Illumina (ILMN -2.98%) knocked the ball out of the park with its second-quarter earnings results. Shares soared after the gene-sequencing pioneer blew away expectations for revenue and earnings. Demand for Illumina's new NovaSeq sequencing system was much stronger than anyone anticipated.
The company's executives discussed its second-quarter performance with analysts after the market closed on Tuesday. Based on the information they provided, I suspect that Illumina's momentum is just cranking up. Here are 10 reasons why. (Quotes courtesy of S&P Global Market Intelligence.)
1. Strong demand for microarrays
NovaSeq wasn't the only great news for Illumina in the second quarter. The company reported microarray revenue increased 16% year over year, driven by a whopping 93% jump in microarray services revenue. Illumina CEO Francis deSouza said that the company is seeing tremendous growth in the ancestry and health trait markets offered by 23andMe and other consumer-focused genetics companies.
This growth is important to Illumina, as its microarray business currently generates 17% of total revenue. The underlying trend in increased interest among consumers for genetic testing should continue to benefit Illumina for a long time to come.
2. NovaSeq expanding the market
NovaSeq was the big story for Illumina last quarter, though. What should make investors really excited is that one-third of NovaSeq customers have either not bought a sequencing system before or previously used benchtop sequencing systems.
This means that NovaSeq isn't just a replacement for Illumina's high-throughput HiSeq systems: It's expanding the market. That's tremendously important for Illumina's future growth.
3. New customers for benchtop systems
Illumina isn't just attracting new customers to NovaSeq. DeSouza stated that "new-to-sequencing customers represented about half of NextSeq, MiniSeq and MiSeq shipments" in the second quarter.
While these benchtop systems don't generate as much revenue for Illumina as its upper-end systems do, there are both short-term and long-term benefits from new customers adopting these systems. Obviously, it makes more money for Illumina in the short run from the system sales. Over the long run, the company will make even more revenue from consumables and services. Even more important, these customers are great candidates to later step up to NovaSeq -- just what Illumina is already seeing happen with existing benchtop system customers.
4. More versions of NovaSeq on the way
DeSouza said that the NovaSeq S4 flow cell version will begin shipping in September to early access customers, with full availability in October. The S1 flow cell version will also be available in October.
Some customers are holding off on placing an order for NovaSeq until these versions are available. That's especially true for the NovaSeq S4, which should be very attractive to current customers with Illumina's high-throughput HiSeq X systems. The company should see a boost later this year from this pent-up demand.
5. Academic customers haven't ordered yet
Most of the orders so far for NovaSeq have come from commercial customers. These customers are able to move more quickly than academic institutions, which typically have to complete grant applications to get additional money in their budgets for a major purchase.
This means that NovaSeq orders will probably ramp up even higher pretty soon. DeSouza said, "Interest from academic labs continues to build as customers work through the ground application process, and this is expected to generate additional demand in the second half of this year and beyond."
6. Lots of HiSeq customers remaining
Remember that Illumina's primary market for NovaSeq was in its base of HiSeq customers. There's a lot of them left who haven't yet placed orders for NovaSeq. DeSouza said that less than 10% of HiSeq customers have ordered NovaSeq at this point, adding that "the bulk of this wave is still in front of us."
Will Illumina flip all of its HiSeq customers to NovaSeq? Probably not. However, it should get most of them on to the new system -- and that means big dollars in new system sales over the next few years.
7. NovaSeq backlog
Most of the talk in Illumina's earnings call focused on the great demand for NovaSeq. However, deSouza also noted that the company currently can't make enough systems to keep up with that demand. Illumina tripled its manufacturing capacity in the second quarter versus the first quarter. That allowed it to ship and install around 80 NovaSeq systems.
DeSouza said that "it will take a few quarters to work down our healthy backlog of more than 100 instruments, as is typical with our product launches." Practically speaking, this backlog means that Illumina still hasn't felt the full revenue impact of the new system sales and hasn't begun to profit from the associated consumables sales -- but that revenue is on the way.
8. NovaSeq margin will improve
As if all of the other good news about NovaSeq wasn't enough, Illumina CFO Sam Samad threw out another positive: Profitability will only get better. Samad stated, "As is typical with a new platform, we are actively working on cost reduction and expect NovaSeq margin to improve over the next four to six quarters."
At first glance, you might think that Europe was Illumina's strongest region in the second quarter. Samad said that the company's European revenue grew 15% year over year. That was higher than Asia Pacific and the Americas, with 12% and 8% year-over-year growth, respectively.
However, Asia Pacific numbers were weighted down by a weak Japanese market. Shipments in China grew by 16% compared to the prior-year period. China should continue to present a great opportunity for Illumina with the country's major precision medicine initiative.
Then there's Helix, the consumer-focused genomics company that Illumina formed in 2015 along with Warburg Pincus and Sutter Hill Ventures. Helix recently launched its online marketplace, which includes products and services for entertainment, family, fitness, health, genealogy, and nutrition.
Helix could be a drag on Illumina in the short term, with higher operating expenses in the second half of the year associated with the spin-off. However, Illumina is already enjoying tremendous success serving other direct-to-consumer companies. Helix could be yet another big source of revenue for the company in the not-too-distant future. As Illumina executive vice president and chief administrative officer Marc Stapley said about the spin-off, "2018 will certainly be an interesting year."