Illumina Inc (ILMN) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2014 Illumina, Inc., earnings conference call.

My name is Jasmine, and I will be your operator for today.

(Operator Instructions)

As a reminder, this conference 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, Jasmine.

Good afternoon, everyone, and welcome to our earnings call for the fourth quarter and 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 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 the fourth quarter and FY14 financial results, as well as detail our guidance for 2015.

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 Cowen Health Care Conference in Boston the week of March 2. 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 very pleased to report that Q4 was another record quarter, which closed out arguably the most impressive annual performance in the history of the Company.

Revenue increased 32% year over year to $512 million, our 13th quarter of sequential revenue growth.

Equally impressive was the leverage we delivered this quarter, as non-GAAP earnings per share grew 93% compared to the fourth quarter of 2013.

These record results were due to strong underlying trends across our customer segments and sequencing portfolio, solid operational execution, and a greater-than-anticipated tax benefit.

Fourth-quarter total sequencing revenue grew 48% year over year, driven by demand across our platforms, record consumables, and continued uptake of our products across market segments, applications, and experimental scales.

Sequencing instrument revenue grew 93% compared to the fourth quarter of 2013, driven by demand for the NextSeq 500 and the HiSeq X instruments.

In addition, HiSeq and MiSeq again exceeded our projections, as customers continue to view these instruments as the NGS gold standard in their respective segments.

As we shared at the JPMorgan conference, in Q4 we added three new HiSeq X Ten customers, and booked a total of 37 systems.

We now have 18 customers who have ordered 201 systems; 134 of which shipped in 2014.

As predicted, Q4 saw noticeably fewer X shipments due to the timing of customer readiness.

Going forward, our order funnel remains healthy, a trend that we project will continue into 2015.

We recently announced new additions to our portfolio, which now includes HiSeq X Five, as well as the HiSeq 3000 and 4000.

Early customer feedback has further fueled our excitement around this expanded family of high-throughput sequencers, which we believe offer tremendous flexibility to address various budgets and scientific priorities.

We expect many labs will have multiple versions of our instruments, and use them to meet different output, time, and economic drivers.

The introduction of X Five, which will ship in Q2, allows adoption of whole genome sequencing with a lower capital investment and an attractive price per genome.

The introduction of this configuration was not prompted by a lack of demand for the HiSeq X Ten.

Instead, it's clear that providing a lower entry price to the X technology will grow the overall market more quickly, and accelerate the evolution to sequencing full genomes.

The HiSeq family has a rich development road map, including the enablement of patterned flow cell technology, with the introduction of the HiSeq 3000 and 4000.

Going forward, we believe most customers will prefer these new systems over the 2500, given the improved economics and throughput.

There will be a number of customers who remain on the 2500 due to the use of validated workflows, or the importance of access to rapid run mode and longer reads.

The introduction of these systems will further catalyze the replacement cycle of older generation instruments.

We estimate that approximately 1,000 HiSeq's in the field cannot run the 1T kits.

These systems are strong candidates for replacement over the next three years, as customers evaluate their run cost economics.

During Q4, demand for HiSeq 2500 exceeded our expectations.

Shipments in the quarter were similar to the levels seen in Q4 2013; and in the Americas, orders reached the highest level seen in the past two years.

To ensure customer satisfaction, we are offering a special promotional trade-in program to labs that received 2500s in Q4.

As a result, we deferred a small amount of revenue to account for this program, which will be recognized over the first half of this year.

Moving to NextSeq, sequential order trends remained strong, with approximately 15% sequential growth in Q4.

Incoming orders continued to be fueled by the over 2,500 new leads we generated from the road show conducted shortly after the product launch.

These leads contributed to an acceleration of adoption by customers in the fourth quarter, and accounted for close to half of all orders, up from the 30% we saw in the third quarter.

NextSeq continues to draw significant interest from the oncology market.

In the fourth quarter, shipments to this segment grew 50% sequentially, and included a multi-unit order for a reference laboratory that is scaled to production level, boding well for future consumable utilization.

The first half of 2015 will see two enhancements to this platform, with the availability of the v2 chemistry, as well as the launch of the NextSeq 550.

The v2 chemistry vastly improves error rates, now consistent with our more mature platforms.

As a result of this improved performance, the machine is now sufficiently locked-down to prepare for open platform clearance, which we expect later this year or early 2016.

Available in Q2, the NextSeq 550 further enhances the platform's flexibility, adding the capability to scan BeadChips.

Initially, we've qualified our Cyto and karyomapping arrays, and will decide whether to enable other arrays based on market feedback.

This functionality is particularly important in reproductive health, as it provides access to our array and sequencing technology with a single CapEx investment.

We're very pleased with the roll-out of the NextSeq platform overall, and believe demand for this instrument will be enhanced with these new improvements.

MiSeq continues to outperform our expectations.

Orders and shipments both exceeded 300 units in the fourth quarter, the highest level seen since the launch in 2012.

New-to-Illumina sequencing customers drove this outperformance, and accounted for more than 60% of orders.

Record orders for the MiSeqDx were generated from customers interested in clinical markets, including HLA and cystic fibrosis testing.

Additionally in the first quarter, we will enable v3 chemistry on the MiSeqDx in RUO mode, and plan to update the intended use to support FFPE samples.

Our competitive position in this market strengthened throughout 2014, which we believe will continue with the introduction of our HLA and forensic sample-to-answer solutions.

Moving to arrays, we continue to witness growth in sample volumes, but at lower prices.

In 2014, volumes grew 5% compared to the prior year; but due to aggressive pricing, total microarray revenue was down 6% for the full year, including a decline of 11% in Q4.

Despite this reduction in revenue, our Ag, IVF, and biobank activities have been strong.

In 2014, large-volume opportunities in both crops and livestock resulted in approximately 2 million samples shipped to high-throughput breeding operations, a 47% increase versus the prior year.

We will continue to focus on arrays as a critical component of our Ag business, and expect sample shipment growth to exceed 25% in 2015.

The IVF market also continues to gain traction.

This business is now approaching $30 million in annual revenue, with a growth of 36% year over year.

We also remain focused on biobanking activities, and as a result, introduced our mega array in the fourth quarter, which provides an improved understanding of diseases and phenotypes across diverse global populations.

We believe this product will provide us with a superior competitive position in the biobanking market.

As an example of our long-term commitment to arrays, we plan to increase our R&D investment, expand our concierge service for custom products, and broaden our commercial activities.

As a result of these additional investments, we are projecting array revenue to be approximately flat in 2015.

We remain focused on delivering complete sample-to-answer workflows to enable new markets.

This strategy includes offerings such as NeoPrep and our HLA product, both of which are expected to ship this quarter.

The strategy also extends to our forensics genomic system, which is now shipping.

With a single workflow, this system enables labs to perform a more robust analysis of a broader range of genetic markers than with existing technologies.

Overall, our market opportunities continue to broaden, as demonstrated by commercial, non-profit, and hospital customers accounting for approximately 55% of shipments in both the fourth quarter and 2014 overall.

This year we made great progress on our strategy to enable clinical markets, as 30% of our instruments went to clinical laboratories.

Additionally, sales to the oncology market, for both research and clinical applications, grew 40% compared to the prior-year quarter.

In 2015, we hope to further catalyze this market with programs such as our recently announced Actionable Genome Consortium and our development program in liquid biopsies.

Liquid biopsies are expected to play a role across multiple segments of the oncology market.

We are focused on first delivering an RUO kit into the market, and expect to be in a position to present clinical utility data by year end.

We will run this test at Illumina's Redwood City CLIA lab to refine the product and develop data for FDA submission.

Similar to NIPT, our strategy here is to provide the best technology into the market, as opposed to offering long-term lab tests or selling to physicians.

Moving now to reproductive and genetic health, the market continues to develop on a global scale, which resulted in 47% revenue growth in 2014 compared to the prior year, with NIPT samples growing 31% sequentially in the fourth quarter.

As we mentioned last quarter, we recently undertook an assessment of our entire regulatory strategy, which was led by our Myraqa team.

We're working with the FDA to determine the appropriate claims and data sets to broaden this market to include the average risk population.

We will share more detailed schedule information once we align with the FDA.

In Q2, we will launch our new VeriSeq NIPT assay, which we believe will enable broader adoption of prenatal testing in global markets.

Based on paired-end sequencing, this assay is ideally suited for decentralizing NIPT, due to its ability to sequence 48 samples per run, and the significant workflow and cost benefits derived by eliminating PCR.

With the development of this new assay, we are moving forward with what we believe to be a superior regulatory strategy.

This includes gaining CE-IVD marking for the HiSeq software in Europe.

Additionally, we plan to gain a CE mark on the VeriSeq NIPT assay, and the associated software, which will enable us to distribute this product as an IVD across the EU, a step that we believe is necessary to develop and penetrate this large market opportunity.

As a result of these strategy changes, as well as recent enhancements we have made to the HiSeq family of products, we decided to suspend our efforts to seek FDA approval of the HiSeq 2500 in the US.

In summary, our Q4 and 2014 results exceeded our expectations, and our momentum remains strong as we enter 2015.

Our new product introductions will continue to fuel the high-throughput market, further enabling customers to tailor their fleet of instruments to meet diverse requirements.

With the most powerful and well-positioned sequencing portfolio available, our technology leadership is delivering robust demand and an expansion into new markets.

Our focus on innovation is stronger than ever, and looking ahead, we expect to deliver significant shareholder value as we unlock the power of the genome.

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

Thanks, Jay.

As Jay described, Q4 marked another solid performance for Illumina, to close out a record year.

Revenue grew 31% in 2014 versus the prior year, to $1.86 billion, reflecting the impact of the new HiSeq X Ten and NextSeq instruments, as well as lower-than-expected cannibalization of MiSeq and HiSeq.

Reported fourth-quarter revenue grew 32% year over year to approximately $512 million.

This strong result can be attributed once again to record sequencing instruments and consumables.

The combined impact of unfavorable foreign exchange fluctuations, as well as deferral of revenue related to our HiSeq 2500 trade-in program for instruments shipped in Q4, resulted in a $15-million headwind.

Global interest in our products remained strong during the fourth quarter.

Shipments in the Americas grew 34% year over year, and European shipments increased 33% over the same period.

In APAC, shipments grew 8% year over year, as strength in China was partially offset by a decline in Japan, as funding disbursements remained constrained in the region.

Instrument revenue grew 75% year over year to reach $156 million in the fourth quarter.

This increase was primarily driven by demand for NextSeq and HiSeq X Ten, as well as strong MiSeq unit shipments and stable HiSeq sales.

Overall consumable revenue in the quarter was $290 million, an increase of 19% compared to the fourth quarter of 2013, as higher demand for sequencing consumables was partially offset by a decline in arrays.

Consumable revenue represented 57% of total revenue, modestly higher than the 54% we saw in Q3, but down from 63% in the prior-year period.

This decrease year over year was due to the strength in sequencing instruments during the quarter.

Sequencing consumable revenue grew 32% over Q4 last year, due to our larger installed base of instruments, including the addition of HiSeq X Ten and NextSeq, and reached record levels during the fourth quarter.

Shipments of our sample prep products benefited from the price reduction we put in place in Q3, which was more than offset by increased volumes, as customer demand for our core DNA and RNA library prep products grew.

MiSeq consumable pull-through remained within our projected range of $40,000 to $45,000.

HiSeq pull-through per instrument, excluding HiSeq X, was roughly flat sequentially, and comfortably in our projected range.

In future quarters, pull-through for HiSeq 2500, 3000, and 4000 will be reported as a family of instruments, and we continue to project a range of $300,000 to $350,000.

In the fourth quarter, consumable utilization for NextSeq and HiSeq X Ten was above our forward-looking guidance ranges that we provided on January 12.

This is a function of how we calculate pull-through, which generally results in an artificially high number in the first year of launch due to the ramp in the installed base.

As a reminder, we are projecting $80,000 to $100,000 of annual consumables on NextSeq; and on HiSeq X, including X Ten and X Five combined, we are expecting to generate $600,000 to $650,000 per year of reagent utilization per instrument.

Services and other revenue, which includes genotyping and sequencing services, instrument maintenance contracts, and revenue from NIPT services, grew 22% versus Q4 2013, to $62 million.

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

Turning now to gross margin and operating expenses, I will 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.

Before I talk about the trends for the quarter, I would like to highlight the GAAP treatment of two significant transactions that we are pleased to have resolved in Q4.

Firstly, we settled the Syntrix litigation for an amount less than our prior accrual, resulting in an accounting gain of $109 million; $27 million of which was recorded in cost of revenue, and $82 million of which was recorded in operating expense.

In addition, we recorded a $30-million intangible asset, reflecting the future benefit of the license acquired.

Secondly, we entered into an agreement with Sequenom, resulting in, among other elements, the pooling of our patents.

As a result of this transaction, we recorded $49 million of legal contingency costs in research and development expenses, reflecting the upfront payments we made to Sequenom.

Both of these items have been excluded from our non-GAAP results.

Turning now to margins, our adjusted gross margin for the fourth quarter equaled 72.3% compared to 73.2% in the third quarter.

The sequential decline is due to the impact of deferred revenue and other items associated with the new product introductions, partially offset by the higher mix of consumables.

Year over year, adjusted gross margins expanded 90 basis points from 71.4% to 72.3%, as the lower mix of consumables was more than offset by improved instrument margins and manufacturing efficiencies.

Additionally, GAAP gross margin expanded 820 basis points versus the prior year to equal 75.1%, primarily due to the aforementioned gain on the Syntrix litigation.

Adjusted research and development expenses for the quarter were $80 million, or 15.7% of revenue, compared to $70 million, or 14.6% of revenue in the third quarter.

The sequential increase in R&D expense was primarily due to headcount additions and other expenses related to our new products.

On a GAAP basis, the increase in research and development expenses to $143 million compared to $85 million in Q3 was primarily due to the upfront Sequenom payment previously mentioned.

Adjusted SG&A expenses for the quarter were $97 million, or 18.9% of revenue, compared to $91 million, or 19% of revenue, in the previous quarter.

The sequential increase in expense was primarily due to commission payments arising from the excellent year-end performance, and higher headcount to support our revenue growth.

Adjusted operating margins were 37.7% compared to 39.7% in the third quarter, a decrease sequentially due to lower gross margin and increased investments.

Operating margin was higher compared to the 32.3% we reported in the fourth quarter of last year, due to the impact of improved gross margin and operating expense leverage.

In the fourth quarter, we recognized approximately $700,000 of adjusted other expense, primarily due to the impact of foreign exchange.

During the quarter, our stock-based compensation was $38 million, lower than the $45 million reported in Q3, which was elevated as a result of additional accrued expense for our performance stock units.

Our non-GAAP tax rate for the quarter was 16.2% compared to 32.6% in the fourth quarter of last year, lower primarily due to the full-year impact of the R&D tax credit and other tax extenders which were enacted in the fourth quarter.

The fourth-quarter rate was significantly better than we expected at the time of our recent pre-announcement, as we benefited from favorable adjustments related to multiple prior-year provisions and higher-than-expected stock deductions.

These favorable items, which surfaced in the last few weeks as part of our normal quarter and year-end close process, equated to approximately $0.06 of EPS improvement.

Excluding the impact of these items, the Q4 non-GAAP tax rate would have equaled 22%; and for the full year, our normalized tax rate would have been 28.2%, which excludes also the favorable tax item we noted in Q3.

Non-GAAP net income was $129 million for the quarter, and non-GAAP EPS was $0.87.

This compares to non-GAAP net income and EPS of $65 million and $0.45, respectively, in the fourth quarter of 2013.

We reported GAAP net income of $153 million, or $1.03 per diluted share in the fourth quarter, compared to net income of $81 million, or $0.56 per diluted share, in the prior-year period.

Current-period results include the aforementioned Syntrix litigation gain, which was offset in part by the Sequenom expense item, and their associated tax impacts.

We generated cash flow from operations of $141 million in the fourth quarter, even after the outflow of $51 million due to the Syntrix settlement and Sequenom agreements.

For the full year, cash flow from ops was $501 million, a new record.

Q4 DSO was 51 days; a slight improvement from the 52 days seen in the prior quarter.

Capital expenditures in Q4 were $35 million, resulting in $106 million of free cash flow.

During the quarter, we repurchased approximately 185,000 shares for $35 million, and we have $130 million remaining under our previously announced programs.

We ended the quarter with over $1.3 billion in cash and short-term investments.

Turning now to our expectations for 2015, we are projecting approximately 20% total Company revenue growth, and non-GAAP EPS of $3.12 to $3.18.

This guidance assumes current currency rates, which would result in a 200-basis-point headwind to growth compared to last year.

Additionally, we are projecting approximately 73% gross margins, full-year weighted average non-GAAP diluted shares outstanding of 150 million, and a full-year pro-forma tax rate of 28%, which does include the 2015 federal R&D tax credit and other tax extenders.

For modeling purposes, we feel it is appropriate to assume the tax credit is passed in Q4; and at that time, we will record the full-year impact.

Therefore, at this point, we expect a Q1 tax rate of approximately 29%.

In summary, we delivered remarkable fourth-quarter results, including impressive revenue growth over a strong prior-year quarter, as well as 93% growth in non-GAAP diluted earnings per share, which capped off an exceptional 2014.

This year we made significant progress on our market development strategies, and we look forward to pushing these investments even further in 2015.

We believe our strategy of technology leadership and market enablement will catalyze the adoption of genomics, and enable us to address the more than $20 billion market opportunity we have ahead of us.

Thank you for your time.

We will now move to the Q&A session.

(Caller Instructions)

Operator, we will now open the line for questions.

(Operator Instructions)

Tycho Peterson, JPMorgan.

Thanks, guys.

Question about maybe just any thoughts you might have about cannibalization with 3000, 4000, and the NextSeq 550.

You've obviously done a good job in the past mitigating cannibalization of the current portfolio, but maybe talk to where you see some potential cannibalization for the coming year?

The 550 will be a purely incremental product and it will be a small increment on top of the standard NextSeq base, since it is really designed to appeal to that set of customers that need to run arrays and sequencing together.

That's not a huge part of the overall market, so we don't anticipate any direct cannibalization there at all.

With respect to the 3000/4000, as we alluded to in the script, we do think that customers in general will prefer getting on the newer road map.

Those who have the ability and the funds to upgrade from -- or to change out 2500s or who are buying new instruments will likely favor the 3000 and the 4000.

We also priced the 3000 version, which is the single flow cell version right on top of the old price of the HiSeq 2500.

That was done intentionally for those customers who may have had grants or tenders in place and would be able to convert the funds that they had allocated for a 2500 directly to a 3000.

So the net of that is that we do expect significant cannibalization over the next year of the 2500, but a catalyzing effect on the older installed base to trade out the older 2000s and early version 2500s for the newer technology.

Then as we think about the implications of decoupling the X Ten with the X Five, you mentioned that didn't imply any slowdown in demand for X Ten, but could you have a better year in orders with X Five and X Ten combined in 2015 than you did in 2014 with just the X Ten?

We certainly could.

The reason we did this is because, as I mentioned, we think we can grow the overall market faster.

Demand for X Ten continues, and since we made the announcement of the X Five recently, our assumptions there have been validated, so there is quite a few customers that we have talked to who have been in our queue who continue to push forward with an X Ten type purchase.

We are pretty confident that most of that pipeline will continue to drive toward an X Ten.

Some of them who might not have gotten there for quite some time may be able to jump in now sooner with an X Five and then upgrade to a Ten unit configuration over time.

So overall, we think, we certainly are going to grow the market faster than 2015 would have been on its own and we have the potential to grow the overall X units faster in 2015 than we did in 2014.

Okay.

If I could ask one last quick one.

Can you quantify the decline in array pricing that you called out?

Are you assuming that there's another leg down on pricing in arrays?

I know you talked about revenues and arrays being flat but how much of the pricing come down?

There's so many different arrays in our product line, Tycho.

I would guess now there is 25 or 30 different array products that we offer.

The prices are so different and the market segments are so different, it is hard for an average to make much sense there.

And I don't actually have a number at my fingertips.

But you can expect array pricing to continue to go down over the next few years, particularly as more customers migrate towards sequencing and the business that tends to stay on microarrays will be the less and less complex part of the market.

You will see, for example, our high complexity arrays like the 2.5 million and the 5 million arrays be a smaller and smaller part of the product line and those are clearly the highest priced chips.

So you will continue to see the overall ASP in arrays go down.

Okay, thank you very much.

Doug Schenkel, Cowen and Company.

Hey guys.

Good afternoon.

You continue to demonstrate the ability to innovate and advance using SBS chemistry, as demonstrated by the recently announced new products and some of the advancements linked to patterned flow cells, and clearly this innovation puts you in a position to generate robust growth, maybe to levels that exceed what's in consensus expectations.

All that said, the investment case for material upside from current share levels seems to be largely predicated on not just the large TAM that exists for you guys but on building confidence in your ability to capture that TAM.

So when we think about the clinical opportunity, what milestones, specifically, should investors measure you by in 2015, including, but going beyond, what you talked about for liquid biopsy in your prepared remarks?

When you think about the TAM that we talked about a year ago, the $20 billion number, there is a number of key things you ought to watch.

They are probably not -- milestone, perhaps, is a little bit of a strong word because these aren't big digital events, but it's continued progress in the development of key markets.

Certainly in POPSEQ, watching what happens there, we had the Scottish genomes program that we announced just recently.

We are yet to understand exactly how those 15 units are going to be used, but early indicators are that, that program may evolve to be something not too dissimilar from what GEL is trying to accomplish.

That would be the number two project we would put in the POPSEQ program.

Clearly, what happened in the State of the Union address at least alluded to the potential of some precision medicine programs in the US, which would be very exciting, of course, if that wound up happening.

Watching that continued progress, particularly with the scale of those projects, will be important announcements for investors to watch.

In the clinical space, what we're doing with the actual genome panel and the roll out of products there.

The additional pharmaceutical companies that may come into the consortium will be evidence of continued progress.

Once we start deploying the actual genome panel into the market, monitoring the uptake of that panel, will be important data to watch.

Clearly, liquid biopsies is a breakthrough opportunity for anybody who is working in that area, and our goal is, as I mentioned in the script, to get some clinical data, some really important clinical data done by the end of 2015 so I think that will be critical, as well.

NIPT, I would watch the expansion into Europe and China, in particular.

The new product we announced there, the VeriSeq NIPT is going to be a key ingredient of that expansion tied to the CE marketing that we are working on in the EU.

All right.

That's really helpful.

Then actually sticking with NIPT, I'm just curious if you can give us a little more color on what prompted the alteration in the PMA strategy there?

Was it largely a function of the new addition of Myraqa?

Was in changes in regulatory reimbursement or competitive dynamics?

Were there technical developments, such as maybe the change in the HiSeqs 2500 FDA strategy?

In terms of timelines, what is a reasonable expectation for us, as we think about getting an update from you?

I put the strategy change in two general buckets: one is product evolution and I will talk specifically about that; and the second, I call market evolution.

On the technology front, what we have done with the 3000 and the 4000 are very important breakthroughs that we have made over the past calendar year.

We were working on the 2500 submission in parallel with that.

Once we got to the point where we knew we were going to launch the 3000, 4000 configurations, if you think about where the 2500 would be at the time it would come out of the PMA submission, for example 18 months from now, which would be the time frame that we had anticipated, that product is going to be pretty long in the tooth.

So we thought that its adoption, approved or otherwise, beginning 1.5 years from now wouldn't be high.

The second part that ties to that from a market perspective is that we think the real growth opportunity in the US market isn't so much in the high-risk space, it is in the average risk market.

So we were really focused on how do we grow the market to embrace average risk.

To do a submission only on high-risk, we thought was also limiting.

So therefore, we've been working with the FDA to define what do we have to do to get an average-risk approval.

With the breadth of that marketplace, we think the other assay method that we have developed, so the second part of the technology evolution, the VeriSeq NIPT assay, is a better technical solution to a broader, more diverse market.

That is true, certainly in Europe, and we think by the time we get through PMA application, it will be true in the US, as well.

Those are the underlying factors.

Now of course, bringing in the Myraqa team gave us the ability to stand back and do a full analysis of our entire regulatory strategy across the Company for all products and that group was instrumental in helping us tune this strategy and make some important changes.

The last part of that question was just in terms of timing.

Is it reasonable to think we will get more of an update this year, given a lot of this it sounds like it is linked to really the efforts that you're making together with the FDA?

It's reasonable to think that we will have an idea this year about what we need to accomplish.

I wouldn't necessarily think it's reasonable that we would have a submission this year.

Okay.

Thanks, again.

Derik De Bruin, Bank of America.

Hi, good afternoon.

Hi, Derik.

I have two quick question.

One is just a housekeeping question.

The stock option expense, Marc, was lower than we had projecting in Q4.

Can you give some guidance on the 2015 number there?

Yes.

For Q4, relative to Q3, I think you're referring to the sequential drop?

Yes, exactly.

Q3 was more the anomaly there than Q4.

In Q3, we had an uptick in expense rate to our performance share plan, given the outperformance of the Company, and that was less marked in the fourth quarter.

In terms of 2015, we haven't bifurcated the stock expense from the other expense line items.

It is embedded in our guidance, but it's probably not far off from the current fourth-quarter rate.

Perfect.

And then back on the NIPT market, I believe we are waiting for approval for the China CFDA.

When does that happen?

And some thoughts on using arrays for NIPT?

The CFDA is a black box, so we don't have much visibility into when the submission may come out the other end.

We're hoping it is months away, not materially longer than that, but the fact of the matter is we just don't know.

So we're watching that very closely.

With respect to arrays, I would say, we continue to believe very strongly that sequencing is a superior methodology for doing NIPT.

It is much more flexible, you can add tests, we think, particularly on turnaround time, this new NextSeq method is a one-day turnaround time on the sequencer, so it's extremely efficient, 48 samples in parallel, very cost-effective.

So we are extremely confident in sequencing being the most important platform for doing NIPT testing.

Thanks.

Dan Arias, Citigroup.

Afternoon guys, thanks.

Wanted to ask maybe a bigger picture question on sequencing instrumentation.

Jay, I think a while back you were asked or you made a comment about sequencing [installs] relative to the number of PCR systems that there were out there as an installed base.

As you guys have broadened the portfolio and started to go after some of these new markets, do you have a bit of an updated view on the total number of sequencers that you think could be in the market in, say, five years?

We could create one here.

No one has asked me the question recently.

I think we used to talk about the capillary number being in the 10,000 to 15,000 as one metric to use, that if you thought about PCR, there is about 50,000 research labs worldwide, vastly more if you considered all the clinical labs, and it's rare to find one of those labs without a PCR machine.

So the PCR installed base is a pretty high number and many labs have large numbers of PCR machines, so that's a very large installed base.

Setting our sights over say a five-year time frame of being in the 10,000 to 15,000 number of NexGen sequencers would be conservative.

We feel like, as we continue to broaden the portfolio and diversify market segments, as we take the technology into applied markets, that the installed base numbers between us and the other suppliers will certainly blow through those ranges in five years.

Okay, great.

That is helpful.

Marc, maybe a question with a bit more of a tangible answer.

Do the new instruments have any impact on the ability to max out the manufacturing absorption and really catch the gross margin at the top end or should any production changes there be pretty seamless?

Any production changes would be pretty seamless, given the type of technology that is inherent in the 3000 and 4000.

The X Five is the same as the X Ten instrument obviously.

It's similar to the comments I made last quarter, that manufacturing capability tends to come in step function, so you build out a new facility and for while it is underabsorbed and then you absorb it and you keep going like that.

We are at a pretty stable point right now with the absorption and the new instruments should just help to continue to drive that.

Okay, thanks very much.

Ross Muken, Evercore ISI.

Good afternoon, gentlemen.

Hi, Ross.

I was curious, I wanted to just dig in on a couple of big picture events that happened over the last few weeks and get your thoughts.

Because it seems like we are building up to where some of the things you have been talking about in the clinical market are starting to become more mainstream, so obviously the President of the State of the Union called out the precision medicine initiative.

You highlighted it.

But it seems like that to me is a recognition of where the market is going and we will have to see what the details behind but I'm curious as to what signal you think that sends?

And then obviously Roche also large pharma company, paid quite a hefty price for someone you likely serve in the oncology space and so it is another pharma recognizing the value of where sequencing is going.

How do you think about those things in terms of these markets we have been talking about for a long time getting closer to a more large-scale reality?

I'd say at 30,000 feet, they are clearly very strong signals and probably, I would say, indicate things happening perhaps even faster than we had anticipated.

I've talked to a lot of investors about what is happening in population sequencing, and our expectation over the next few years that there will be a number of countries that jump into this in a very serious way.

We frankly thought the US was behind in terms of its willingness to consider this.

Obviously, it is still not an approved project here and there is lots that has to happen to actually figure out what this project is and whether the appropriation gets approved to fund this project.

But the signals that are being given and how rapidly they have come, I find extraordinarily encouraging and validating of the overall value that sequencing can provide in understanding human health and in making dramatic improvements in health care, both in treatment and in economics.

With respect to pharma, I have been a pessimist over the last five years about Pharma beginning to readopt sequencing in a large way.

Of course, they did that 15 or 20 years ago with their very large sequencing labs with the prior-generation technology, and as we all know, not much came out of those efforts.

My expectation was that pharma was going to be pretty much in the back room insofar as large-scale sequencing, only outsourcing it when needed on a specific project, but of course using it in day-to-day research in their laboratories.

What we've seen over the past 18 to 24 months begins to indicate otherwise.

We saw deCODE being purchased by Amgen, we saw Regeneron's announcement of their plan to sequence 100,000 exomes, we have now seen Roche plan to put their clinical patients through, at least what we believe, to put those through the Foundation Medicine method.

So we are beginning to see pharma come into this market in a very robust way and we are beginning to adjust our own expectations that this may be a very rich market.

Genentech is the other example.

The recent announcement of Genentech doing sequencing projects with HLI.

Obviously, very important developments and all bodes well for adoption of sequencing in the pharma industry.

Great.

Maybe just on NIPT, where are we in the high-risk adoption [curve]?

I think you said in general, volumes were up 30%, which seems like sequentially still a very big number.

So help us understand where we are in that?

And then what are the discussions like with FDA and others on the average-risk population?

We have to separate by geographies to talk about NIPT in that way.

In the US, I would say we are -- the adoption is significantly more than 50% now, it's probably not 75%, so it's probably in between.

Growth continues, more labs are jumping into the space, so we continue to build overall volume and momentum in the high-risk group.

As we've talked about before, average-risk is a much larger market; even though ASPs will be lower, the numbers pf samples are dramatically higher.

Right now, that it is very clear that, at least the evidence that we have presented publicly in the paper we published, that the utility of this method is the same in an average-risk population, although the frequency is much less.

So our conclusion from that, and I believe the FDA's conclusion will be that this test will get used in average-risk and it is for that reason that we want to work very closely with them to make sure whatever product we get approved, can support with data and evidence and approval, use of this method in average-risk population.

We don't know the timing of that and so, as I said before, we are working with the FDA to understand what does that clinical trial need to look like and how big are the data sets and what type of data do we need to gather, but that is all well underway.

Quite different in other markets.

I would say in the EU, the penetration is vastly less.

It varies country to country.

In aggregate, I would guess we are in the 5% range, it may be even less.

China, less than that, but huge potential and probably a market that will come on very quickly as products get approved in China.

The average-risk market will come on very quickly in China and more slowly in the EU.

That's super helpful, and thank you again, and congrats, Rebecca and guys.

Thanks, Ross.

Amanda Murphy, William Blair.

A question on population sequencing, again, if I may?

Sure.

Obviously, there has been a lot of talk about it, but I'm just curious, if you think about the installed base you have with the X Ten, and obviously, now with the X Five.

How do we think about that opportunity in terms of incremental instrument demand?

Obviously there is a lot of capacity out there with whole genomes and there's clearly a benefit from the consumables side.

But is there a way to think about population sequencing in terms of incremental demand from the instrument side versus what you have already in the backlog?

Amanda, I would say, as we go forward, particularly if we're out a year or two, the usage of an X Ten will get a little blurry, in terms of what is done on a population sequencing basis and what is done otherwise.

Right now we think of population sequencing programs as ones that are sponsored by the government and are really directed to understanding the diversity of the population, in some countries understanding a reference genome that is likely underrepresented in a reference work that has been done previously and then understanding the variation in their local population and trying to learn enough about those variations, medically, to be able to influence what is happening clinically in that country.

That is how we think about POPSEQ.

In the US, there is lots of sales we have made of X Tens that are not that, but in other countries there are some that are certainly borrowing sample streams from the clinical work that is going on in the country; Garvin being an example.

If you think about that, could Garvin become a POPSEQ project in the next five years?

Maybe they will.

Sidra is another example, where we are installing an X Ten and there's the possibility that, that morphs into a population sequencing project.

I think the lines are going to get a little bit blurry, but probably in the next year or two, we think of these POPSEQ projects as digitally incremental to what we are doing in the base X Ten business.

Got it.

Okay, thanks.

In terms of the -- a follow-up to Tycho's question earlier on the HiSeq 4000, 3000 demand, if you will.

Obviously, there is a benefit to getting the 3000 versus the 2500, but have you done enough -- I know it is early -- but enough market research at this point to assess whether the 4000 will drive an incremental product cycle?

Obviously, if you have a -- you're incented to buy the 3000 vis-a-vis the 2500, but do you think that there will be a decent amount of HiSeq 2000s or 2500s that will upgrade to the 4000, given the incremental benefits?

We are trying to be cautious about the words we use there, because I think I know how you are using the word upgrade and we get that confused a little internally, too.

Just to be clear to everyone, you can't take a 2500 and truly upgrade it the way we think about upgrading an instruments.

In a sense, you have to buy a new one, but it is whether the old one gets largely turned off and so that is a change out, we probably need to come up with a better word to describe it.

We do think that will happen and that the 4000 and 3000 in combination will be a big incentive to that.

We talked about that a bit when we announced the 1T kit, that the systems that were capable of doing 1T would cause the older 2000s in the field to begin to upgrade to the newer versions of the 2500.

For those who didn't do that, they'll skip right over the 2500 and go to at least the 3000 if not the 4000.

I would say that I don't think the 3000/4000 create a new customer segment.

It's not a different type of user, it's just vastly better economics.

It is on a new road map with patterned flow cells and newer technologies and so to the extent any customer can get the money to get to a 3000 or 4000, they will opt to do it.

Have you guys quantified what the 1 Terabase upgrade or a new product cycle was from a hardware perspective?

I know you obviously had the software upgrade, but did you -- what is the upgrade cycle from a 2000 to the new Terabase from a hardware perspective.

Did you ever quantify that?

There's only -- you mean in terms of numbers of installed base?

Yes, just curious.

I know obviously everyone, if you could get the software upgrade, you would, but just in terms of who bought a new 2500 to get the Terabase reagent kit vis-a-vis the old instrument that couldn't (multiple speakers)--?

We have never parsed those numbers out.

There has been a couple of analysts who have made estimates about what fraction of our installed base of 2000s and 2500s could not run the 1T kit.

Those estimates have been made but we have never said what that number was.

Okay.

Thanks, guys.

Bill Quirk, Piper Jaffray.

Great, thanks, good afternoon, everybody.

First question, Jay, you mentioned in your prepared comments that about 30%, I believe was the number, of the instruments in this quarter went to clinical customers.

So I'm curious, with the new NGS codes that went live in early January, any feedback in terms of the smoothing or perhaps [less-than-smooth] reimbursement that some of these customers are seeing?

And maybe you could just talk to us a little bit about how you guys are thinking that playing out here over the year?

Thanks.

I would say it's a little early for us to have any actual evidence of the impact of the codes.

I haven't from our teams gotten any data yet or any direct feedback from customers on behavior changes or changes in reimbursement, so we don't really have any data.

Obviously, we think it's going to be helpful and Palmetto just did an approval of an NGS code as well, which we think will be helpful, but too early for us to know what the impact is going to be and whether it is a direct effect on volumes or usage or lab economics yet.

Got it.

Then another one on NIPT, [hot] topic today.

If we are thinking about adoption to the average-risk population, obviously societies endorsing that is going to help out in a pretty meaningful way and there's certainly some estimates kicking around when ACOG [munch up in] and endorsed average-risk.

Are you guys expecting to see that this year?

We have heard dates as soon as perhaps April, May, or roughly in conjunction with the annual meeting?

We have heard that, as well.

We are not counting on that so I would say our internal plans indicate or assume that it would likely happen some time in 2016, not in 2015.

Having said that, it's possible that it could come earlier.

We were surprised when ACOG adopted the high-risk tests earlier than we expected, so we've been on a conservative end of that curve, but that's the safe place for us to be in terms of our own internal modeling, so we're assuming some time in 2016.

Got it, thanks, guys.

Dan Leonard, Leerink.

Great, thank you.

What is your assessment of the IP landscape in liquid biopsy?

Is IP a meaningful factors as you think about getting a product there?

It's, from what we have seen so far, a much more straightforward IP landscape than what we've seen in a lot of other markets, particularly in NIPT.

Clearly there will be companies who claim they some fundamental IP around this as happens almost in every application area.

When it all gets sorted out, these assay methods are pretty standard.

There's not a lot of raw invention in the assay methods, just being used to sequence blood in a slightly different way, so we think it's a relatively open field from an intellectual property perspective.

Got it, thank you.

Isaac Ro, Goldman Sachs.

Thanks.

Just want to follow up on liquid biopsy.

Looking past the [ITPs], also curious how you're looking at the competitive landscape.

As you look at the companies that have self-identified in this market, there are few that seem to be more or less piggybacking your own NGS technology and then there are a few others that have some sort of a proprietary chemistry.

Do you feel that you have most of the assets you need to be successful [on a go] standalone basis, in liquid biopsy?

First off, I'd say we are not planning to do this on a standalone basis.

Many of the companies that have announced projects and beginning to show some clinical data in NIPT, most of them use sequencing as their underlying method.

There are a few other alternatives, but most of them use sequencing, and most of them use our platform.

We will continue to encourage that.

Those are going to be great customers for us because remember, in the US, even though we are developing our own method, we don't have the ability to go out to the labs and to teach those labs how to use that method because of the home brew rule.

So in the US, we will go through the FDA and try to get an improved test, we will run an LDT as necessary to gather data to build clinical evidence, and encourage the overall market to grow with lots of different methods here.

It's going to be a diverse set of methods, we believe, for NIPT -- for liquid biopsy.

There's a number of different ways to go about it.

There will be some companies who choose to have very targeted tests that have limited indications.

There will be others that go after much more universal methods.

Our option that we have chosen is to go toward the more universal test, even though we will march through some more targeted collections of variance on the way.

Got it.

That make sense.

Thanks.

Then just on the forensics platform, that's a market where I think of the customers as being in many cases either government-funded or crime labs and the like, so just maybe if you could help us understand your go-to-market strategy there, who your initial target customers are and what kind of channel investment you would make?

Thanks a bunch.

Francis, you want to take that?

Sure, you are right.

Our approach actually from a commercial perspective is to take what we believe is a significantly superior offering in this market through our specialist channel that overlays on our sales force and targets exactly the kind of labs that you were talking about.

We made the announcement a couple of weeks ago and we expect to be out in the field this quarter and through the rest of the year, targeting those labs.

Thanks.

Steve Beuchaw.

Hi, good afternoon, and thanks for taking the questions.

I wonder, Jay, if you could take the approach that you have been using in NIPT with the review that Myraqa has given of the approach and maybe give us that same lens on your approach in clinical and oncology.

What has your work with Myraqa taught you about how to approach that market?

I'd say there's a couple of things.

One is that we will be going for CE approval in Europe faster than we might have otherwise.

That's a critical step for us to take and it's one that is vastly easier to take than a FDA approval.

So you will see us do that much more aggressively than perhaps we have done historically.

The second thing I think you'll see us do that is a bit of a shift is we will go for, in the US, for open platform approval first.

That will allow others to put their assay methods on our platforms before we get a specific assay method of our own approved.

So those are two strategic changes that came out of the review by Myraqa that apply across the board.

The other thing I'd add is, look, we are really excited about the work going on in the Actionable Genome Consortium, in terms of setting the standards for the sample and target prep for the reporting, the informatics, and we have regulatory bodies that are sitting in as interested observers in the AGC process and are looking at what the AGC will publish.

We like the way that process is playing out and you can expect us to continue to do more of that kind of activity.

As you put it all together, how do you think about the growth in the oncology business forward, from a very strong 2014?

We are quite optimistic about it.

Even without Actionable Genome and liquid biopsy, our core oncology business is growing very nicely, at least the Corporate growth rate if not a bit higher.

So there continues to be very strong demand.

If you look at a fraction of NextSeqs we are selling into oncology, it is high.

So there's just general pull now into these types of applications increasingly broadly, so it's not just the big cancer centers anymore.

And then you layer on top of that the step-functions we think we could provide with the Actionable Genome panel and with a successful liquid biopsy product, that puts inflection points in the curve, but those inflection points are still a ways out.

Perfect, thanks so much, everyone.

Jack Meehan, Barclays.

You can move on.

Jeff Elliott, Baird.

Thanks for the question.

Jay, I'm wondering, since it's been about a year since you launched the X Ten, can you reflect on the experience your customers have had in things like gathering samples, sample prep, managing the data?

And then as a follow-on, any change in thought on opening up to other samples besides whole human genomes on the X Ten?

There's a couple of observations there.

One that we have highlighted previously is that, clearly, we are selling this technology much more broadly than our original assumptions, and as a result of that, we have a greater fraction of our customers of X Tens that need to bring up new capabilities that perhaps they didn't have before.

It's one thing if you are The Broad and you know how to sequence massive numbers of samples and you have pipelines in place, informatics in place and 400,000 samples in the freezer.

That is one extreme and clearly they came up to speed on the X Ten extraordinarily fast.

But there are lots of other customers that need to build out brand new sample prep pipelines and that takes some time.

Informatics is a challenge and that part is a challenge for everybody, even including The Broad, to be able to analyze the vast number of samples that can be created by the X Ten.

But clearly no one would work on that problem unless we had the X Ten in the market, so it's very important that we delivered this technology and that's really catalyzing the world to begin to work on the problems of how you analyze tens of thousands of whole genomes at one time.

The informatics will keep up, although it tends to lag.

There is always a concern, and I reflect back that when we launched our first 300k genotyping chip, everybody was so worried about the challenge of analyzing all that data.

Now that's a pittance compared to what we can do on an X Ten.

So that counts for the spectrum of adoption rates or usage rates on X Ten.

So we do have the ability now to analyze internally what fraction of the time each of these instruments is used by the X Ten customers and that falls across a very broad spectrum and it's for the exact reasons that we have just discussed.

I'm sorry -- you had a second part to your question?

The [locations] opening up for other applications?

Right now, we have no plan to open the applications.

Today, you should think of the X technology as being whole human genome.

At some point in the future, we may reconsider that decision, but as of today, it's a whole genome sequencing box.

Great, thank you.

Bryan Brokmeier, Maxim Group.

Thanks for taking the questions.

You previously alluded to a pace of PMA submissions that the FDA has never seen before from the entire market as a whole.

Have you had discussions with the FDA and what is their feedback then on your plans and their ability to handle it?

I am sorry.

I don't understand the first part of that.

That was the sheer number of PMAs that the FDA deals with?

Back about a few quarters ago, you talked about the FDA, and they usually only approve two or three PMAs per year and you are planning to bring more submissions to them than they have seen in the entire market.

So I was wondering if they have had any feedback on their ability to handle that?

Yes.

I don't think that's going to be a constraint at the FDA.

The data sets that we are providing here, they know how to review them procedurally, so I don't think there's necessarily a challenge around that.

The bigger challenge here is the intellectual leap everyone is making to a new generation of approved product, one where there is not a one-to-one correlation anymore between what comes in and what possible result you could conclude from the data set.

And that is the big leap that needs to be made and where we and the FDA need to work together to figure how do you actually validate these new products.

They truly are a different class than have ever been approved before, and getting over that hurdle and understanding and perhaps evolving whatever we decide to do collectively there, is where the big challenges is, as opposed to just handling the sheer number of submissions.

Thanks, Jay.

The second question is for Marc.

Gross margins have recently benefited by the higher margins on the instruments you've introduced in the last year.

Are the margins on the instruments you just recently announced at similar levels as the instruments last year?

And what impact will the program -- the trade-in program that you talked about today have on gross margins?

The impact of the trade-in program you have seen marginally in the fourth quarter.

We'll unwind that through Q1 and Q2 as that program wraps up in the first half.

On the new instruments, I would think of those as being similar gross margins to the instruments that we currently have, with the exception of obviously the X Five is a higher price per unit than the X Ten, so obviously there is a slightly better gross margin on the X Five.

Okay, thanks a lot.

I would now like to turn the call over to Rebecca Chambers for any closing remarks.

Thank you.

As 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 first fiscal quarter.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

To you all, have a great day.