. In order to provide some additional color on transition, as of Q2, approximately 45% of high-throughput giga bases sequenced and a little over 25% of high throughput consumables revenue was on NovaSeq X Plus. In terms of the pace of shifting mix from 6K to X, to date, on average, roughly 5 percentage points of high-throughput sequencing consumables revenue has moved from NovaSeq 6000 to NovaSeq X PLUS each quarter. As this transition progresses, the impact of price continues to reduce. If this trajectory holds, almost half of high throughput sequencing consumables revenue should transition to the NovaSeq X by mid-2025, continuing to reduce the impact of pricing transition and converting volume growth into higher revenue growth thereafter. I hope you find this additional information helpful. We are increasing our disclosures around the NovaSeq X to give you a clearer picture of the progress we are making in this important transition. Moving to sequencing activity. total sequencing Gb output on our connected high and mid-throughput instruments grew more than 40% year-over-year and approximately 10% quarter-over-quarter. Growth in activity from both research and applied and clinical customers was healthy. Although not a predictor of near-term revenue, Gb output provides us with a directional view of underlying applications demand and levels of utilization of our instruments and consumables. Sequencing instruments revenue for Core Illumina of $116 million for Q2 grew 5% sequentially but declined 40% year-over-year. The year-over-year decline was driven by two factors: one, lower NovaSeq X placements as compared to significant preorder launch-related shipments in the second quarter of 2023; and two, an expected decline in mid-throughput shipments as capital and cash flow constraints continue to impact purchasing behavior and moderate instrument placements. Core Illumina sequencing service and other revenue of $143 million was up 7% year-over-year, driven by an increase in revenue from strategic partnerships as well, as higher instrument service contract revenue on a growing installed base. Moving to the rest of the Core Illumina P&L. Core Illumina non-GAAP gross margins of 69.4% for the quarter increased 240 basis points year-over-year. This strong gross margin performance was driven primarily by a more favorable revenue mix of sequencing consumables and also, importantly, execution of our operational excellence initiatives that improved productivity and delivered cost savings. Core Illumina non-GAAP operating expenses of $516 million were down $15 million year-over-year, reflecting reductions in headcount and several other cost containment initiatives. Putting it all together, Core Illumina non-GAAP operating margin was 22.2% in Q2 2024 compared to 21.2% in the prior year period. This came in well above our guidance of 18% as well as our expectations due to higher-than-expected revenue, better-than-expected gross margin and strides our organization has made in reducing operating expenses. Below the operating income line, Core Illumina non-GAAP other expense of $13 million in Q2 includes 11 days of interest expense for the $750 million delayed draw term loan we drew in full on June 20, 2024. Core Illumina non-GAAP net income for Q2 was $174 million or $1.09 per diluted share. Core Illumina non-GAAP tax rate was 24.2% for the quarter. Our non-GAAP weighted average diluted share count for the quarter was approximately 159 million. Moving to Core Illumina cash flow and balance sheet items for the quarter. Cash flow provided by operations was $243 million. CapEx were $30 million and free cash flow was $213 million. We ended the quarter with approximately $994 million in cash, cash equivalents and short-term investments. Moving now to 2024 guidance. While we were encouraged by our results in Q2, we see several puts and takes as we consider the remainder of the year. On one hand, our customers' capital spending remains constrained. On the other hand, our consumables business, especially high-throughput, driven by the transition of NovaSeq X, remains solid. We are therefore reducing our revenue expectations, especially for instruments, for the second half of the year. Core Illumina full year revenue is now projected to be down 2% to 3% from 2023 or down 1.5% to 2.5% on a constant currency basis. Approximately half of the decline from our prior guidance is due to our lower expectations for our business in China and broader Asia. And the other half is a result of our reduced expectations for mid-throughput and NovaSeq X shipments. From an instruments versus consumables perspective, at the midpoint of the Core Illumina revenue guidance range, sequencing instruments revenue is now projected to decline in the mid-30s rate relative to 2023. Sequencing consumables revenue is now projected to grow towards the upper end of the low single-digit range versus 2023. Now about the remainder of P&L. Illumina has been able to execute on stated operational excellence initiatives, delivering operating leverage above our previous expectations. We thus are raising our Core Illumina non-GAAP operating margin guidance to a range of 20.5% to 21%. This reflects the margin expansion achieved in Q2 2024 but we are also reducing our forecasted operating expenses for the second half of the year. We continue to make progress against our expense actions as well as several operational excellence initiatives under our internal clinical continuous improvement program. We've now launched several new initiatives under this continuous improvement program which we expect will deliver an additional $200 million in expense savings over the next few years. We'll talk about this in more detail at the upcoming strategy update. Additionally, we expect the Core Illumina non-GAAP tax rate to be approximately 25%. And lastly, we are introducing guidance for Core Illumina non-GAAP diluted earnings per share in the range of $3.80 and $3.95 for full year 2024. This range includes second half interest expense resulting from the $750 million delayed draw term loan we put in place in June this year. For the third quarter of 2024, we expect Core Illumina revenue in the range of $1.075 billion to $1.085 billion. The decline from the prior year is driven predominantly by lower NovaSeq X instrument shipments given the significant backlog we worked through last year following the launch. For the third quarter, we also expect Core Illumina non-GAAP operating margin of approximately 20%. The sequential decrease from the second quarter is primarily due to lower revenue and timing of the project spend delayed from Q2. We expect the third quarter non-GAAP Core Illumina tax rate to be approximately 25% and Core Illumina non-GAAP diluted EPS between $0.80 and $0.90 which, again, includes the said interest expense. With that, I will now turn it back over to Jacob for his closing remarks. Thank you.

Thanks, Ankur. Before we move to Q&A, I would like to spend a couple of minutes on our latest innovations. For 26 years, Illumina's highest-value asset has been our innovation engine. One example from the quarter is the launch of our latest version of our DRAGEN software which added significant enhancements to our analysis tools. Bioinformatics has become a key driver for customer decisions and this new release includes our most accurate multi-genome mapping technology, advancements in machine learning and the ability to genotype difficult genes to unlock deeper insights. Looking ahead, I'm excited to share the next round of NovaSeq X solutions. As you recall, the NovaSeq X Series we announced in late 2022 includes 2 systems: the NovaSeq X Plus which has been shipping globally since March 2023; and in NovaSeq X, our single-flow cell high throughput sequence for customers looking for a lower-cost entry point to the X Series. The X will begin shipping in Q4 of this year and will be upgradable to the X Plus. Also in Q4, we will introduce 100-cycle and 200-cycle 25B flow cells designed for high-output counting applications such as single cell and proteomics. Additionally, our next software update for the NovaSeq X and X Plus will enable increased yield and other improvements. I'm also pleased with the opportunities Illumina has to further enable the multiomics ecosystem. We will share more next week but one recent highlight was our acquisition of Fluent BioSciences, a company with single-cell technology that sources and labels complex cell mixtures to be processed for sequencing. Fluent's approach will make single-cell analysis available to a broader set of customers. Together with the specialized multiomics software solution from our Partek acquisition, Fluent's solution is yet another building block in our efforts to create greater value for our customers by further integrating their workflows. We want our customers to have the flexibility to adopt the tools that best fit their needs. Illumina will therefore remain an open NGS platform and is committed to maintaining and supporting our existing single-cell partnerships. I'm looking forward to speaking more about our vision, our strategy and our financial outlook next week at our strategy update. This virtual event will be on Tuesday, August 13. Please make sure to register through our Investor Relations website. Thank you for joining us today. I'll now invite the operator to open the line for Q&A.

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

Congrats on a nice execution here. Maybe, Jacob, a lot of details here in the deck. But if I just look at the guidance and tie that with your Nova X commentary, the pull-through was about $1 million. But I think there was some details about the amount of data being generated on X versus the revenue contribution. Is the delta, sort of the pricing impact, is that how we're supposed to model this transition? So when you think about the guidance change here, I didn't see an orders number for X. How much of this sort of change is coming from high-throughput versus mid-throughput on the instrumentation side?

Thank you, Vijay, and I appreciate your comments on the strong quarter as well. We wanted to share more insights on how to better model our expectations. We are certainly very pleased to have reached the milestone of $1 million in annual pull-through on the X. The information you received from Ankur can provide additional insight to help guide you on our current position, future direction, and the impacts of pricing versus volume. Ankur?

Yes, sure. Vijay, so yes, as you saw, we've added some more disclosures, specifically, to help everyone think through the transition here. Let me just lay it out as I said in the script. So in terms of transition from 6k to NovaSeq X, what we're saying is roughly about 45% of the consumables volume within high-throughput is now on X. So we're nearing roughly about 50%. In the second half of this year, if the trajectory holds, half of the volume would have moved to NovaSeq X. What I also included was that the pace of that mix is that we're seeing roughly about 5 points of mix shifting from 6k to NovaSeq X every quarter. And if that trajectory holds, by next year, we should also get to about half of revenue coming from NovaSeq X. So that's on the trajectory. To your question around the volume growth, yes, the overall Gb sequenced was about 40%. That is across high-throughput, across mid-throughput. And as you think about high-throughput revenue growth of about 1%, the delta is roughly the pricing and the change of the mix impact there.

And we'll move to our next question, it comes from Conor McNamara with RBC Capital Markets.

I’d like to follow up on that. If we consider that volumes increased by 40% while sequencing consumables remained flat, we’re looking at about a 40% impact on pricing. Should we expect this type of pricing challenge as the 5% conversion progresses, or was it greater at the beginning of the NovaSeq X launch? I'm trying to understand what the pricing impact will be.

Yes, let me address that. Initially, it's higher, and more of the volume shifts to X, which continues to lessen the impact of pricing. I'm primarily trying to clarify the data. If you look at it from a broader perspective, the transition from 6k to X would have led to an overall price decline of easily over 60% to 70% on a Gb-to-Gb basis. As this transition progresses, our baseline keeps decreasing. As the mix improves, we approach the halfway volume transition point in the latter half of this year. Based on this projection, we could reach the halfway revenue transition point by mid-next year, with the pricing impact continuing to decline.

And just one quick follow-up on pricing. Are you seeing any pricing changes on the equipment side, if you had to give price? Or has that been relatively stable?

Yes. Overall, we've seen stable pricing for the NovaSeq X Plus. That's why we're now introducing the NovaSeq X, which offers a lower price point for customers with budget constraints who still want access to the NovaSeq series. This model allows them to later upgrade to the NovaSeq X Plus to take advantage of both flow cells. We expect to see customer interest in this offering later this year with the launch of both models.

And we'll move next to our next question, Patrick Donnelly with Citi.

Jacob, maybe one on the $200 million cost savings initiative, I know you want to save some of it for next week, I'm sure. But can you just talk a little bit about, first, the pacing? And then second, where you're seeing opportunities? I know from investor conversations, a lot of people have circled that R&D line. Big question is whether you guys are willing to kind of use that as a lever, again, over 20% here? Can you just talk about, again, if there are any areas that are off limits in terms of the cost reductions? And where you're focusing on for those expense controls? It does feel like there's a lot of opportunity in the P&L. So I'd love just to discuss that a bit.

Yes, I want to start by emphasizing that there are no areas that are off-limits. We are evaluating all aspects of the profit and loss statement, and the $200 million reflects that. At this moment, we are not sharing specifics on the progress of this initiative. However, I can confirm that we are thoroughly examining all components and will share further details next week. Regarding research and development, we are assessing how to allocate our spending effectively. My approach to R&D involves closely reviewing each project and assessing its value using stringent metrics, such as net present value and return on invested capital. Given my background in R&D, I am not just focusing on a high-level figure but rather concentrating on the programs that will drive overall growth for the company and enhance shareholder value. Therefore, we are not relying on a top-down budget and are examining this with great attention to detail. Ankur, would you like to add more?

Yes, sure. Yes, as we said, we'll likely share a little bit more details during the strategy there next week. But what we are laying out here is the steps we are taking towards a multiyear margin expansion strategy. And we'll focus across all areas where we can lead to a structurally better and sustainable cost structure for the company in the long term. So more to come but the focus is across all opportunities across all lines.

And our next question comes from Doug Schenkel with Wolfe Research.

As I analyze the multi-quarter trend, it appears that consumable revenue reached its lowest point in the fourth quarter at $687 million, then rose to just under $700 million in Q1 and now stands at just under $740 million in Q2. Even though you've indicated that instrument revenue will decline over 30% year-over-year, it seems you're expecting instrument revenue to stabilize between $110 million and $120 million each quarter this year. Assuming there's no significant change in that outlook as we look to next year, if instrument revenue remains stable at these levels and consumables continue to grow each quarter with an expanding installed base and increasing usage, wouldn't that suggest a return to mid-single-digit revenue growth next year? Am I missing something? I'm not seeking guidance or asking you to anticipate anything for the Analyst Day next week, but from a mathematical perspective, what might I be overlooking?

Doug, I think you're right in your assumption is that and what we said earlier on that, we believe that the consumer growth is the right indicator for the turn into a better performance for the company. I still think it's too early to have a detailed conversation about '25. I mean we've seen in the last few days that there's a lot of moving elements. We have a U.S. election coming up. There are still concerns about what is happening in the Middle East. Of course, the interest rates, we will see where that goes. But of course, we are doing everything we can to get back to a much better growth trajectory than we have been on for the past few years.

Yes. And the only thing I would add, Doug, you're pointing to the right metrics. That's exactly how we're looking at that business as well. And as Jacob said, lots of moving parts here. You've seen the recent prints around the macro. So too early to call on 2025. But the trends we are seeing on the X transition, on the high-throughput consumables, as well as the fact that the impact of pricing should continue to erode or become lower over time are all positive factors, right? This year, what we've also seen is the overall Gb output growth during the first half of the year has been very strong. First quarter was over 35%. We're now seeing over 40%. If you look at last several years' sort of 5-year average, that was more in the 20s to mid-20s range as well. So several moving parts. The fundamentals of the business seem to be moving in the right direction but still too early to call for '25.

And our next question comes from Dan Arias with Stifel.

Ankur or Jacob, how is the clinical community moving to adopt the X? And then what kind of expectations should we have for those labs adopting the 25B kit? And if those two things are presumably later than the research community, does that represent an incremental headwind in the back half of the year or '25 if you then have to start thinking about the pricing pressure there? Or do you think that there was a point where elasticity in the clinical markets is actually something you guys are talking about. Do you think that can start to work for you as we head into next year?

Yes. We are observing that the academic environment is progressing more quickly than the clinical sector, and there are valid reasons for this. As is known, products and assays must be validated before moving into full production. Many of our clinical customers are focusing on maintaining their current validated products while also developing new assays, with several new releases occurring in recent weeks. Consequently, we are beginning to see this shift. We believe that most of our significant clinical clients already have multiple systems in their labs, and we do not anticipate any major shifts or transitions. We expect stability in this area going forward, so I am not particularly worried about changes in trajectory.

And we'll move to our next question from Tycho Peterson from Jefferies.

I want to probe into some of the mid-throughput comments. I know you're talking about capital cash flow when rate's stable. Can you maybe talk a little bit more as to why you don't think that's a competitive issue?

Yes, we can certainly address that. As I mentioned earlier, we take competition very seriously and have experienced competition throughout our history. Illumina has faced competition all along. That said, I am adopting a proactive approach that is different from what I encountered when I joined the company. We're beginning to see significant impacts from this in both the marketplace and our company culture. Regarding the mid-throughput space, we recognize that China continues to be a point of concern due to competitive pressure, but this has remained consistent over the past quarters. Secondly, we are closely monitoring each deal and have good insights into our current position. Looking at the data, we haven't noticed any changes in win rates; they have remained stable over the last few quarters. Consequently, we believe that the primary influence on this situation is the economic environment.

Okay. And then a follow-up. If you're expecting 50% of high-throughput Consumables to transition to X by mid-'25. I guess, how much more do you expect to transition and therefore, the price pressure to work its way through the model? And should we expect 2025 to be a year that's below your forthcoming long-range plan?

Yes. Let me just make sure we got the right number there. So from a volume perspective, we should cross the halfway mark here in the second half of '24. As in Q2, we saw the 45% of the volume to come on X. The 2025 references, half of the revenue should transition over into the X. And with every 5, 7-point mix, the impact of the price continues to go down and the contribution of that volume into revenue continues to increase. Specifically around, Tycho, 2025, we'll talk about this. There will be several moving parts. So we'll talk about this when we get to the guidance point.

And we'll move to our next question from Subhu Nambi with Guggenheim.

Thank you, Ankur, for the detailed insights on NovaSeq X and 6000 dynamics. I have a follow-up question regarding the offshore placement of NovaSeq X. What is the distribution between clinical and research customers? Among the clinical customers, how does the ratio of new customers to replacements look? For existing customers who are purchasing the X, are they shifting their current assays to the X model, or are they mainly utilizing the X for new assays that usually need more in-depth or viral sequencing? I’m particularly interested in this last aspect, as it appears that the usage of the 6000 is quite significant.

Yes. Subhu, I don't know if we've specifically provided that data mix between clinical and research segmentation. We've generally said it's roughly half and half, I believe, right, Salli, in the past but not something that we're providing on an ongoing basis. Now in terms of our clinical customers transition to X, the general approach is still around newer tests, where most of the clinical customer focus is from an X perspective is to develop newer tests on X at the time of launch and then you see the high volume. And Jacob can add more color there.

Yes, that's absolutely correct. And we're seeing mostly of these new tests being higher intensive of sequencing. So there's, of course, interest of getting more samples but sample is not the only parameter here. We're certainly seeing many of our customers looking for larger panels. It's going to hold genome sequencing, including new insights, for example, on genetic insights in your panels and so on and so forth, deeper sequencing in itself. So that's what we see in the clinical space. If you look into the academia space, there's a lot going on, certainly in single cell and in other areas. Now we're starting to see an uptick in spatial which requires much higher intensity of sequencing. So that's what we're seeing right now.

Our next question comes from Puneet Souda with Leerink Partners.

I would like to clarify the mid throughput. Is there a cost per gigabase that you can adjust to reduce expenses in the short term and compete better in that market? Or do you believe that the comment about Nova X you made earlier indicates that the pricing for it, compared to the X-plus with the single flow cell, is actually decreasing to fill a potential gap with competitors in the mid-throughput segment?

Yes, thank you for that question. I believe both options are viable. With the NovaSeq X, using one flow cell allows you to run all applications and take full advantage of the pricing we offer for the NovaSeq Plus flow cells. In terms of mid-throughput, we certainly have the opportunity to adjust our pricing if needed. However, the situation is more complex. While there are many skilled individuals in competing teams, we sometimes get too focused on narrow definitions of claims. This can lead to limited views of interim workflow steps based solely on claims, and we might overlook broader applications or performance that rely on limited data. In most cases, our solution meets the entire computational chain through DRAGEN, significantly enhancing quality and decreasing overall workflow costs. When you consider all these factors, even with a premium cost per gigabase, you will find that our comprehensive workflow costs, application breadth, and computational power set us apart. I believe our customers recognize this. I agree we could improve our communication on this front, and we'll provide more insights next week, including examples of our differentiations for both mid-throughput and high-throughput from our R&D department.

Okay, that's helpful. I'm trying to understand why now is the right time to make changes in the commercial organization. What specific changes are being implemented? Are you making adjustments to the quota-bearing sales force? Some of those strategies have been historically effective. You have a strong product in the market, so I'm curious about what is prompting these changes. What are they?

Yes, I believe it was important to merge our marketing and sales teams prior to Everett joining us. By combining these two teams, we create synergies and align our leadership. We now have one commercial team, which is our first step. Secondly, we have closely examined how to increase the number of quota-carrying sales representatives in the field and enhance our application capabilities as we expand our focus on multiomics. We also see a significant role for informatics moving forward. This isn’t about altering regions or regional structures, but rather about increasing our presence in the market.

Got it. And for the last question, how should we consider the overall pull-through? It’s already over $1 million. What does your math suggest about where that could eventually go?

Yes, we are definitely encouraged to have reached $1 million annually for the X Series. We believe this is not the final point or the maximum and expect it to grow further. We are already seeing customers achieving much higher figures, which motivates us about its potential. However, we are not yet ready to provide a detailed projection on how high it could ultimately go.

And our next question comes from Sung Ji Nam with Scotiabank.

I have a question for Ankur. Could you provide us with more insight regarding your outlook for China, Greater China, and AMEA? Analyzing the growth trends from the past few quarters, they appear to be quite stable. However, I am curious about your guidance, as you mentioned that half of it is related to China and Asia. How has your expectation shifted since the last quarter? Do you foresee a significant decline in those regions moving forward?

Let me begin by discussing our situation in China. It is still too early to determine where we stand in the economic cycle. Currently, the economy remains weak and our customers are facing constraints. We have not observed any significant changes in the competitive landscape in China, which continues to be a challenging market. However, I am optimistic about our progress. As mentioned previously, we have appointed a new head of Region in China who has been in position for just over a quarter. She is actively working to optimize our commercial structure, focusing on increasing field presence and enhancing our back office operations. Additionally, she is working on resetting partnerships and refining those relationships, while also considering targeted pricing strategies for specific product groups. We are also looking to introduce more IVD products in China. There is a lot of activity underway, and while I believe we will see positive changes eventually, it is too soon to offer detailed insights. Ankur, could you provide further insights regarding the rest of Asia?

Yes, let me provide a bit more detail because we've incorporated this into our guidance. Our prior estimates and expectations regarding China did not anticipate a significant recovery in that market. Nonetheless, if you examine the sequential performance, there was a subtle increase, although it remains down compared to the previous year. The business in China has struggled for more than six to eight quarters. In fact, when you consider Illumina's overall performance year-over-year, my midpoint guidance for the full year is approximately 1.5 points lower on a constant currency basis, or 2 points when adjusted for constant currency. A significant portion, nearly two-thirds of that decrease, is attributed to China. Despite many commercial efforts and team changes on our end, we are not observing signs of recovery. The overall environment there appears challenging, and I wouldn’t expect any increase in business volumes for the remainder of the year. Therefore, we have removed that from our forecast to mitigate risk.

And our next question comes from Eve Burstein from Bernstein Associates.

Great. In the last few months, we've seen both Quest and LabCorp announce or expand collaborations with one of your competitors. Can you remind us what portion of your revenue comes from those companies? And then I can imagine some reasons why those companies would act differently than other of your clinical customers. So for example, I'm guessing that they do a higher portion of LDTs and FDA-approved tests, so they don't need as many of the X boxes. Maybe there's a more natural fit. But why shouldn't we take this as a major sign of potential share loss in the clinical market, not just potentially a hit to revenue if and when assays shift to the X and X Plus?

Yes. I think I suggest you speak closer to those companies about their decisions on making collaboration agreements with other parties in the NGS space. I think we are focusing on, first and foremost, provide the highest quality to our customers. Because I think there is a little bit over rotation here on a price that goes for a very, very limited application space. And it's not really addressing what you can do for actually the patents you do today or the whole genomes. So on the other hand, I think it's not only about providing a price, also providing a product and a solution where you have confidence in that the vendor can provide and continue to support you. So I think there's many more details that go into this. And we, here, at Illumina will continue to do our best to provide the best solutions but not only focusing on one single element in the workflow, the cost of sequencing but the whole cost of workflow and providing the highest quality of answers to our customers.

And our next question comes from David Westenberg with Piper Sandler.

Can you discuss the pricing transition in XLEAP? I understand that XLEAP in the mid-throughput category is backwards compatible, and you mentioned a 60% adoption rate. What is the actual dollar impact of this pricing change? Could you provide guidance for this year regarding this? Additionally, I have a follow-up question about the validation step needed for clinical throughput. Could you elaborate on that?

First of all, 60% of our installed base has downloaded the software, which indicates strong interest in the XLEAP chemistry. We’ve noticed significant interest in the P4 flow cell, which has been available for some time, and now we're also seeing traction with the P1, P2, and P3 models. We have a different pricing strategy for XLEAP chemistry, which is one of the interesting areas, and we are also offering higher quality sequencing with increased capacity. Ankur, could you share more details about our transition status? Regarding validation, the process of moving from standard SBS chemistry to XLEAP chemistry depends on the assays being used. Generally, normal validation procedures must be followed when switching software or assays, and each clinical lab is familiar with that process. There are no specific steps required from our side for this transition. Ankur, would you like to elaborate on our current status with the transition?

Yes. In terms of the transition from XLEAP to our previous consumables, there will be a pricing change, but it will be significantly smaller and likely more proactive compared to what you've seen with the X side. From a modeling perspective moving forward, the volume of empty consumables is a much smaller portion of our P&L and revenue compared to our ex-consumables business. Therefore, the impact on the overall revenue line will be significantly smaller.

Got it. And then just a quick follow-up on Fluent. What's the intention there in terms of pricing? Can you drive pricing even lower than that? And in terms of pricing in bundles, have you thought about how you would do bundled pricing? And just on intellectual property, do you feel comfortable with that? I know that involves an emulsion step versus a microfluidic step. Does that provide you with protection? There has been a lot of intellectual property in that space.

We are very excited about the Fluent acquisition. We believe that the Fluent technology will promote wider adoption of single-cell solutions. There are opportunities in mid-throughput areas where customers can easily access single cells, and for high-volume patient testing, the cost of each individual cell is competitive and can effectively meet market needs. It is still early to discuss our commercialization strategy, but we will present Fluent as an appealing option. We will continue collaborating with all partners and single-cell providers in the industry to ensure they have a competitive offering on our platforms as well.

And we'll move to our next question with Dan Brennan with TD Cowen.

Jacob and Ankur, maybe just a clarification first and then just a question on just consumables. On the clarification, I think you said there's really not much of a margin drag as you move actually into the mid-throughput, is that correct? Because we were under the impression, I think, actually you presented $9 per Gb and I guess, on-label price for NextSeq might have been something into the teens or low 20s. So maybe you can just speak to a little bit how the margin impact flows through as your mid-throughput base adopts XLEAP?

Yes. So I'm saying there will be a margin drag. What you're looking at is the list prices but the on-market prices are likely different from where the list prices are already and then second, on the margin drag side, given the contribution that mid-throughput consumables make on our overall revenue is relatively a smaller part of my P&L. That drag on full Illumina P&L is going to be generally manageable.

But I will also say that the R&D team has done a great job together with manufacturing to lower the price of the XLEAP chemistry. So it actually comes with a lower COGS and, thereby, less of a drag on the margins.

Got it. I know you provided a lot of details during the presentation about volume. Did you discuss the revenue growth in the research and clinical segment for the quarter, particularly for NGS? How did that break out? Also, could you provide some insights on what is expected in the 2024 guidance regarding research and clinical areas, along with any potential competitive impact, even though it seems you’re having considerable success? I assume the success is more on the research side than on the clinical side. Any additional details would be appreciated.

Yes. So we're not normally splitting that out but I can tell you that we are growing healthy on both sides of the academic and the clinical part of the business.

And ladies and gentlemen, that concludes our Q&A session. I will now hand the call back over to Salli Schwartz.

Thank you for joining us today. As a reminder, a replay of this call will be available in the Investors section of our website. This concludes our call and we look forward to seeing you at our upcoming Investor Day and other events.

Ladies and gentlemen, this concludes today's call. You may now disconnect.