Rebecca Chambers - Senior Director, IR Jay Flatley - CEO Marc Stapley - SVP and CFO Francis deSouza - President.

Tycho Peterson - JPMorgan Doug Schenkel - Cowen and Company Derik de Bruin - Bank of America Ross Muken - ISI Group Dan Arias - Citigroup Dan Leonard - Leerink Partners Amanda Murphy - William Blair & Company Isaac Ro - Goldman Sachs Bill Quirk - Piper Jaffray & Co.

Steve Beuchaw - Morgan Stanley Zarak Khurshid - Wedbush Securities Jeff Elliott - Robert W. Baird & Company, Inc. Miroslava Minkova - Stifel Nicolaus.

Good day, ladies and gentlemen, and welcome to the Q3 2014 Illumina Inc. Earnings Conference Call. My name is Whitley, and I’ll be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (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, Investor Relations. Please proceed..

Thank you, Whitley. Good afternoon, everyone. And welcome to our earnings call for the third quarter of fiscal year 2014. 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 our third quarter financial results, as well as provide 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. 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 Illumina files with the Securities and Exchange Commission, including Illumina’s most recent forms 10-Q and 10-K. With that, I will now turn the call over to Jay..

Thanks, Rebecca, and good afternoon, everyone. I’m very pleased to report that Q3 was another outstanding quarter for Illumina and arguably our most impressive quarterly performance to-date. Revenue increased 35% year-over-year to $481 million, our highest year-over-year growth rate since Q2 2011 and the 12th quarter of sequential revenue growth.

Equally impressive was the leverage we delivered this quarter, as non-GAAP earnings per share grew 71% compared to the third quarter of 2013. These record results were due to strong underlying trends across our sequencing portfolio in almost all geographies, as well as strong operational execution and a favorable tax rate.

Third quarter total sequencing revenue grew 47% year-over-year driven by record sequencing consumables, continued placements of our new instruments and growth in NIPT testing.

These results demonstrate the value of the most extensive sequencing portfolio available as we continue to experience a robust uptake of our products across markets, experimental scales and applications. Sequencing instrument revenue grew 55% compared to the third quarter of 2013 fueled by demand by HiSeq X Ten and the NextSeq 500.

In addition, HiSeq and MiSeq demand remains strong highlighting those instruments position as the NGS gold standard in their respective segments. Markets strength continued for the HiSeq family of products including HiSeq X even compared to Q3 of last year when we shipped 100 HiSeqs.

Shipments were higher both sequentially and year-over-year and ASPs improved due to mix shifting towards the higher priced models. We continue to be very pleased with the level of interest in HiSeq X Ten as demand remains well above our original assumptions.

In total, Q3 saw four HiSeq X Ten orders, two of which we shared with you on the last earnings call. We now have 15 customers who have ordered a total of 164 systems since the product launch in January.

Included in these figures are new orders from DKFZ, a cancer research center in Germany, who will be offering whole-genome sequencing for cancer patients, as well as SciLifeLab in Sweden, who will be participating in the Swedish National Sequencing Project.

As mentioned on the last call, we have sufficient manufacturing capacity for HiSeq X instruments and the patterned flow cells to meet demand. As a result, the quarterly shipment rate is now largely determined by our customers’ readiness to absorb and utilize systems.

During the third quarter, our unit shipments continued to ramp and we’re now working with these sites to validate and integrate the systems into their work flows. Looking forward to Q4, we're forecasting shipment of noticeably fewer Xs based on our current estimate of customer readiness.

It should be noted however that we have a substantial backlog of instruments and a strong funnel of opportunities which we believe will sustain shipments of this configuration of HiSeq Xs through mid 2015.

Demand for HiSeq 2500 benefited from new-to-HiSeq customers, which accounted for 40% of the instruments ordered, as well as existing laboratories looking to upgrade their fleet from earlier generation machines.

During the quarter we received 8 multi-unit orders at least half of which came from customers looking to refresh their fleet with one terabase or 1T enabled instruments.

This is the second quarter where we've seen evidence of an upgrade cycle and we expect this trend to continue over the next year or two as customers with older generation HiSeqs evaluate upgraded options appropriate for their applications, work flow and economics.

HiSeq 2500 remains an integral part of our portfolio with a rich roadmap ahead including the recently announced rapid v2 Reagent Kit that delivers 2x250 base pair paired-end reads and up to 300G of data in 60 hours. These longer reads will enhance studies in a number of fields including cancer, microbial genomics and agriculture.

Additionally, the kits will provide researchers with the ability to more accurately identify gene fusions and tackle more complex metagenomics, and de novo assembly projects. Moving to NextSeq, the rollout continues to go incredibly well with order receipts growing sequentially each quarter since launch including 15% growth in Q3.

We now have more than 350 NextSeqs placed globally. We've also seen an increase in new to Illumina sequencing customers as a result of adding NextSeq to our portfolio accounting for more than 30% of the orders during the quarter. NextSeq also continues to generate significant interest from the commercial segment which accounted for third of orders.

These labs are focused on oncology, NIPT and microbiology and are choosing NextSeq due to the breadth of applications, the flexibility of the work flow and the attractive cost per base. Many of these customers are exploring or implementing NextSeq in translational or clinical production settings, boding well for future consumable utilization.

Overall response to NextSeq continues to be very favorable as evidenced by the number of repeat customers seen in the third quarter.

This is due in part to the exceptional performance of the instrument in the field which will be further bolstered by the v2 chemistry we just introduced at the American Society of Human Genetics meeting currently underway here in San Diego.

Including in the v2 release are new die sets and improved cluster chemistry, both of which boost the signal-to-noise ratio, thereby improving accuracy and bringing the instrument up to the standard of our flagship HiSeq platform.

With the availability of the v2 chemistry in early 2015 and other enhancements made since launch, the rate of data quality improvement of NextSeq has greatly exceeded any instrument that we previously brought to market. We continue to be pleased with the roll out of this platform and expect sequential shipment growth through next year.

Demand for MiSeq continues to outperform our expectations and there’s little evidence if the cannibalization we first anticipated. Orders grew year-over-year as new-to-sequencing customers see the price point, ease-of-use and ability to perform long reads as points of differentiation.

Again, this quarter we saw large multi unit orders from the CDC, public health labs and the FDA, demonstrating the importance of MiSeq as an applied markets tool for pathogen detection, food borne diseases and toxicological events.

Order dynamics are largely unchanged from the trends we've seen in prior quarters with approximately two-thirds of the instruments coming from government, commercial, translational and clinical laboratories and close to 70% of orders from new customers to MiSeq.

Our strong competitive position has resulted in installed base of over 3,000 instruments and we continue to expect MiSeq to be the choice for applied markets as well clinical and translational users. Moving now to arrays, this quarter total micro array revenue declined approximately 2% year-over-year which was better than our forecast.

Growth in genotyping services, and IVF was offset by a decline in our Infinium genotyping business. Importantly, the Infinium business declined less than prior quarters due to demand from agriculture customers purchasing our iSelect and our Bovine arrays.

During the quarter, array sales to Ag customers grew 26% year-over-year and we continue to project strong interest from this segment. Additionally we had particular success with new opportunities as we won two biobanking and two large consortia deals which have improved our outlook for this market over the next year.

We now expect arrays to be down mid teens in Q4 due to a difficult quarterly comparison resulting in low-to-mid single digit decline for the full year. Beyond 2014, we’re projecting the array business to be approximately flat. We remain focused on enabling new markets by delivering complete sample to answer workflows.

This strategy includes sample prep solutions such as our new library pre kits in NeoPrep, our sample to answer HLA and MiSeq forensic products launching in the coming months and bioinformatics solutions from BaseSpace and NextBio. With regard to NeoPrep, we continue to perform extensive testing and performance validation.

As we just highlighted at ASHG, our team is consistently generating high quality libraries from low DNA input and we’re now focused on assay optimization, reliability and manufacturing readiness.

Meeting our rigorous targets is requiring more time than we originally expected and as a result, we will begin data testing shortly with four commercialization expected in spring of 2015. As part of our strategy, we continue to enhance our bioinformatics capabilities.

BaseSpace now has a total of 50 apps already meeting the year-end goal we set at the beginning of the year. This quarter in partnership with AB SCIEX we added a suite of apps to the BaseSpace store called the SWATH Proteomics Cloud Tool Kit.

These apps make BaseSpace a single storage and processing location for genomic and proteomic data to simplify biomarker discovery and aid research into diseases such as cancer, diabetes, Alzheimer's and heart disease.

Additionally we improved our ability to ingest data into our automated pipeline by a factor of eight, which has led to increased interest from enterprise level customers with large data sets. As a result, during the quarter we won two new accounts, one from biotechnology company and the other a cancer center.

Overall our market opportunity has continued to broaden as demonstrated by commercial non-profit and hospital customers accounting for approximately 55% of shipments. This quarter we made great progress on our strategy to enable clinical markets.

For example, sales of our product and service portfolio to oncology and reproductive health customers, accounted for approximately 40% of total dollar growth in the third quarter compared to the prior year period.

During the quarter, we formally announced the Actionable Genome Consortium with major cancer centers, Illumina and the [Board] (ph) as founding members. The consortium has developed a set of standards that we expect to be published early next year and we're hard at work on a product that we believe will meet those standards.

Additionally, we announced strategic partnerships with AstraZeneca, Janssen, and Sanofi to develop a universal NGS-based oncology test system. This system will be used for clinical trials of targeted cancer therapies with a goal of developing and commercializing a multi gene panel for therapeutic selection.

We hope to share additional partners with you in the coming quarters. An important component of our clinical strategy has been focused on strengthening our regulatory expertise since the acquisition of Myraqa. This team has already had great impact on the organization.

With the addition of Maya and her team, we've greatly enhanced our regulatory and quality leadership and are now focused on an assessment of our entire regulatory strategy which we expect to be concluded in the coming months. We look forward to sharing the results of this work over the next several quarters.

Moving now to reproductive and genetic health, the market continues to develop on a global scale. The launch of the VeriSeq PGS solution for MiSeq has been well received and led to the sales of 10 MiSeq systems this quarter to new to sequencing customers. We plan to launch VeriSeq for use on NextSeq by year end.

In NIPT interest in send out testing grew nicely in the quarter which led in part to 70% sequential growth in sample succession in record revenue.

Additionally our agreement with Berry Genomics to co-develop a cost effective, easy-to-use assay for NIPT in China continues to progress well and we expect the CFDA to approve Berry's submission in the coming quarters. In summary, our Q3 results exceeded our elevated expectations.

With the most powerful and well positioned sequencing portfolio available, we’re witnessing a robust uptick of our products and expansion into new markets. Our focus on research, development and overall innovation is stronger than ever and looking ahead we expect to deliver a 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 third quarter results..

Thanks, Jay. As Jay described, Q3 was another remarkably strong quarter for Illumina.

Revenue grew 35% year-over-year to approximately $481 million as a result of momentum across our entire sequencing portfolio, including record sequencing consumable shipments, significant demand for our HiSeq X Ten and NextSeq instruments, and stable demand from MiSeq and the HiSeq 2500.

Global interest in our products remained strong during the third quarter. Shipments in the Americas grew 37% year-over-year due in part to year end spending by customers at the NIH and other federal institutes.

In APAC, shipments grew approximately 27% year-over-year, as strength in China was partially offset by a decline in Japan due to delays in funding disbursements which we expect to be remitted in early 2015.

Europe was particularly impressive in Q3, which is traditionally a slower quarter in the region as we saw 40% increase over the same period last year due to strength in HiSeq X Ten and the rest of our sequencing instrument portfolio.

Instrument revenue grew 51% this year to reach $150 million in the third quarter due to strong NextSeq placements, stable MiSeq and HiSeq sales and our record number of HiSeq X shipments. Consumable revenue in the quarter was $261 million, an increase of 21% compared to the same quarter last year.

High demand for sequencing consumables was partially offset by a decline in arrays. Consumable revenue represented 54% of total revenue, which is down from 60% in the prior year period and slightly lower than the 55% we saw in Q2, due to the strengthen in sequencing instruments and maintenance contracts during the third quarter.

For the remainder of 2014 and through 2015, we expect consumables as a percentage of revenue to continue to be around this level. Sequencing consumable revenue was approximately $200 million, an increase of 36% over Q3 of last year, due to our larger installed base of instruments including the addition of HiSeq X Ten and NextSeq.

Across our sequencing portfolio, consumables reached record levels during the third quarter. Shipments of our sample prep products grew 35% compared to the prior year due to strong interest in our Nextera and TruSight-targeted families of library prep products as well as our stranded mRNA and total RNA kits.

MiSeq consumable pull-through remains within our projected range of $40,000 to $45,000. For the third consecutive quarter, the number of customers running up full production levels increased, the vast majority of which are oncology, HLA and microbiology accounts.

HiSeq pull-through for instrument excluding HiSeq X was comfortably in our projected range of $300,000 to $350,000 and higher sequentially despite the vacation impact typically seen in the third quarter. In the fourth quarter we are projecting similar utilization levels. It is still too early to provide guidance from NextSeq or HiSeq X pull-through.

However, we are seeing evidence that our early estimates to utilization maybe close. NextSeq utilization is trending towards our expectations and HiSeq X utilization is currently averaging around 50% of theoretical maximum. We hope to share formal pull-through estimates in early 2015.

Services and other revenue which includes genotyping and sequencing services, instrument maintenance contracts and revenue from NIPT services, grew close to 70% versus Q3 2013 to $64 million.

This improvement was driven by growth in NIPT services which benefited from test fees as well as increased [verified] [Ph] revenue; ongoing growth in our extended maintenance contracts associated with our larger sequencing installed base, and strength in genotyping services which was driven by strong demand from a genealogy customer.

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.

Our adjusted gross margin for the third quarter equaled 73.2% compared to 70.9% in the second quarter, as a result of improved overhead absorption associated with higher production and improved service margin.

Year-over-year, gross margin expanded 300 basis points, as the impact of the low mix of consumables was more than offset by improved instrument margins as well as higher fixed cost absorption. We have grown into our investments in manufacturing and service facilities and are seeing meaningful leverage as a result.

Adjusted research and development expenses for the quarter were $70 million, or 14.6% of revenue, compared to $70 million or 15.6% of revenue in the second quarter. While R&D expense was flat sequentially, we expect to continue to incrementally invest in R&D in Q4.

Adjusted SG&A expenses for the quarter were $91 million, or 19% of revenue, compared to $92 million, or 20.5% of revenue, in the previous quarter. The marginal decreases attributed to capitalization of expenses associated with our global business process program and lower outside services spending.

Adjusted operating margins were 39.7% compared to 34.8% in the second quarter and 32.4% reported in the third quarter of last year. Operating margins were higher year-over-year due to the impact of improved gross margins and operating expense leverage.

In the third quarter we recognized approximately $1.6 million of adjusted other expense primarily due to the impact of foreign exchange. During the quarter our stock-based compensation expense increased to $45 million compared to $36 million in Q2 as a result of additional accrued expense for our performance stock units.

Our non-GAAP tax rate for the quarter was 21.3% compared to 29.4% in the third quarter of last year, as a result of the reversal of reserves related to prior year returns. Excluding the impact of these items, the key three non-GAAP tax rate would have equaled 31.6% which does not include the benefit of the R&D tax credit and other tax extenders.

Non-GAAP net income was $140 million for the quarter, and non-GAAP EPS was $0.77. Excluding the discrete tax benefits mentioned previously, non-GAAP EPS would have been $0.67. This compares the non-GAAP net income and EPS of $63 million and $0.45 respectively in the third quarter of 2013.

We reported GAAP net income of $93 million or $0.63 per diluted share in the third quarter, compared to net income of $31 million or $0.22 per diluted share in the prior year period.

Current-period results include $5 million recorded in cost of goods to reflect the ongoing royalty on B-Chip sales associated with the Syntrix litigation including interest. Additionally we recorded $7 million in operating expense associated with the settlement of a legal dispute.

We generated cash flow from operations of $146 million during the third quarter, slightly lower than the previous quarter due to an increase in working capital. DSO decreased to a record 52 days compared to 53 days last quarter, as a result of more linear shipments throughout Q3 and our collection efforts.

Inventory increased $22 million sequentially driven by raw materials and working process to support our Q4 forecast. Capital expenditures were $29 million resulting in $117 million of free cash flow. We ended the quarter with $1.3 billion in cash and short-term investments. Given our record results we have updated our guidance for 2014.

We now project revenue growth of approximately 30% year-over-year compared to the previous guidance of 25% to 26% growth. This revenue guidance takes into account lower HiSeq X shipments as Jay previously mentioned, weakness in Japan funding, and a slight foreign exchange headwind.

We are expecting non-GAAP diluted EPS of approximately $2.63 to $2.65 higher than our prior guidance of $2.26 to $2.28.

Modeling considerations include full-year weighted average, non-GAAP diluted shares outstanding of $129 million, and a full year pro forma tax rate of 26% which takes into account the impact of the 2014 federal R&D tax credit and other tax extenders that have yet to be enacted.

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

Excluding the impact of discrete items in Q3 2014 previously mentioned, a more normalized tax rate for the year is 29%, slightly better than our prediction coming into the year due to employee stock activity resulting in higher deductions.

In summary, we delivered remarkable third quarter results including 35% revenue growth and 71% growth in non-GAAP diluted earnings per share compared to the prior year.

The leverage in the second half that we predicted coming into this year is even greater than we anticipated, due to a combination of expended instrument margin, strong overhead absorption, our focus on cogs and operating expense leverage.

We are committed to continue to deliver new products, to segment our technology leadership and enable us to address the more than 20 billion market opportunity ahead of us. Our results so far this year position us even better to do so. Thank you for your time. We will now move to the Q&A session.

To allow full participation, please ask one question plus a related follow-up if necessary keeping it to two questions the most. Operator, we'll now open the line for questions..

(Operator Instructions) Our first question comes from the line of Tycho Peterson from JPMorgan. Please proceed..

Thanks, nice quarter guys.

Just kicking it off on the reagent kits, can you maybe just help us put it in context as to how you think about that opportunity, just about driving some customers to upgrade older HiSeqs, or is it better pricing capture, or opening up new segments as you alluded to in microbial? Just how do we think about the importance of those announcements in the grand scheme of things?.

Well there were several of them, three that we announced. Certainly the Long-Read kits will help address on the margin a couple of applications, they are little more challenging to do a Shorter-Reads so the 2x250 kits will help on some of the microbial applications in metagenomics. So that's our market expansion capability.

The additional kit that we launched for HiSeq X allows the systems to run PCR free, so it opens up additional sample prep methods. And those are important, because the PCR free methodology has less bias. So we’re bringing that capability forward to the X customers as well as some improved coverage for the standard preps as well.

So it improves in particularly [EC] [ph] rich regions - improves the overall coverage and flattens the curve there. And then the third thing we announced we're not yet shipping and that's v2 Reagent for NextSeq which will begin shipping in the first quarter.

And that’s an overall quality improvement to what we are doing on NextSeq and we’ve been working on this for some time of course but it wasn’t ready to release this version of the kit when we first started shipping the instrument but it will overall take the quality of the NextSeq data up to what we get on our best HiSeq instrument.

So it is an overall second generation Reagent Kit for NextSeq. So market extension again..

Okay, and then follow-up question on NIPT, you did have one customer announce they were moving over to arrays.

Can you maybe just talk about risks of other following that path? And secondarily, talk about next steps for you in NIPT, and any color on time lines for the average risk submission?.

We as you might imagine have done a very close evaluation of how well you can run NIPT on arrays and we are convinced that you can’t achieve the same quality with arrays that you can get on sequencing.. That particular customer that did shift over was a very minor revenue customer for us.

So we don’t think it will have any significant impact on our overall revenue forecast. With respect to average risk, we are seeing some leakage of the test into average risk markets already. That clearly is happening largely in the U.S. and probably will start happening in China as well once we get CFDA approval there. So that’s growing the market.

And as we’ve spoken before, we are working on additional publications and clinical studies to support the average risk version of the test. We've published our first one.

We believe a couple of other of our customers who are working in this area have studies that they are going to publish as well and those collectively will help just get into practice guidelines and ultimately reimbursed..

Okay.

But no comment on time lines for your own submission on average risk?.

No comment at the moment..

Okay. Thank you..

Our next question comes from the line of Doug Schenkel with Cowen. Please proceed..

Good afternoon guys and congrats on a good quarter. So, I guess my first question is on margins; you generated incremental operating margin of just under 50% this quarter, which is well above the incremental margin generated in the first half, which I think was closer to 30%. There wasn't a huge change in the trajectory of spending.

The upside here is largely a function of the stronger than expected revenue growth. And your guidance for the year seems to imply that you expect similarly robust incremental in the fourth quarter.

So I'm just wondering over the next few quarters, how should we think about this? Should we expect a pull-forward of investment on a higher revenue growth and new programs? Or are you comfortable with this type of margin improvement as we think ahead?.

Yeah Doug, it's Marc. So a couple of things I mean you are right, to point that out.

The revenue growth obviously came a lot faster than any investments we’ve made in the quarter but some of the benefits you saw in leverage sustainable for example, some of the benefits in gross margin like the improved absorption that we've seen in the quarter and our focus on cost of goods sold.

We had a program for sometime to focus on elements in there. As well as of course discounting and you get the benefit of the incremental margins on the new instruments like HiSeq X and NextSeq that we talked about previously.

So those would be somewhat sustainable, of course as we move into the future and we invest in manufacturing of service capabilities, you get a step function impact there until you grow into those facilities as we have done largely with what we have today.

And on the operating expense side I’d say, while we were flat sequentially in R&D for example we do expect as I mentioned in prepared remarks to invest in R&D going forward in the fourth quarter and also in SG&A, we have seen some benefit of capitalization of some of our cost related to our global business performance program this quarter and that goes across the geography of the P&L.

But you're right, if you look at the guidance for the rest of the year and therefore for Q4, we do continue to see some leverage not as much as in the third quarter but certainly some and it’s a little early to talk about 2015 at this point..

I would add Doug that, as it becomes clear that we're exceeding our revenue by the scale of this beat at least, we begin to release incremental headcounts that's over the budget and that's obviously to support the field activities associated with a higher revenue and also to continue to invest in additional R&D programs.

But I might say that, we're not for example tackling some major new program just because we’ve had this revenue beat. So it's incremental additions to R&D and sales and marketing, not sort of wholesale additions for brand new programs.

Francis, do you want to comment on the instrument margins in conjunction with Marc's?.

Sure. As Marc touched on, one of the things that is driving better operating margin and gross margin is the mix in instrument. So specifically as the X and NextSeq becomes a bigger part of our sales in a given quarter, those instruments were designed from the ground up to be higher margin instruments.

And so that delivers some of the leverage you’re seeing and actually we’re seeing them perform even better than we had planned already..

Great. That's really helpful. And for my second question I'm sure there's going to be a lot of questions on X Ten, so I actually want to ask a question about the 2500.

Keeping in mind 2013 was a really strong year for the pre X Ten HiSeq line, the quarterly pace of placements slowed a bit in the first half of this year; this is probably in large part due to tough comps and likely some cannibalization or pausing due to the X Ten and NextSeq launches. Sounds like things got a little bit better this quarter.

I'd argue you sounded as good in describing the 2500s as you have all year. You talked about multiple instrument orders, some evidence of a replacement cycle.

Are you feeling a little bit better for the outlook for reacceleration in HiSeq instruments revenue growth?.

Well I guess I wouldn’t describe it as better because we never felt bad about it to start with. And I guess I would call HiSeq sort of in the stable range. I mean it bounces around a bit quarter-to-quarter but kind of in the similar range of shipments as we saw on the beginning of the year.

And we feel really good about the new chemistry we are bringing forward on HiSeq and the multi unit orders were fantastic. The new customers coming in to that platform continue to be impressive. So it's got a long life and it’s a great product line for us so it will continue for long time..

Great. Thank you..

Your next question comes from the line of Derik de Bruin with Bank of America. Please proceed..

Hi good afternoon. So it's nice to see the array business improve. Did I hear you say flat in 2015? And also could you talk about the bio-bank win from the size of these projects? And also just about the ag bio. I have been reading the literature.

It just seems like there's some big bovine projects that are gearing up, and just a little bit more color on how you are thinking about the business?.

On the Ag projects there are quite a few of these around the globe that are of real size and obviously we are being very active in those, they are competitive. But we are feeling really positive about it.

We did say that we expect the business to be approximately flat next year, little hard to predict that down to the specific percentages but I think to a first approximation, we think it will be flat.

We think the biobanking business is going to be - have some resurgence here over the next couple of years and they tend to be projects of reasonably big sizes 10,000 to upwards of 100,000 samples. Having said that, these projects tend to be use arrays of relatively low complexity. So the price per array continues to fall in the marketplace.

So that offsets the number of samples by lower pricing..

Great.

And just a general follow-up, I had a lot of questions from investors about the potential implication of the FDA's plan to LDT regulation, and is this changing how your customers are thinking about how they're going to deliver products and how they build out their CLIA labs? Could you give us some feedback from what you're hearing from customers in terms of how they are looking at the new landscape going forward?.

Well I think it depends on what type of test the customers are running. So the ones that are in the long range program of the lower risk test, those customers had many years to adopt and adapt their method. And so I think sort of postponing any decisions about what they do.

The ones that are in the higher risk categories, I think are evaluating what the probability is that the FDA would come in and require them to register their test because we don’t have any final guidance. I think anybody has made complete decisions here but everybody is evaluating their options.

I think overall for Illumina its probably a positive – somewhat positive development for our business overall because we have the ability to take products through the FDA particularly if they're sequencing based on our platform and we can partner with many companies who decide either for competitive reasons or for regulatory reasons that they want to get their test registered and cleared to the FDA, we can help with that..

Great. Thanks..

Your next question comes from the line of Ross Muken of ISI Group. Please proceed..

Good afternoon. It seems on the oncology side, particularly in pharma you're starting to make some real inroads, you've announced some partnerships. Historically, when we've seen some of these more key announcements, it's led to a lot more discussions with those who are maybe slower to get to the at least press release line.

Maybe can you just give a little more color about what the market reaction is, particularly in that space through some of your efforts and some of the things that have now obviously been brought to market, and where the discussions are going also with the existing players, and the sorts of things they're contemplating using sequencing for as they adapt it into their clinical trial process?.

I guess I'd say Ross, there's a spectrum of responses. We've announced three so far, we have a quite good pipeline of others that we think we have the prospects of closing here over the next two to four quarters we will join this. There are some who are going to take a wait-and-see position and you might guess who those are.

And then there's a couple for a reason you might imagine who aren’t going to work with Illumina, one in particular, and we’ve tried to work with some of those subsidiaries of that company. And I think we’re going to continue to try to see if we have any success there, but that one is probably less likely than the others.

I think that most of these companies will place multiple bets in this area. So, I wouldn’t be surprised to see competitive announcements.

And it will depend on the company’s ability to deliver these products and how well they work particularly around issues like low input sample, the ability to deal with FFPE, the critical considerations for dealing with samples in the oncology market.

And we’re very confident about our ability to deliver a great product here and Tina and her group are very hard at work putting that product together..

Thanks. And maybe on the BaseSpace side it seems like you continue to make this a focus, you made some progress, there's been some announcements there as well.

Can you talk to the evolution of that business model and the pushes and pulls on what has been the key elements of that becoming a larger percentage of the P&L? I know it's obviously important to the overall workflow..

We still don’t think of it as a major contributor at the P&L line, at least not yet. It’s in an investment mode, we’re continuing to build out the infrastructure of BaseSpace, adding applications in the app store, I mentioned in my script that we’ve now have 50 applications and we’re continuing to push to get lots, lots more.

I think particularly interesting this quarter was the proteomic applications that we added in partnership with AB SCIEX and this is interesting because it’s a different data type than we produce.

So, it begins to demonstrate the ability of BaseSpace to work across data types and housing this data all in one place gives you tremendous power to do translational types of analysis across these various applications. So, I think that’s a very positive development. We’re integrating it more and more tightly with NextBio.

So, I think that will be an important addition to the overall architecture. But, I guess in the next year or two, we wouldn’t think about it as a large revenue contributor..

Fair enough, congratulations again guys. Tremendous execution..

Thanks Ross..

Your next question comes from the line of Dan Arias with Citigroup. Please proceed..

Hi. Thanks and good afternoon. Jay, you have been pretty clear about making sure you scale properly.

So, on manufacturing and leaving aside the X Ten dynamics, anything that you're finding you have to do differently or pivot on, so to speak, in terms of production in order to accommodate the way that the system orders are coming in through the three platforms?.

Not really anything structural, I mean, we’re continuing to add space in particular locations where we're focused on manufacturing the newer instruments, Singapore being one of those, we're expanding in Singapore because we make NextSeq there, its our first instrument launch out of Singapore.

What else, not really much change here in San Diego we are relocating our reagent manufacturing which is in the facility couple of miles away from our main campus here, on to our campus, so that will take about 18 months to complete.

But that’s under way, but that’s not really idea of structural change, it’s really just convenience of having the rest of those people closer to the development teams and the rest of the employees on site.

Francis, do you have anything?.

I think exactly along the lines that you talked about it, it’s a set of things that are on continuous improvement.

Another thing we’re doing for example is, we’re expanding our logistics partnership to improve operations here in the Americas, it’s sort of a core element of our scaling and you’ll see us expand that relationship in the coming quarters for example..

Okay, that's great.

Wanted to ask about the Genomics England contract, have the revenue expectations that you guys have given for that project include the clinical interpretation services that you are in running for, or if you were to be chosen there, would that be added into what you've talk to previously?.

That would be incremental. So, as – I am sure you saw there were 10 companies that have made it to the next round, the revenue that we mentioned in our press release was related simply to the sequencing services..

Yeah, okay. Thanks..

Your next question comes from the line of Dan Leonard with Leerink. Please proceed..

Thank you.

Can you talk about the visibility you have into your X Ten customers' readiness for samples, since that is the gating factor for further X Ten shipments?.

Yeah, visibility is actually fantastic because we’re in each of these sites pretty much everyday working with these customers, making sure they’re bringing up their sample pipelines and ensuring that the instruments are running well. So, we know exactly where they are pretty much on a week-to-week basis.

And even if customers want to take units – in general, we don’t want them to be installed and sit idle for weeks at a time. And so we tend to meter them out in sort of as we said proportional to the customers ability to use those instruments.

We also are working hard on, as we mentioned previously, some improvements in software to wrap around these systems to make them easier to use. Originally when we launched the HiSeq X Ten, we thought it was going to go largely into large scale centers that knew how to sequence really well and already had a complete infrastructure.

And as we’ve described, that’s not universally the case. And as a result of that, we’re working on improvements in the software that will help the less experienced customers get up to speed faster and allow the ramp to increase and improve..

Thank you.

And then for my follow-up question Jay, do you have any visibility into the NextSeq order book that you're able to talk about, or is that more of a book and ship type of business with little visibility?.

Well, I think we have about the same visibility on NextSeq as we do on MiSeq or HiSeq, we tend to manage our pipeline out about nine months and we have a sales force tracking tool, salesforce.com that we use, that looks at opportunities and manages them through a very reasonably predictable funnel.

And I guess our close rate on NextSeq has mirrored what we have experienced on the other products. So, if we see an opportunity, a collection opportunities out seven months from now are statistics on how likely they are to close in any given window is roughly the same as across our other instruments.

So, I’d say the visibility is about equivalent to what we have on MiSeq and HiSeq..

Okay. Thank you..

The next question comes from the line of Amanda Murphy, William Blair. Please proceed..

Hey, thanks. I had a follow-up question to Doug's earlier question on the HiSeq. So it sounds like you are getting some traction in terms of a replacement cycle.

I'm curious, is it just a function of time at this point, or is it that maybe you need to give the market a bit more in terms of throughput and performance to try and continue to further that upgrade cycle?.

Well, we’re doing both. It’s certainly is a function of time but partly the reason is the function of time is that we continue to make the 2500 better over time. And as we add new capability to that and things like long reads, the gap between what you can do on a 2500 and what you could do on the older systems gets bigger.

And so I think those two factors work in conjunction and over the next couple of years I think will drive a relatively significant upgrade cycle for us..

Got it.

And then also on the X Ten consumable usage, just curious can you give us some context in terms of the installed base now in terms of how they are using the machines, are they a mix of high-end and maybe people who are just ramping up? The purpose of the question is just thinking about how that might trend going forward? With the HiSeq, obviously, it's been relatively flat within a range; is that how we should think about X Ten per machine usage?.

Well, we have a mix of customer types, Amanda. So, we do have some of the earliest users who are the high throughput users that we expected in there fully operational and running in production mode. So that tends to buy us their reagent store, the higher end.

And then we have reasonable distribution to customers who are new to large scale sequencing and that tends to drag it down. So, you’ll see customers all the way from probably the 70% to 80% utilization on the high end down to the sort of 20% utilization on the low end..

Okay.

And that should maybe stay relatively similar going forward then?.

Well, no.

We hope to push the low ones up and those are both a function of developing the sample pipeline and making sure that those pipelines are rich in numbers and that those samples arrive on a regular basis and – for example, several customers who are using these in a service environment and those tend to be kind of lumpy until you actually build up a bigger backlog of customers that are using them regularly as a service.

But we tend to – or we want to push those lower percentage users up to the 50% rate or so. So, that’s certainly our hope here over the next six months..

Got it. Okay, thanks very much..

Your next question comes from the line of Isaac Ro with Goldman Sachs. Please proceed..

Good afternoon guys, thanks. Just want to ask a question about gross margin.

I saw a pretty big improvement there and was hoping maybe you could deconstruct the drivers of the improvement a little bit? And specifically if you could comment on how much of the improvement in gross margin is due to better pricing across the instrument lines versus overall business mix, just trying to figure out what drove the improvement and how to think about it going forward?.

Well, let me give you some general comments and I don’t know if Marc will have anything more specific, but, I think one underlying trend that’s critically important here is overall increasing margins on the instruments.

We talked a bit about that on HiSeq X, because there's a price point and the fact we’re not discounting those, our margins on that product compared to the percentage margins we get on the 2500 are substantially higher. So, that’s been a key driver particularly in a quarter like Q3 when we shipped a fair number of HiSeq X’s.

NextSeq as Francis mentioned had a very aggressive gross margin target from the day we first put it into product development and well, you never quite are at the target you want when you first start shipping a product.

We’ve grown into that target quite quickly on NextSeq as the volumes have been very strong and so we’re starting to get the volume discounts on the components that we would have expected and we’re coming down the cost curve of our NextSeq at a pretty good clip.

So, that means that NextSeq is an overall very positive addition to the gross margin cycle. I see MiSeq as a bit of a headwind in the other direction because we lowered the price of MiSeq and it’s relatively stable instrument from a technology perspective to gross margins on that box compared to where we were say a year ago or less percentage wise.

So, I think instruments are probably the biggest part of the story here and had we not had that great improvement in the instruments, the margins would have gone the other direction because the overall mix between consumables and instruments has gone more towards instruments and so it’s obviously a great thing that we made those improvements and the net of it is a positive overall lift of the gross margin number.

Another key factor of course is the fact that just the amount of revenue beat that we had in the quarter pushes our factories to very full utilization. So overhead absorption is a huge factor as we get to that marginal $10 million or $15 million of extra revenue on a given quarter.

The incremental margin on that last bit of revenue is huge because you fully absorb value or overhead..

Yeah, nothing really specific to add Jay. It’s kind of hard to bifurcate the increase in gross margin but with the improvement as you mentioned in the instruments, and then also remember the other instruments moving more towards the HiSeq 2500 and away from say the HiSeq 2,000 a year ago etcetera would have helped a little bit.

And those are as I mentioned in my remarks, we expect the mix of consumables and instruments to be kind of static around that mid-50s level and so, even with that the kind of gross margins we’re seeing as sustainable as long as we view it on how significant investments in the future in production capabilities.

As Jay mentioned, we’ve been running pretty flat out on lot of our facilities and that’s given us tremendous leverage. So I think really, I would put that leverage as probably one of the biggest drivers and then the instrument margins and the effect of that as another..

The last thing I would add is that our field experience on the instruments is continuing to get better.

We put a lot of energy into this over the last couple of years and we had some challenges with valves and things like that, liquid handling, a couple of years ago in some of the instruments and so our warranty experience is continuing to improve, particularly in the newer instruments like NextSeq where we made data much more solid state instrument which helps the overall margin numbers..

That's great color. Thanks a bunch.

Just one other on the general demand outlook on instruments, I think you mentioned in your prepared comments that you had a pretty good uptake of both NextSeq and MiSeq for new customers, and I was wondering if you can give me a sense for NextSeq specifically how many of those customers are new Illumina NGS users? And then secondly, for MiSeq can you give us any sense of what you think MiSeq versus MiSeq DX demand will look like over the next however period of time you're willing to talk about? Thank you..

Well, NextSeq, we said that about a third of the orders came from new customers and so we think that's new to Illumina, so we don’t have any other products from us and the great thing about that of course is that it’s pure market expansion and that’s what this system was designed to do, is to hit a price in a performance window that would bring in new applications and new customer types.

And so, I think we’re rapidly experiencing that with NextSeq and we’re really pleased with how that product’s is being accepted into the marketplace overall.

I am sorry, the second part of the question was?.

MiSeq, just wondering if demand outlook there, you have MiSeq DX now, so should we be assuming that the majority of the users are on the DX side versus researcher or could be more evenly split?.

No. I see the DX as still a small fraction of the total MiSeq that we ship. It’s a growing percentage and I think over time will become more and more as a fraction of the total. We do see I think a general uplift in MiSeq purchases in general just because we have an FDA approved box.

So customers might buy MiSeq, do their initial clinical development on a system that’s cheaper because it’s a $25,000 uplift if you buy the DX version and then when they actually go to deploy, they might deploy on the DX version.

And, so that’s one of the reasons that we think over time the fraction will increase but right now it’s still a small percentage of the total..

That makes sense. Thank you..

Your next question comes from the line of Bill Quirk with Piper Jaffray. Please proceed..

Great, thanks. Good afternoon everybody.

In terms of the v2 consumables rollout here Jay, how should we think about Illumina's role in making sure that that's a fairly seamless transition? In other words, should we expect any, albeit temporary, slowdown in the systems that are going from v1 to v2?.

No, I don’t think so. In this case, these reagents are either direct substitutes, say in the case of NextSeq there'll be probably a six month overlap or seven customers who want to continue to use the one simply just for continuity in their experimental data, but the shift to V2, there’s no pricing difference, there’s no output difference.

So, I don’t think of any risk of lag in the marketplace and similarly for DX, we’ve just broadened the number of applications that customers can run. So, we don’t think of anything at all, be a potential accelerator of consumables that there won’t be any pausing that we anticipate..

Okay, excellent. And then secondly, just on sequencing reimbursement and I'm thinking outside of NIPT, candidly there's been some mixed messages, somewhat negative from payers, but yet the customer lab experience tends to be a little bit better.

Where are you in terms of thinking about reimbursement and helping make this as seamless a process as it can be for customers?.

Well, as you know, the only direct test that we market is the NIPG test where we're largely reimbursed. So, Illumina doesn’t have a direct need to get reimbursement for other products that we have.

Of course our customers do and as a result of that, we are working at a more global level with the payer community to undertake some very interesting proof of principal projects, I would call them where we’re demonstrating the sort of the efficacy of using sequencing in diagnostic environments as well as the potential improvements in health economics.

And, if we can begin to demonstrate that, I think it will help the overall environment for reimbursement and I think that’s the critical role that Illumina needs to play here..

Very good. Thanks guys, great quarter..

Thank you..

Your next question comes from the line of Steve Beuchaw of Morgan Stanley. Please proceed..

Good afternoon and thanks for taking the questions. I will ask two on oncology. One, sorry if I missed it, but I believe in the last quarter you gave a dollar figure, Jay, for the size of the oncology business in the quarter and a growth rate. It would be great to get an update on how that trended in the third quarter.

And then I will go ahead and ask my follow-up in oncology and it relates to the Actionable Genome Consortium.

Now that you're getting closer to the commercialization of a panel, the filing of the panel product and closer to the publication of that document, I wonder if you can share any learnings from that process and give us a sense for how that might be impacting your thinking, thinking about how you ultimately structure and commercialize that panel product.

Thank you..

Yeah, on the first question, we said last quarter that we had about $90 million of overall revenue that came from oncology in total, so that was research and clinical applications. We think that’s gone up a bit in Q3 not dramatically. So, still less than $100 million I’d say in Q3.

With respect to what we’re doing with the Actionable Genome Consortium and observations, a couple, one is that they are very excited about the work because they got it done faster than we thought. So they’ve put the standards in place and it’s being prepared for publication as we’ve mentioned.

The second observation is that there’s a general tendency toward increasing content on the panels and we’re trying to figure out ways of making sure that we don’t get gene creep, I guess is probably the right word to use where the panel just keeps getting perpetually larger because everybody wants their incremental five genes.

And so locking down exactly what the content needs to be is challenging and an opportunity.

Clearly in the long run Illumina's view is that this ought to get to whole genome, but that’s going to take some time particularly because this panel we want to be as tightly correlated with actionable outcomes as we can possibly make it for the treating physicians and that’s what’s going to be necessary to begin large scale of option..

Great. Thank you so much..

Our next question comes from the line of Zarak Khurshid with Wedbush Securities. Please proceed..

Thanks, good afternoon everybody. Jay, it sounded like you said that there's 70% sequential NIPT sample growth? Just want to confirm if that's right, and if so, what are the drivers? And if you could talk about how LabCorp and Progenity, those two wins are playing out..

Yeah, that’s the right number. It’s a big number, it’s kind of startling to us when we actually got the statistics on that and it’s the progress of our test send out business largely through third parties, not from our direct sales force. So, our direct sales force we continue to not add resources to the direct team.

So, this is through some of the third party deals that we’ve done in the United States. Both the lab core and the progenity relationships continue very positively and we’re excited about both of them..

Great, thanks. And just quick follow-up on the SG&A leverage, very impressive there. In the recent past, I know you've talked about having to invest to develop new markets. How much active market development are you doing right now, and how are you thinking about that for next year? Thanks a lot..

Yeah, I’d say we’re doing quite a bit of market development in the target markets that we’ve already talked about, those being HLA and forensics in particular. We’re going to all the trade shows. We’re meeting routinely with customers. This is from a marketing perspective, not from a sales perspective.

We are engaging with the KOLs and the thought leaders. We’re holding meetings with those KOLs. So all the normal things you’d expect in terms of getting the market ready for the launch of these products we’re deeply involved in. So, big investment going on there, but quite targeted. So, it's a handful of people. It’s not the entire sales force yet..

Great. Thanks..

Your next question comes from the line of Jeff Elliott with Robert W. Baird. Please proceed..

Yes, thanks for the question. The first one is on the X Ten, you mentioned some of the higher throughput customers are at a 70% to 80% consumables utilization rate, I guess 70% to 80% of the theoretical max.

Is there any reason why that couldn't get up closer to 100%? And then as a follow-on, obviously it's below the third quarter, but when I look at the sequential implied guidance to the fourth quarter, it's not as robust as it's been in prior years; is that just a matter of the X Ten slowdown you mentioned sequentially, or is there anything else in the fourth quarter?.

Yeah, I’ll take the first part and I'll let Marc handle the second part.

Yeah, we would never expect any customer to get to 100% on our most proficient HiSeq 2500 users who have these up and running for years and have very intricate limb systems for re-queuing samples and sample quality, control to high 80% or maybe up to 90% in the most extreme cases. So, getting to 70 or 80 HiSeq platform is pretty darned good for now.

They might inch up a bit but 90 is, when we take the maximum if you ran it absolutely every minute of the year, we always take 10% off as where we start the calculations. You could never really get above 90%..

Yeah, on the fourth quarter guidance, I think it’s exactly what you said. The biggest driver is the reduction in HiSeq X placements in the fourth quarter that we’ve talked about. A couple of headwinds as well. We’re not expecting Japan to pick up in the fourth quarter. So, similar to Q3 in that respect it was significantly down.

And then also foreign exchange headwind, think about it in terms of about 1% of revenue or thereabout. So, three things combined is really what’s behind the growth rate, the guidance that drives the fourth quarter number..

Great, thank you..

Our next question comes from the line of Miroslava Minkova, Stifel. Please proceed..

Hi Jay, hi Marc, congratulations on the quarter. Let me perhaps ask a question about clinical markets. There have been some major milestones, it seems, over the past quarter with the Actionable Genome Consortium and the pharma agreements, and most recently the Myraqa acquisition.

At the ASHG meeting here, it seems like there's quite a bit of focus on the clinic.

Can you perhaps share with us how you feel about the progress you are making in the clinical markets versus your plan? And maybe update us on the time line for IVD submission for NIPT and the onco panels?.

I guess on the clinical penetration, I would firstly say that what’s happened over the last couple of years has greatly exceeded our expectations of how fast the clinical markets would adopt next generation sequencing.

This was initially driven largely by what happened in the NIPT market, we need to essentially create those catalysts in the oncology market, which we’re working very hard on and use the rationale behind what we’ve done with the Actionable Genome Consortium and the onco panel consortium. On the foot side of that, I’d say there’s a lot yet to be done.

So, as a company we are very focused on trying to work hard to become clinically ready and this requires improvements across much of our infrastructure in order to be able to deliver and support clinical customers to the standards that they’re accustomed to and that’s everywhere from how fast we can get our service person to their laboratory to how fast they can get reagents once they order them to how well they can trace back a single component of a reagent all the way through the supply chain.

And so as a company we are working on implementing that infrastructure and at the same time retaining the nimbleness that we’re known for in the research market. So, there’s challenges around that, but it’s a project that we’re very involved in right now and we’ll be investing in heavily over the next three years or so.

With respect to IVD submissions, we don’t really have any new news for you today.

Our goal is to have the first version of the AGC defined product into the market in 2015 that will be for RUO purposes and then we’ll begin doing the clinical trials with that product and depending on how long those clinical trials it will determine the timeframe for doing submission to the FDA.

It won’t be gated by the product itself, but it will be gated by how long and how extensive the clinical trial work needs to be and we don’t really have any new updates on the NIPT submission at this point..

Okay great. Thank you.

And perhaps on the 15 X Ten customers or orders that you have, would you be willing to share how many of these are actually up and running?.

Well, other than the last few, almost all of them have at least one system now..

Okay, great. Thank you so much..

So of the 15, I don't know this number exactly, but I would say 11 of them probably have one or more systems now..

Excellent. Thank you so much..

Ladies and gentlemen that concludes today’s Q&A. I’ll now turn the call back over to Ms. Rebecca Chambers for closing remarks..

Thank you, operator. As a reminder, a replay of this call will be available as a webcast in the Investor 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 our fourth fiscal quarter..

Ladies and gentlemen that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day..