Analyst Conference Summary

conference date: October 20, 2015 @ 2:00 PM Pacific Time
for quarter ending: September 27, 2015 (third quarter, Q3)

Forward-looking statements

Overview: Revenue growth good, but missed guidance.

Basic data (GAAP):

Revenue was $550.3 million, up 2% sequentially from $539.4 million and up 15% from $480.6 million in the year-earlier quarter.

Net income was $118.2 million, up 16% sequentially from $102.2 million, and up 26% from $93.5 million year-earlier.

Diluted EPS was $0.79, up 14% sequentially from $0.69, and up 25% from $0.63 year-earlier.

Guidance:

Fiscal 2015 non-GAAP revenue growth of 18% y/y, with EPS $3.29 to $3.31.

For Q4 revenue near $570 million with non-GAAP EPS $0.78 to $0.80.

Conference Highlights:

"The fundamentals of our business remain strong, despite a 3% miss to revenue expectations,” stated Jay Flatley, CEO. “Our competitive position and product development pipeline are as robust as ever, which we believe will enable our continued penetration of the enormous market opportunities ahead.”

Shipments to clinical and translational customers grew over 40% y/y. Oncology customer shipments are now 20% of revenue. NIPT revenue growth continues.

Array revenue was down 17% y/y, but is not less than 15% of revenue, and it stabilized in Q3 and it projected to grow slightly in 2016 due to agricultural applications.

HiSeq sales exceeded expectations, with revenue flat against prior year difficult comparisons. Customer count is now 25. NextSeq sales were stable y/y. MiSeq sales showed a slight decline. 4000th MiSeq order during the quarter. NIPT specific NextSeq orders grew 60% y/y, driven by China.

Consumable revenue was up 23% y/y and represented 58% of total revenue.

Services revenue was up 23% to $79 million, driven by NIPT service growth.

The quarter included a $24.8 million GAAP tax benefit due to a court ruling.

Non-GAAP numbers: net income $120 million, flat sequentially from $119.7 million, and up 5% from $114 million year-earlier. Diluted EPS was $0.80, flat sequentially from $0.80, and up 4% from $0.77 year-earlier. Gross margin was 73.2%, up sequentially from 72.4%, and flat from 73.2% year earlier. 36% operating margin, down sequentially from 37.4%. Non-GAAP figures exclude legal settlement benefits, stock-based compensation, amortization, non-cash interest expense, a tax benefit, and smaller items.

In the quarter Illumina launched TruSight® Tumor 15, a panel designed to identify variants in 15 genes commonly associated with oncology therapeutics; launched new TruSeq® Custom Amplicon, Rapid Exome and Exome library preparation kits; introduced Infinium® arrays that explore genetic variation through population and disease specific genotyping;
Launched BaseSpace® fully integrated Laboratory Information Management System (LIMS) solutions; and expanded the rights of use for the HiSeq X™ Sequencing System to allow customers to perform whole-genome sequencing of non-human species.

Illumana also entered into a collaboration with Memorial Sloan Kettering Cancer Center to conduct research studies focused on understanding the biology of circulating tumor DNA;
entered into collaborations with Burning Rock and Amoy Diagnostics to develop clinical applications in China for oncology diagnostics.

The formation of Helix, a joint venture to empower consumers to discover insights into their genomes was announced.

Illumina completed the acquisition of GenoLogics.

Cash, equivalents and investment balance was $1.44 billion, down sequentially from $1.51 billion. Long term debt was $1 billion. Cash flow from operations was $181.0 million. Free cash flow was $151.5 million. Capital expenditures were $29.5 million. $37.5 million was used to repurchase stock and $204.7 million was used to settle the 2016 senior notes.

GAAP cost of revenue was $162.7 million, leaving gross profit of $387.5 million. Operating expenses were $246.8 million, consisting of: $99.2 million for research and development; $136.5 million for selling, general, and administrative; legal contingency $15 million; headquarters relocation benefit $5.2 million; and a $1.1 million acquisition related expense. Leaving income from operations of $140.8 million. Other expense was $11.9 million. Income tax provision $13.3 million.

Stock-based compensation expense was $32.2 million.

Q&A:

Benchtop market, why not a market demand issue? Combination of factors. More sales people would have helped. Sales focussed on high end, hard to get them to focus on low end machines. Japan demand was low.

2016 operating expenses? Our Q4 rate should give you a clue, especially if you consider the effect of Helix in 2016.

Competitors have launched enhancements. What can you tell us about your new development efforts and competitive dynamics over the next two years? We have a rich portfolio of product opportunities and new markets. Less of a % of R&D is going into platform technologies. We are investing more in full sample to answer solutions. We can't talk about specific products in the pipeline. Our new products are more complex than they were a few years ago, and need much more documentation, including clinical trials. But they can open up new markets in a regulated space. We have to spend more to open up these new markets.

The HiSeq non-human extension is going to have a positive impact; we have customers set to use this.

MiSeq and HiSeq in hospital setting? We are seeing a broad adoption of instruments in the clinical markets. We are seeing new to NGS customers starting with the MiSeq family.

What gives you the confidence you can maintain a 15% growth rate in 2016? First there is the increase in consumable from machines sold the year before. We believe Japan will come back in 2016. Arrays coming back should help still, and population sequencing services.

New cancer product & others, customer feedback? Early indications on TruSight Tumor 15 are positive, but it is too early to have any revenue slope on that as we just launched the product. We think we have the content of the panel right for the research market. But we cannot sell it as a diagnostic product without going through the FDA, and might choose a different product for that. Reimbursement could also be challenging.

Capacity expansion vs. new customers? The figure we gave for HiSeq X includes a good mix of both. The X5 should be thought of as a stepping stone to the X10.

Diagnostics market opportunity, reimbursement issues? We are working with trade agencies to influence regulations and reimbursements. We hope to get misguided results fixed. We want to get standards created, and are working with the FDA and foreign regulatory bodies. We are also doing clinical trials to demonstrate the value of our products.

Neoprep and digital fluidics are very important to us, and there will be many products developed based on them. But the technologies will need to get incredibly simple to use so that they can be useful to hospitals and smaller institutions.

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