Rebecca Chambers - Senior Director-Investor Relations Jay T. Flatley - Chief Executive Officer & Director Francis A. deSouza - President & Director Marc A. Stapley - Chief Financial Officer & Senior Vice President.

Tycho W. Peterson - JPMorgan Securities LLC Doug A. Schenkel - Cowen & Co. LLC Derik De Bruin - Bank of America Merrill Lynch Jonathan Groberg - UBS Securities LLC Daniel Arias - Citigroup Global Markets, Inc. (Broker) Amanda L. Murphy - William Blair & Co. LLC Isaac Ro - Goldman Sachs & Co. Ross Jordan Muken - Evercore ISI Dan L.

Leonard - Leerink Partners LLC William R. Quirk - Piper Jaffray & Co (Broker) Steve C. Beuchaw - Morgan Stanley & Co. LLC Zarak Khurshid - Wedbush Securities, Inc. Jeff T. Elliott - Robert W. Baird & Co., Inc. (Broker) Dane Leone - BTIG LLC Tim C. Evans - Wells Fargo Securities LLC.

Hello, everyone, and welcome to the Second Quarter 2015 Illumina, Inc. Earnings Conference Call. At this time, all participants are in listen-only mode. Towards the end of this session, we will hold a question-and-answer session. And as a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to the Vice President, Investor Relations and Treasury, Rebecca Chambers..

Thank you, operator, and good afternoon everyone. Welcome to our earnings call for the second quarter of fiscal year 2015. 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; Francis deSouza, President; and Marc Stapley, Senior Vice President and Chief Financial Officer.

Jay will provide a brief update on the state of our markets. Francis will comment on product performance and Marc will review our second quarter financial results, as well as provide updated 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 Morgan Stanley Healthcare Conference in New York the week of September 14. 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 pleased to report that Q2 was another strong quarter for the company. Order receipts exceeded our expectations resulting in a record exiting backlog. Revenue increased 21% year-over-year to $539 million, slightly above the guidance provided on last quarter's earnings call.

The leverage we delivered this quarter was also remarkable as non-GAAP earnings per share grew 40% compared to the second quarter of 2014. These robust results were due to strength in sequencing revenue and solid operational execution.

Second quarter total sequencing revenues grew 28% year-over-year driven by record consumables and strength in services. Shipments to clinical and translational customers grew 45% year-over-year to approximately 40% of total shipments further demonstrating the expanding utility of Genomics.

Oncology was a significant driver of this mix as use of NGS expanded in hospital laboratories and commercial molecular diagnostic settings. Shipments to all segments of oncology grew approximately 35% year-over-year.

Over the past several quarters, we've shared some of our strategies to penetrate this market which include our onco panel and liquid biopsy programs. We're on track to deliver – release one of the onco panel as an RUO product by the end of the third quarter.

This initial release includes 15 genes critical in oncology and sets the groundwork for our onco panel products that will be CE-IVD marked and FDA approved. We're committed to delivering the enhanced 170-gene version of the onco panel to address the needs of the research market early next year.

We will also be providing this product for use by our pharma partners in their clinical trial. Our liquid biopsy program continued to make progress during the second quarter.

As part of this effort, a study was recently published in the Journal of the American Medical Association which showed specific examples where discordant NIPT results were detecting maternal cancer. Our development teams are optimizing assays and exploring their clinical power for use in this exciting frontier of genomics.

Our market development strategies in reproductive health also contributed to the higher mix of clinical and translational customers in the second quarter. Sales to IVF reference laboratories increased 25% in Q2 with approximately 20% of sales now coming from VeriSeq PGS.

As a reminder, VeriSeq PGS is our sequencing-based pre-implantation genetic screening solution used as laboratories transition from the older generation arrays. Total NIPT revenue including products, services and test fees grew more than 50% versus the second quarter of last year.

This result was due in part to a doubling of test send-out samples, as well as an increase in product sales to NIPT providers globally. Our partnership with Berry Genomics, the second largest NIPT company in China, is progressing well after the recent Chinese FDA approval of Berry's assay and the NextSeq CN500.

This has resulted in an increase of shipments for resale to Chinese hospitals that are bringing NIPT in-house. During the quarter, we signed a similar deal with Annoroad, the number three NIPT player in the region, and will jointly bring together Illumina sequencers with Annoroad's assay development capability.

We believe the sustainability of NIPT revenue growth will come in part with the availability of our next-generation solution VeriSeq NIPT. We're in the final stages of the European regulatory process for the software and hope to have CE-marked shortly. We will follow with the CE mark on the VeriSeq NIPT product for distribution as an IVD solution.

During the second quarter, we signed five new partnerships outside the U.S. and now have a total of 19 VeriSeq NIPT customers working on installing the protocol in their respective laboratories. Moving now to arrays, we continue to witness growth in sample volumes, but at lower prices.

In the second quarter, Infinium volumes increased 29% yet total microarray revenue declined 11% year-over-year. Despite this result we have positive trends in the array market to share.

First, total genotyping orders were up 16% versus Q2 2014 driven in part by strength in agriculture due to the continued adoption of genomic selection in livestock for which our Bovine arrays are well suited. For the year, we're projecting arrays to decline in the mid to high single-digits compared to the prior year.

We expect the second half to be positively impacted by new custom products that will launch as a result of our increased R&D investment in arrays.

This expanded product line includes an updated Immunoarray with an additional 140,000 markers of new content as well as a drug dev array which combines available genomic data with advanced computational tools that enable researchers to test targets earlier in the therapeutic development process.

Last thing I want to highlight are sample to answer solutions for forensic and HLA markets which continue to gain traction. The number of customers evaluating our TruSight HLA solution has close to doubled since Q1.

We continue to build broad awareness for our MiSeq FGx solution and recently held a webinar for more than 400 target customers to further educate them on the importance of NGS in the forensics setting.

Encouragingly we now have at least one major law enforcement customer in every region of the world, an important first step to broader market adoption. Overall Q2 was another solid quarter for the company. Our momentum continues driving demand across our diverse customer base.

As we move into the second half of 2015 and beyond, our relentless focus on market development and innovation in our sequencing portfolio will be critical factors in our ability to penetrate the large and untapped opportunities ahead of us. I'll now turn the call over to Francis who will provide a detailed overview of our product results..

Thanks, Jay and good afternoon everyone. I am pleased to provide an update on the performance of each of our product families in the second quarter. As Jay mentioned, total sequencing revenue grew 28% over the second quarter of 2014.

This included sequencing instrument growth of 13% year-over-year due to demand for HiSeq and NextSeq, offset in part by lower HiSeq X shipments. Again this quarter, we saw strong interest from new to Illumina, next gen sequencing customers who accounted for more than 45% of instruments ordered.

This class of users is primarily interested in gaining exposure to sequencing through the MiSeq and NextSeq benchtop platforms. With this in mind, we have introduced a MiSeq promotion called New to NGS.

This starter bundle includes training, sample prep and core consumables as well as the instrument and service plan needed to get a new sequencing lab up and running. We expect this to not only build the funnel of new customers, but also promote our entire sample-to-answer MiSeq solution in a cost effective manner.

Order dynamics for our benchtop instruments are largely unchanged from the trends seen in prior quarters. Across this portion of our portfolio, more than 45% of instruments ordered came from clinical and translational centers. As a result of these factors, MiSeq and MiSeqDx sales in the quarter continued to be strong.

Rounding out our benchtop franchise is NextSeq, which saw a 16% sequential increase in shipments. Development activities in reproductive health and oncology markets drove demand, which together accounted for close to 40% of quarterly NextSeq orders.

Oncology customers grew close to 50% compared to the prior year as we saw a large, multi-unit order from a liquid biopsy company, as well as orders from customers focused in gene panels.

Reproductive health customers also bolstered demand with the June availability of NextSeq 550, which enables both sequencing applications and microarray scanning for cytogenetic testing on a single platform. These data points are a strong indicator of broader adoption across a diverse set of customers.

We have made great progress improving the success rates on NeoPrep, and as a result the product is now in full commercial shipment with the TruSeq Nano prep kit. NeoPrep is very well matched to the benchtop sequencer market and we're pleased with the feedback received from early access sites on the instrument's performance and reliability.

We plan to release the TruSeq mRNA kit shortly, and are actively working on building out the application menu for the system to further drive interest in this platform. Moving now to our high-throughput sequencing instruments, in the second quarter, demand for the HiSeq family of products profited from the impact of HiSeq 4000 and the HiSeq X Five.

As expected, shipments of HiSeq instruments will lower sequentially and year-over-year. We continue to expect HiSeq X orders and shipments to remain lumpy quarter-to-quarter and dependent on the timing of funding and customer readiness. Interest in the X platform remains high as we continue to add new customers in Q2, raising the total to 22.

As well as ship systems to existing customers to increase their capacity Exiting the quarter, our HiSeq X order funnel remains healthy resulting in an expected quarterly order rate of 20 to 30 HiSeq X units. We have recently introduced new products and services to further improve the performance of HiSeq X.

This includes the launch of an improved v2.5 flow cell, which has been made broadly available to our install base, as well as the associated software and firmware updates. We also launched Illumina SeqLab, an integrated solution to help our customers maximize quality and throughput of their sequencing facilities.

Through a partnership with GenoLogics and Hamilton Robotics, the Illumina SeqLab is designed to standardize and optimize the whole human genome sequencing workflow, reducing the time lab personnel need to spend operating the instrument and ensuring quality results.

This solution includes the limb system, liquid handling robotics, data analysis and the consulting services a lab would require to get up and running as a next customer. We believe the addition of these offerings will increase the consumable utilization of our customers by moving them more quickly up the adoption curve.

Momentum grew through the first half for the expanded HiSeq family of instruments, including the HiSeq 3000 and HiSeq 4000. As expected, we saw an increasing fraction of orders migrate from the HiSeq 2500 to the HiSeq 4000, which just one quarter after launch became clearly the leading HiSeq platform sold.

Interest in this instrument fueled higher shipments, both sequentially and year-over-year. Demand was driven in part by multi-unit orders from genome centers and commercial customers standardizing on the platform.

We remain excited about this expanded portfolio given it offers tremendous flexibility to address various budgets and scientific priorities. Moving now to an update on informatics, I am pleased to share that we recently hired a new general manager of our Enterprise Informatics business unit, Sanjay Chikarmane.

Sanjay joins us from SAP and brings with him over 20 years of experience in enterprise software. I want to thank Nick Naclerio for the terrific work he did as the GM of this group and we look forward to him being able to focus full time on our opportunities in corporate and venture development.

We saw meaningful progress in the adoption of BaseSpace during the second quarter. We now have 65 applications available and app launches increased 45% compared to the first quarter. We saw 17% increase in runs uploaded sequentially and close to 50% of our accounts are current users of BaseSpace.

We continue to focus on more fully integrating our data solutions to further build the informatics ecosystem surrounding the Illumina portfolio of sequencers. I will now turn the call over to Marc who will provide a detailed overview of our second quarter results..

Thanks, Francis. As Jay mentioned, total revenue grew 21% year-over-year, slightly exceeding our guidance. On a constant currency basis, revenue grew 25%, bolstered by incoming orders that exceeded our projections, resulting in an impressive book-to-bill ratio of 1.1.

This strong order trend will benefit shipments over the coming periods as the vast majority of the backlog is shippable within the next four quarters. Shipments in the Americas grew 32% year-over-year due to strength in HiSeq instruments and HiSeq X consumables.

European and APAC shipments increased 16% and 2% respectively over the same period as growth in these two regions was muted due to the impact of currency. APAC shipments declined $20 million sequentially as expected, due primarily to continued weakness in Japan as funding remained constrained.

We expect a very slight improvement in the Japanese funding environment in the second half of this year, returning to normalized levels in 2016. Instrument revenue grew 11% year-over-year to $155 million in the second quarter, particularly encouraging given the strong Q2 2014 comparison.

This increase was primarily driven by demand for NextSeq and HiSeq. Overall, we're very pleased with the HiSeq family of products as the lower sequential HiSeq X shipments were more than offset by the increased interest in the HiSeq 4000.

Overall consumable revenue in the quarter was $303 million, an increase of 23% compared to the second quarter of 2014 as higher demand for sequencing consumables and library prep was partially offset by a decline in arrays.

Consumable revenue represented 56% of total revenue, up slightly from 55% in the prior year period, and lower than the 57% we saw in Q1. Sequencing consumable revenue was very strong, growing 36% over Q2 of last year. HiSeq X and NextSeq utilization exceeded the respective guidance ranges we have provided.

Quarterly shipments of NextSeq consumables were strengthened in part by increased adoption of the enhanced v2 reagents which became available late in the first quarter. During the quarter, 5 of the 22 HiSeq X customers accounted for approximately 70% of X consumable shipments.

And as a result we continue to see meaningful opportunity to raise pull-through of our lower utilization customers. With the recent introduction of the Illumina SeqLab, we should be able to accelerate new customers' ability to implement large-scale sequencing workflows and increase pull-through as a result.

MiSeq utilization was in our projected range of 40k to 40k, and HiSeq pull-through for instruments, including HiSeq X, was in our projected range of 300k to 350k. Services and other revenue, which includes genotyping and sequencing services as well as instrument maintenance contracts grew 35% versus Q2 2014 to $77 million.

This improvement was driven by growth in NIPT services which benefited from increased test send out revenue, genotyping services and extended maintenance contracts associated with the largest sequencing installed base.

Turning now to gross margin and operating expenses, I will highlight our adjusted non-GAAP results which exclude non-cash stock compensation expense and other items. I encourage you to review the GAAP reconciliation of non-GAAP measures included in today's earnings release.

Our adjusted gross margin for the second quarter was 72.4%, an increase compared to 72.2% in the first quarter. Year-over-year adjusted gross margins expanded 150 basis points due to efficiencies in leveraging manufacturing operations which were offset in part by currency headwinds.

Adjusted research and development expenses for the quarter were $85 million or 15.8% of revenue, higher compared to $80 million or 14.9% of revenue in the first quarter due to the impact of additional head count and outside services expense.

Adjusted SG&A expenses for the quarter were $103 million or 19.2% of revenue, an increase compared to $97 million or 18% of revenue in the previous quarter due to higher headcounts and outside services associated with our ERP program.

As we have shared previously, as an organization, we've spent a tremendous amount of time and effort preparing to implement a new ERP solution, SAP, which we expect to go live next week. To-date this project has spent three years and will, we believe, enable us to scale our operations more efficiently and effectively to support long-term growth.

While this launch represents our single largest phase, we will continue to invest over the next few years in similar projects that enhance our ability to scale. Returning to our results, adjusted operating margins were 37.4% compared to 39.3% in the first quarter, low sequentially as we added 315 net hires in Q2.

Operating margin was higher compared to the 34.8% reported in the second quarter of last year due to the impact of improved gross margins and operating expense leverage. In the second quarter, our stock-based compensation equaled $33 million, up slightly sequentially.

For the remainder of 2015, we expect stock-based compensation expense to increase from the levels seen in the first half due primarily to the impact of our annual grants and growing employee base.

Our non-GAAP tax rate for the quarter was 28.9% compared to 29.8% in the second quarter of last year due primarily to the benefit of increased manufacturing in Singapore. Non-GAAP net income was $120 million for Q2 and non-GAAP EPS was $0.80.

This compares to non-GAAP net income and EPS of $85 million and $0.57 respectively in the second quarter of 2014. The impact of foreign exchange lowered Q2 non-GAAP EPS by approximately $0.06 relative to last year.

We reported GAAP net income of $102 million or $0.69 per diluted share in the second quarter compared to net income of $47 million or $0.31 per diluted share in the prior-year period. Cash flow from operations equaled $171 million.

DSO increased to 62 days compared to 59 days last quarter and inventory increased 9% in parts prepared for our systems transition. Capital expenditures in Q2 were $41 million due to spending associated with our ERP implementation as well as other ongoing investments focused on scaling the organization resulting in $130 million of free cash flow.

During the quarter our Board of Directions authorized a new 10b5-1 share repurchase program of $150 million which we will use to manage dilution from employee grants. In addition, we have $96 million remaining under our previously announced discretionary buyback program. We ended the quarter with $1.5 billion in cash and short term investments.

Turning now to our expectations for the remainder of 2015, we continue to project approximately 20% total company revenue growth and 23% growth on a constant currency basis based on current exchange rates. We've increased our 2015 non-GAAP EPS projection from $3.39 to $3.45, up from $3.36 to $3.42.

Additionally, we continue to project the full-year pro forma tax rate of 27% which assumes 2015 federal R&D tax credit and other tax extenders of past prior to our fiscal year end.

For modeling purposes, we feel it is appropriate to assume a Q3 tax rate of 29% given the expectation that the R&D tax credit will be passed in Q4, and at that time, we will record the full-year impact.

In conclusion, I would like to punctuate a number of key fundamental performance indicators related to the second quarter results, firstly, robust instrument revenue growth driven by strong HiSeq and NextSeq shipment; secondly, sequencing consumables growth of 36% year-over-year, our eighth consecutive quarter of growth in excess of 30%; an order quarter which exceeded our expectations resulting in increased backlogs across each major line of business and our highest ever exiting backlog; and finally, significant performance in our Americas region, allowing us to manage through the impact of currency, as well as the weak funding environment in Japan.

We believe these fundamentals combined with our technology leadership, new product introductions and a focus on market expansion will enable us to continue to catalyze the broad adoption of genomics in 2015 and beyond. Thank you for your time. We will now move to the Q&A session.

To allow full participation, please ask one question, and rejoin the queue if you have additional questions. Operator, we'll now open the lines..

Our first question comes from the line of Tycho Peterson with JPMorgan..

Thanks. Actually, Jay, I want to see if you can elaborate a little bit on your comments on the array market? I mean if we think about this, you've stepped up your R&D there, you've talked about bio bank contracts and you did do the Neogen agreement.

So I'm just curious as to why you think that market is going to be down mid- to high-single digits?.

Well, I mean the comps are tough on the array market overall and a lot of it has to do with pricing, Tycho. Our unit volumes continue to increase in general in the array business, but pricing is becoming increasingly aggressive there. The bio banks to do the large-scale projects that they want to do are only enabled at pretty aggressive price points.

So I think it's that combination that's causing us to predict the array business to be down overall. We had a good order quarter in arrays, but a lot of that is going to be in backlog and shipped out over the next two to four quarters..

Okay. And then if we think about kind of swing factors for the back half of the year and things that could drive upside on the revenue line, you've got population sequencing, NIPT. One the HiSeq 3000/HiSeq 4000 uptick, that's another thing that potentially could accelerate quite a bit.

Maybe just talk a little bit about the dynamics of HiSeq 2500 customers because you have rapid run mode in the HiSeq 2500, but not the HiSeq 3000/HiSeq 4000, so what percent of those customers do you think pulled out? And I guess what are you telling customers on HiSeq 2500 in terms of phasing it out overall? Are you maintaining any commitment to servicing it for the next year? Or what are those discussions like?.

Well, we have a long-term commitment to servicing any instrument that we put in the field and we typically will do that for five years to seven years after we stop shipping it. So even after we declare something no longer available for sale, we'll continue to support it for a long time, so there's no concern there.

We did see, in the quarter, a great shift toward the HiSeq 4000, which is what we predicted would happen, the performance of that instrument, the price per base, the pattern, the flow cell roadmap are all important ingredients for people to move to the HiSeq 4000.

You can almost think of it as a slightly de-rated X that's allowed to run all applications. So that was, we think, largely responsible for that shift. We do think over the next year to two that the people buying the HiSeq 2500s will gradually decrease and it'll, in some sense, obsolete itself.

But the one feature that we have on the HiSeq 2500 that customers like a lot is that rapid run feature. So we're taking a look at whether, at some point in time we want to introduce that on the HiSeq 4000, but right now, we're not actively working on that feature..

Okay. Thanks. I'll hop back in the queue..

Our next question comes from the line of Doug Schenkel from Cowen & Co..

Hey, good afternoon, guys. So I think the first thing I want to do is just try to align order and placement commentary with the Q2 revenue model.

Were there any timing dynamics that impacted the pacing of placements such as, but not limited to, funding? Really I guess what I'm getting at is were there some issues where customers wanted instruments but maybe weren't able to pay for them based on the timing of, say, when NIH funding becomes more available? And I guess related to that, the 20 to 30 instrument order rate guidance that you provided on a quarterly basis, I think that's new.

You talked about shipment timing lumpiness.

Would you be willing to say if you were in the 20 to 30 placement range this quarter?.

Yeah, I'd say we were in that ballpark during the quarter, Doug. And we think that's going to be the rough range. Some quarters will be a bit higher, some might be a bit lower and that's why we've made the lumpy comment in the script.

In terms of customer buying patterns, customers always want to buy more sequencers if they had infinite money and so it is the case that people who don't have money would want to get a sequencer earlier if they could. But that's not a unique thing to the second quarter.

I think what we saw in the second quarter was very strong orders but some labs are not ready to take delivery, and that was true in fact in some X's where we received orders for complete X systems, X Tens in fact, but the labs aren't ready to take those instruments, and so some of those shipments will be spread out over the next two to four quarters.

That was true in the array business as well. We got some large array contracts that will ship over time, and I think that's why you see a pretty big gap between the order receipt rate and where the revenue wound up..

Okay. And then I guess the follow-up is really just sort of a simple guidance question. If you beat your internal expectations for Q2, if order backlog is now at a record level and if momentum built over the course of the quarter, I guess I'm just curious if you contemplated increasing full-year guidance, and if not, why? Thank you..

Well, we always contemplate what we do with the guidance, keeping it the same, raising it or lowering it based on what our expectations are.

We do have a rich backlog, as we cited in the script, but we don't know exactly when these labs are going to be ready to take delivery and customers move their delivery times in and out all the time, every quarter. So we do have a little bit of uncertainty in the exact timing of shipments of parts of the backlog.

Having said that, we think the fundamentals of the business are strong with the new orders that we received, we are really, really pleased. And as I said in the script, we exceeded our order plan during the quarter, and we're really pleased with that outcome..

Okay. Thank you..

Our next question comes from Derik De Bruin from Bank of America..

You there, Derik?.

Hi, good afternoon. Sorry about that. Hey, just a couple of quick ones.

So can you give a specific backlog dollar number?.

We didn't..

Okay, you said 1.1 though? Is that what I heard?.

Yeah..

That was book-to-bill, book-to-bill..

Okay, book-to-bill. Got you. Okay, book-to-bill. Got you. Right. So have you seen any issues in terms of any changes in the Chinese market, ordering and some of the economic stuff going on right now impact how you're sort of looking at that market, going forward? And then I have one quick call after that..

No, I don't think we've seen – we haven't seen any real changes in the Chinese market over the last couple of quarters. The research funding was better in the Chinese market maybe 18 months ago than it has been over the past year.

That's been masked a bit in China, particularly in 2014 because we had such a large number of X placements that we didn't expect in China. So our performance is quite good in 2014 in China. This year it won't be quite that good because we'll have X shipments into China..

Great, that's helpful.

And then just one quick one, on the JAMA paper that you just did on the aneuploidy detection in pregnant women and finding that, I guess besides looking at chromosome aneuploidy, what are you looking at in terms of either point mutations or small indels or something like that, I mean is your liquid biopsy technology capable of addressing those types of changes in assay nodes?.

Oh, sure. I mean the question on liquid biopsy is what is the right assay method or combination of assay methods that we know..

Correct, yeah..

Aneuploidy will pick up some types of cancers. Nobody quite knows yet the fundamentals of the biology, so we don't know exactly which ones would be picked up by that method versus permutations versus fusions versus methylation.

So there's many things we're exploring there, and I think lots of companies are working on this to determine what the best methods might be. And I suspect the market is going to wind up as a whole host of different tests that will be complementary to each other..

Thank you..

Our next question comes from the line of Jon Groberg from UBS..

Great. Thanks a million. So Jay, if you or someone were just saying from the outside, their first kind of look at this might be revenue relative to at least Street expectations to kind of in, the gap there has been narrowing, you have tough comps in the second half, no real new instrument launched to speak of.

Can you maybe just talk – I know you talked a lot about your order growth and how excited you were.

But could you maybe I don't know, just talk about your comfort and the visibility that you have in the second half and that you have with the guidance that you've outlined for the rest of the year? And then as a follow-up to Mark, can you maybe explain a little bit – you mentioned inventory was up because of the ERP that was going to go live.

Can you maybe talk a little bit about the receivables as well? Thanks..

Yeah, Jon. I think our visibility is about as good as it has been historically. I won't think we have a lot more or a lot less than we've typically had. I think one key factor we're dealing with is the weakness in the Japanese market.

So in Japan even though it was weak, Q1 was an okay Japan quarter and Q2 was always the worse Japan quarter, so certainly that was a factor in the revenue in Q2. And we caught up on the backlog of HiSeq X shipments.

So now we're really in very much a steady state in terms of where we are in terms of balance between orders and shipments and I think that steady state gives us pretty good confidence going into the back half of the year.

The sales force is feeling really good about the overall momentum of the business and a lot of the new hires that we're bringing in are in the commercial part of the organization because we do feel very strongly that there's lots more business out there to be had and as we expand our commercial reach, that we'll be able to incrementally bring in more revenue with existing product lines.

We are continuing to launch new products even though we haven't pre- announced any new systems. We have lots of products in the pipeline that will be announced virtually every quarter from here through next year..

And then Jon, on your question about inventory and receivables, you're correct, inventory, we talked about being up 9% and it was related to the ERP implementation and our building of safety stock to ensure a smooth transition there.

On the receivables, the DSO was up slightly from 59 days to 62 days just purely based to the timing of shipments being more back end loaded. And I'd say the AR book is still very, obviously, high quality and that's the DSO we're very happy with..

Okay. Thanks..

Our next question comes from Dan Arias..

Good afternoon, guys. Thanks. On the NextSeq system, Jay, I think back in, I believe, January you talked about the road show that you guys went on after that product was launched and I believe at the time you said you had generated something in the neighborhood of 2,500 or so leads.

Any way you can talk to how much of that you've worked your way through or converted just in order to try and get an updated view of the placement funnel there?.

Well, I don't have that number at my fingertips in terms of the size of the pipeline now. We did that road show shortly after launch in the early part of 2014. And we've seen benefit of that because the NextSeqs are marching up every quarter. I think the v2 chemistry has helped a lot.

So any customers who felt there was a slight difference in quality from NextSeq to HiSeq, that's now totally neutralized with the v2 kits on the NextSeq. So we're really bullish on NextSeq, I think particularly in the NIPT market as we launch the VeriSeq NIPT broadly as we penetrate China with that platform.

As larger panels come into the market where you need more throughput to run the panels, I think NextSeq is going to be really, really important product for us..

Okay. Maybe just as a follow-up on the X systems, I'm sure it's a combination of both, but maybe in general I'm curious whether you're finding that with the discussions that you're having on buying an X Five versus an X Ten, is it more a function of capital and funding right now, or is it more based on throughput and capacity? Thanks..

I'd say it's a combination. So the X Fives that we're selling are to customers who will likely become X Ten customers at some point in time, but they want to walk before they run, if you will, and they're willing to pay a little bit extra on the price per genome for a while until they really understand what their pipeline looks like.

So it's a combination of overall capital cost and whether they think they're ever going to get to an X Ten or not.

To be clear here, we're also seeing the HiSeq 4000 I think as a very important addition right along that spectrum, and so it's the case that some people who might have wanted to buy an X One or X Two had we offered that are now really happy with the HiSeq 4000 product line that allows them to run all the different applications that we have in the portfolio..

Okay. Thanks very much..

Our next question comes from Amanda Murphy with William Blair..

Hi. Good afternoon. So I just had a two-part question on the HiSeq. The first part is, I think pre-4000, pre the launch of the HiSeq 3000, HiSeq 4000 you were shipping roughly 70, 80 platforms a quarter.

So I'm curious, is that still the case and is that what you expect going forward just given that potentially the HiSeq 2500 to HiSeq 4000 conversion may not be exactly one-to-one given the throughput differences? And then the second part is there was also a discussion originally around the 1000 or so platforms that couldn't access the v4 chemistry of the 2000s and 2500s, maybe upgrading to the HiSeq 3000 or HiSeq 4000.

So I'm curious if you're seeing any evidence of that, either this quarter in shipments or in the backlog. Thanks..

So I'd say the number you cited for the total for all the HiSeqs, 2500s up through the 4000, is in the range and we're hoping the HiSeq 4000 gives us a lift there over the next few quarters. So we're doing really well in combination. The mix shifted very dramatically this quarter away from the HiSeq 2500 and toward the HiSeq 4000.

In terms of people doing upgrades, we don't have a lot of great data on that yet. We're certainly seeing some HiSeq 2500 customers who buy HiSeq 4000s turning off their HiSeq 2500s. And so we'll be – the way we report our reagent pull-through takes into account a certain fraction of the HiSeq 2500s that get turned off in the field.

And so that's how we do the accounting there and at some point, maybe we'll have to update the installed base of HiSeq 2500s for you. We're not prepared to do that today, but we'll probably do that at some point. Yes. So I guess that's all I had to say.

Did I answer your question, Amanda?.

Yeah. I guess I was just trying to get at whether there was this kind of evidence of incremental demand? And I guess you've talked a bit qualitatively, but incremental demand as the HiSeq 3000 customers perhaps couldn't access to before and then maybe they went on and bought the HiSeq 4000 because of the cost per base advantages.

Maybe they weren't planning on buying it, but the advantages on the cost perspective were so great they opted to do that?.

Yes. That we're definitely seeing. We had a couple genome centers that ordered multiple HiSeq 4000s and the reason they did is because they could add a couple HiSeq 4000s and turn off some of the older HiSeq 2500s that they might have in the fleet. And so we're definitely seeing that pattern happen in the field and I think we'll continue to see it..

Got it. Thank you..

Our next question comes from Isaac Ro with Goldman Sachs..

Hi. Good afternoon, guys. Thank you.

Jay, just hoping you could comment on maybe, broadly speaking, where you think we are in the adoption curve for X Ten? Just assume – and part of that question, I guess wondering if your guidance assumes that any new population sequencing studies get initiated in the second half of this year?.

Yeah. I'd say we're in the stable part of the X Ten lifetime right now, so that's why we gave the, sort of the quarterly ranges we should expect for your modeling purposes.

I do think any large-scale population sequencing projects could be incremental to those numbers, so throughout the rest of this year, we don't have built in any large purchases for singular population sequencing projects. And that's because it's hard to know when any of those will close and they tend to be relatively long-term sales cycles for us.

So that would be upside if perhaps somebody bought 20 or 30 for doing a large-scale project..

Sure. That makes sense. Thank you. And then just a follow-up, maybe a longer-term question on liquid biopsy, appreciate your comments on the maternal cancer study that was published.

I'm just wondering, as you think about like the size of some of these markets and what it costs to develop an IVD that's got the sensitivity and specificity that you need to have, is maternal cancer the type of product that you think is worth going after? Or is it just really an example, kind of proof of concept, and maybe there are other markets where liquid biopsy would be more compelling to start?.

Yeah. I think what we published really was just an example that was, I guess we call it, incidental. Right? So the test was not designed to detect maternal cancer. We got discordant results.

And when we went back to investigate in connection with those women that were in the paper, those 10, we were able to show that in fact what we were detecting was in fact cancer. So that isn't really how you would design a test if your goal is to detect cancer. It would be a very different test.

It would be deeper sequencing, it would probably include other kinds of markers and as I said earlier, we're investigating lots of different methods and trying to understand which cancers are best detected, with which assay methodology.

Ultimately, the goal here would be to create as general a panel as you can but likely this whole market will begin with more targeted panel types from us and from others that have specific knowledge of the variants that are known in particular cancer types. But you wouldn't use the existing NIPT test as sort of the default liquid biopsy..

All right. That makes sense. Appreciate the comments. Thank you, guys..

Our next question comes from Ross Muken with Evercore..

Good afternoon, guys. So I'm going to stick just on the topic of instrumentation or just sort of pushes and pulls. So we've sort of hovered around $150 million or so a quarter for, I don't know, four or five quarters now. You sort of intimated that X Five, X Ten will be in that sort of 20 to 30 placement units a quarter range.

As we think about what's going to break us out of this band to resume obviously at a huge step up from sort of the $100 million or so, or $85 million to $100 million range you've been doing for some time.

If we think about the next phase of the step up, is it really predicated on a new platform launch or is it, to your comments before, maybe something that develops in POP Sequencing that's sort of outside you're privy today to be able to model or is it come from one of the other smaller platforms? I'm just trying to get a sense for where you see the biggest ability to see that trajectory change..

Ross, I think it's going to come from all the new application areas that we're working on in the market development. And POPSEQ is really only one of those. Average risk is another and the whole VeriSeq NIPT platform we think will enable that. And that's starting to penetrate the market in Europe.

It will be a significant contributor in China here over the next year or two in terms of NextSeq placements. I think what's going on in the consumer market is we have some impact in sequencing.

I think over time the whole consumer space will begin to migrate away from arrays and toward sequencing because of the additional power you get from knowing all the bases rather than just the targeted bases.

What we're doing in forensics and HLA, we're in the very early phases of adoption in those markets, and those markets are going to be reasonably widely distributed, meaning there's lots of places that will run those applications and therefore I think will support instrument placements as well.

So if you look at the existing lineup of hardware, I think the upward momentum in instruments will be driven by market development across new applications..

And maybe looking at operating leverage, so you've been growing, it's on my math, on an organic basis OpEx in the 20%s and 30%s, sorry, on SG&A. That started to slow and you've got some really good leverage in 4Q and 1Q, and it continued to slow this quarter.

How should we think about that line because it looks like R&D has been more constant sort of 20%, how should we think about the investments you need in the commercial organization, and how much leverage you can show there, and how we should think about that relative to the top line momentum?.

Well, on a non-GAAP basis, our R&D and SG&A went up as a percentage of revenue this quarter from last quarter, so we do have a lot of open reqs. We have a lot of important things to be working on and so we're going to continue to add head count in key areas in commercial and in the R&D and research groups.

So we're not at the point right now where we're predicting additional expense leverage, and we think that's the right position for the company to take. Again, non-GAAP we're at the 37% plus operating margin and we're pretty pleased with that..

Great. Thanks....

Ross, we added – I mentioned in my remarks, we added 350 net heads to punctuate Jay's point a little bit. And you'll see a full quarter effect of those additions in Q3 plus the new additions, the open reqs that Jay mentioned starting to filter..

Perfect..

Our next question comes from Dan Leonard with Leerink..

Thank you. Can you comment on interest from new customers in the HiSeq 4000? I believe you gave commentary on the benchtop market, but I don't think there was commentary on the high-throughput market..

Yeah, I mean, clearly we have new customers in the HiSeq part of the market as well, Dan, but it's much less as a percentage than we have on the desktop instrument version just because of the capital cost. And most of the people who have been in the Sequencing market already own some version of a HiSeq, so they wouldn't be a new customer to us..

Okay. And my follow-up, Jay, I'm trying to better understand the sequential decline in consumables revenue. I hear you that arrays were weak, but just given the relative proportion of arrays versus sequencing and all the commentary on sequencing, I would've thought sequencing consumables would have been enough to sequentially offset array weakness.

Can you help me understand what I'm missing?.

Yeah..

Yeah. Dan, I can cover that. Obviously, Q1 was very strong sequencing consumable growth. Q2 continued to grow but it was obviously offset by the array business decline, which pulled the overall growth number down.

But as I mentioned on the call, we've seen, boy, we've seen eight quarters now of sequencing growth, sequencing consumable growth in excess of 30%. So we're very pleased with the Q2 result. I mentioned that both HiSeq X and NextSeq were slightly above their ranges, and the other instrument were within their ranges.

So we're very comfortable with that outcome..

Okay. Thank you..

Our next question comes from Bill Quirk with Piper Jaffray..

Great. Thanks. Good afternoon, everybody..

Hi, Bill..

I want to thank you for the comment around the clinical and the translational instrument trend. It looks like that ticked up here nicely in the quarter.

Can you help us think about maybe the bigger picture here? And what I'm trying to balance is we had this very rapid adoption curve going on in the clinic, and frequently around oncology as well as some other applications. But at the same time it looks to us like there's a little bit of inconsistent reimbursement trends in the States.

And so I'd kind of love to hear some longer term thoughts there. And then also we're seeing some really nice, encouraging interest over in Europe as well, and any color there would be great. Thanks..

Okay.

Reimbursement is classically a challenge for customers in the lab business, but part of the work we're doing in the onco panels is to deal expressly with that problem, and why we're working so hard to get IVD products approved so that we can have standardization around the products which makes the reimbursement easier because you have the clinical evidence and you have an FDA approved product.

So our whole focus is to push these products toward IVDs that we think we think will accelerate the overall reimbursement. With respect to Europe, I'd say we had a good quarter in Europe. It was not as good as the Americas, the Americas really, really had a great second quarter.

So we're super strong in the Americas, good in EMEA and not good in APAC is the sort of overall profile of the geographies..

Got it. And then just a quick one for Francis regarding the ERP system, you mentioned that you're going live here in about a week or so.

Is there any – and I certainly recognize you've been hiring a lot of people so you have additional OpEx, but is there any potential decline or associated reduced spend associated with that now that you have it implemented or I should say will have it implemented next week?.

Sure. Actually, Marc is driving our ERP implementation. So maybe I'll turn it over to you, Marc..

Yeah, Sure. I wouldn't expect any immediate reduction in spend other than what's in capital in general, because there's the project related expenses tend to hit there. We still need a significant team to continue to manage through the initial period which we call hypercare and then on an ongoing basis.

And then thinking about longer-term, one of the reasons for doing these projects is it enables us to scale and grow at a rate that is lower than the revenue growth and give us some leverage. And we would expect to see some benefit from a system like this over time, over a longer period of time.

But we're going to be in this mode of implementing follow-on phases of ERP for the foreseeable future..

Got it. Thanks guys..

Our next question comes from the line of Steve Beuchaw with Morgan Stanley..

Hi. Good afternoon. Thanks for taking the questions. I'll start on the X. I'll reiterate the thanks for the 20 to 30 guidance. That certainly gives us more clarity there.

Just as a follow-up to Isaac's question, I wonder, given how specific HLI has been about their plans to ramp up capacity this year, have you incorporated any HLI capacity expansion into that 20 to 30?.

Well, we've incorporated an overall forecast that kind of averages our probabilities across all the customers we know of. If the kinds of comments that have come out of HLI actually come to fruition, that's going to be an upside to the number if that happens in 2015..

Okay. And then on NIPT, you made a comment here in the Q&A about thinking about moving to average risk. I think the last time you commented on that process you had a view that in the U.S. that move might be more likely for late 2016.

Am I sensing that maybe you're a little bit more optimistic about the timing there given some perhaps more open-minded language from ACOG here recently?.

Well, I guess our view hasn't changed on when we think ACOG or the guidelines will change with respect to average risk. But we are seeing the test being increasingly used in average risk patients, largely on a self-pay basis.

And I think in Europe that will happen, particularly with the launch of the VeriSeq NIPT, I think labs have a more efficient way to do NIPT testing which will make the self-pay market more assessable. And so I think you'll see the leakage rate into average risk increase..

And specifically, we view the ACOG commentary as a positive step in that direction because they removed their recommendation that you don't use NIPT for average risk screening, and so we feel incrementally we're seeing steps towards that timeframe..

Got it. Very clear. Thanks everyone..

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

Hi there, everybody. Thanks for taking the questions.

How important or meaningful was Berry following the Chinese FDA approval in driving your NextSeq backlog and NextSeq sales in the quarter?.

We did get some orders from Berry, it wasn't a gigantic single order placement, I think they'll be spread out over time. So we did get some units from them but nothing that in and of itself moved the needle in a big way..

Sounds good, Jay. And then a follow-up on NeoPrep, how are things shaping up with the pipeline there? Any thoughts on attachment rates to HiSeq currently and as we think out into the future? Thanks, guys..

Yeah. The incoming order rate is pretty good on NeoPrep. We're just – we've been anxiously awaiting the time when we felt we could fully ship this product and we're now there. As we mentioned in the script, we worked really hard on this and it's complex to get this product super robust because we do tens of thousands of operations in a single run.

And if you look at the statistics on this, if any one of those operations fail, a sample doesn't work. And so it's required some really great engineering to get this to where we've gotten it now and we're feeling really comfortable about it with the first kit, we're close to releasing the second kit, and then we've got a line-up of kits behind that.

So we've made really fundamental improvements to the technology and we understand it really, really well.

So I think you're going to begin to see the shipment rate increase and the shipments in Q2 were really pretty insignificant because we were still dealing with a handful of test customers to make sure we got them very happy with the platform and the results, success rate results on the instrument..

Wonderful. Thank you..

Our next question comes from the line of Jeff Elliott with Baird..

Yeah, thanks for the question. First one from me, Jay, on SeqLab, do you have any color you could share on where that offering could bring customer utilization on the X Ten, really in light of your comment about the concentration of utilization amongst the handful of customers.

And then as a follow-up, do you have any plans right now to expand the X Ten to other sample types or beyond whole genome sequencing?.

Yeah. I'll make a comment on that and maybe Francis can add some comments about the product itself. Our hope certainly is that having SeqLab in place allows us to accelerate pretty substantially the rate of customers coming up the curve on a HiSeq X Ten.

As we've plotted the consumable rates, you heard us say in the script that it's very biased, the consumables are very biased toward a few customers at the high end.

And then it's – we've used the word bimodal but really if you look at the plot it just trickles down in a relatively linear fashion to customers at the low end, particularly geographies who are not using it as much as they should.

And so our goal is to just move all those customers up and I think having a software architecture around the boxes that simplifies all the lab management challenges that customer have, is going to push that up.

We're not ready to sort of quote a rate on how fast that will go or what it'll do, but given the fact that we're already running above our guidance in terms of consumables on the X, to the extent we can move that curve at all is going to be very, very helpful to us.

Francis, any comments on the product itself?.

Yeah. Sure. So one thing we heard consistently from customers around the X is that they were viewing the IT and informatics challenges as daunting and as, frankly, taking them time to actually get the lab up and running. And so the idea with SeqLab is to provide them this integrated solution that'll help them in a number of ways.

One, it'll speed up how quickly they get the lab up and running. And then two, it'll enable them to be higher velocity sequencing labs. We have data, for example, when we look at our BaseSpace users, the data we have suggests that – today about 50% of our customers are connected to BaseSpace.

And the data shows that customers who are connected to BaseSpace, on average are higher velocity customers than other customers, and so we see that in higher pull through. And so the idea with SeqLab is to enable our high throughput customers to get that same benefit..

There was a second part to your question I didn't get to.

What – remind me what that was?.

Yeah. Opening up the X Ten to other sample type? Their – yeah..

Right. Yeah. Well, we continue to evaluate that. We've, in our planning sessions debate every quarter what the future of the X will look like in terms of whether we stick with X Five, in terms of how the units are deployed and whether we open other applications or other organisms.

We don't have any decisions we're ready to share today about that, but we continue to evaluate it. And if some point, it's likely we'll make some changes on the X platform, but nothing to report today..

Great. Thanks, guys..

Our next question comes from the line of Dane Leone with BTIG..

Hi. Thank you for taking the questions. So I just wanted to kind of revisit the consumable question, Q-on-Q because it seems to be a topic of concern.

Could you maybe clarify some of the projects that you have going on with the HiSeq X customers to help them ramp up? And how you kind of see that playing out? We've spoken to people in industry and saying, yeah, getting samples can be difficult and it's going to take time.

Just maybe any color there in terms of how you see that higher utilization, higher capacity genome center really ramping up over the next couple quarters?.

Well I'd say on the X Ten – X Fives and X Tens, the classical high throughput sequencing labs are the ones that are at the high end of the user group that we have today. So they already knew how to do sequencing. They had plenty of samples. Many of them had samples in the freezer that they just couldn't fully sequence before because of price points.

So those customers tend to already be at the high end of our curve.

The ones we're working on are the ones that don't have the limb systems in place, don't have the analytics in place to analyze the data, and so some of them will turn on their X system and all of a sudden they've got 5,000 genomes, but they don't know how to analyze the genomes, and so they slow down a little bit until they figure that out.

So SeqLab helps that a lot. In some places, we can help with samples; in some places, we can't. We just have to let them deal with their sample acquisition challenges. Some of that has to do sometimes with consent.

Some of it has to do with whether they're trying to access clinical pipelines and regulatory issues around access to clinical pipelines and samples. But in some cases, we can help customers get access to projects if they're doing things more in the service business and we do do that pretty routinely.

And then you have at the very low end of our utilization curve, those customers where the purchase is almost more of a vanity buy, and we try to not do many of those.

In fact, we push back on quite a number of customers who've said, we want to be in this game and there was really no clear thing they were going to do with the X, and so we haven't sold to them. But there's still a few at the low end that are not utilizing the system as we expect they should..

Okay. Great. Thank you..

Our next question comes from the line of Tim Evans from Wells Fargo Securities..

Thank you. It seems like there might be a little bit of a disconnect if we frame things in terms of your TAM which you've laid out. Arguably, the commentary around some of these markets has been that uptake has been maybe faster than we've expected, and yet your revenue growth for the year has been – your expectations haven't really gone up in tandem.

Can you comment about whether you still feel comfortable around some of the key assumptions that went into building some of the bigger pieces of that TAM model?.

Yeah, I think we feel quite comfortable with that, and in fact, there's things that have happened since we talked about the TAM that not only make us comfortable with the numbers we gave, but probably would cause us, if we were to revise them today, to do that in the upward direction.

In our markets, in general, the way the markets develop is that you see a gradual adoption rate, which extends over some relative period of time, a year or a couple of years, depending upon the market segment, and then the market hits an inflection point, and that inflection point can be driven by factors such as reimbursement, by the publication of clinical studies.

In the case of NIPT, it became a marketplace that exploded because the clinical data came out and replaced an invasive test. And so in oncology, we're going to see that inflection point happen. Is it going to happen a year from now or two years from now, it's hard to predict.

But there will be an inflection point in the oncology market where that market will explode. And that would be around perhaps the time when in-practice guidelines it becomes standard of care to sequence every tumor when it's biopsied, and that will cause the market to grow very, very quickly.

In the POPSEQ market you'll see that inflection point once you begin to see the existing POPSEQ projects begin to demonstrate the fact that sequencing whole human genomes actually has an impact on the quality of care and the economics of health care. And once you start seeing that, that market will explode as well in our view.

In the consumer market I think there's factors around that as well that we could go into about what's going to kick the consumer market into high gear. But I think there's some potential things that might happen here over the next year or two that could do that as well..

That's very helpful. Thank you..

I will now turn the call over to 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 the third fiscal quarter..