10x Genomics, Inc. Q2 FY2023 Earnings Call

Hello, everyone. Welcome to the 10x Genomics Second Quarter 2023 Earnings Conference Call. I will now hand the call over to your host, Cassie Corneau. Cassie, please go ahead.

Thank you and good afternoon, everyone. Earlier today, 10x Genomics released financial results for the second quarter that ended on June 30, 2023. If you have not received this news release or would like to be added to the company's distribution list, please send an email to investors@10xgenomics.com. An archived webcast of this call will be available on the investor tab of the company’s website, 10xgenomics.com, for at least 45 days after this call. Before we begin, I'd like to remind you that management will make statements during this call that are forward-looking statements within the meaning of Federal Securities Laws. These statements involve material risks and uncertainties that could cause actual results or events to differ significantly from those anticipated, so you should not place undue reliance on forward-looking statements. Additional information regarding these risks, uncertainties, and factors that could cause results to differ can be found in the press release 10x Genomics issued today and in the documents and reports 10x Genomics files with the Securities and Exchange Commission from time to time. 10x Genomics disclaims any intention or obligation to update or revise any financial projections or forward-looking statements due to new information, future events, or otherwise. Joining the call today are Serge Saxonov, our CEO and Co-Founder, and Justin McAnear, our Chief Financial Officer. We will host a question-and-answer session after our prepared remarks. With that, I will now turn the call over to Serge.

Thanks, Cassie, and good afternoon, everyone. On today's call, I will start with an overview of our strong second quarter performance in both single cell and spatial. Next, I will share an update on our progress and momentum in each of our three platforms, highlighted by our customers’ tremendous enthusiasm for and rapid adoption of Xenium. I will then turn the call over to Justin for a more detailed look at our financials, business trends and outlook for the rest of the year. We delivered a strong second quarter, with revenue growing 28% year-over-year to $147 million. Our results were driven by growth across our single cell and spatial portfolios, led by solid performance and execution in the Americas and EMEA and strong demand for instruments across all three platforms. This was partially offset by continued headwinds in China, as Justin will discuss. The clear highlight this quarter is our momentum in spatial biology. In Q2, we leveraged our manufacturing scale and expertise to quickly ramp Xenium shipments, yet even so, orders outpaced shipments. Not only is Xenium increasingly recognized as the best performing platform for In Situ analysis, but we have also continued to see strong demand for our Visium suite of spatial discovery tools. This quarter's results reinforce the strengths that have always differentiated us: The velocity of our world-class innovation engine, backed by our broad commercial and manufacturing scale. We continue to work to improve efficiency and drive operational excellence throughout the company so we can maximize and deliver on all of the incredible opportunities ahead. Now, let me share more about each platform, starting with Chromium, the unambiguous leader in single cell analysis. In Q2, driven by strong performance in the Americas and EMEA, Chromium consumables once again delivered double-digit year-over-year growth, despite ongoing challenges in China. The performance, scalability and ease of use of our broad consumables portfolio is an important differentiator that continues to resonate with researchers and drive demand. In particular, we're seeing momentum continue to build for Chromium Flex. We're now one year into this launch, and it's clear we’re still just getting started. The increasing traction and enthusiasm from our customers further strengthens my conviction that Flex has the potential to be transformative to the Chromium franchise over the long term. Looking ahead, we expect to launch our Feature Barcode application for Flex later this quarter. This new assay will enable researchers to simultaneously profile gene expression and cell surface proteins on a cell-by-cell basis across multiplexed samples and millions of cells. This is part of our long-term plan to broaden the menu of applications within the Flex portfolio by enabling more samples, more scale and more analytes. As we expand the capabilities available on Flex and more customers see the power and performance of this assay, we expect it will keep driving placements of Chromium X Series instruments. We're seeing strong demand for the X Series, as placements increased sequentially and are up robustly year-to-date. We're pleased with the continued traction we’re seeing for the X Series across a broad range of researchers, whether they are new to 10x, first-time instrument owners or existing Chromium Controller users upgrading to this powerful tool for single cell analysis. We believe the positive momentum we’re seeing for our Chromium instruments and consumables reinforces the long runway we have ahead, both within our initial home court of cellular atlassing and beyond. We have established strong beachheads in translational and biopharma applications, but it’s still very early relative to the expected large potential. Two recent papers highlighted the power of our single cell portfolio in translational research, revealing particularly inspiring insights into the future of cancer care. In Nature Medicine, researchers published a new gene signature, uncovered with 10x tools, that could help determine the persistence of CAR-T cell therapy. And a study in the journal Blood showed how 10x single cell analysis together with the power of AI could provide a crystal ball for predicting drug response in chronic myeloid leukemia. It's awesome to see the continued growth of our Chromium portfolio in translational research. We believe our first-to-world single cell FFPE capabilities, exclusively on Flex, will help open up even more single cell research in translational and biopharma settings moving forward. Now, turning to spatial, where both our Visium and Xenium platforms delivered very strong growth during the second quarter. In Visium, we continued to see robust demand for our CytAssist instrument, which is now one year into launch. It's clear CytAssist has removed the key workflow challenges with the initial, manual Visium assays. By giving researchers a better experience and a better workflow and better data, CytAssist is driving increased demand and spurring more routine use of the Visium platform. In fact, this quarter, sales of our CytAssist-based consumables doubled our instrument-free assays, reinforcing how CytAssist is now the preferred method for Visium research. With CytAssist as the foundation, we continue to invest to expand the breadth of capabilities available on the Visium platform to enable more analytes and more applications. This quarter, we launched our Visium CytAssist Gene and Protein Expression Assay. Our unique morphology-first workflow enables researchers with three analytes in one, high-plex protein, whole transcriptome RNA, and H&E staining, all on the exact same tissue section. In addition, our team continues to make excellent progress on Visium HD, which will be offered exclusively on CytAssist. This ambitious project has been as exciting as it has been challenging, but these are precisely the types of challenges 10x is built for. And the data is looking spectacular. We can't wait for our customers to experience the power of unbiased whole transcriptome spatial discovery at single-cell-scale resolution. We look forward to sharing more updates on Visium HD as we get closer to launch. Now, turning to Xenium, which we firmly believe is the best performing platform for In Situ analysis. What this quarter's results demonstrate is the momentum we have as we bring the whole-of-company effort to capturing the full Xenium opportunity: We have momentum with researchers, as more and more labs independently complete their own Xenium experiments and gain immediate access to powerful, high-quality data. We have momentum in manufacturing and operations, where we ramped production faster than we initially expected. We have momentum with our commercial team, with a high velocity of orders during the quarter and a continued focus on delivering a world-class customer experience. And, we have momentum with our product roadmap, as we've continued to expand our broad menu of targeted and custom gene panels and deployed new firmware and software updates to deliver even higher levels of sensitivity and throughput. This incredible progress is a testament to the strength of our innovation engine, the scale and expertise of our manufacturing network, the breadth and depth of our commercial function, and the talent and dedication of our team. With our unique combination of differentiated chemistry, high-end, sophisticated components and powerful onboard software, Xenium is a premium instrument carefully engineered to optimize performance straight out of the box and well into the future. We invested to build a best-in-class system so we could deliver best-in-class performance. With every run, researchers are seeing directly that Xenium’s real differentiation was never in the rhetoric; it was always in the results, which they are now routinely generating in their own labs with their own precious samples. We built Xenium to just work in the hands of researchers, the same as our other products. What that means is Xenium just works with very high specificity, ensuring the vast majority of signals are true biological transcripts rather than misleading noise. In an analysis of datasets, Xenium’s False Discovery Rate was less than 1.5%, which we believe is best-in-class. This excellent performance has now been corroborated by multiple customers. Xenium just works with high sensitivity, even on difficult tissues, enabling researchers to reliably measure their genes of interest, even when those genes are lowly expressed. We expect that sensitivity will get even more of a boost with the latest version of our onboard software, which we released last month. Xenium just works with best-in-class throughput. Xenium enables researchers to analyze the most tissue area, in the least amount of time, using the fewest number of slides. Our recent software update builds on our already leading throughput; researchers can now run 12 one-centimeter square tissue sections in about a week. Based on a competitor’s user guide and recommended run time, it would take six weeks to scan the same amount of tissue. Xenium just works on a broad range of tissues, from mouse brain to more complex human samples, including breast, brain, colon, skin, lung, lymph node and more. Xenium also generates high-caliber results on various sample types, including Fresh Frozen, FFPE and tissue microarrays. And, Xenium boasts an efficient and easy-to-use workflow, which we've heard some customers describe as easier than Chromium. Xenium just works with a broad menu of fit-for-purpose and customizable gene panels to help customers answer their specific research questions. We are now shipping five pre-designed, validated panels and expect to launch three more by the end of the year. With each of these offerings, researchers can also spike in their own custom genes to ensure they are not limited in any way by gene selection. In addition, in Q2, we launched a fully custom gene panel to give researchers maximum flexibility. Our differentiated menu of pre-designed, partial and fully custom gene panels is increasingly validated in the field and resonating well with researchers, who appreciate the ability to study their exact genes of interest. In fact, more than half of our panel orders to date have incorporated some level of customization. As part of our exciting and ambitious Xenium road map, we're also planning to launch a 5,000 plex panel in mid-2024. Generally, more plex comes with more tradeoffs. As you dial up plex, you may need to dial down sensitivity, specificity and throughput. This can lead to plex quantity without data quality. With Xenium's unique chemistry, however, we can scale to many thousands of genes and still deliver high levels of specificity, sensitivity and throughput, all of which are critical to the utility of these assays. And lastly, Xenium just works with its differentiated approach to software and data analysis. Xenium is the only platform to feature comprehensive primary and secondary onboard analysis in parallel with the instrument run. This means researchers can see their results on the Xenium instrument immediately after the run is done, without requiring massive uploads, onerous downloads, time-consuming data transfers or expensive Cloud subscriptions. Customers who want more off-instrument interpretation can easily do so using Xenium Explorer or a wide variety of open-source tools. We built Xenium to be the best-performing system for In Situ analysis, both at launch and for the long term. Beyond our gene panel pipeline, we are driving a robust, multi-year Xenium road map that we expect to feature in-demand applications like isoform mapping, SNV detection, xenografts, CAR-T tracking, and gene fusions among many other applications. These differentiated capabilities can be uniquely enabled by Xenium's chemistry. All together, this remarkable combination of features is earning rave reviews from our customers; one even told us he jumped for joy when seeing his Xenium data for the first time. This enthusiasm from our customers along with the system's proven strength, performance and momentum in the field should reinforce the fact that 10x is leading the way in spatial biology and has been for a decade. Through our internal investments and acquisitions of emerging companies such as Spatial Transcriptomics, ReadCoor and CartaNA, we have built incredible products, developed foundational intellectual property, and have deep experience and customer insights that have been instrumental to our technology leadership. At 10x, we absolutely relish the opportunity to help founders and scientists take their ideas and transform them into products that can be used by researchers to fundamentally change our understanding of biology. Our unwavering commitment is to our mission and to driving innovation to push science forward. We have invested well over $1 billion in research and development to bring new tools to researchers, and we will always strive to do what is right by our customers. That means delivering breakthrough products that perform as promised. After all, there's no cutting corners when it comes to cutting-edge technology. We've made the necessary investments in both R&D and IP to build a premium product that delivers exceptional performance. Seeing this validated, time and again, by our customers has given us even greater confidence in the potential of this product to lead to the next revolution in the life sciences. I firmly believe that Xenium may be one of the most transformative technologies in our industry in decades. It's up to us to lean in and capture the tremendous opportunity we have ahead. Seizing this opportunity is our top priority, and we're going to leverage our strong foundation, broad commercial reach and solid financial profile to deliver on the full promise and potential of this technology. Before turning the call over to Justin, I would like to give an update on our intellectual property portfolio, which is an essential part of our innovation engine. During the quarter, we achieved a significant milestone as we now have more than 2,000 patents issued or pending, including more than 70 issued and allowed in the second quarter alone. Of these more than 350 relate to In Situ technology. As we have said, it is our general policy not to license our patents to others, but to protect our sole right to own and practice our patents. We will be steadfast in our focus on protecting the inventions that scientists have worked so hard to create, as our innovation is what fuels and funds the development of future 10x technologies that benefit researchers, and ultimately patients around the world. We're executing on our mission with a solid foundation built on incredibly strong fundamentals. Our team is fully dedicated to driving growth, improving operational excellence and leveraging the unique strengths that have always set 10x apart. With that, let me turn it over to Justin for more details on our financials.

Thank you, Serge. I'll start by reviewing our financial results for the three months ended June 30, 2023. Then I'll provide an update on our outlook for 2023. Total revenue for the quarter was $146.8 million compared to $114.6 million for the prior year period, representing a 28% increase year-over-year. Starting with consumables. Total consumables revenue was $112.5 million, an increase of 15% over the prior year period. Chromium consumables revenue was $100.8 million, up 11% year-over-year and spatial consumables revenue was $11.7 million, up 70% year-over-year. Turning to instruments. Total instrument revenue was $31 million, an increase of 110% over the prior year period. Chromium instrument revenue was $12.9 million, down 8% year-over-year driven by lower sales of Chromium Connect, while the total number of Chromium instruments sold in the quarter increased year-over-year. Spatial instrument revenue was $18.1 million. Our Visium CytAssist instrument launched at the end of Q2 last year and our Xenium instrument launched in Q4. So we did not have material spatial instrument revenue in Q2 of last year. Services revenue was $3.4 million, which increased 74% over the prior year period. Moving on to our revenue by geography. Americas revenue of $91.5 million grew 29% over the prior year period. EMEA revenue of $31.2 grew 22% over the prior year period. And revenue in APAC was $24 million, a 33% increase year-over-year. We continued to face challenges in the APAC region, again, largely driven by China. On our last call, we had said we expected Q2 performance in China to be roughly similar to what we experienced in Q1. However, we saw further pressure in the region beyond what we had anticipated. We are not immune to the challenging macroeconomic environment in China right now, and believe this impacted demand and exacerbated the dynamics we've been seeing with inventory levels. We continue to focus on driving demand with our end customers in this market while working with our distributor partners as they manage inventory. Turning to the rest of the income statement. Gross profit for the second quarter of 2023 was $99.6 million compared to a gross profit of $86.9 million for the prior year period. Gross margin for the second quarter was 68% compared to 76% for the second quarter of 2022. The decline in gross margin was driven primarily by the strength we saw in Xenium placements this quarter. As I shared on our last earnings call, in the early quarters of Xenium adoption, we expect overall company gross margin to trend lower as more instruments are sold, given that the Xenium instrument carries a significantly lower margin than our other instruments. As customers ramp up their Xenium utilization, the Xenium consumables, which have a gross margin comparable to our existing products will become a larger portion of the revenue and increase our overall margin over time. Total operating expenses for the second quarter of 2023 were $163 million compared to $150 million for the second quarter last year. R&D expenses were $71.5 million compared to $70.7 million for the second quarter of 2022. SG&A expenses were $91.5 million compared to $79.3 million for the second quarter of 2022. The increases in R&D and SG&A expenses during the quarter were primarily due to increased personnel-related costs and operational expansion. Operating loss for the second quarter of 2023 was $63.4 million compared to a loss of $63.1 million for the second quarter of 2022. This includes $45.7 million of stock-based compensation compared to $36.3 million for the corresponding prior year period. Net loss for the period was $62.4 million compared to a net loss of $64.5 million for the second quarter of 2022. We ended the quarter with $391.4 million in cash and cash equivalents and marketable securities, net of restricted cash. Turning to our outlook for 2023. We are raising our guidance and now expect full year revenue to be in the range of $600 million to $620 million, representing growth of 16% to 20% over full year 2022. Our updated guidance reflects our second quarter performance as well as continued Xenium momentum with better visibility into our operational ramp. This is offset by the weakness we've seen in APAC, primarily driven by China, and reflects the continued challenges in APAC that we expect for the rest of the year. Our drive towards becoming free cash flow positive has instilled a cost discipline that has helped us effectively manage our headcount and other spending across the organization. I have mentioned before that one of the biggest factors in becoming free cash flow positive would be the slope of our Xenium ramp. To support a steeper adoption curve, we will need increased operational capacity, inventory builds, installation capacity, service and support. This quarter continues to add to the early enthusiasm and demand that we are seeing for Xenium. It deepens our conviction in the long-term potential for spatial biology. We are leaning in even further to this opportunity and believe such investments will be foundational to our long-term growth, but they will come with near-term impacts to our gross margin and cash flow objectives. As it relates to other items impacting our free cash flow, we still expect a significant reduction in capital expenditures in the back half of this year. When looking out over the next 12 months, we are anticipating about $35 million to $40 million of total capital expenditures. About 1/3 of this relates to the final payments for our new operations facility in Pleasanton, which we expect to transact in Q3. While we see a path to becoming free cash flow positive by year-end, we believe that now is the time to prioritize the investments in driving Xenium adoption. We will continue to focus on disciplined spending and managing our strong cash balance. At this point, I'll turn it back to Serge.

Thanks, Justin. Before we open it up for Q&A, I want to take a moment to thank our team. At 10x, we're continuing to push the bounds of what's possible, which is both exceptionally challenging and profoundly rewarding. It's been especially energizing for us to see the incredible customer enthusiasm and momentum for Xenium, which will usher in a new era of genetic analysis. I personally believe this technology has the potential to be as big as anything in the history of the life sciences. While it's still very early, we're starting to see a broader understanding and appreciation of the power and potential of spatial biology and single cell more generally to revolutionize human health. In fact, Eric Topol, a highly regarded physician-scientist and author of several best-selling books on the future of medicine, recently described spatial biology as the hardest field in life science for making new discoveries about human health and disease. Testimonials like these validate once again our conviction in the endpoint. In the not-so-distant future, we expect just about all tissue samples will need to be analyzed at single cell resolution, large scale and with spatial context. We believe we have the best products and technologies to achieve this vision. And as a result, we are uniquely positioned to bring the future forward. We're bringing the whole-of-company effort to ensure we get absolutely everything out of the incredible opportunity we have ahead. With that, we will now open it up for questions. Operator?

With that said, we'll go ahead and get started with Patrick Donnelly from Citi.

Serge, maybe one on Xenium, as that adoption continues to pick up, can you just talk about what you're seeing in the market in terms of feedback when you get competitive wins? Is it a focus on the specs being superior? Is the market just big and early enough that it's less of that head-to-head competition in terms of sales? And then any color, I think you mentioned orders outpace sales a bit. But any color on order growth or trends there would certainly be appreciated?

Thank you for the question, Patrick. The market is certainly competitive, and as we've mentioned before, there has been some confusion regarding expectations until recently. Many aspirational claims have been made. The shift in dynamics over the past couple of quarters is that people can now clearly see which systems operate effectively and how well they perform. Notably, the feedback on Xenium has been extremely positive. We've discussed the quality of the data before and our analysis of its sensitivity and specificity has been validated in real-world applications, which is resonating strongly and generating word-of-mouth. Customers are experiencing quick run times and prompt data retrieval. For instance, one customer completes a run on the weekend and is presenting the data at a conference by Tuesday. This rapid turnaround is remarkable and it’s rare to see technology with such immediate adoption. What's resonating most is that Xenium works well from the start and the data quality is exceptional, as reported by a variety of users. While these are early deals, all indicators point to significant potential and escalating momentum and enthusiasm.

Okay. That's helpful. And then probably one for Justin just on China. Not surprising here, maybe a little bit of further pressure in the region. Can you just talk about, I guess, what you guys are seeing there? I know you talked a little bit about the end customers, you guys go through the distributors, service providers, maybe you're not quite as close to the end customer. But I guess what are you hearing? And then as you adjusted the guide, I think you said a little bit of headwind from China maybe Xenium moving up. Can you just talk about what the moving pieces were in that $10 million bond?

Yes, Patrick. I'll begin with China. China has definitely not met our expectations for this quarter, and the macro environment there is quite challenging right now. Overall, demand in that region has been weak. We also think this situation has worsened the inventory issues we've previously discussed. Therefore, we do not anticipate any improvement in the near term, at least for the next couple of quarters. Regarding guidance, these factors have been included in our updated range. Despite the challenges in the APAC region, particularly in China, AMR and EMEA have shown strong performance. When considering our updated guidance, we expect AMR and EMEA, specifically Chromium, to finish the year with growth in the mid-teens year-over-year. As pressures continue in APAC, we expect the average for Q3 and Q4 in that region to be roughly flat compared to Q2, with a slight decline anticipated in Q3. Overall, on a global scale, spatial is holding steady, continuing the momentum seen in Xenium this quarter. Additionally, CytAssist had a very strong quarter, though I would expect some decrease in demand for CytAssist eventually, as we often see a surge in demand following new product launches. Therefore, we expect spatial to remain stable worldwide from Q2 through Q3 and Q4.

Next up, we have Dan Arias from Stifel.

Maybe just to follow up Patrick there on Xenium. Serge, can you comment on your own manufacturing capabilities? I mean it sounds like you're pushing hard to ramp and expand what you can do there pretty quickly. When do you envision being at the point where production shouldn't be considered a constraint on placement?

Yes, we have been investing in our operations as stated. Initially, when we entered the market, we were quite cautious in our approach. We have certainly scaled up to a new level of production now, and that's what Justin was referencing regarding our outlook for the next couple of quarters. Last quarter, shipments were outpaced by demand, creating a dynamic situation. We are continuing to work on scaling up, especially in preparation for next year and beyond.

Next up, we have Dan Brennan from TD Cowen.

This is Kyle in for Dan. I wanted to ask about CytAssist. Can you provide any insights on how placements of CytAssist have trended compared to the last few quarters?

Kyle, this is Justin. I can provide some general insights. In the third and fourth quarters of last year, we experienced strong demand for CytAssist. We shipped a limited number at the end of the second quarter, but the third quarter marked its official launch. There was a slight decrease in the first quarter, and currently in the second quarter, we're nearly at the same level as in the third and fourth quarters of last year, showing an increase over the first quarter.

Got it. And so with all these CytAssist placements, how should we sort of think about busy pull-through going forward? Has this driven a lot of demand for Visium projects?

Yes. When we examine the numbers, we observe a significant divide; laboratories that have CytAssist utilize more Visium consumables compared to those that do not. There remains an open question that we are investigating regarding a selection effect: laboratories that are more inclined to use additional consumables are also more likely to purchase a CytAssist instrument. We continue to monitor how this will impact the numbers. However, qualitatively, it's clear that CytAssist greatly facilitates running Visium and generally produces excellent data. We have received positive feedback and considerable interest, and it is a fundamentally enabling instrument. Therefore, we remain optimistic about its potential to drive further growth.

Next up, we have Kyle Mikson from Canaccord.

One on the chroming business that grew 7% year-over-year on EP comp in the first half. I know there was the China headwinds and the placement mix consisted of less connects in the quarter. But you originally guided to that low teens growth for the business. I know that's now updated. It sounds like what you just said, Justin, but I guess I'm just wondering like what factors are going to occur in the second half to get you to that low teen as well or whatever it is now. And if there's any like nonmacro-related deterioration in demand for the products? And maybe if you just talk about it by region, it could be kind of helpful just to give a comment in that area.

Yes. Sure, Kyle. So first off, overall, when we initiated our guidance at the beginning of the year, we talked about low to mid-teens Chromium growth at the worldwide level. We talked about the impacts that we're seeing in APAC, primarily driven by China. When we incorporate that along with AMR and EMEA being on track to what we expected they would be at the beginning of the year. You're right, we do end up year-to-date in the high single digits. But when we look at how we expect to end the year, we expect that AMR and EMEA both will be in the mid-teens plus. And that's what's being worked into our overall guidance range. AMR and EMEA on track or a little more and building in the weakness that we saw in APAC driven by China carryforward.

Next up, we have Morgan Stanley.

So juggling a few earnings calls here, so apologies if you touched on this, Serge, but can you give us some color on what you're seeing in the In Situ market right now in terms of pricing? How aggressive are you prepared to be there to lock in customers into your ecosystem? And as you think about sort of consumable pull-through starting to ramp on some of those initial placements. Any anecdotal evidence or bookends you can share?

Tejas, there's definitely a lot happening in In Situ. Our main focus is on the customer, and we are adapting our pricing strategies to current trends, particularly in a competitive environment, to ensure customers make the best choices. I want to emphasize again that our system performs exceptionally well and produces the best data in the market, as confirmed by other customers. It operates effectively in the field, and we've noticed that some early customers are processing a significant number of samples in a short time. Typically, these early adopters are the most inclined to embrace new technologies. We expect that later adopters will require more time to onboard and ramp up. However, we are seeing many positive early indicators regarding the potential volume of samples these systems can handle.

Got it. Okay. That's helpful. I have a quick follow-up regarding the Flex side. Where are customers currently in the adoption phase for Flex? What percentage of those early adopters have completed their initial pilot and evaluation trials and have switched over? Additionally, looking at the bigger picture, how do you see differentiated innovation providing macro insulation, and how does that factor into your guidance?

Let me address the question about Flex. Flex has been experiencing general adoption and is scaling up across our customer base. It's not only the early adopters but also some translational customers. We have some of our core customers transitioning to Flex. Often, it's not about switching people from their existing workflows or studies, but rather about adding incremental studies or projects. When they start a new project, they are increasingly conceptualizing it with Flex, as it addresses many logistical challenges. The multiplexing capability enables them to achieve a significantly lower price per example, allowing for larger studies. Though it's still a relatively small part of the overall Chromium franchise, it's on a positive trajectory, especially as we consider expanding the single-cell market over time. We are seeing encouraging signs.

Tejas, so all of our products, our view of them are built into our guide. We still have a decent range on our guidance heading into the back half of the year. And so those different scenarios are built in.

Next up, we have Mike Ryskin from Bank of America.

Great. I got a couple of quick ones here, hopefully. One was just starting on Xenium CytAssist, instruments versus consumables. You talked through the pacing of CytAssist, that was really helpful. We can kind of back into Xenium numbers then. But I want to focus consumables on spatial. By our math, that's been kind of flattish, relatively flattish 4 quarters in a row on a dollars basis, more or less. So question is, when does that start to really accumulate? And that kind of goes to the point of like as the installed base of Xenium goes higher and higher, at what point do you think that will really kick in and you'll start to see that razor-razorblade model on the special side really start to churn?

Yes, Mike. Regarding your question about the overall spatial performance and specifically about Visium, it's challenging to assess the platform's impact at a global level, especially with the effects from China and the APAC region. This could lead to misinterpretations. However, spatial has shown strong performance in the AMR and EMEA regions, while APAC and China have faced some challenges. Additionally, we've observed that CytAssist customers are increasingly ordering and utilizing more Visium, which is a positive development. This trend seems to be addressing some of the workflow challenges users experienced initially, indicating that this approach is likely the future direction for the platform. Moreover, the consumables for Visium and CytAssist are beginning to surpass the older Visium consumables.

Next, I want to switch to the margin side of things. I think you flagged pretty extensively to us that gross margins were going to be negatively impacted by the Xenium ramp, just given the incremental lower gross profit dollars on that instrument as you're ramping it. Is Q2 a bottom or sort of close to the bottom there? I guess it's hard for us to sort of back into these numbers, but is this a good place for gross margins to level out and then start to grind higher again? Or do you anticipate that going even lower 3Q, 4Q, to your point, as Xenium placements continue to ramp higher?

Yes. To begin, let's examine the year-over-year change in gross margin. The primary factor driving this change is the shift towards In Situ when we account for smaller fluctuations. Looking ahead into the rest of the year, gross margins might decrease further if we continue to place more Xenium instruments each quarter. However, as we enhance our manufacturing capacity to produce more units, the cost per instrument will reduce, leading to improvements in unit economics. It's important to remember that when we developed the Xenium instrument, our aim was to optimize performance and speed to market rather than cost. Based on the positive outcomes we're seeing in the field, this was the right decision. While there is a short-term impact on the company's gross margin, our focus isn't solely on the margin from each instrument, but rather on the consumable revenue stream enabled by it. We aimed to create the best instrument in this domain, and we have succeeded. Additionally, customers buying this instrument now are receiving exceptional value compared to competitors. As more customer data is collected and feedback becomes available, it will support our long-term strategy. Currently, it's clear that this instrument is not priced according to the value it provides, and I believe we will have chances to adjust that in the future.

Next up, we have John Sourbeer from UBS.

This is Tianqi calling in John. So just to kind of build on what Mike just asked, do you guys sort of share the kind of like target margin profile for Xenium, let's say, when the volume is high enough?

So this is Justin. When we look at Xenium, we don't necessarily separate the instrument from the consumable. We look at the Xenium business overall and what we expect that to ramp to. And so early on, when the mix shift is primarily more towards instruments, and we're taking time to ramp up the consumable stream you're going to see, I think, the greatest impact. And then over time, as those consumable streams ramp up, those are going to become a larger part of the revenue overall, and they'll bring the margin up in the longer term.

Got it. The second question is about Chromium Flex and the exciting news regarding the Feature Barcode application. Do you see Flex and the Feature Barcode applications helping to accelerate the clinical adoption of single-cell technologies in areas like diagnostics and precision medicine? How should we consider that?

Yes, it's a good question. Ultimately, the answer is yes. Flex enables single cell analysis to work with clinically relevant samples collected from tissues for the first time. It allows for fixation at the point of sample collection and importantly supports single cell analysis of FFPE samples, which is how most clinical tissues are stored. We are still early in the adoption of single cell technology as it progresses from basic research to clinical settings, but there is growing interest in translational studies. Researchers are gathering cohorts of patients, phenotyping samples, and using single cell analysis to identify biomarkers, which is essential for later clinical applications. Flex is definitely facilitating this transition along that path.

Next up, we have Matthew Sykes from Goldman Sachs.

This is Ivy calling in for Matt. You mentioned you're working with distributors in China on inventory levels. Can you talk through what that looks like? And then if you expect to see these issues continue into next year?

This is Justin. I'll take that. You need to look back at the end of Q4 and the start of Q1 when we implemented our usual annual price increase. This year, however, the price increase was greater than in previous years. Typically, distributors purchase extra inventory at the lower price before the increase takes effect, up to their inventory limits. At the start of this year, we had higher inventory levels, faced issues in China, and the inventory didn't decrease as much as the distributors anticipated. We've been managing the situation since then, and the inventory levels remain high. This occurs against the backdrop of the challenging macroeconomic conditions we've discussed earlier. It takes time for these issues to resolve because we sell to a distributor, who then sells to the service provider, and finally, the service provider sells to the end customers. Given that structure, we don't expect any improvement in Q3 or Q4; we anticipate the average for those quarters will be similar to Q2. We’re hearing some reports of improvement in activity levels, but mostly anecdotal. Therefore, we need to forecast based on what we can observe right now, which still indicates high inventory levels amid lower demand.

Our next participant is Mason Carrico from Stephens Inc.

Maybe 2 quick ones for me here. For CytAssist placements during the quarter, did you guys share the percentage or mix of placements that are going to new 10x customers or new Visium customers versus customers who are already utilizing Visium? And how does that compare to what you've seen the last few quarters?

I don't think we've shared specific details around that, but it's a reasonably balanced mix, I would say. There is substantial number of CytAssist are going as you would expect, to current Visium customers who've been using sort of the legacy manual assays. But also, there's a material number of customers that are new to Visium. They're buying CytAssist to get into the Vision workflow because it now is kind of opening up possibilities that weren't really open before. And some of those substantial products have been previous 10x users of single cell, but there's also some new to 10x users entirely as well. And I think that the relative fractions have been fairly similar over the last couple of quarters.

Got it. Okay. And for union placements, have you observed any bundled orders with those placements, whether related to CytAssist or Chromium? Additionally, could you provide any insights on the types of instruments or customer segments that are driving these orders?

Yes. We've certainly seen customers kind of coming in into the full 10x ecosystem. And we are certainly not adverse to encouraging that. In fact, when people do want to go in and buy all 3 instruments, we give them special deals and especially those come with consumables. That happens. And we've talked about before just how much value there is to a customer being able to use all 3 platforms to interrogate their biology. And we're seeing that in workflows where very, very frequently people are using a Chromium experiment to map out the cells and the genes that they then want to put on custom panel for Xenium. And oftentimes, when they're running Xenium experiments on a particular tissue that they then follow up on that same section. Put it on CytAssist and run a Visium experiment to get a more comprehensive view of the tissue. And we've talked about this before. There's a lot of science to be discovered by using all 3 platforms, and that's definitely resonating with a lot of our customers as well.

Next up, Justin Bowers from Deutsche Bank.

In your prepared remarks, you mentioned that you were able to increase production faster than anticipated in the first half. Could you provide some insight into the bottlenecks you were able to overcome? Are there any additional challenges as you increase production in the second half of the year, or have you mostly resolved those issues?

I'll start with the operational capacity. Going back to the beginning of the Xenium launch, our priority has been customer success, and we focused on a measured rollout to ensure our early customers were successful in generating data from their instruments and interpreting that data. We achieved early success in that area. Afterward, the focus shifted to operational capacity, ensuring we had enough components, high yields, and sufficient space. Our new operations facility contributed significantly to this. The quality control processes and installation and support resources were also crucial. I want to commend our operations team for their scaling efforts over the quarter. However, they face daily and weekly challenges that they're actively addressing. Our goal is to consistently maintain this level of production as we move into Q3 and Q4. Looking ahead to next year, we will need to increase component inventories, which means higher work-in-progress on the balance sheet, as well as more support and installation personnel. Over time, the bottleneck can shift from one area to another.

Yes. Regarding the Xenium panel, we have been continuously adding more panels. We offer several options, including human breast, lung, and brain panels. There will also be a new panel available for multi-tissue analysis and cancer. This range covers various applications across different tissues. Furthermore, we provide a fully customizable cost option that many of our customers are utilizing along with standard data. We are continually expanding our offerings, which is crucial as it ensures that customers can measure the specific details they are interested in. As we expand our content, we enhance the platform's capabilities and reach.

Next up, we have Matt Larew from William Blair.

Just one. And Justin, relates to the conversation around progress towards cash flow positivity. So you kind of alluded to some of the things that you're working on. If I think about what you're undertaking from sort of a working capital perspective and how that might burden cash versus maybe more onetime costs related to capacity expansion and then resulting in perhaps initial underabsorption versus things that will be more sustainable, like additional people, technology, et cetera, just as we're thinking about sort of building out the model and how we get towards that cash flow positive number. How should we be thinking about maybe those different buckets of investment areas?

Matt, that's a very insightful question. There are different flavors of the type of impacts that we're going to see as we go up the ramp. And so the ones that I just talked about around building up inventory and buying components in advance and stockpiling those because some of those supply chains are new and relationships are new and suppliers are new and things like that would be expected to smooth out over time as you're able to get further up the ramp and have those be more established. So I see those maybe as things that would spike during the ramp for a few quarters and then hopefully smooth out as they become more routine. When you think about the operational capacity. A lot of that is going to be fixed. But as you scale up the units, you're going to be able to better leverage that fixed cost. As you think about the installation and the support, those are things that are working well right now that can also become more efficient over time. So again, as the units increase and when you look at the unit economics there. I would expect leverage there as well. But you've got to build capacity for these things in advance of when you're going to need them. And so then when you are going up a ramp, you are going to be underutilized for some period of time because of the nature of having to build something in advance. And so that's why I pointed that out as we head into the year for the free cash flow positive, becoming free cash flow positive is really an important goal for us, and we're continuing to work towards it. And there is still a path for us to hit that by the end of the year. We expect to be very close to free cash flow positive. But when you look at where we are in this ramp with it being steeper and us having the decision around accelerating the investments here in spatial and Xenium or holding to the cost line absolutely to make sure that we hit the target at the end of the year, I'm losing the constraints in a targeted way to make sure that we do what's right to support and grow the spatial opportunity and realize the full potential that we have there. So I hope that answers your question.

Next up, Rachel Vatnsdal from JPMorgan.

It's Noah on for Rachel. We've seen a lot of drugs come online in the commercial market, which has reignited interest in several disease areas, including Alzheimer's, could you give us a sense if you're seeing any of these really large drug launches to influence any earlier than clinical market-related work, Alzheimer's, maybe some big GLP-1 interest. We've typically seen that commercial markets will influence pre-commercial markets. So have you started to see that flow through at all in some of the work for any of your instruments?

I think our focus has primarily been on the early discovery phase, with the expectation of progressing further down the workflow at biopharmaceutical companies. When considering the bigger picture, there's definitely a growing incentive to invest more in foundational scientific research and subsequent R&D as we witness an increase in larger launches of new drugs and modalities. I believe this will lead to further investment. Additionally, investing in new technologies that enhance our understanding of fundamental science allows for a deeper level of insight. We are certainly noticing the utility of our products, particularly in the cell therapy space, which is a significant emerging area, and we also see this expanding into other modalities.

And our last person up today is Kyle Mikes and Kyle, I believe I cut you off a little early on your questions. So if you'd like to form your next question, please do so now.

No worries. Just one for you Serge, on the 5,000 Flex panel for Xenium that's planned for mid-'24, at AGBT, that was just proof of concept, I believe, when would early access begin for that? And then would that come before Visium HD?

Yes. We haven't given an updated timeline on really either of those. It's a good question. I mean both products are incredibly exciting, and we're seeing really great internal data but we're not yet sharing the precise timelines.

Well, thank you, everybody. That concludes today's call. Thank you for joining. You may now disconnect.