Illumina Inc (ILMN) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2014 Illumina Inc.

earnings conference call.

My name is Whitley and I'll be your Operator for today.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Rebecca Chambers, Senior Director of Investor Relations.

Please proceed.

Thank you.

Good afternoon, everyone, and welcome to our earnings call for the second quarter of FY14.

During the call today we will review the financial results released after the close of the market and offer commentary on our commercial activity, after which we will host a question-and-answer session.

If you have not had a chance to review the earnings release, it can be found in the investor relations section of our website at www.illumina.com.

Participating for Illumina today will be Jay Flatley, Chief Executive Officer, Marc Stapley, Senior Vice President and Chief Financial Officer, and Francis deSouza, President.

Jay will provide a brief update on the state of our business and Marc will review our second-quarter financial results as well as provide our updated guidance for 2014.

This call is being recorded and the audio portion will be archived in the investor section of our website.

It is our intent that all forward-looking statements regarding our expected 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 information available and Illumina assumes no obligation to update these statements.

To better understand the risks and uncertainties that could cause actual results to differ, we refer you to the documents that Illumina files with the Securities and Exchange Commission including Illumina's most recent Forms 10-Q and 10-K.

Before I turn the call over to Jay, I would like to let you know that we will participate in the Morgan Stanley Healthcare Conference in New York the week of September 8. For those of you unable to attend, we encourage you to listen to the webcast presentation which will be available through the investor relations section of our website.

With that, I will now turn the call over to Jay.

Thanks, Rebecca, and good afternoon, everyone.

I'm delighted to report that Q2 was another exceptional quarter for the Company.

Our business continued to demonstrate strong underlying trends across all geographies and in nearly product lines.

As a result, Q2 revenue increased 29% year over year to $448 million, our 11th consecutive quarter of sequential revenue growth and our best year-over-year growth rate since Q2 2011.

Second quarter total sequencing revenue grew 44% year over year driven by impressive demand for consumables, our new instruments and NIPT testing.

These results clearly demonstrate the breadth of our portfolio with options for customers across all experimental scales and applications.

Sequencing instrument revenue grew 51% compared to the second quarter of 2013, fueled by strong demand for HiSeq X Ten and the NextSeq 500, while MiSeq and HiSeq also exceeded our expectations.

Once again, cannibalization between our systems was insignificant and will be irrelevant looking forward as the manufacturing processes for each product are equivalently scalable including HiSeq X Ten.

As you all know manufacturing capacity for HiSeq X Ten has been governed by supply of the high resolution cameras and the pattern flow cells.

As we began the second quarter, volume production of the pattern flow cells had only recently begun.

But I'm pleased to report that this process has steadily improved and we no longer expect flow cell production to be a gating factor for HiSeq X shipments.

As a result of this progress, we recorded revenue on a significantly higher number of HiSeq Xs in Q2 compared to Q1.

We anticipate the future shipment rate to be largely determined by our customers' readiness to absorb the systems which we expect will extend into the first half of 2015 for announced deals.

The unprecedented demand for HiSeq X Ten has exceeded our most aggressive assumptions, and moving into Q3, I'm pleased to report that this trend continued.

Since the last earnings call, we've received four additional orders.

The first from the Baylor College of Medicine and the second from Sidra Medical and Research Center, as well as two additional customers who have chosen not to be disclosed at this time.

These additional orders bring our HiSeq X Ten customer count to 13 for a total of 144 HiSeq Xs.

We're no longer planning to necessarily announce each order as individually they're not material given our large shippable backlog.

That being said, we have a strong funnel of opportunities for the remainder of this year and into mid 2015.

Both the Genomics England and the Sidra Medical and Research Center announcements highlight that population sequencing is beginning in earnest.

We were very pleased to recently disclose alongside Genomics England that Illumina Cambridge would be the preferred partner for the sequencing portion of the 100,000 genomes program.

While there are not many details I can share about our role in our project today, we are working towards a definitive agreement and will be happy to provide additional information when possible.

The creation of a high throughput genomic center at the Sidra Medical Center in Qatar is another notable milestone for population studies.

The center will focus on human whole genome sequencing for rare genetic disease in addition to their work on population studies.

The facility will help advance genetic mapping projects including the creation of the Arab consensus genome.

These population sequencing programs are just two of the many that are being discussed globally and we look forward to providing further updates as these projects reach greater maturity.

Overall demand for the HiSeq family of products has increased over the last few quarters and this trend continued in Q2.

Shipments were higher both sequentially and year over year as ASPs improved due to customer purchases shifting toward HiSeq 2500 and X Ten and away from HiSeq 1500 and 2000.

Demand for the HiSeq 2500 benefited from 10 multi unit orders including HiSeq X Ten customers looking to supplement their fleet for applications outside of whole genome sequencing.

Approximately half of the HiSeq 2500 demand came from existing customers looking to build out capacity and gain access to the one terabase or 1T chemistry.

We began to see evidence of an upgrade cycle during the quarter as customers with older generation instruments placed HiSeq orders to capture the benefits of 1T.

We expect this trend to continue over the next year or two as customers with older generation HiSeq instruments assess our portfolio to determine which instrument would be optimal given their applications, work flow and economics.

Approximately one third of 1T eligible instruments have purchased the required upgrade and we expect this figure to increase dramatically in the third quarter.

In Q2, we reached a historic milestone for HiSeq products as we surpassed $2 billion in shipments since inception, cementing HiSeq as the most successful next generation sequencer ever.

HiSeq 2500 remains a very important part of our instrument portfolio with a long road map ahead of it including regulatory clearance and read length enhancements.

Once such enhancement, the 2 by 250 read length kits will ship in the fourth quarter and we're on track to submit the HiSeq NIPT assay to the FDA.

Additionally, the TruSeq synthetic long-read kits are now shipping.

Based on the molecular technology we acquired in 2013, this kit includes a streamlined library prep method with master mixed reagents, improved chemistry to reduce bias and integration with BaseSpace to enable a full sampled answer work flow, generating high quality virtual reads of up to 10 kb.

This new library prep kit works across a much broader set of applications including genome finishing, metagenomics, de novo assembly, meta-assembly and human genome phasing.

Moving to NextSeq, our product launch activities continue to generate significant interest resulting in sequentially higher orders and shipments in Q2.

Importantly, NextSeq has hit a sweet spot with oncology, NIPT and microbiology customers due to the breadth of applications and the flexibility of the work flow.

As an illustration of this, half of orders came from commercial customers many of which are exploring the use of NextSeq in a translational or clinical production setting.

Feedback on NextSeq continues to be very favorable due in part to the exceptional performance of the instrument in customer hands.

Both quality scores and output are exceeding specifications as we're regularly seeing greater than 85% Q30 performance in selected (technical difficulty) 40G.

This along with the early customer data has supported demand for NextSeq and we look forward to a continued successful roll out of this instrument.

Cannibalization of MiSeq by NextSeq was insignificant again this quarter as the platform is uniquely suited for particular applications and customer groups.

MiSeq orders benefited from our trade-in program for third-party instruments as well as a bundling promotion which offers a discount to customers when both a NextSeq and MiSeq are purchased together.

Customer dynamics for MiSeq are largely unchanged from the trends we saw in prior quarters with approximately two-thirds of instruments ordered by government, commercial, translational and clinical customers and close to 70% of the orders from new customers.

Additionally, this quarter we once again received follow-on multi unit orders from existing customers building capacity and production facilities and from public health institutions including the FDA and the CDC.

Moving now to arrays.

This quarter total micro array revenue declined approximately 10% year over year as growth in genotyping services and IVF was more than offset by a decline in our Infinium genotyping business.

This was primarily due to the completion of a large multi year bio banking project and lower demand from a consumer customer as opposed to a change in our market share which we estimate to be stable at approximately 80% of the genotyping market.

As a result, we're updating our expectations for the array business in 2014, the impact of which is included in the guidance we provided today.

For the full year we now expect this business to be down mid to high single digits due in part to the factors noted previously as well as the absence of revenue from our Eco PCR products, which were previously reported in the array line.

Beyond 2014, we expect this business to stabilize if not grow due to the impact of consumer, agricultural and IVF demand.

We remain focused on delivering complete sample to answer work flows, enabling new markets to embrace NGS technology through a variety of applications.

As part of our strategy, we continue to enhance our bioinformatics capabilities.

BaseSpace now has a total of 38 apps and we're tracking having approximately 50 available by year end.

During the quarter, we also enhanced the BaseSpace onsite product which now includes our variant studio analysis tool and native apps which previously had only been available in the cloud offering of BaseSpace.

Our sample to answer products announced at the January investor day remain on track for delivery this year and we look forward to updating you on the demand trends for NeoPrep and MiSeq forensics over the coming quarters.

As a demonstration of the diversification of our business, again this quarter commercial, nonprofit and hospital customers accounted for approximately half of shipments.

And in the Americas, clinical orders grew more than 50% in the first half versus the prior year.

Sequencing uptake in the oncology market also continues to gain significant traction.

In the second quarter sales to research, translational and clinical oncology customers grew more than 30% versus the prior year to approach $90 million in shipments.

Our efforts to bolster adoption in this field are also progressing well.

The actionable genome consortium which consists of the major cancer centers as well as other key stakeholders including Illumina has reached consensus on a broad set of standards for using NGS in the clinic and plans to publish their recommendations next year.

Feedback from customers points to standards being a critical factor to drive the adoption of NGS in the clinic.

Additionally, we continued to further our discussions with pharma partners regarding a development of our onco panel and hope to have announcements to share on this topic in the coming quarters.

This week Dr. Tina Nova joined Illumina as a General Manager of Oncology business.

Tina is a great addition to our team and we're delighted to have her on board.

Her group will execute on the strategic vision Dr. Richard Klausner has put in place as CMO an Interim General Manager of Oncology.

I'd like to thank Rick for the dynamic leadership he provided over the last six months in this acting role.

As part of our clinical readiness strategy, we recently completed the acquisition of Myraqa, a regulatory and quality consulting firm specializing in IVD and companion diagnostics.

The team is nationally recognized due to their deep regulatory, quality, clinical biostatistics and IVD development expertise.

As we move into the clinical market, obtaining regulatory approval for our products and the products of our partners has become increasingly important.

With the addition of Myraqa, our regulatory team has now tripled in size allowing us to run a broad parallel portfolio of regulatory products through our pipeline.

Myraqa accelerates our vision of advancing the adoption of genomics in the clinic and we're very pleased to welcome Mya Thomae and her team to Illumina.

The financial impact of this traction was included in the guidance we provided in April.

In reproductive and genetic health, we made significant progress during the second quarter in both IVF and NIPT.

We successfully launched our new Preimplantation Genetic Screening product, VeriSeq PGS, on the MiSeq platform and will also be available on NextSeq later this year.

The NIPT market continues to grow and we're very pleased with the performance of our business in the second quarter.

Verifi volume and service revenue came in at record levels and additionally we received New York State approval for average risk testing and announced technology transfer agreements with Biomnis, Genoma and the Center for Human Genetics and Diagnostics.

Under these agreements, they will use the HiSeq 2500 to develop and perform NIPT.

We're in discussion with more than a dozen other potential customers for similar technology transfers.

Additionally, we recently announced an agreement with Berry Genomics to co-develop an NGS system to provide a cost-effective easy to use assay for NIPT in China.

This system has already been validated in a clinical setting and is in late stage review by the Chinese Food and Drug Administration.

In summary, Q2 was another remarkable quarter with strong uptake of our new sequencing platforms coupled with rapid expansion into new markets.

In particular, the progress we've made in the clinical market validates our strategy and the utility of sequencing in health care.

We're confident in our technology leadership and believe we will continue to deliver significant growth as we unlock the power of the genome.

I'll now turn the call over to Marc who will provide a detailed overview of our second-quarter results.

Thanks, Jay.

As Jay described, Q2 marked another exceptionally strong quarter for Illumina.

Revenue grew 29% year over year to approximately $448 million as a result of significant uptake of our HiSeq X Ten and NextSeq instruments, record sequencing consumables and stable demand for MiSeq and HiSeq products.

Globally, demand for our products remained strong during the second quarter.

Shipments in the Americas grew 19% year over year and Europe saw a 45% increase over the same period last year.

In APAC, shipments grew approximately 50% year over year.

Instrument revenue grew 48% this year to reach $140 million in the second quarter due to the introduction of HiSeq X Ten and NextSeq.

The demand across our sequencing portfolio continues to demonstrate that each of our products plays a key role in the sequencing ecosystem and collectively meet our diverse customers' needs.

Consumable revenue in the quarter was $247 million, an increase of 15% compared to the second quarter of 2013 primarily due to high demand for sequencing consumables which was partially offset by a decline in array consumables.

Consumable revenue represented 55% of total revenue down from 62% in the prior-year period and lower than the 58% we saw in Q1 due to the strength in sequencing instruments and maintenance contracts during the second quarter.

Sequencing consumables grew 34% over Q2 of last year due to our larger installed base of instruments including the addition of HiSeq X Ten and NextSeq to the portfolio.

HiSeq and MiSeq consumables reached record levels during the second quarter.

This translated to MiSeq utilization towards the top of our projected range of $40,000 to $45,000.

MiSeq pull-through continued to benefit from a large number of accounts running at full production levels.

In fact, approximately a quarter of MiSeq consumables were ordered by these production level accounts most of which were clinical customers as MiSeq is now being routinely used in lab developed tests and diagnostic settings for oncology, HLA and microbiology assays.

Given this trend, we continue to project MiSeq pull-though of $40,000 to $45,000 per year.

HiSeq pull-through per instrument, excluding HiSeq X Ten, was in our projected range of $300,000 to $350,000.

In the third quarter, we do expect consumable utilization to decline modestly across all platforms as a result of typical seasonality associated with the vacation season.

While it is too early to provide an estimate of NextSeq or HiSeq X pull-through, both instruments generated healthy consumable purchases during the quarter.

HiSeq X Ten consumables in particular were meaningful as customers performed validation studies and initiated their whole genome projects.

Services and other revenue, which includes genotyping and sequencing services, instrument maintenance contracts and revenue from verifi sales grew close to 75% versus Q2 2013 to equal $57 million.

This improvement was driven by ongoing growth in our extended maintenance contracts associated with a larger sequencing install base, strength in genotyping services and growth in NIPT services which benefited from test fees as well as increased verifi revenue.

Turning now to gross margin and operating expenses.

I'll highlight our adjusted non-GAAP results which exclude legal contingencies, non cash stock compensation expense and other items.

I encourage you to review the GAAP reconciliation of non-GAAP measures included in today's earnings release.

Our adjusted gross margin for the second quarter equalled 70.9% compared to 70.4% in the first quarter as the impact of the lower mix of consumables was more than offset by improved sequencing instrument margins.

Year over year, gross margins expanded to 140 basis points as a result of improved instrument and services margins.

Adjusted research and development expenses for the quarter were $70 million, or 15.6% of revenue, slightly higher compared to $65 million, or 15.5% of revenue in the first quarter to increased labor and clinical trial expense.

Adjusted SG&A expenses for the quarter were $92 million, or 20.5% of revenue, compared to $84 million, or 19.9% of revenue in the previous quarter.

The increase was primarily due to consulting expenses associated with our global business process program as well as additional outside services and labor expense.

Adjusted operating margins were 34.8% compared to 34.9% in the first quarter and 32.3% reported in the second quarter of last year.

These were higher year over year due to the impact of improved gross margin and operating expense leverage.

In the second quarter, we recognized approximately $700,000 of adjusted other income.

Our non-GAAP tax rate for the quarter was 29.8% compared to 30.7% in the second quarter of last year, which at that time included the quarterly impact of the 2013 R&D tax credit.

Non-GAAP net income was $85 million for the quarter and non-GAAP EPS was $0.57.

This compares to non-GAAP net income and EPS of $60 million and $0.43 respectively in the second quarter of 2013.

We reported GAAP net income of $47 million, or $0.31 per diluted share in the second quarter, compared to net income of $36 million, or $0.26 per diluted share in the prior-year period.

Current period results include $31 million recorded in other expense net for the extinguishment of debt associated with the 0.25% 2016 convertible repurchase.

As well as $5 million recorded in cost of goods to reflect the ongoing royalty on BeadChip sales associated with the Syntrix litigation including interest.

We generated cash flow from operations of $178 million during the second quarter, higher than previous quarters due to increased cash collections, combined with a reduction in tax and compensation-related payments.

DSO decreased to 53 days compared to 63 days last quarter as a result of both the more linear shipments and our collection efforts.

Capital expenditures were $23 million resulting in $155 million of free cash flow.

During the quarter, we repurchased approximately 508,000 shares for $72 million as part of our discretionary repurchase plan.

And we now have $165 million remaining under our previously announced program.

Additionally, we priced $1.15 billion of convertible senior notes significantly improving the maturity of our debt which now comprises $320 million due to 2016, $633 million due in 2019 and $517 million due in 2021.

We repurchased $600 million aggregate principal amount of the existing 2016 convertible senior notes for a total consideration of $1.24 billion, which removed approximately 3.5 million shares from our diluted share count.

Note that the [15 million] warrants associated with the call spread on the previous 2014 debt have now been extinguished.

We ended the quarter with $1.1 billion in cash in short-term investments.

Given our strong first half results and our ability to largely satisfactory HiSeq X demand, we have updated our guidance for 2014.

We now project revenue growth of 25% to 26% year over year, an increase from the previous guidance of 21% to 23% growth and non-GAAP diluted EPS of $2.26 to $2.28 higher than our prior guidance of $2.10 to $2.15.

Additional modeling considerations include fully weighted average non-GAAP diluted shares of 149 million which assumes a stock price of $175 and a full-year pro forma tax rate of 29% which includes the 2014 federal R&D tax credit that has yet to be enacted.

If the tax credit and other tax extenders are not passed, our annual tax rate would increase by approximately 200 basis points.

In summary, we delivered strong second-quarter results and are projecting significant growth through 2014 and beyond.

We continue to drive technology leadership of market expansion to become the clinical standard enabling us to address the more than $20 billion market opportunity ahead of us.

Thank you for your time, we will now move to the Q&A session.

To allow full participation, please ask one question plus related follow-up as necessary keeping it to two questions at most.

Operator, we'll now open the line for questions.

(Operator Instructions)

Tycho Peterson, JPMorgan.

Nice quarter, guys.

First on the population efforts with Sidra now in the press release, can you talk as little bit about what the backlog looks like for additional population studies and any numbers you could put around the Sidra effort in terms of placements?

Well when we use the word backlog, Tycho, we actually consider backlog to be orders that are unshipped.

So beyond Sidra, there's really nothing in backlog.

In terms of what the prospect channel looks like, of course in England we've announced that we are the preferred provider there.

We've not yet signed the agreement, so until we sign that agreement, we won't actually have a purchase order and have that in backlog.

But beyond those two, we're working around the globe with probably 10 to 15 potential prospects in these -- in that pipeline range from customers who are very early on in their thinking to ones that are much more advanced.

We suspect that it will take some number of years for these to begin to roll out in volume.

But we continue to be quite optimistic about the concepts around population sequencing and that when you look out over a three to five year window, that it will become a significant part of our business.

With respect to Sidra specifically, the first purchase order was for HiSeq X Ten and some related equipment that goes along with that.

The next set of questions will be the pace with which they begin to do population sequencing and if that accelerates dramatically over the next year or so, will they need more instruments and we just don't know the answer to that yet.

Okay.

And then as a follow up, can you talk a little bit about the Berry collaboration, what the thought process was there?

Are you expecting this to accelerate into average risk maybe faster than US?

How do you think about the dynamics of the market and maybe revenue impact?

Yes, we do expect it will get to average risk populations faster in China, the -- with the birth rate in China, the market opportunity there is absolutely enormous.

And as most of you probably know, the CFDA in China put a stop to routine NIPT testing.

They allowed some labs to continue to do the testing in order to generate clinical information, and we've been clearly working with some of those laboratories with Berry.

They are working with us in partnership around some changes to the instrument to have it manufacturable in China, software changes, some specifics on the sample preparation to have a product that is suitable for the Chinese market that sequences at the right depth for the kind of test that's required in that Chinese market.

And as we mentioned in the script, we're in late stage evaluation through the agency in China.

Okay.

And if I could ask one clarification, did the time line in NeoPrep slip?

I think you originally said over the summer and I'll hop off now.

I would say it slipped but a few months Tycho, and that's really because we want to do very extensive testing of this product before we put it into the market.

Because we're going to deploy six assays on this platform before the end of the year and the sample prep market is extraordinarily important for us.

And we think we will place a lot of instruments quickly once we start shipping this.

We want to make sure that this instrument and the associated assays are extraordinarily robust.

So we've added a couple of months of testing into the program time line and so it has slipped a bit.

Okay.

Thank you.

Doug Schenkel, Cowen and Company.

Starting with a follow up to Tycho's -- one of Tycho's questions.

Clearly the recent announcement with Berry Genomics highlights the fact that NextSeq was designed to clearly have a role in NIPT.

As we think about the outlook for NIPT in the non high risk market and the need for a lower price, lower cost solution, would you be willing to comment a little bit on how important a role NextSeq is supposed to have in reducing the cost and helping you move more aggressively into the low risk market?

Yes, Doug, I'd say that NextSeq is a very, very important product for us in NIPT.

And probably the way to best think about this is in the environments where NIPT testing is very centralized, which we think will be probably be more the case in the US, that HiSeq will be the better option because it's very large sample flow and the cost per read is lower on a HiSeq than on a NextSeq.

However, a large share of the world's market, and particularly as we get into more average risk testing, will become more distributed.

And in that case NextSeq is absolutely the perfect product because it multiplexes at the right kind of level to deal with the more moderate sample flows that you'd have in a distributed environment.

So for the broad Chinese market where there may be 3000 hospitals that could be doing NIPT testing, NextSeq is a much better product for that environment than HiSeq even with a slightly higher cost per read because you don't have the dead time in between runs and the impedance match is better to the sample flow, NextSeq is the ideal product.

Okay and then if I could follow up on -- follow up with a longer term outlook question.

Illumina is clearly one of the few companies out there with a revenue base of over $1 billion that can still generate mid to high 20s revenue growth.

You're clearly playing from a position of strength right now and you have the currency to pursue a lot of different directions.

I make these observations six months after you named a new President who yields from the tech industry a few weeks after you acquired clinical expertise with Myraqa, and in the midst of a summer where you're talking about doing more in areas such as liquid biopsy and just added Tina Nova to the team.

It seems like there's some signs that Illumina may not be content to be just an arms dealer over the next few years.

As we sit here a few weeks in advance of when you typically go into your planning and budgeting meetings for the upcoming year, it seems like a good time to ask how you're thinking about the future.

And I'm not suggesting there is any thought that you're not going to continue to dominate your core market and drive the pace of sequencing innovation.

What I'm really wondering here is if you're thinking that this is the time to increasingly use your strength to move beyond just being an arms dealer and if so, how should we think about the outlook for investment in strategic developments over the next year or two?

I think that there's really been no change in our strategy here and I guess I would characterize our strategy as one that goes beyond being an arms dealer but not one that is a company that is selling clinical tests directly to physicians and running in our own laboratories, other than to gather clinical data to submit products to the FDA for approval.

Our real focus and one of the key reasons that Myraqa was so important to us, is that we need to begin to run a very significant number of products through the regulatory cycles inside the Company, the clearance cycles, at a pace that almost no other company has ever done, frankly, particularly as we get into these PMAs.

The FDA only approves two to three PMAs a year and we're going to try to push a whole bunch of products through there in the next three years.

So we need that resource to accelerate it.

And the strategy is to get these through the FDA, get them approved and then sell a bundled solution that includes the kit, the software, the instrument, the analytics, the cloud support that's necessary to implement this and in some cases data sharing.

So in our view that's well beyond an arms dealer, it's selling a complete solution.

What it's not doing, again to be clear, is taking those products directly to physicians and running the product out of our own laboratories.

Okay.

Thank you.

Derik de Bruin, Bank of America.

You said something interesting, or several things interesting, but the one I found interesting was you were talking about the move to do NGS standards in the clinic and your involvement in that.

Could you talk a little bit about that?

I'm curious is this standards for everybody's platform in terms of what you need for NGS or is this -- was this more focused on Illumina?

I'm curious what were the representation from the other sequencing firms and how does the regulatory and the standard environment flesh out?

Yes, this was a consortium we put together under Rick's vision and creation.

It consisted of a handful of working groups that included large cancer centers, some academic representation, some peripheral participation from the FDA, although they were not actually part of the committees themselves, and Illumina.

So there were not sequencing vendors as part of this.

But what our goal was to do here was to set standards that these committees believed would meet the needs of a clinical community.

So this wasn't -- the committees themselves were not driven by Illumina, we didn't chair any of the committees.

But the focus was all around some of the seminole questions that our customers have about how do you prepare the sample, what sample input volumes do you need.

How do you handle FFPE?

What's the concentration?

How deep do you need to sequence?

How do you analyze and report out the data?

What do you do with incidental findings?

And so each of these committees have completed their work in what we call phase 1 and we plan to publish this information.

So it's going to be available to anybody, so any other sequencing vendor could use these same standards to deliver products into the community.

But we thought getting those done and getting them done quickly, which we have accomplished I think in a very short period of time, was critically important to move the market forward.

Great, thanks for the clarification on that.

And one question, so can we talk arrays for a moment?

And give us a little bit of flavor in terms of how your array business is fragmented.

Give me some idea in terms of what's cyto, what's ag bio bio banking, what's regenotyping, getting a sense because if you're talking about growth of bio banking ag bio and some of these other ones in the future DTC stuff, I want to get a flavor how to better model it (inaudible) standpoint.

Yes, we don't publicly break down all the sub categories in the array business but Infinium is clearly a big part of our array business.

More and more is going toward customized chips within the Infinium product line so our more focused array products.

As a result of that, we now have a whole group that's really -- or focused totally on creation of custom products, both sequencing and arrays because of that trend.

Ag continues to be a good market.

It's growing probably mid-single digits, I'd say in the ag market.

Most of that market is now arrays and not as much sequencing.

Back couple years ago, sequencing was the new thing there because you had to sequence a bunch of these organisms initially to be able to develop the array products.

But today it's more of an array based market.

IFV I think is coming on strong there.

It's a very young market and one that has a tremendous amount of upside opportunity, although part of that will go to sequencing as well over time.

The parts of our market that were a bit weak as we mentioned, were in some segments of consumer.

We have a couple of consumer customers that are doing extremely well, but we had one customer in particular that had lower volumes in the quarter.

And as I mentioned, we in terms of year-over-year comparables we had a large project that wrapped up and that's helped -- or that caused the Infinium volume to drop somewhat.

As far as a quick follow up, how many more of the bio banking deals are out there in terms of just the size of the opportunity and where things are in the negotiations?

I know there have been some announcements on that, I'm curious in terms of globally what are people doing with it and are people going to move more towards sequencing when they're doing the bio bank characterization?

I'd say there's probably over the next few years a handful of bio bank projects is probably the right way to think about it.

Our expectation is that those would not move to sequencing anytime soon.

And the reason is that typically almost by definition a bio bank project is a very large number of samples and so you need extremely low price per sample.

I mean, these projects tend to be in the $50 to $100 per sample range.

And so sequencing is probably not the technology that's going to address that market segment.

Great.

Thank you very much.

Dan Arias, Citigroup.

Jay on the X Ten given the way that demand and manufacturing capabilities are tracking at this point, are production and capacity something you think will be a factor next year or do you think that at that point you are able to manage through the types of shipment numbers that your pipeline implies here?

Yes, I think our capacity is going to be fine at this point.

We're still a bit in the catch-up mode to the backlog because we booked so many right out of the chute in the first 1.5 quarters that this product was in the marketplace.

And as we discussed with all of our new product launches, you can't build capacity to instantly drive down the backlog or else when you get to the more steady state your capacity is too high.

So we have to keep the capacity a bit higher than the incoming order rate to begin to drive down the backlog.

I suspect by the end of this year we'll be at a steady state rate on HiSeq X Tens in terms of a match of incoming order rate to production volumes.

Yes, okay.

That's great.

Maybe one on the clinical markets, how are you thinking about RNA-Seq and the ability to move in on QPCR for gene expression assays?

RNA-Seq continues to be one of our most important applications.

In fact, it's one of the core uses of NextSeq, it's a fantastic instrument for doing RNA-Seq, some of the new sample prep products that we've launched are targeted expressly at that market.

And so I do think we're going to continue to eat away at PCR type applications for doing expression.

And RNA-Seq's the perfect platform to do it and as the price of the sample prep kits continue to come down, I think it becomes more and more competitive with PCR.

Thanks a lot.

Ross Muken, ISI Group.

Good afternoon, guys, and congrats.

Thanks, Ross.

Thanks, Ross.

On the X Ten customer base if we think about the evolution of the conversations you guys are having, I'm assuming there's some interesting incoming requests to discuss with you project ideas or the like.

How is the type of customer or the mix or geographic changed?

I'm curious in a sense where you see one country pursuing a massive endeavor of looking at hundreds of thousands or eventually multiples of that samples, do you see other countries in the region where budgets are also at similar levels say well we would like to discuss something else?

I'm trying to get the sense for the network effect and where it had the most surprising shift and where not, maybe.

Let me see But in terms of the profile of customers so far in X Ten, we've probably been surprised by the overall interest in Asia.

That's an area that's way surpassed our expectations.

I would say what's happened in Europe is about what we expected, and there's some good continued prospects in Europe that we think will wind up being Q3 or Q4 type opportunities.

In terms of a network effect, I guess we haven't seen maybe other than a couple of examples, customers feeling like they had to buy one because their competitor bought one.

We've seen maybe a few examples like that.

There probably have been more purchases outside of customers who have years of experience in sequencing than we may have thought.

Our profile going in was that probably two thirds to maybe three quarters of the customers would be those types who already knew how to sequence and just wanted to up their production levels and reduce their costs.

And we're probably more like 50/50 or maybe even less than that.

And so we have a lot of new customers to sequencing, using these platforms which actually is requiring us to emphasize software more and put the others some more integrated software capabilities around the X Ten for those sets of customers.

Any other observations?

Marc, do you have other observations on X Ten customer types that --

Not than punctuating the point you just made around the difference in mix than what we originally expected.

The diversity of customers that we have that are buying X Tens is significant.

There's at least one of every type of customer we might have expected and some that we didn't who were buying the system or interested in it.

Yes, and I say that if you get back to the population sequencing part of your question, there's only a couple of these that we'd really put in the population sequencing category so far.

Yes.

So as usual Jay you were exactly on point with my confusing question.

So thank you again and congrats.

Amanda Murphy, William Blair.

I had a couple of questions on the HiSeq.

The first, I don't think you mentioned the -- where you sat in terms of the consumable range this quarter.

And then in terms of the puts and takes there, obviously you've got the upgrade and then sample prep and then curious, how the HiSeq utilization is trending with the few customers who also have an X Ten now.

Yes, Marc, you want to take this?

Yes, so Amanda, on the range what I did say in the prepared remarks was the HiSeq utilization was within our range of $300,000 to $350,000.

Okay.

A while back we stopped giving a precise number because you do see a fluctuation quarter after quarter depending on a lot of factors including customer buying patterns, large orders placed beginning end of the quarter that kind of thing.

So yes, it was within our range and there was nothing unusual to call out there and we continue to model that kind of utilization going forward.

And even if you think about those customers that have bought an X Ten, in fact Jay mentioned some of those customers have even purchased HiSeq 2500 to fuel their non whole genome sequencing demand.

That hasn't changed.

The X Ten, I mean has not changed our expectations on the HiSeq range at all so that $300,000 to $350,000 is still very applicable.

I think on average that's exactly right.

We do have probably a couple of customers who bought X Tens that may be using their HiSeqs a little bit less.

So in those specific customer sites, the revenue from consumers some of it's shifted to X Tens off the HiSeqs.

But on average it's not having a measurable effect on the overall consumable number.

And on sample prep, to that specifically obviously NeoPrep as Jay mentioned earlier is a really important product for us in that area and that's something that we would hope to fuel sample prep gains going forward as well.

And then in terms of the upgrade, you said that a third who could upgrade have.

Is that specifically to the customers that have an upgradable HiSeq meaning the software upgrade?

And then curious what you're seeing in terms of the install base that can't -- doesn't have access to the terabase, have you seen them actually pursue any kind of upgrade cycle at this point in terms of new instrumentation?

Yes, the one third statistic was of the eligible instruments and that's probably about in the range that we would have expected.

We think it will continue to go up here over the next couple of quarters.

And in the prepared remarks I mentioned a bit about what we're seeing on upgrades, that we think we are beginning to see those older customers begin to upgrade and we think the pace of that will probably continue and if anything probably accelerate a bit into 2015.

And we think that overall upgrade cycle could last a couple years.

And you still think then a quarter -- I think you said a quarter to a third of the install base that can't upgrade may at some point, is that still what you're thinking?

Well we've never given a number.

We've -- I think there's some analyst estimates out there but we've never given a number on the fraction that are eligible.

Got it.

Okay, thanks very much.

Dan Leonard, Leerink.

For my first question I was hoping maybe you can give more color on the magnitude of the sequential growth in NextSeq.

It seems a lot of the conversation is focused on X Ten.

Sure, we were really pleased with what's happening with NextSeq, we've generated a lot of market demand.

We're just now beginning to come up on cycles where people will start having submitted grants and grants will start coming out of the pipeline.

So if you think about it, most of the units we've sold to date would have been through people who didn't have to go through a grant process.

And so there's probably a little bit pent-up potential energy in the pipeline right now.

As we said in the prepared remarks, half of those systems are coming from commercial type customers as well.

So it's a product that's really appealing in market segments that like oncology that really is a different segment than the MiSeq.

And early on as we have talked about, we were a little concerned about the cannibalization that NextSeq would have and we haven't seen that.

It's a lot of brand new customers to sequencing technology and a lot of commercial usage of the system.

So we're very optimistic about beginning to convert the pipeline and continuing to grow it.

And the product I have to say is working exceptionally well in the field.

This is by far the highest quality product we've ever produced and the solid state and nature of the way this is designed and manufactured I think is really paying off in terms of lower warranty costs and really high MTBFs in customers hands as well as sequencing performance.

Got it.

And then for my follow up Jay, I wonder if I'm missing something on the consumable line that the sequential growth in consumables was the lowest it's been in five years, and I know you said there was a -- the consumer customer for arrays was down sequentially, but I think that was the only sequential delta.

I think your genotyping comment was a year-over-year comment.

So I'm curious what the plug is and I wonder if it's the distribution of all of the utilization of these sequencers you're installing might be a bit more bimodal than it has been in the past.

If you could address that.

No, it's really the difference between sequencing and arrays here.

So the sequencing year-over-year consumable growth was very strong, arrays was not.

And that's really the bottom line.

And so the average of those two is what gave us the overall number that we quoted as being lower than what you've seen in the past.

Okay.

Thank you.

Isaac Ro, Goldman Sachs.

Want to ask a question about the comment you made earlier, 70% of system orders are from new customers.

Wondering if you give us a color, some color -- okay, I'm sorry.

Well maybe at a broader level, for the new system orders you're getting from -- I'm sorry, the orders you're getting from new customers, can you give us a sense of the mix for the various instrumentation platforms and maybe how that compares to your current install base?

By mix, do you mean mix of new versus existing?

I'm curious you --

You mean application?

You're -- of your various instrumentation platforms, what the mix looks like for the new customers.

Are they preferentially buying more MiSeq versus NextSeq versus HiSeq, that kind of granularity as we think about the future run rate on the pull-through those boxes will generate?

Yes, so we need to be a bit careful about how we use new here to make sure that we're all in synch.

So when we said for example 70% of MiSeq orders are from new customers, those are customers that are new to MiSeq.

So they've never had a MiSeq before.

They could already have a HiSeq.

So I think given that, breaking it down the way you asked isn't probably logical or doesn't make a lot of sense, if you see what I mean.

Sure, okay.

Maybe just another way to look at it would be if you could give us a sense of any aggregate as you look at your funnel for sales going forward, can you give us a sense of how many of the potential orders you think you're going to get could be from totally new NGF customers?

Yes, so I would say we're probably looking in any given quarter, depending upon which quarter it is, somewhere between 10% and 20% of our customers are brand new to NGS.

Got it.

Okay and last one if I could sneak it in would be Marc for you on the tax rate side.

It looks like the guidance there is a little bit lower and wondering if maybe, if there's anything specific there that's driving in and what your priorities are around tax rate, certainly tax rate is a topical issue across the market these days?

Thank you.

Yes, Isaac, nothing has really changed around our strategy for the tax rate in particular.

We've been moving consumable manufacturing to Singapore, arrays is largely there.

We did a little bit of change in bringing the HiSeq X consumable back or into San Diego initially, but we did put an instrument NextSeq in Singapore.

So no real change there in our manufacturing location strategy.

The tax rate drop that you've seen is largely other factors, I would say including things like compensation expense and so on that are higher than we expected.

So that's really, I think, the key there.

In terms of other strategies and what's fashionable right now and things like the inversion activities going on, that's something that the way we think about that is that would be a secondary benefit, if anything, to more strategic play we would make and that's a completely different question.

We'd have to look for the business strategy fit before anything else.

And if the tax benefit was there, that would be great.

But as we've said before, those are large -- those kinds of large opportunities we don't see many of those existing out there.

Got it.

Thanks, guys.

Jon Groberg, Macquarie.

Two quick questions for me.

First Jay, I think you gave a number of $90 million in the quarter for sales going to, not sure exactly how you define it, cancer customers.

So wanted to get a little bit more of a sense of what you are including in that?

That's all oncology, so it's research, translational and clinical.

And the reason we do it that way, Jon, we've tried to break it down other ways but so many of our customers are in these hybrid situations where you -- sometimes they're doing research and sometimes they're doing more translational or clinical work particularly on HiSeqs and so it's very difficult for us to get a clear breakdown of who's in which bucket.

Okay.

And out of curiosity for you, my second question here, did you give a -- did I miss it, did you give growth rate on what that grew on a year-over-year basis, cancer?

We didn't give a growth rate for that.

I'm sorry, we gave a shipments growth rate of 30%, that's right, shipments we did, 30%.

30%.

Okay, thanks.

And then my second question, Jay, for you strategically as you think about sequencing and arrays, obviously your focus has been much more on sequencing, it's been a higher growth business, more investment there.

One of your bigger competitors is actually starting to show some signs of life after being dead for quite a while on that side.

Is your willingness to compete on that side of the business changed at all and as your view of how quickly some of those applications could move to sequencing, has that changed at all?

I'm curious strategically how you're thinking about your businesses there.

Thanks.

Yes.

Well I would say in the past few years, our R&D investments have been biased more towards sequencing and we plan to remain extremely competitive in the array market.

And if anything, you might see us shift a little bit more investment back toward arrays, both commercially and in R&D.

It continues to be a very big business for us with great gross margins.

And so we continue to look on it as being very complimentary to sequencing.

Many applications we think will continue to move over to sequencing but those tend to be much more on the expression side than on the genotyping side.

The genotyping array market today is pretty much a low cost per sample market.

And whether you're in ag or whether you're in consumer, you're talking about per sample costs in the $50 to $150 range.

And so it's going to be a while before sequencing becomes applicable to those markets.

But expression is quite different because the quality of the data you get from sequencing is so vastly enriched from what you get from an array, an expression.

And so those are applications that we're continuing to move over from arrays to sequencing.

Okay.

Thanks.

Bill Quirk, Piper Jaffray.

First off, Jay, can you comment about the recently interesting rhetoric from the FDA as well as a couple of Senators around LDTs and obviously the potential for increased regulation here?

And I'm guessing that this may be part of the move to expand the regulatory team, but certainly would love your thoughts here given that this market is obviously becoming pretty important to Illumina and certainly would expect it to become more so in coming years.

Yes, it seems like at least from what I've read that most of the rhetoric isn't coming from around the FDA, not from the FDA themselves here, and there are various camps that are asking for more progress on this issue.

As you know, the question of how LDTs are going to be regulated has been out there for several years at least.

And so we don't have a particular crystal ball on this other than to reiterate the position that we've taken before where we've said we think it's unlikely that there will be global requirements for all LDTs to become FDA approved.

And there's -- and that's driven by the sheer number of tests, I mean even if those were all submitted, the FDA would take years and years and years to be able to analyze and approve those tests.

And the fact that so many of them are critically important to the healthcare system.

And so we do think that if regulation of LDTs does come down it would more likely being targeted for very high risk test or some subset of tests.

It could also potentially require future tests to be regulated but grand fathering in existing tests.

So those are some of the options that are on table and we don't know where the FDA is going to wind up on it.

But clearly we're prepared to do whatever is necessary here and we have particularly now with our acquisition and [Myra] joining us, the regulatory horsepower to put things through the FDA we think in a way and at a rate that most others don't, particularly around sequencing technology.

Got it.

Thank you.

Zarak Khurshid, Wedbush Securities.

Jay first a question on the research side of the business.

How much of the [NIH] budget do you think you account for today and where do you think that's going over time?

Well as a percentage of the total, we're still very small from the overall budget.

If you looked at a breakdown of it, massive amount of it goes to bricks and mortar and labor and the amount that goes to extramural grants and then the fraction of those extramural grants that come to sequencing, still a very small percentage.

Got it.

Okay and then as a follow up on an NIPT which we love so much, how do you think about the pricing in the average risk setting in China, thinking about the margins for those 3000 lives?

I know the pricing environment is tricky there, so how do you think about the economics for those customers?

Thanks.

Yes.

Clearly the pricing is going to be lower in China to begin with and lower yet for average risk.

It's probably likely in China that there will not be as much bifurcation of testing as you're beginning to see in the US where there's higher -- test for higher risk patients being at higher price point and being a test that's got a higher quality standard perhaps than an average risk test does.

So I think in the US you're going to see bifurcation, perhaps in Europe as well.

In China it's likely to be one standardized test.

The price points will be lower than what we see anywhere else in the globe probably in the range of $300.

Even at that, we think on the Next platform our margins are going to be just fine.

Peter Lawson, Mizuho Securities.

Jay I wonder if you could talk through the GS diagnostic pipeline and what timelines you have for FDA submission on new tests?

Sounds like there's a (inaudible) coming.

Thank you.

Yes, so in NIPT in particular, we've talked about the fact that we're submitting our verifi tests to the FDA and we remain on track to have that submission before year end.

We have a whole series of other projects, some around companion diagnostics.

We've announced one with Amgen that we're working on to submit through the FDA.

The result of our work on the onco panels and the actual genome program will result in products that will need to go through the FDA as well.

And we're in discussions with quite a number of sequencing partners who want to put their technology through the FDA and partnership with us.

And so you start adding all that up, it's a lot of work and it requires a bigger team than the team we had and hence the acquisition and investments we're making in regulatory.

And then on the array business, what parts of that do you think exist in three years time?

I think the consumer part will certainly exist, the ag part will continue to exist.

I suspect what we traditionally think of as whole genome association will likely not exist in three years, so that part will be gone.

I think most of the expression part of the array business will have moved to sequencing in that time frame.

I think some of the prenatal and IVF applications will move away from arrays to sequencing as well, fundamentally better technology.

So -- but it's the low cost, high volume markets that will continue to stay on arrays, ag, consumer being part of the two standouts.

Operator, we're ready for our last question.

Bryan Brokmeier, Maxim Group.

Beyond NIPT, how does the clinical market adoption of NGS in Europe, China and other regions compare to that of the United States?

I'd say it's probably fastest in the US outside of NIPT.

The Chinese market will come along quite quickly in other areas as well, particularly in oncology.

So we're beginning to work very directly in that marketplace with some of the thought leaders around oncology.

I do think markets like Japan will begin to come on quickly as more oncology products come into the market whereas there are laggards in some of the reproductive health markets for structural reasons and societal reasons.

I think Europe will come along generally slower than most, although you can get CE Mark on these products perhaps earlier because of the way the lab systems work in Europe, it's a much more distributed market and therefore adoption in general tends to be somewhat slower.

Okay, thanks.

And then also in terms of APAC, you've talked about -- you put up extremely strong order growth this quarter and over the last few quarters you've discussed it as really being driven by the growth in Japan, haven't really talked too much about China.

I was wondering if you could share your thoughts around what you're seeing in China and how that's -- if you saw any change late in the quarter from what you saw in the last couple quarters?

Yes, we actually have seen somewhat of a change there.

So our China business was actually quite strong in the quarter.

In fact, it led -- the over performance in Asia was led by China this quarter.

Japan was actually somewhat soft and we do generally see that in Q2 because Q1 is such a strong quarter because of the end of the funding cycle in Japan.

There's always a downturn in the second quarter, but this year in particular there's restructuring going on inside of Japan and the creation of essentially the equivalent of an NIH there, which has caused a structural disruption in the funds flow that we think will last a couple of quarters.

So our Japan business is a bit softer, we think it'll probably be a little bit softer next quarter.

But these are funds that are going to continue to flow as we get into Q4 and Q1 next year.

So in some ways it's just pushed out of some of the business in Japan temporarily.

Okay.

Thanks a lot.

There are no further questions in queue.

Thank you, Operator.

As a reminder, a replay of this call will be available as a webcast in the investors section of our website as well as through the dial-in 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 the third fiscal quarter.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a great day.