Illumina Lights It Up

By Jim Crumly Markets Fool.com

Shares of DNA sequencing leader Illumina (NASDAQ: ILMN) soared 17% the day after CEO Francis deSouza presented at the 2017 J.P. Morgan Healthcare Conference. The big news was the launch of a new family of sequencers that could reenergize sales of high-end instruments, something that investors were hoping for and that I discussed as a possibility last week. The new line, called NovaSeq, will likely renew the company's growth, but not immediately.

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Image source: Illumina.

Why NovaSeq is a big step forward

The core technologyin NovaSeq is a major step forward in advancing performance and decreasing sequencing costs at the top of the line. Flow cells were given a new design based on nanotechnology for a greater density of DNA clusters per run. This will result in higher throughput and lower flow cell costs. In order to maintain accuracy at these smaller geometries, the optics systems had to be redesigned, laser power increased, and dyes reengineered for higher emissions. The end result is an increase of the core scanning speed by a factor of four, and the equivalent of a human genome per hour. This technology will remain the core building block for new high-end instruments for years to come.

The NovaSeq 6000, selling for $985,000 and shipping on a limited basis in March, will be able to sequence up to 48 whole human genomes per run and has three times the throughput of the current highest-performance model, the HiSeq X.Usage costs will be 20% lower compared with the HiSeq X, and 45% less than those of the next model down the line, the HiSeq 4000. The company also emphasizes the flexibility the products will have regarding configuration options and upgradability, as well as the operational costs they'll save through improved workflow.

The performance and cost improvements should drive a nice upgrade cycle for the company. But the instrument's pricing should bring in new customers, too. The capital requirements for the high end were prohibitive for many customers, as the HiSeq X was available only in bundles of five or 10, at costs of $6 million and $10 million, respectively. With the entry cost of NovaSeq below $1 million, new customers should appear.

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This should fix the lineup problems

In recent quarters the HiSeq 2500/4000 products have been the weak point in instrument sales. Low-volume customers were able to get whole genome sequencing on the desktop midrange product for one-third the instrument price. High-volume customers were buying the HiSeq X line and getting one-third the usage costs. Sales of the "tweener" HiSeq products, along with their desirable utilization rates, were declining and were a big factor in recent disappointing growth numbers. The economics and the flexibility of NovaSeq should fix this problem. Illumina expects that NovaSeq will eventually replace the entire HiSeq and HiSeq X lines. The simplified lineup should be easier to sell and more efficient to manufacture and service.

The company has long maintained that as prices go down and speeds go up, more demand for sequencing will be generated. In the last conference call, the CEO said:

So, we continue to hear from our research customers especially, that there are lots of projects that they would like to take on, and they will do that as the price of sequencing comes down. And so, whether it's much deeper sequencing they want to do in oncology research, or more single cell research, there are a whole set of projects that we hear about from customers that they don't feel they can take on at this price point, but they are looking forward to the price points continuing to go down. So, I continue to deeply believe in the elasticity of the demand in the research customers.

He was certainly looking forward to NovaSeq as he said this. Illumina bears believe that the company has hit a wall of demand for sequencing and that the need for new instruments and supplies will inevitably grow slowly from here. NovaSeq should test these conflicting views.

But investors shouldn't expect results soon

It will take time for this product announcement to make a difference in business results. Manufacture of this product will be more challenging to ramp up than for the HiSeq X, which was leveraged from a platform that had been in production for years. The new architecture has smaller geometries, which means new manufacturing processes and more precision are required. We shouldn't be surprised to see production delays along the way. In fact, the company will only be able to produce a couple dozen units in Q1, and the VP of operations stated that NovaSeq will have a "very, very different profile and ramp-up period" compared with the HiSeq X. The company has not supplied a shipment forecast beyond Q1.

Further, the sales cycle could be lengthy as research labs try to understand the new product and adapt their processes and supplies inventory in preparation for its use. In the meantime, customers may hold off on planned purchases of the older products until the newer ones are available.

And it's definitely not guaranteed that usage and supplies revenue will immediately take off once the NovaSeq units are delivered. The company has said utilization often dips for a while around upgrade cycles as customers get familiar with the new machine. And given the lower operating costs of the new machines, usage will need to increase just to keep revenue flat.

A revamp of the high end of the instrument line was exactly what Illumina needed to get growth back on track. And long-term investors shouldn't lose sight of the big picture: Understanding genomics at a deeper level will only become more crucial to healthcare going forward. Highly valued Illumina stock, however, may have a bumpy ride for a while.

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Jim Crumly owns shares of Illumina. The Motley Fool owns shares of and recommends Illumina. The Motley Fool has a disclosure policy.