Earnings Call
Illumina, Inc. (ILMN)
Earnings Call Transcript - ILMN Q3 2021
Operator, Operator
Hello, and welcome to the Illumina Q3, 2021 Earnings Call. Following the presentation today, we will have a Q&A session. I would now like to hand the conference over to Brian Blanchett, so Brian, please go ahead.
Operator, Operator
Good afternoon, everyone and welcome to our earnings call for the third quarter of 2021. During the call today, we will review the financial results released after the close of market and offer commentary on our commercial activity, after which we will host a question-and-answer session. If you have not had the chance to review the earnings release, it can be found on the Investor Relations section of our website at illumina.com. Participating for Illumina today will be Francis deSouza, President and Chief Executive Officer, and Sam Samad, Chief Financial Officer. Also joining us today is Bob Ragusa, Chief Executive Officer of GRAIL. Francis will provide an update on the state of Illumina's business. Bob will provide updates on GRAIL's business. And Sam will review both core Illumina and GRAIL Financial Results. 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 Exchange Commission, including Illumina's most recent Forms 10-Q and 10-K. With that, I now turn the call over to Francis.
Francis deSouza, CEO
Thank you, Brian. And good afternoon, everyone. Illumina's third quarter was another exceptionally strong quarter, with $1.108 billion in revenue, up 40% year-over-year, and once again, significantly ahead of expectations. Our customer base continues to expand rapidly. In the first three quarters of 2021, we added 50% more new customers than in all of 2020 or 2019. Because of this strength across our business, we are raising our full-year revenue growth outlook for the third quarter in a row, to approximately 36%. This is approximately double the growth rate and $567 million higher than the midpoint of the range we guided to at the beginning of the year. I will talk through the third quarter results for Core Illumina as defined as Illumina, other than GRAIL, and then I'll turn the call over to Bob Ragusa, the CEO of our GRAIL subsidiary to cover the GRAIL business. Core Illumina revenue was $1.106 billion. Sequencing instrument revenue was up 65% year-over-year. We exited the quarter with a record instrument backlog, a positive leading indicator for future revenue. Sequencing activity in the quarter was also strong, with sequencing consumable revenue up 45% year-over-year, setting a new record. Our high-throughput platform order volume is accelerating. Oncology testing, population sequencing, and drug discovery initiatives drove record NovaSeq consumables and instrument shipments. Oncology testing customers represented the highest proportions of NovaSeq shipment for the quarter as large oncology testing labs added to their fleets to support expanded reimbursement for therapy selection testing. Drug discovery is emerging as the new application for high-throughput sequencing, with opportunities across common diseases ranging from obesity to aging. Our mid-throughput platforms also drove growth and expanded our installed base. In the third quarter, over 50% of NovaSeq 1,000 and 2,000 placements were new to Illumina customers or to customers upgrading from low-throughput instruments. These instruments continued to unlock new applications. Researchers at Tulane School of Medicine are using the NextSeq 2000 for single-cell experiments focused on infection and inflammation. The team is working to develop inhaled vaccines for pneumonia and use single-cell RNA-seq on a NextSeq 2000 to study the immune cells elicited by this vaccine platform in a recent paper published in Science Immunology. Bench-top platforms also saw significant growth year-over-year, with the highest number of MiSeq shipments since Q4 2015. MiSeq coupled with our COVIDSeq 96 sample assay is enabling labs around the world to engage in local pathogen surveillance. This quarter MiSeq placements in both Argentina and Brazil brought COVID surveillance to local communities in conjunction with broader national programs. Now, turning to clinical and research and applied segments, Oncology Testing, our largest market segment, had another record quarter. Sequencing is becoming the standard of care in therapy selection, which is driving robust demand for Illumina's sequencers and our oncology testing customers are rapidly scaling their fleets in response. Reimbursement for genetic testing for therapy selection continues to expand, with over 70% of insured lives in the U.S. now covered for these tests. Additionally, there are over 60 targeted and immunotherapy treatments currently on the market, highlighting the power of comprehensive genomic profiling in matching patients to treatments. TruSight Oncology 500, our research-use-only Comprehensive Genomic Profiling assay, had another record quarter with over 340 customers now using the assay in their labs. In September, we announced the CDx partnerships with Merck to develop and commercialize tests, leveraging TSO 500 content, and an HRD status based on Myriad's myChoice in patients with ovarian cancer. Approximately 300,000 women around the world will be diagnosed each year with ovarian cancer; the 5th deadliest cancer for women. This partnership will help these patients access additional treatment options with the goal of improving care. In reproductive health, we saw another quarter of strong year-over-year growth. Over 80% of pregnancies in the U.S. are now covered for noninvasive prenatal testing. We are seeing additional progress as states begin to incorporate the ACOG guideline revision from last year into their prenatal screening programs. In California, the prenatal screening program is being revised to include non-invasive prenatal testing and the state has now issued a request for proposal. NIPT is increasingly being incorporated into guidelines outside the U.S. as well. In September, the Italian Ministry of Health issued new guidelines supporting the use NIPT in a contingent model. With the continued momentum in coverage guidelines, our end-to-end VeriSeq V2 solution is gaining traction across global markets. Genetic disease testing also posted another strong quarter as broad reimbursement and compelling clinical utility data drive a shift to whole genome sequencing. This quarter, the result of the groundbreaking NICUSeq trial, co-authored by Illumina scientists, were published in JAMA pediatrics. The randomized time-delayed trial demonstrated that clinical whole genome sequencing drives a twofold improvement in both diagnostic efficacy and change of clinical management for acutely ill newborns. We are working to ensure that families and NICU patients around the world can access these tests. In the U.S., Michigan recently became the first State to offer rapid whole genome sequencing to acutely ill infants and children, regardless of insurance. Other states like California and Florida are making progress in this direction as well. Outside the U.S., last week, we announced a pilot program in Israel to implement whole genome sequencing for critically ill infants suspected of having a genetic disorder in neonatal intensive care units. This program will accelerate time to diagnosis for these patients and support rapid clinical decision-making. Turning to our research and applied segments, we saw another strong quarter of sequential and year-over-year growth. The 30-plus population genomics initiatives that we support around the world drove growth in the quarter. The accuracy and scalability of our sequencing platforms combined with our end-to-end solutions like Illumina Connected Analytics make Illumina an ideal partner for large sequencing initiatives. The value of these population programs is expanding across clinical outcomes, research, and drug discovery. This traction is generating significant interest and investment for additional programs like Our Future Health, the UK’s largest ever research program focused on developing new ways to detect, treat, and prevent disease. Just yesterday, we announced that Illumina Connected Analytics solutions are being used by HostSeq, part of the Canadian COVID-19 Genomics Network. Our sequencing and bioinformatics solutions will be used to identify biomarkers that can help predict potential risk of serious disease, and support the development of novel therapeutics to combat COVID-19. We anticipate these types of population programs will become increasingly critical to innovation as their findings translate into greater use of sequencing in clinical workflows and actionable data for drug discovery. We're already seeing this with the initial data from the UK Biobank as the program concludes, Regeneron is utilizing the UK Biobank data in multiple ways, including defining more than 500 genes with variant trade associations linked to higher risk of diseases like hypertension, asthma, and liver disease. As part of the dataset to create new obesity medicines in partnership with AstraZeneca. Companies like Relay Therapeutics are utilizing genomic data along with AI and machine learning to advance drug discovery. COVID surveillance drove $55 million in sequencing shipments in the quarter, of which $15 million were instrument purchases as concerns about variants continue to heighten the focus on surveillance efforts. We see the infrastructure for COVID surveillance as the foundation for broader pathogen surveillance to increase around the world. For example, CERI, a new genomics facility in South Africa, was launched this quarter with capabilities to bolster the pandemic and epidemic response across Africa. With resources like this in place, sequencing data from 51 of the 54 countries in Africa is now available in real-time. A total of 50,000 SARS-CoV-2 genomes have been sequenced, two months ahead of Africa CDC schedule. Turning to GRAIL. In August, we closed our acquisition, which we believe will help accelerate patient access and affordability for multi-cancer early detection screening. I am delighted to introduce Bob Ragusa on his first call as GRAIL's CEO. Bob most recently served as Illumina's Chief Operations Officer, and he has more than 30 years of experience in genomics. He played a critical role in providing the sequencing systems for the Human Genome Project and was responsible for significantly scaling Illumina's business in more than 140 countries and enabling the first NovaSeq shipments. With his decades of deep expertise, Bob is uniquely positioned to lead GRAIL during a time of extraordinary growth and discovery. I will now turn the call over to Bob to discuss GRAIL's business updates.
Bob Ragusa, CEO of GRAIL
Thank you, Francis. I'm honored to lead the talented team at GRAIL to advance the mission to detect cancer early, when it can be cured. I am pleased to share a few thoughts on our recent progress. First, I want to highlight gallery commercial progress. We see significant pre-reimbursement opportunities for Galleri and are encouraged with the momentum across our three primary channels. In the employer channel, we're gaining momentum and expect to announce notable new partnerships in the technology, industrial, professional services, and transportation sectors. We are also successfully engaging with key high-cancer-risk areas of public sector employers such as firefighters. For health systems, we are focused on establishing strategic agreements with influential systems in the medical community to increase awareness and experience with Galleri. Health systems are also strategic partners to generate real-world evidence in key patient communities and regions. To date, we have signed agreements with several health partners who are planning to start providing access to Galleri in the fourth quarter. We're also in contract discussions with several additional influential health systems that we expect will begin offering Galleri to patients early next year. In addition, we are excited to see interest from progressive and innovative payers, including Medicare Advantage, where we expect to communicate our first partnership soon. Medical practices are an important driver of the Galleri launch. We have agreements with several of the largest primary care private practice networks and expect to continue to expand in this area. We are focused on onboarding physicians in these networks and see positive prescriber trends. We also recently partnered with Genome Medical, an independent healthcare provider, to serve individuals who prefer a telemedicine option. We launched this service several weeks ago on galleri.com and believe this will be an important future pre-reimbursement growth driver. In addition, we partnered with PWN Health, a national telehealth network, to further extend our service capability for some employer programs. Additionally, in September, the state of New York granted approval for the Galleri test. The standard set by New York state represents one of the most rigorous levels of validation required for a laboratory-developed test. Finally, there is tremendous excitement around the recent start of the NHS-Galleri study. A 140,000 participant, real-world randomized controlled study that has generated widespread national and international media coverage. This is part of England's national priority to speed up earlier detection of cancer to improve survival. Enrollment has been robust and is on track with our expectations. Based on data generated from this initial study, access to Galleri could expand to around 1 million people in 2024 and '25, and to a larger population after that time. Lastly, I would like to note that the reported GRAIL revenue represents both revenues recognized from the sale of our Galleri tests and revenue generated from our MRD collaboration agreements with biopharmaceutical companies. We are encouraged by the initial test results generated with our partners and plan to expand the number of pilot studies to support development of MRD and PDX product opportunities. We also expect MRD and PDX collaboration to become a more important component of GRAIL's revenue mix and is an attractive future growth driver of our business. I look forward to sharing with you more about GRAIL progress in the coming quarters. Now I will turn it over to Sam.
Sam Samad, CFO
Thanks, Bob. As a reminder, our third-quarter financial results include the consolidated financial results for GRAIL for the period beginning after the acquisition closed on August 18, 2021. I'll start by reviewing our consolidated financial results, followed by segment results for Core Illumina and GRAIL, then conclude with our outlook. I will be highlighting 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 the supplementary data available on our website. Third-quarter revenue, once again, significantly exceeded our expectations, growing 40% year-over-year to $1.108 billion, driven by core Illumina revenue growth of 39% and $2 million of revenue from GRAIL. For the third quarter, GAAP net income was $317 million or $2.08 per diluted share, which included a $900 million gain from our previously held investment in GRAIL as a part of the acquisition, and $654 million in day one compensation expense related to the GRAIL acquisition. Non-GAAP net income for the third quarter was $221 million, or $1.45 per diluted share, which included $0.19 of dilution from GRAIL operating losses and $0.06 of incremental dilution from the $9.8 million shares issued to fund the GRAIL acquisition. Our weighted average diluted share count for the quarter was approximately 153 million. Moving to the rest of the consolidated P&L. Non-GAAP operating expenses of $528 million increased $57 million sequentially, primarily due to the inclusion of GRAIL non-GAAP operating expenses of $50 million for the quarter and a $7 million increase in Core Illumina non-GAAP operating expenses. Non-GAAP operating expenses increased by $163 million year-over-year, driven by $50 million of GRAIL non-GAAP operating expenses and a $113 million increase in core Illumina non-GAAP operating expenses. Non-GAAP other expense of $6 million increased $4 million sequentially and was $13 million lower than other income in Q3 of last year as expected. The year-over-year decline was primarily due to lower interest income on short-term investments as we repositioned our investment portfolio and subsequently liquidated our holdings to fund the GRAIL acquisition, as well as interest expense on the term notes issued in Q1 2021. The non-GAAP tax rate of 13.2% decreased from last quarter and year-over-year due to the tax impact of including GRAIL in Illumina's consolidated results of operations. The decrease in the non-GAAP tax rate year-over-year was partially offset by discrete tax benefits recorded in the third quarter of 2020, related to prior-year return adjust and tax reserve releases. Moving to segment results, I will start by highlighting the financial results of Core Illumina. Core Illumina revenue grew 39% year-over-year to $1.106 billion, driven by record shipments for both clinical and research. Core Illumina sequencing revenue of $1.013 billion grew 43% year-over-year and represented 92% of Core Illumina revenue. Core Illumina sequencing consumables revenue grew 45% year-over-year to $723 million, led by record NovaSeq consumable shipments that grew over 50% year-over-year. Sequencing instruments revenue for Core Illumina grew 65% year-over-year to $180 million driven by record NovaSeq shipments that again more than doubled year-over-year due to accelerating demand in oncology testing. NextSeq 1,000 and 2,000 orders reached a new high in the quarter. And there was solid growth across all mid and low throughput systems year-over-year. We ended the quarter with record sequencing instrument backlog that is almost doubled the backlog entering the year. Revenue from COVID-19 surveillance again exceeded our expectations due to the sustained focus on variant tracking and surveillance infrastructure scaling in the quarter, contributing approximately $40 million in sequencing consumables revenue and $15 million in incremental instrument revenue. Core Illumina sequencing service and other revenue grew 11% year-over-year to $110 million, driven by higher instrument service contract revenue on a growing installed base as well as GEL sample growth. Moving to regional results for Core Illumina. Revenue for the Americas region was $581 million, growing 33% compared to the prior year period. Revenue growth in the region was driven by record oncology testing shipments and ongoing population genomics initiatives such as all of us. The regional performance was also driven by COVID surveillance strength due to expanded Public Health Network Adoption of NGS in Latin America. EMEA delivered revenue of $313 million, representing 47% growth year-over-year. EMEA's performance was driven by significant growth across all clinical markets and strength in emerging markets. Population genomics initiatives partially driven by UK Biobank, which concluded in Q3. COVID surveillance testing also contributed to the strong third quarter performance in the region. Greater China revenue was $122 million representing growth of 47% year-over-year due to continued clinical strength in the region led by NextSeqDx demand in hospitals and oncology testing. Almost half of the NextSeqDx shipments were for new to Illumina hospital customers. The expanding footprint in hospitals is helping drive growth in infectious disease testing, which more than doubled year-over-year. Finally, APJ revenue of $90 million grew 45% year-over-year, driven by sequencing instrument growth from clinical demand for NextSeq 2000, as well as consumables revenue growth across oncology testing and research. Moving to the rest of the core Illumina P&L. Core Illumina non-GAAP gross margin of 71.3% declined sequentially by 50 basis points due primarily to one-time revenue from the NIPT patent litigation settlement recorded in the prior quarter. On a year-over-year basis, non-GAAP gross margin increased 390 basis points due to increased fixed cost leverage on higher volumes, partially offset by higher freight costs as a result of the pandemic. Core Illumina non-GAAP operating expenses of $478 million were up $7 million sequentially, but overall were lower than expected due to the timing of hiring and project spend shifting into Q4. As expected, non-GAAP operating expenses were up $113 million year-over-year due to increased performance-based compensation expenses and headcount growth, as well as additional investments to support the significant growth of our business. Core Illumina non-GAAP operating margin was 28% compared to 30% in the second quarter of 2021. Operating margins declined sequentially as expected, mostly due to $20 million of one-time patent litigation settlement revenue recognized in the prior quarter. Transitioning to the financial results for GRAIL. GRAIL revenue of $2 million for the quarter consisted primarily of Gallery test fees, the multi-cancer early detection tests that commercially launched in June, as well as moderate MRD partnership revenue. GRAIL, non-GAAP operating expenses totaled $50 million for the quarter, which consisted primarily of expenses related to headcount and clinical trials. As a reminder, GRAIL's third-quarter financial results are for the period beginning after the acquisition closed on August 18. Moving to cash flow and balance sheet items for consolidated Illumina. Cash flow used in operations was $272 million, which was an outflow for the quarter due to expenses related to the GRAIL acquisition. DSO of 50 days compared to 44 days last quarter driven by revenue linearity. Third-quarter 2021 capital expenditures were $52 million, and free cash flow was a negative $324 million. We did not repurchase any common stock in the third quarter. We ended the quarter with approximately $1.3 billion in cash, bank balance and short-term investments. During the third quarter, we used $2.9 billion to fund the GRAIL acquisition. Before I discuss guidance, I wanted to acknowledge that I'm especially proud of our team's strong execution to fulfill surging demand and deliver another record quarter in a challenging global environment. While there were some small pockets of supply constraints for certain products and specific geographies this quarter, there was no material impact thanks to our team’s incredible efforts. We will continue to source, produce, and operate with agility to enable further growth and support our customers. Moving now to 2021 guidance, we now expect full-year 2021 consolidated and Core Illumina revenue to grow approximately 36%. This represents consolidated revenue of approximately $4.41 billion for 2021, or revenue growth of approximately $1.17 billion compared to 2020, and an increase of approximately $100 million compared to the midpoint of our prior guidance. For fiscal 2021, we now expect Core Illumina sequencing revenue to grow approximately 39% year-over-year, driven by continued momentum in our base business. We now expect Core Illumina non-GAAP operating margin to be between 27.5% to 28%, which reflects our higher revenue expectations. We expect Core Illumina operating expenses for Q4 2021 to increase by approximately $50 million compared to Q3 2021, due to the timing of expenses shifting from Q3 into Q4, increased investments to support the robust growth of our business, as well as expected payments in Q4 2021 related to certain partnerships. Our focus continues to be on improving the Core Illumina operating margin leverage over time. We now expect our non-GAAP tax rate to be approximately 17.5%. We now expect consolidated non-GAAP earnings diluted share in the range of $5.50 to $5.60. Which includes dilution from GRAIL operating loss of approximately $1 and incremental dilution of $0.15 from the 9.8 million shares issued to fund the GRAIL acquisition. We now expect GAAP earnings per diluted share in the range of $4.41 to $4.51. We now expect diluted shares outstanding in fiscal 2021 to be approximately 151 million. For the Fourth Quarter of 2021, we expect non-GAAP earnings per diluted share in the range of $0.35 to $0.45. And GAAP earnings per diluted share in the range of $0.10 to $0.20. We expect diluted shares outstanding for the fourth quarter of 2021 of approximately 158 million. Now I will hand the call back over to Francis for his final remarks.
Francis deSouza, CEO
Thank you, Sam. Our third-quarter performance reflects the strength of our business, the talent and dedication of our people, and the enduring value of our mission. Before I close, I would like to highlight how we are furthering this mission through our ESG work. Human health and the health of the environment are intertwined, as are our company mission and our commitment to operating responsibly and sustainably. In the third quarter, we announced aggressive environmental goals, including our Net Zero commitment to advance the climate component of our ESG strategy. Sam and I will discuss this strategy in greater detail at our inaugural ESG Investor event on November 16th, and we hope you will join us. To close, we saw remarkable performance and broad-based strength across our business in the third quarter. We are both inspired and excited to see this momentum continuing into Q4. We again raised our annual revenue guidance, and with our record instrument backlog, we're on pace for a strong finish to an exceptional 2021. We will build upon this strength as we seize opportunities to expand existing markets, including oncology testing and infectious disease along with new applications. Sequencing data will enable this expansion as we usher in the era of genomic medicine, and Illumina will be at the forefront of these innovations, supporting our customers as we collectively advance human health. Now, I'll invite the operator to open for Q&A.
Operator, Operator
Thank you. The Q&A session is now open. In the interest of time, we ask that you please limit your questions to one at a time. We have the first question on the sidelines from Dan Brennan of Cowen. Dan, please go ahead.
Dan Brennan, Analyst
Great. I thought for the first question, I would want to begin on the outlook for the fourth quarter. After a really strong start to the year, you're raising guidance. But the fourth-quarter outlook looks to be conservative to us. I'm just wondering a couple of things here. Is there anything implied further for COVID testing? I know you had $25 million to $30 million per quarter originally in your guidance, so the reduction to the strong COVID here in Q3. Given the easy comp and the backlog and the momentum, I am just wondering why the fourth-quarter outlook might not be stronger. And then I have a follow-up. Thank you.
Sam Samad, CFO
Yes. Thank you, Dan, this is Sam and hope you're doing well. Welcome back and good to have you on the call. For Q4, first of all, let me talk about the full year. We are raising our revenue guide to approximately 36%. For Q4, I think there are a couple of areas that you need to keep in mind. One is the conclusion of the UK Biobank initiative. This has been an incredibly productive and important initiative from a population genomics standpoint. That will likely present a $20 million quarter-to-quarter headwind or reduction in terms of revenues in Q4 versus Q3. So that's one area. The second area is COVID surveillance. COVID surveillance has been strong for the year, with continued testing and sequencing of positive samples across the globe. For Q3, we have $55 million of COVID surveillance revenue in the quarter, that represented $15 million of instruments and $40 million of consumables. For Q4, our expectation is that we will have $35 million of COVID surveillance revenue, which represents a modest amount of instrument revenues, about $5 million, and then approximately $30 million of COVID consumables. That represents another $20 million reduction from Q3 into Q4. When we think about that sequential momentum, the core business is really strong. And when I say core business, I mean our clinical business and research business, you heard comments from Bob around GRAIL, but there is that reduction associated with those two items, which is COVID surveillance as well as the UK Biobank concluding.
Dan Brennan, Analyst
Great. And then in terms of clinical, Francis, and therapy selection, you gave a lot of color there, you talked about customers rapidly adding platforms. Could you give us a sense of the install base that's supporting this customer base? What that's been growing at and what's the backlog look like and outlook for further growth in that area? Thank you.
Bob Ragusa, CEO of GRAIL
Yeah. Thanks, Dan and I'll add my welcome to the call. It's great to see you covering us again. I talked about the strength in the oncology segment, specifically oncology therapy selection testing because that has really been one of the breakout stories for the whole year. What’s really driving that story is a few things. 1. We saw a significant expansion in reimbursement for genomic testing for therapy selection play out in the U.S., now we have a significant base in the U.S. that has coverage for genomic testing. At the same time, we've seen a move towards larger panels as Comprehensive Genomic Profiling really gains traction in the market. Those two have created a powerful force and oncology therapy selection testing. We're seeing our customers expanding their fleets. Now in terms of how that's playing out, you're seeing it play out across all segments. Some of our larger customers are significantly expanding their fleets and specifically expanding their NovaSeq fleet because of the demand they’re experiencing, as well as the anticipated demand going forward. But you're also seeing new customers and smaller customers get into oncology therapy selection. One of the interesting messages to look at, and it takes into account more than oncology but oncology is one of the biggest drivers of it, is if you look at the strength in the NovaSeq instruments, you’d see we're placing a lot of NovaSeq instruments and we have a very strong backlog of NovaSeq instruments. At the same time, you're seeing really strong pull-through in NovaSeq. So, that's sort of the pot of gold at the end of the rainbow, right? Because you're putting a lot of instruments out there and yet pull-through remains high end, the high end of the range we've talked about. To your question about the outlook going forward, I'd say that's a really good positive indicator for what people are experiencing today and what they are expecting going forward.
Dan Brennan, Analyst
Great. Thanks, Francis.
Operator, Operator
Thank you, Dan. We now have the next question from Vijay Kumar from Evercore. Vijay, please go ahead when you're ready.
Vijay Kumar, Analyst
Hey, everyone. Congratulations on a solid performance, and thank you for taking my question. I want to ask about the Q4 guidance for fiscal '22. The updated EPS range of $5.50 to $5.60 suggests approximately $0.30 to $0.40 for Q4. Could you clarify if there are any one-time costs or unusual conditions affecting this figure? It seems like an annualized run rate of $1.60 doesn't add up. I’d like to confirm that my understanding of the Q4 assumptions is correct. Additionally, should comparisons to fiscal 2021 be a concern since many of your competitors are projecting normalized growth? Given your remarks about backlog, it seems like surveillance will play a significant role this year, but with that 36% figure, should comps be a focus and what is your perspective on this?
Sam Samad, CFO
Yes, let me start by discussing Q4. We mentioned an EPS guidance of $0.35 to $0.45 for non-GAAP EPS in Q4, accounting for the effects of GRAIL. There is approximately $0.80 dilution related to GRAIL and about $0.09 dilution from the weighted average share count due to shares issued for the GRAIL acquisition. These factors specifically affect the $0.35 to $0.45 non-GAAP EPS for Q4. Regarding the core Illumina business, I noted some revenue dynamics. As for operating expenses, there are costs I previously mentioned. First, some expenses were shifted from Q3 to Q4, which explains the lower-than-expected operating expenses in Q3, while Q4 has seen an increase in anticipated spending. Additionally, there are partnership-related operating expenses expected in Q4 that are significant and specific to this quarter. Concerning 2022 guidance, we won’t provide detailed guidance on this call, but I can confirm that the fundamentals of the business remain very strong. The GRAIL dilution estimate of $3.25 to $3.75 for 2022 still stands and has not changed. As you’ve heard, our backlog is robust, and in terms of instruments, the core fundamentals for clinical and research aspects are exceptionally strong.
Vijay Kumar, Analyst
I'm sorry, just one clarification, Sam. The $3.25 to $3.75 dilution from GRAIL, that is not incremental, right? You guys have taken a $1.15 of dilution in fiscal '21. So, the $3.25 to $3.75, that is inclusive of the $1.15?
Sam Samad, CFO
That's total dilution for GRAIL in 2022. That's not incremental; that’s the total dilution that we expect, $3.25 to $3.75 impact on non-GAAP EPS in 2022.
Vijay Kumar, Analyst
Thanks for clarifying. Thanks, guys.
Operator, Operator
Your next question comes from Tycho Peterson of JPMorgan. Tycho, please go ahead.
Tycho Peterson, Analyst
Thanks. Sam, I want to hone in on your supply chain comments a little bit. It sounds like limited disruption up till now. We have heard about customers not being able to get flow sales and limited NovaSeq shipments, and you did exit the quarter with record backlog. Can you maybe just touch on the supply chain dynamics now, given the low telegraph and well-publicized shortages of semiconductors but also cameras and high adoptables?
Francis deSouza, CEO
Hey, Tycho, this is Francis. So, I'll start by saying, it's a good question because anytime you have just such a big beat and you have demand coming in so far ahead of expectations, I think now we're looking at the guide we put out now is over $500 million over the midpoint of the guide we put out to the year there. Anytime you have such a big beat playing out against the backdrop of a pandemic, the first thing you look at is the supply chain, your ability to serve. As we said on the call, I'm incredibly proud of the work the team has done in terms of demand capacity planning to make sure that we are able to stay ahead of this big demand we're seeing. And as we pointed out, we started to see this demand build at the tail end of the last year. The teams did a lot of work on a number of fronts. First, they worked around making sure that our inbound supplies could cope with the demand that was coming. That meant things like building safety stock internally of supplies coming in, ordering items that would have long lead times, sometimes up to a year plus in advance, or things like resins where we knew there might be shortages. We started investing in increasing our own production capacity, whether it’s cartridges, and closed sales, or raise, across the board. By the first half of this year, we were significantly increasing capacity to build a supply. In addition to that, we started to invest starting last year and increasing our ability to move production. For example, we expanded our warehousing capacity in Eindhoven and opened up a new center in Eindhoven. We doubled the capacity we had in Eindhoven. Similarly, we expanded capacity in Japan this year from our warehousing perspective, we put a new warehouse in Brazil this year, and we also continue to invest in strengthening the transportation links between these hubs. We started to build safety stock on the outbound side to make sure that we had enough inventory on site to cope with what we knew was going to be strong demand, which ended up being much stronger than we even expected. The vast majority of our core consumables now, we have safety stock on hand that's six to eight weeks of supply. Our team did a terrific job calling it early and then jumping on it to make sure that we have the capacity to supply the demand coming in.
Bob Ragusa, CEO of GRAIL
Yeah. The only thing I would add to that, thank you, Francis, is that the backlog is really strong and driven by the demand. All of those things that Francis mentioned are actions that we've taken to ensure there's continuity in the supply chain and we're fulfilling customer orders on time. There have been a few isolated customer instances where there have been extensions of lead time which is normal. That's very much something that we see every quarter. But in general, the backlog is really driven by demand, not driven by any supply issues that are causing that.
Operator, Operator
Thank you. We now have a question on the line from Tejas Savant of Morgan Stanley. Tejas, please go ahead.
Tejas Savant, Analyst
Hey, guys. Good evening. I have a quick question on GRAIL. Francis, do you have any updates from the regulators now that they've had some time to digest your decision to close? Have you heard anything from them on the structure of the whole separate agreement and the possibility of the fine? And then secondly, can you just lay out your plans to build out the commercial infrastructure here, now that Galleri is live and you started to see early traction from the Mayo Clinic and some of the other partners you highlighted in the prepared remarks?
Francis deSouza, CEO
Yes. I will first discuss the regulatory process and then hand it over to Bob to share insights on commercial expansion. Regarding the regulatory process, there have been no surprises. It is unfolding as we anticipated. We are actively involved with the European Commission, and things are progressing. We expect a decision on the phase two review in Europe toward the end of Q1; however, it may be slightly delayed. We are also awaiting the trial date for the jurisdiction trial in Brussels, which is on schedule. In the U.S., we are finalizing the administrative trial that recently took place, and we anticipate a decision around the end of Q1, possibly by early next year. Everything is proceeding as we expected concerning the hold separate. The order issued aligns with our expectations and is generally consistent with the hold separate we implemented voluntarily in anticipation of the process. Overall, there have been no significant surprises, and everything is unfolding as planned. Now, I will pass it to you, Bob.
Bob Ragusa, CEO of GRAIL
Thanks, Francis. In terms of the demand picture, we see significant pre-reimbursement opportunities for Galleri across three main channels: employer, health systems, and medical practices. One of the key elements of working with the team now is to ensure that we can ramp up the commercial scale of the organization to really meet the demand that's out there. We will eventually have to ramp up our entire operations so that we have the ability to deliver a great customer experience at scale. We’re excited to take on that challenge because we find ourselves in a position of having product that is so strong, and now we have the opportunity to build out all the commercial elements and delivery elements to deploy Galleri in a big way.
Francis deSouza, CEO
Yes. Maybe I'll just add one other thing just from a personal perspective. We've rolled out the GRAIL test to Illumina employees. As I know, some of you listening may also have. Again, as a CEO, there are a few times in your career when you get to roll out something that's universally beloved and will save lives. We have started to see feedback from the first participants who have been able to identify early-stage cancer because of the Galleri tests. The cancers they're talking about are ones that don't have other screens. This is a personal realization of the power of this test.
Operator, Operator
Thank you. We now have a question from Patrick Donnelly of Citi. Patrick, please go ahead when you are ready.
Patrick Donnelly, Analyst
Hey, guys. Thanks for taking the questions. Francis, maybe one on China. Can you just talk about what you're seeing there? There is obviously a lot of noise in different parts of the market and you guys put a pretty good result. Can you talk about the trends there you're seeing and expectations going forward?
Francis deSouza, CEO
Yeah, we have continued to see a really strong performance out of China. Overall, we had 47% year-over-year growth. The growth in China continues to be driven by the clinical markets. Our strategy, starting last year, of really focusing on the emerging hospital market is really paying dividends. It's a market that's really embracing not just NIPT, which they embraced early, but increasingly also starting to roll out oncology testing and genomic testing more broadly. We're seeing progress there, driven by the terrific partner ecosystem that we’ve built up in China. That's really paying off. We're actually seeing a tailwind associated with some regulations that have emerged, allowing the use of LDTs in Shanghai, and that has been fairly recent but is already starting to pay dividends as we see more labs being established to generate their own LDT testing capability. That's helping drive some growth there, and we're definitely excited and optimistic about what's happening in China for us right now.
Patrick Donnelly, Analyst
Okay. And then maybe one on the population sequencing; you called out the UK Biobank concluded this quarter. Can you just update us on how you're feeling about those rolling out? And again, as we see some data and see the use of UK Biobank's potential for that to become a bigger piece for you guys?
Francis deSouza, CEO
Absolutely. One of the things that is really great to see is the broadening of the base of population sequencing customers. We talked about the fact that we've been cultivating over 50 of these opportunities, and we're now at the stage where over 30 of these opportunities are already generating revenue. That’s really good to see from a diversification perspective. What’s great about it is a lot of these population sequencing initiatives are driven from a national health perspective. They aren’t just research projects; what you're seeing is countries embrace genomic testing as part of the standard of care in a health system. That's terrific because it allows us to deliver valuable information to patients. It's also a very durable model; once built into the healthcare system it ramps up to population scales and goes year after year. Another exciting aspect is we're starting to see the emergence of cohorts, a lot of them involving pharma partners, that are looking to generate population-level data from some of the big data repositories worldwide, like biobanks. That's an emerging component, building parts of the population sequencing ecosystem right now too.
Operator, Operator
We now have Derik De Bruin of Bank of America on the line. So, Derik, please go ahead. You may proceed with your question.
Mike, Analyst
Hey, this is my question for Derik. Thanks for taking the question. Got a couple of quick ones, and I'm just going to focus on the sequencing instruments side of the business. You called out really broad strength in NovaSeq, NextSeqDx, 1,000 to 2,000 and the MiSeq. That's pretty much the majority of the portfolio. But total sequencing instruments revenue still declined sequentially. So, I'm just wondering if you could talk to pricing dynamics or an AFT if there's anything unusual going in there mid-year? And then I've got a follow-up on that.
Francis deSouza, CEO
Yes. Thank you, Mike. I appreciate the question. In general, there is really no fundamental change at all in instrument demand from Q3 or Q2 into Q3. We do have sometimes some ebb and flow between the quarters in terms of instrument revenues. NovaSeq had record revenues for the quarter with record placements, doubling the placements from last year. As we said, we exited the quarter with record backlog in terms of instruments. So, I would say there's some very small movements here and there, but nothing significant in terms of why we were slightly down from Q2 to Q3. In terms of sequencing instruments for COVID surveillance, I would say that was a minor factor as well from Q2 into Q3.
Sam Samad, CFO
There were a few fewer sequencing instruments that were placed in Q3 compared to Q2, so that had a little bit of an impact there as well. But in general, demand is exceptionally strong as we talked about, with doubling of the NextSeq 1,000 and 2,000 placements versus prior years, not just last year but historically. The NovaSeq demand is exceptionally strong.
Francis deSouza, CEO
Yeah, let me reiterate what Sam just said. Look, we are walking into Q4 with a record instrument backlog. It's a really strong position to be in. We had record instrument shipments in Q3 for NovaSeq and the pull-through on NovaSeq, even with all the instruments placed, should be at the low end of pull-through. Even so, the total average pull-through on NovaSeq is at the high-end of the range we've talked about. There’s just a lot of activity happening with NovaSeq in the field, and that's causing customers to place the orders that are driving the record backlog as we enter Q4. So, we feel that it's a really incredibly strong position to be in.
Operator, Operator
Thank you. We now have Puneet Souda of SVB Leerink on the line. Sir Puneet, please go ahead. When you're ready.
Puneet Souda, Analyst
Thanks, Francis. I’d like to ask a question on GRAIL. This is for Francis and also for Bob. Just in terms of the trials you need to conduct at this point in time, you mentioned the UK NHS trial ongoing. Obviously, you've committed to GRAIL and taken on the dilution, but in terms of the overall trials that you need that are prospective registrational trials that the FDA needs to look at, that are prevalence reflecting trials in order to get a screening assay approved in the market, could you walk us through that? What are you doing to progress towards that? What's the timing? Is there trial data that you can initiate or any other banked samples that you have already collected that you can potentially run and submit that data? I'm trying to understand the more than 50,000 to 100,000 patient trial needed to get FDA approval and then eventually reimbursement and guideline inclusion?
Francis deSouza, CEO
Maybe I'll start, and then turn it over to Bob. What I said before continues to be true today, which is in the U.S. this test has been rolled out as an LDT and it doesn't need anything more. It's on the market today, it's a self-pay test that you can order today. Some employers are already covering it. There are some health systems looking to roll it out. If it's a concierge system, it could be part of a subscription model or early models. Nothing in the U.S. is needed for the test to continue on the market. It's been on the market since June. Nothing in terms of trials is needed for the existing revenue sources Bob talked about to be real. Everything in terms of studies and data is published: the early studies came out earlier to reinforce the huge amount of data put out onto the market so far, so nothing more is needed there. As for the NHS, the NHS is a self-contained trial, meaning that it has designed the milestones and progress that would get comfortable rolling it out at a population scale. They rolled out the path that said it could start with about 140,000 and then scale up to a million in the next couple of years and then go to a population scale. It’s a fully self-contained process. They’ve identified what they need to see; they’re partnering with GRAIL, as we've said and that’s what we continue to see. I'll turn it over to Bob.
Bob Ragusa, CEO of GRAIL
Thanks, Francis. There are three key elements driving this forward. 1. The NHS study that we've talked about, with 140,000 participants that will expand over the years, will provide an enormous set of data. 2. We also have the Pathfinder study, which will conclude in the middle of next year. So far the data to date has shown generally consistent results with the early validation, which is very, very positive to this point. 3. The Galleri reflection registry study we’ll look at the experiencing of clinical outcomes of 35,000 screening-eligible patients over the age of 50 who were prescribed the test from a healthcare provider; enrollment began this quarter and that will also provide significant data on the marks to reimbursement. I also want to amplify what Francis said: There is a tremendous amount of pre-reimbursement activity and opportunities for Galleri; while the march to reimbursement is incredibly important, it's not the only factor to look at.
Operator, Operator
Thank you. As we are almost out of time, our last question comes from Kyle Mikson of Canaccord. Kyle, please go ahead.
Kyle Mikson, Analyst
Hi, thanks for taking the questions. I just wanted to confirm one thing here on GRAIL. First, on timelines; I hope this was alluded to earlier, but the pause in the investigation has been resumed in early February now. Most of these decisions for trials and reviews are expecting first quarter of '22. I just wanted to ask how much clarity will be provided when these events conclude? Obviously, it's been a pretty polarizing topic. I just think it'd be helpful to understand the level of visibility regarding, I guess, the regulatory outcome that you expect to have beyond the first quarter of '22. And just one other thing to tack on here; the GRAIL revenue performance in the quarter looks like it was maybe arranged over spreading out throughout the 3 months at the annualized $20 million. Just want to understand what the maybe test volume trends are and possibly even reimbursement as well would be helpful. Thanks.
Francis deSouza, CEO
Yes. As we think about GRAIL, I want to be clear that our path forward is a priority. I know it's been a question investors have asked. Our perspective is to continue to work through the trials. I will give you an update on that. We want to ensure that GRAIL continues to create value because that means that no matter what scenario plays out, we can deliver significant value to shareholders. If we can achieve GRAIL’s huge success, it's obviously valuable; if we can create value, that's still a big win for people getting screened as well as for shareholders. If you look at the progress at GRAIL since we announced the deal: they've published study results, launched their product on schedule in June, initiated phase two with NHS. They said they would roll it out for 140,000 customers, signed up other healthcare systems and employers in the U.S. It’s clear the business has created significant value from maybe 12-15 months ago when we announced the deal. Our focus is to make sure that Bob and his team have everything they need to create a valuable business. We will ensure our shareholders see a win, no matter what the outcome is. Our decisions we expect in Europe come on two fronts: the phase 2 results due in February around that timeframe, maybe late Q1, maybe Q2, waiting for a date in trial around jurisdiction in Brussels, which is also a first-half thing, maybe Q1, maybe Q2; hopefully we prevail, and then we're done, but if not there will be some appeals. In the FTC, we expect a decision in Q1 around the administrative process. There will be a re-review or appeal up to the commissioners. If we don't prevail, then we likely end up having a district court in the back half of next year. That’s the process. Now I’ll turn it over to Bob for any other color.
Bob Ragusa, CEO of GRAIL
Yeah, just on the revenue question: GRAIL revenue represents both revenues recognized from sales of our Gallery test as well as revenues generated from our MRD collaboration agreements with biopharmaceutical companies. We expect the MRD PDx collaboration income to continue as an important component of gross revenue and an attractive future growth element of the business. We do expect the mix of the GRAIL pharma MRD revenue components during early launch to be variable from quarter-to-quarter, and so the overall revenue isn’t a great indicator of sample volume.
Operator, Operator
Thank you. As you have no further questions, I will hand it back to Brian Blanchett for some closing remarks.
Operator, Operator
Thank you. As a reminder, a replay of this call will be available on the Investors section of our website, as well as through the dial instructions contained in today's earnings release. Thank you for joining us today. This concludes our call and we look forward to our next update following the close of 2021.
Operator, Operator
Thank you again for joining. Today's Illumina Q3 2021 Earnings Call has now concluded. You may now disconnect your lines and have a lovely day.