Illumina, Inc. (ILMN) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 Illumina Inc. Earnings Conference Call. My name is Jackie, and I will be your coordinator today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Ms. Rebecca Chambers. Please proceed.

Thank you, and good afternoon, everyone, and welcome to our earnings call for the third quarter of fiscal year 2013. 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, President and Chief Executive Officer; Marc Stapley, Senior Vice President and Chief Financial Officer; and Christian Henry, Senior Vice President and General Manager of our Genomic Solutions business. Jay will provide a brief update on the state of our business and Marc will review our third quarter financial results. This call is being recorded and the audio portion will be archived in the Investors 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 Piper Jaffrey conference in New York the week of December 4. 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'll now turn the call over to Jay.

Thanks, Rebecca, and good afternoon, everyone. I'm really excited to share with you today my thoughts on how we've recently reorganized the company for growth, our outstanding Q3 results and a robust outlook for our core sequencing platforms. Last week, we announced organizational changes that will help us continue our growth in existing markets, take the next steps into new markets and further catalyze the use of our technologies in the clinic. We better aligned our business units with our customers, centralized core cross-company functions and consolidated our commercial channel. These changes are effective January 1, and we're excited to share more with you next year on our progress to catalyze the new market opportunities ahead of us. Q3 was a remarkable quarter for Illumina, delivering our 8th consecutive quarter of sequential revenue growth. Revenue grew 25% year-over-year to $357 million as a result of positive underlying trends across all geographies and most product lines. In the third quarter, approximately 45% of shipments were to commercial, nonprofit and hospital customers, a further demonstration of our increasingly diverse revenue base, less and less exposed to government funding. Previously, we had projected to reach a goal of 1/2 our revenue coming from applied markets within 5 years. But given the progress we've made to date, I'm confident we will accomplish this goal shortly. Over the last few weeks, there's been speculation as to whether the government shutdown would materially impact our fourth quarter results. While the shutdown was very unfortunate for a few of our customers, we have not seen a material impact on spending patterns. Importantly, for most customers, external funding was flowing as expected during the shutdown. With the government now open and operating under a continuing resolution, we're seeing customary purchasing patterns. We expect this to continue going forward as customers and grant allocations maintain preference for sequencing over other technologies, as has been the case for the last few years. I'll now turn to the specifics of our Q3 results. This quarter, total microarray revenue decreased 3% year-over-year, as a decline in instruments and consumables dollars more than offset substantial demand for genotyping services. This quarter, we processed approximately 90,000 consumer, agriculture and research genotyping samples, a new record and a trend we expect to continue. As we've previously shared, the array market trend is toward large sample numbers at lower complexity and thus lower ASP per sample. As a demonstration of this, year-to-date, Infinium sample orders have already exceeded the total level seen in 2012, as a result of demand for our Infinium, HumanCoreExome and Omni Exome products. We remain confident in the long-term outlook for the array market, which we believe will be bolstered by recent product introductions, including our updated Infinium arrays, which enable 24 samples per chip. By increasing the samples per array, we improve the economics to our customers and empower them to perform more studies based on even larger sample numbers. Initially, this format will be rolled out on the OmniExpress and OncoArrays, but will be made broadly available across the Infinium product line next year. The advancements made in our Array format have facilitated new array pricing that we've recently introduced. While this announcement was made just a short time ago, we've already been in dialogue with customers who are planning new large volume GWAS studies enabled by this pricing. The feedback reinforces our thesis that the array market has remaining elasticity, a theory that we plan to test by unlocking the portion of the market which demands lower price points, including biobank and large agricultural opportunities. Our custom OncoArray leverages the 24-sample configuration and affordable pricing. This array began shipping in October to early access consortium members and we plan to offer the OncoArray to non-consortium customers in 2014. Another custom array product that is building excitement is our new PsychArray [ph]. Designed by the Psychiatric Genomics Consortium and based on the HumanCoreExome chip with an additional 50,000 custom probes, this product will be used to conduct genome-wide meta analysis on large sample numbers in an effort to identify robust and replicable associations. As we move into 2014, we expect additional exciting projects similar to the OncoArray and PsychArrays [ph]. Turning now to our sequencing business. Our results demonstrate our competitive strength, the penetration of NGS into new applied markets and the acceleration of clinical adoption. Sequencing revenue grew 37% year-over-year in the third quarter, driven by impressive demand for consumables and HiSeq instruments. Sequencing consumables grew 38% over Q3 of last year due to higher utilization of HiSeq instruments and our larger installed base, as well as growth in our Sample Prep business. Q3 Sample Prep shipments grew more than 25% year-over-year, due primarily to interest in our Nextera-based product lines. Specifically, our Nextera Rapid Capture custom enrichment and Nextera XT product offerings yet again saw increased demand in the quarter. Year-to-date, shipments have already eclipsed full year 2012, and there continue to be extensive opportunities for growth in this area. We remain focused on delivering a portfolio of Sample Prep products with improved ease-of-use and a more complete user experience. As part of this focus, our collaborations with leading vendors of robotic platforms have advanced. This quarter, we delivered a fully automated method for TruSeq stranded RNA and have additional automation methods in the late stages of development. This program is an example of our efforts to equip our customers with automated Sample Prep solutions. Turning now to instruments. Q3 sequencing instrument revenue grew 26% compared to the third quarter of 2012, primarily as a result of robust demand for HiSeq instruments. Since the launch of the HiSeq platform close to 4 years ago, there have only been 4 quarters in which we shipped more than 100 units, the level we shipped in Q3. Current customers remain capacity-constrained. And as a result, more than half of the HiSeq units ordered were from existing customers. We also saw customers scale their facilities, including centers in Japan targeting biobank sequencing. New customers accounted for approximately 40% of HiSeq orders and as evidence of our extended geographical reach, more than 1/2 of these customers were located outside the United States. Commercial, translational and hospital customers continue to place significant value on the benefits of the HiSeq 2500 rapid run technology. This quarter, more than 80% of HiSeq shipments were for the 2500 family, and importantly, commercial and translational customers accounted for about 1/2 of HiSeq sales. Customer feedback continues to highlight the inherent flexibility and speed provided by the rapid run technology. In the third quarter, we introduced our new reagent kits for MiSeq, which doubled the throughput to 15G per run by increasing the number of reads and overall read length. With the introduction of this new reagent kit, we have enabled more applications to be run on the platform, including exome sequencing, RNA-Seq and targeted RNA. Interest in this product enhancement has been high, and since launch, approximately 20% of MiSeq reagent revenue has come from the new kit. This product enhancement again furthers the value we deliver to customers by continually improving instrument performance and adding to our leading position in the benchtop sequencing market. Again, this quarter, more than 50% of MiSeqs were ordered by nonacademic customers due to enthusiasm from pharmaceutical, translational and clinical segments. Many of these customers are interested in our TruSight content sets. To date, close to 200 customers have used our panels, primarily the tumor, inherited cancer and exome sets, and are validating the assays in their laboratory setting, a process which typically takes 9 months. We also recently introduced our new TruSight 1 panel, which includes more than 4,800 genes with known associated clinical phenotypes. We're excited to hear from more customers at ASHG regarding interest in this new panel. We remain keenly focused on enhancements to our core technology in areas such as long reads and ordered arrays. Our development efforts in ordered arrays will enable us to selectively deliver kits and applications where we feel the advantage will offer the highest market value. We expect the first customer experience with ordered arrays around yearend and remain very excited to launch both of these technologies. As you know, our workflow architecture includes BaseSpace, an integrated cloud ecosystem. To date, there have been more than 13,000 launches of applications housed by the BaseSpace App Store. We recently signed new app partners, providing informatics tools for viral metagenomics with path GeneDx [ph] and pathway analysis through GenoMatrix (sic) [GenoMatix]. We have broadened the number and functionality of apps. And as part of our continuing effort, we're hosting a BaseSpace developer meeting today at ASHG with more than 120 developers. The goal of this meeting is to enable networking, idea exchange and education about the BaseSpace platform. Alongside this event, we announced the BaseSpace native application programming interface, which allows developers to run tests and deploy their apps directly inside the BaseSpace environment. Existing and potential developers will now have a simpler, faster and inexpensive way of making their tools public in a powerful distribution channel. Moving to FastTrack Services. This quarter, we shipped more than 3,000 whole human genomes, close to a 90% increase from the 1,600 genomes in the prior year period. This quarter saw orders for more than 10,000 genomes, a new record. Our partnership with the Global Genomics Group contributed to this result, and we look forward to working with them to investigate novel biomarkers and biological pathways involved in the development and diagnosis of cardiovascular diseases. Additionally, today, we announced the start of a 3-year project in collaboration with the University of Cambridge and Genomics England to sequence 10,000 whole genomes of children and young adults with rare genetic diseases. This project is the beginning of the U.K.'s effort to sequence 100,000 genomes and our participation validates our scale in high-throughput sequencing. These programs, alongside many other population projects being discussed, are going to be critical to accelerating the discovery of new associations between the human genome and disease. We're seeing very rapid adoption of noninvasive prenatal testing and our position in this market has been bolstered with our Verinata acquisition. During the quarter, we signed a supply agreement with Natera and our conversations with other NIPT customers are progressing forward. Verinata is 1 of 2 providers able to service the New York state as a result of the laboratory permit we received for the verifi tests. Importantly, physicians now can recommend verifi for women pregnant with twins, as we've extended the capabilities of the test to this population. Reproductive health remains a key market and our new organizational structure and leadership will enable us to create a strategic brand position by delivering a more integrated portfolio to our customers. Given the tremendous opportunities for our sequencing and array technologies, we need to continue to focus our R&D and commercialization priorities. And as a result, we're exiting the qPCR market. This decision was due in part to our belief that sequencing delivers advantages over qPCR technology for gene expression applications. It's important to note that any decision to exit a platform or stop a program is always difficult, but we pride ourselves in being decisive and deliberate when it comes to allocating resources. As a result, we plan to cease selling the Eco qPCR instrument and our NuPCR assays by the end of this year and will continue to provide service and support to the installed base for our customary period. The financial impact to future non-GAAP revenue and EPS is minimal, and all operating expense currently allocated to the qPCR franchise will be reprioritized to other programs. In summary, we're seeing significant momentum in our markets, we're focused on finishing 2013 on a high note and we look forward to our opportunities in 2014. We're inspired by what our customers are accomplishing with our technology and remain dedicated to improving human health by unlocking the power of the genome. I'll now turn the call over to Marc, who'll provide a detailed overview of our third quarter results.

Thanks, Jay. As Jay mentioned, the third quarter marked another exceptional period for Illumina. This included our second highest order quarter ever and record shipments, both leading to record revenue. Third quarter revenue was $357 million, an increase of 25% year-over-year, which included organic revenue growth of about 20%. Strength in sequencing consumables and continued impressive demand for HiSeq instruments led to this quarterly performance. Globally, demand for our products remained strong in each region during the third quarter. Revenue in the Americas grew 25% year-over-year and Europe saw a 27% increase over the same period last year. In APAC, revenue grew 22% year-over-year, driven by continued strength in Japan, where HiSeq instruments had a particularly good quarter. Instrument revenue grew 21% year-over-year to reach $100 million in the third quarter. This increase was primarily driven by incredibly robust year-over-year demand for HiSeq instruments, as well as higher MiSeq shipments. MiSeq orders were down slightly sequentially due in part to multiunit orders in Q2, but were up year-over-year. This quarter, we completed the remaining HiSeq 2500 upgrades, deriving revenue of $3 million. With the launch of the HiSeq 2500, we've delivered higher data quality, with inherently more flexibility, all at a faster turnaround time. As a result, this is one of our most successful product rollouts to date and customer feedback remains immensely positive. Consumable revenue in the quarter was $216 million, an increase of 22% compared to the third quarter of 2012, primarily due to our growing installed base, as well as higher demand for Sample Prep and sequencing consumables. Consumable revenue represented 60% of total revenue compared to 62% in both Q2 and the prior year period, primarily due to the further strength this quarter of HiSeq instruments. In Q3, annual HiSeq pull through per instrument was well within our projected range of 300k to 350k, significantly higher year-over-year and up slightly sequentially as the typical seasonality associated with the vacation season was more than offset by increased customer utilization of core sequencing consumables. This quarter, MiSeq utilization was below our annual projected pull through range of 45k to 50k. We believe this was due in part to high throughput labs using HiSeqs in place of MiSeqs in an effort to receive the best economics. This trend, in addition to more than 70% of MiSeqs being placed with new customers year-to-date and customers taking 2 to 3 quarters to validate assays under development, has led us to reset our annual MiSeq projected pull through range to 40k to 45k, which we view as a stable range going forward. Services and other revenue which includes genotyping and sequencing services, instrument maintenance contracts and revenue from Verinata grew more than 60% versus Q3 2012 to equal $38 million. This improvement was driven primarily by an increase in genomes processed year-over-year, demand for our genotyping services from agriculture and consumer customers, the ongoing growth in our extended maintenance contracts associated with a larger sequencing installed base and revenue from Verinata. Turning now to gross margin and operating expenses, I will highlight our adjusted non-GAAP results, which exclude legal contingencies, impairment of assets primarily associated with the Eco and NuPCR product lines, noncash stock compensation expense, expenses related to Roche's unsolicited tender offer 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 was 70.2%, as compared to 69.5% in the second quarter, due to lower warranty costs and sales of higher-margin instruments. Year-over-year, gross margins were 30 basis points lower due to the impact of acquisitions and the lower mix of consumables. Adjusted R&D expenses for the quarter was $61 million or 17.2% of revenue, compared to $59 million or 17% of revenue in the second quarter. The sequential increase in R&D expense was primarily due to the impact of headcount addition and the acquisition of ALL, both of which are important components of our long-term growth. Adjusted SG&A expenses for the quarter were $74 million or 20.6% of revenue compared to $70 million or 23 -- 20.3% of revenue in the previous quarter. The sequential increase was primarily due to the acquisition of ALL, additional headcount to support our planned commercial growth and our project focused on improving global business processes. Adjusted operating margins were 32.4% compared to 32.3% in the second quarter, as higher revenue more than offset the impact of ALL and increased headcount. Compared to the 35.1% reported in the third quarter of last year, adjusted operating margins were lower due to the impact of acquisitions, as well as increased investment in R&D and SG&A to support our long-term growth. In the third quarter, we recognized approximately 800k of adjusted other income. Our non-GAAP tax rate for the quarter was 29.4% compared to 33.9% in the third quarter of last year and lower than expected due to a onetime adjustment to prior year returns related to the R&D tax credit. Non-GAAP net income was $63 million for the quarter and non-GAAP EPS was $0.45. This compares to non-GAAP income and EPS of $54 million and $0.41, respectively, in the third quarter of 2012. We reported GAAP net income of $31 million or $0.22 per diluted share in the third quarter compared to $30 million or $0.22 per diluted share in the prior year period. Current period results include an impairment charge of $25 million for the remaining assets associated with the Eco and NuPCR product lines and $4 million recorded in cost of goods to reflect the ongoing royalty associated with BeadChip sales, plus interest. Expenses related to Roche's unsolicited tender offer were $1 million. Going forward, we're very pleased to announce that we do not expect to incur further tender offer-related expense as the associated contracts have come to an end. We generated cash flow from operations of $83 million during the third quarter, capital expenditures were $19 million, resulting in $64 million of free cash flow. We ended the quarter with $1.03 billion in cash and short-term investments; Q3 inventory was $160 million, lower than the second quarter, despite sequential revenue growth. DSO increased modestly to 60 days compared to 55 days last quarter as a result of a significant percentage of shipments in the last month, as was expected for Q3. As mentioned on our Q2 call, during the quarter, we retired approximately 3 million warrants associated with the 2014 convertible debt call spread for $125 million. As we have outlined, our business has exceeded our expectations year-to-date. And as a result, we are boosting both our revenue and earnings per share guidance. For 2013, we are now projecting approximately 22% total company revenue growth, an increase in the previous guidance of 20%, and full year non-GAAP EPS of $1.75 to $1.77, higher than our prior guidance of $1.68 to $1.72, which reflects a strong EPS figure in Q3 and ongoing investments that will occur in Q4. These projections include the impact of the Verinata and the ALL acquisitions, as well as additional investments expected to incur in Q4 to support our long-term growth. Assumptions embedded in this guidance include full year gross margin of 69.5%, stock compensation expense of $105 million, and the full year pro forma tax rate of 30%. Lastly, at the current stock price, full year weighted diluted shares outstanding are expected to be 139 million. In summary, we have had really encouraging year-to-date results. We remain focused on building our business to support a multibillion-dollar revenue stream and are driving what we believe to be the most innovative commercial and product strategies to support the long-term opportunities that we face. 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. Operator, we'll now open the line to questions.

[Operator Instructions] And our first question comes from the line of Tycho Peterson with JPMorgan. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: First one, just on the reorganization. I guess, with the new divisions, we've been getting a little bit -- few more questions about your plans in oncology. Wondering if you can talk a little bit more about this strategy there and maybe the thought process behind the reorg?

I'll be happy to, Tycho. So the strategy in oncology is to focus on continuous improvement of the tool set that we provide to that market. We don't believe, as we've stated previously, that Illumina is going to take a proprietary position in particular tests in the oncology market that we would provide through our own lab operations, but rather, we're going to continue to improve the sequencer, obviously, as well as the automation of the Sample Prep, focus on specific aspects of Sample Prep that need to be optimized for the oncology market and really fine tune the software to make the ability to decipher cancer genomes ever more powerful. And so it's really a focus on the customer base for oncology, as well as improving that tool set that this business unit will be focused on. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: Okay. And then, a follow-up, just on the funding, and I appreciate your comment on the government shutdown, but a number of labs did miss the October funding cycle. Can you just talk about how we think about a lag effect to the extent that some of those customers now have to wait until February to submit grants?

Well, there may be a few of those, Tycho. But we think it's really going to be noise in our financials. So we haven't seen any specific changes in our forecast as a result of labs not getting funded. So that there certainly probably are a few of those, but we don't think there's going to be any impact on us.

And our next question comes from the line of Doug Schenkel with Cowen and Company.

You talked about growth in the clinical applied and commercial markets. In our checks, it seems like demand from biopharmaceutical companies is driving increased utilization of sequencers at many of your existing customers' labs. And the sense we get is there could be a number of new partnerships announced over coming months pursuant to areas such as companion diagnostic and biomarker research. I'm wondering, are you seeing any notable increase in demand from biopharma for instruments directly? Or do you expect biopharma for at least the near term to be more of an indirect driver to demand through existing customers?

I'd say some of both, Doug. We certainly have seen increased demand for instrument purchases for the routine research going on in the biopharmaceutical industry and we get orders for the labs around the world on a routine basis. We also have seen a real shift in the technology focus for companion diagnostics, I'd say probably over the last 18 to 24 months, moving away from 1 or 2 biomarkers that are typically measured using PCR, much more toward sequencing the entire genes that are relevant as a potential diagnostic for their medicines. And that's for obvious reasons that we now understand that there's many variants in these genes that could cause the gene to misfunction or malfunction. So we're very optimistic about the potential for companion diagnostics to move towards sequencing. I think, in terms of partnerships, they are always challenging because the need of the pharmaceutical industry is to have a product ready the day a drug gets released into the market, be globally available. And as we all know, the fraction of those drugs that actually get approved by the FDA is pretty small. So making a very large investment years before a drug decision date is a challenging business model. So we're working through that, but I think there is going to be a big opportunity for us there.

Okay. That's helpful. And then, one more question. For a while, there have been concerns that Illumina is on the cusp of losing momentum or saturating the market for instruments that have an ASP around $700,000. And then, you head into this period where you said you could see a seasonal slowdown and there was certainly concern about funding uncertainty and then you placed 100 HiSeqs. I think, over the last couple of months, you held your planning meetings for 2014. It might be interesting for us to hear about areas where you think you could be on the cusp of a slowdown and maybe some other areas where you think you're still in the very early innings. And keeping in mind, the Street continues to model a moderation in the pace of HiSeq placements over coming quarters, it would be interesting to hear if you're seeing anything that would really make sense at all that suggests that, that makes sense at all?

Well, we've continued to be surprised a bit on the upside, frankly, by the HiSeq performance. So we didn't model HiSeqs to be quite as good as they have been over the past year. But I think it's reflective of the fact that the world just needs to do more and more sequencing. As we model out our existing markets and the new emerging market opportunities, the demand for sequencing over the next 5 years is going to be absolutely enormous. And we've said this for years and years, we do believe that we're still very early in the cycle of how sequencing will be applied. There is no other displacing technology that's likely to come online in the next 5 years. And so we continue to believe that this is going to be an absolutely enormous market and there will be demand for very high throughput instrumentation at ever decreasing prices per genome. And I think that all fuels the strategy around the high-end part of our product line.

Yes, I also think, Jay, that the fact that the 2500, that we were able to develop that technology and improve the utility of the system, enabled us to get into accounts that wanted to get into high throughput sequencing, but the turnaround time was just a little bit too long. And so the 2500 has given us that boost in terms of market penetration that I think will continue to extend into the future.

And our next question comes from the line of Derik De Bruin with Bank of America.

So on your decision to sort of exit the PCR market, is that more a reflection on just the competitive landscape in that market and sort of the pricing dynamic and that the entrenched players are more entrenched? Or that other people have entered that market and so pricing's just coming down so fast that you're not seeing that you have a competitive advantage?

There are number of factors. Certainly, it is a highly competitive market and we recognized that going in. And part of our strategy, in fact, was to take the pricing in this market to a point that we thought Eco would support and I think we were very successful strategically in doing that. I think, the second factor is the reality that many PCR applications, more and more of them, are moving towards sequencing. And I think, the third reality is that as we, year-to-year, compare the project opportunities we have for R&D investment, we never could get the PCR projects over the threshold. And so we always have more array and sequencing programs that have higher ROI to the company than the PCR programs had. And for us to be successful in that market, we would have had to continue to evolve the instrumentation and develop lots more assays. And those investments just didn't make sense compared to our alternatives.

Great. So obviously, you have the BaseSpace as an issue today. And one of the questions I continue to get from investors is, are you guys actually making money on BaseSpace? Or have you demonetized that asset? Could you just give a little bit more about how we should think about that in our financial models?

I wouldn't put anything in the financial models for now on BaseSpace. We are starting to make some money on the paid applications, but it's immaterial to our revenue. We do have, as I think I've mentioned previously, a wide-ranging model of what BaseSpace could potentially yield to us. But we're being very conservative in our own internal modeling on that. We're very excited about the progress we're making and we're anxious to get feedback from the developer conference today to see if we've sort of kicked the enthusiasm up to another level.

And our next question comes from the line of Dan Brennan with Morgan Stanley.

Jay, I thought maybe you could give us a little more color on your ex-U.S. trends in the quarter. I think you mentioned more than 50% of your instruments on the NGA side were from orders -- excuse me, orders came from ex-U.S. customers. Can you put some maybe color around that? Are these direct government orders? Kind of what's the sense of breakdown between government, academic and clinical? Any insight you can shed about what the future looks like ex-U.S.?

Yes, I'd say first in general, we had surprising strength in Europe in the quarter. Q3, because of the summer holidays, we're always a little worried about Europe in July and August. And it turned out to be very strong for us with growth, really the strongest year-to-year in that region. In terms of instrument placements, we saw a real strength in Asia on the HiSeq platforms. So a couple of very large accounts, particularly those in Japan, were buying HiSeqs to begin to focus on biobank sequencing. So we probably exceeded our plan on HiSeqs in the Asian territory. I'd say overall mix, we grew in research, but we were probably stronger growth rates outside of research.

Great. And then maybe on the U.S. traditional academic customer base, I think at our conference, you had indicated one of the surprising observations or features, was just how high the utilization level was of those customers. I'm just kind of wondering, is -- maybe can you tease out the demand drivers there? I mean, certainly I think you've enabled better Sample Prep process probably fill their -- kind of fill the tanks more and you also have more grant dollars coming in. But kind of how sustainable do you think the trends are from some of your bigger U.S. academic customers?

Well, we're pretty confident in the trends, Dan. I mean, they're feeling really good. What we've done around the system certainly helps. It's much easier for customers to prepare samples and get them into the sequencers. The software is vastly easier now, much more automated, takes less compute power to analyze a genome. The better we can do at allowing people to deduce the relevant biology from the result allows them to pour more money back into sequencing because they get to the answer faster. So I think all of that has helped build the pipeline for samples coming into these centers. The breadth of applications has helped a lot as we've expanded our portfolio more and more into RNA applications, into metagenomics. I mean, this whole idea now of sequencing the flora in the gut is getting a lot of traction. I think cancer sequencing is beginning to come on more and more. And so the increasing application breadth, coupled in part to the fact that we're continuing to reduce the cost per base, is just expanding the market as we'd hoped it would.

And our next question comes from the line of Amanda Murphy with William Blair. Amanda Murphy - William Blair & Company L.L.C., Research Division: So I had a question on the Cancer Panel. I'm curious, obviously, you're not directly kind of having conversations with the payers. But just in terms of your end users, what are they saying about payer propensity to reimburse for some of these more complex cancer panels? And just curious in terms of physician adoption, what that's looking like.

Well, for the more complex panels, it's more challenging because there's a relatively small set of reimbursed genes right now that are routinely reimbursed and I don't know exactly what that number is but I think it's in the range of 6 to 10. And those are typically reimbursed historically using stacked codes from PCR. That's all changing now with the new coding systems. We could probably get information from Foundation on their larger panel, in terms of reimbursement rates. I don't know -- happen to know what it is. But I think as the increased validation of the cancer panels comes into the marketplace, you're going to see increased levels of reimbursement. And just, I think, today or yesterday, Foundation published some information about analytic validity of their FoundationOne test. Amanda Murphy - William Blair & Company L.L.C., Research Division: Okay. And then just switching topics on the microarray business. I'm just curious, is there anything to keep in mind from a comparison standpoint quarter-over-quarter? And then also just -- should we be thinking about that business -- I know you've said kind of flat, I think historically. Should we be thinking about that being maybe down a little bit year-over-year going forward?

I think flat is the right place to have it. It bounces around a little bit from quarter to quarter depending upon what happens in the consumer markets and other places. So I think flat is probably the right place to hold your model. In terms of quarter-to-quarter comparisons, Marc, anything that you have on your mind?

Nothing. No, nothing really. I mean, don't forget BlueGnome is in that number and BlueGnome is doing well. I would say, as you go forward with the new pricing model that Jay talked about, we have to see how that -- we're testing the elasticity, we have to see how that works out a little bit. But I agree with Jay on the flat modeling as probably the right thing to do.

Yes. It ebbs and flows a little bit, Amanda, as well because when we launch a new product like in Q4 with the Psych and OncoArrays, we have some new products beginning to ship and we have some pent-up demand for those products. And then as those get into the marketplace next year, we'll launch other targeted arrays.

I do think that we are -- continued to be committed to investing in the array platform and you see that with the 24 sample array. That really opens up new markets and there are a lot of different discussions in agriculture in other areas that are ongoing that give us some sense of why this business will continue to be an important part of what we do going forward.

And our next question comes from the line of Dan Arias with UBS.

Maybe one on the clinical side of things. Jay, are you able to give us a rough sense of how at this point you feel like the overall clinical HiSeq rounds are breaking down collectively in terms of panels versus exomes versus whole genomes?

I don't have any statistics in front of me on that, Dan. I would say clinically, whole genomes -- these are guesses, are probably in the range of 5%, 10%. Exomes are probably, I don't know, 25% or 30% and the rest would be targeted panels.

Yes. I think that's probably -- at least 1/2 of it's got to be panel driven.

Right.

Yes, okay. That helps. Just trying to get a sense for what the user base is looking at this point. And I guess, as a follow-up, you mentioned that some Sample Prep products are in their advanced stages and informatics is getting its own business. So can you just sort of give us an update on where the R&D priorities are today? What are you focusing on? And then maybe if you'd be willing to make a comment on some of those new upfront products, that would be great.

Well, I could say, generically, a large fraction of our R&D is always focused on new platform technologies. So you can imagine about 1/2 of the overall R&D spend, if you take research out of it, I'm talking about product development here, is focused on what's happening in our platforms. And so that would be sort of the core sequencing reagents and instrumentation and evolutions of those platforms. Probably of their other half, probably 1/2 of that is focused on various assay methods and automation of those assay methods, including now we're spending money on our investments in ALL and bringing that technology into the product portfolio. And so hopefully, we'll see some very nice developments there over the next couple of years. And then the remainder is in software and we continue to put a lot of emphasis on the back end part of the software as we've gotten better and better at sort of processing the raw data off the machine, we need to now move downstream and figure out how do we help our customers interpret genomes much more quickly and efficiently.

And the other element -- I mean, Jay already mentioned research. And the other element within development would be some of the clinical trials and studies and things that Verinata, for example, might do to drive the twins' test recently, for example. That's just one of those specific examples.

And our next question comes from the line of Bill Quirk with Piper Jaffrey.

First off, Jay, could you elaborate on the 40% of HiSeq placements going to new customers? Are these competitive -- I guess, former competitive platform customers? Or generally speaking, are they fairly new to sequencing?

Well, it's some of both. So some of those customers are customers who have been using alternate technologies that are now coming over to HiSeq. Some are capillary customers that are finally moving over to NGS and moving to our platform. Some are new labs and institutions that we've been in previously but are now getting funding to build their own sequencing labs. So it's a mix of those 3 different situations.

Okay. And then as a follow-up, you commented on the MiSeq consumables in the quarter. Can you just give us an update in terms of the overall placement trends?

Well, I'd say placements for the quarter were about on target for what we expected. As Marc mentioned, sequentially, the order rate was down a little bit but not materially. So we feel really good about the platform. We continue to have a very high win ratio, about what we've said in the past, if not maybe a little bit better. So we continue to feel really good about MiSeq.

And though shipments were, as I must have said in the remarks, shipments were up quarter-over -- year-over-year, as well as quarter-over-quarter and orders were up as well year-over-year.

Year-over-year.

And our next question comes from the line of Isaac Ro with Goldman Sachs.

The first one had to do with just the commercial [Technical Difficulty] So I'm just wondering if you could talk a little bit about the type of person you're looking to lead that division, whether that person would be sort of from an academic background or clinical or perhaps biopharma.

We missed the beginning of the question, Isaac. So which business unit?

So for the oncology unit, I think Richard Klausner was named as interim head. So I'm just wondering as you think about a permanent solution, what kind of a person are you looking for?

We're looking for somebody who has domain expertise in cancer, so they need to be technically embedded in the world of what's going on in cancer genomics. But we also need somebody who is an operator, somebody who can work with our customers, work on large deal transactions, can run a group of development teams that will be inside the business unit. And so it needs to be a combination of somebody who's technologically savvy and has a strong operational background.

Got it. And then maybe just on the technology for a minute. We have seen -- obviously, you guys have a dominant position in the marketplace today. But at the same time, there have been some competitive wins away where the customer said its speed is a factor. So I'm just wondering, how big a percentage of the clinical market ballpark do you think, for example, infectious disease, might require faster turnaround time? Is that an area where you think the SBS chemistry can still make material improvements? Or do you think it's sort of less relevant of a factor when you add it all up?

Well, first, I'd say that SBS will continue to get better on cycle time. We've made enormous improvements over the last few years and we will continue to make great improvements there. We think that cycle time for most applications on the MiSeq product is good enough. For many of the experiments that our customers do on MiSeq, it happens roughly in a shift. If you're doing much longer read lengths, which only we can do on the desktop platforms, then it might stretch out to 1 day or maybe a little bit longer. I think there is going to be, in the long run, a market for very rapid turnaround, which might be 15 minutes to half an hour. But I don't think there's any technology yet that's really addressing that market segment. And I don't think that will be enormous. But there will be, if you fast forward a couple of years, an opportunity to develop technologies for doing screening of patients entering hospitals, as an example, triage. But no one can quite do that yet.

And our next question comes from the line of Amit Bhalla with Citi.

Jay, I didn't hear you mention anything about Moleculo in your prepared comments. So could you give us an update there on early demand and workflow improvements?

Yes. So we're running that in our service laboratory now. So I alluded to it briefly in the technology section. We are working on the kit version of Moleculo and we expect to have that, Christian?

First part of next year.

In early next year --

Yes.

Is when we think that kit will hit the marketplace. So we're -- we continue to be very excited about the enabling capability that those long -- synthetic long reads will bring to the market.

And second, your commentary about just Asian demand. In the past, you've called China out specifically for strong quarters. Can you talk about China specifically this time around? And have you been able to renew an agreement with BGI on the clinical side?

Yes. We don't have anything specific to say on China for the quarter. In terms of country-by-country, we don't normally break it down publicly to that level of granularity. I think that we do continue to believe that overall, the China market is a very strong opportunity for us going forward and we're making continued investments there, both in feet-on-the-street and also in some partnership-type opportunities. With respect to BGI, we do not yet have the clinical agreements signed.

And our next question comes the line of Tony Butler with Barclays Capital.

Jay, if I could just stick with Moleculo. Could you comment on the phasing analytic services and where you are using Moleculo in-house? And with those early access customers, I think in the past quarter, there seemed to be some excitement, has that grown? In other words, have early access customers increased? And second question is where are you from a timing perspective on MiSeqDx, CF and a post CE mark?

Yes, I don't actually have the statistics on how many customers have run Moleculo in the quarter, so I don't have that data in front of me. We can probably come back to you with some information about that. But I think from what I've heard, the people that are using it are getting great results and the performance of the technology is really good. With respect to the FDA approvals, we have a number of approvals in front of the FDA, the analytical version of the instrument, as well as the CF panel. And we are simply waiting for the approvals to happen. There's no way to predict when those might come out. And I think at least parts of the FDA were shut down during the government closures. And so that probably put a little bit of a delay into the process.

And our next question comes the line of Dan Leonard with Leerink Swann.

My first question, how should we think about the level of investment necessary to support your new organizational structure? Should we think that 2014 is another investment year?

Well, I think the other way to think about that is that it will be an investment year, but one that's scaled back to some extent from what we did in 2013. So you can think about expenses growing more in line with revenue. Next year is certainly not an increase and maybe a bit of a decrease as our overall percentage of revenue.

But I wouldn't necessarily tie that to the organizational change, the organizational structure. I don't think that really adds anything material to what we would otherwise already have been planning.

Our goal there is to try and make the organizational change neutral with respect to expenses. So it's not -- Marc is exactly right, it's not driven by the org change.

Okay. And then my follow-up question, can you comment on whether or not Verinata's on track with your plan from a financial perspective? It seems like it ranked last in your contributors for year-over-year service growth. And also, whether it's on track towards your 2014 expectation, when you expect it to be accretive?

Yes, we'll update on 2014 when we come to give 2014 guidance. But Verinata is doing very well. You have to remember that Verinata for us, is -- it's really broader than just Verinata, it's the NIPT business. And the business case of Verinata was based on how well NIPT does relative to had we not completed the acquisition. So tracking it along that basis, it's doing pretty much as we anticipated. But as we said, there was a lot of -- there's going to be a lot of delicacy in the negotiations. And while Jay said, we've actually agreed, one, everything else is progressing forward. So more information to come on that in the future.

And your next question comes from the line of Vamil Divan with Credit Suisse. Vamil Divan - Crédit Suisse AG, Research Division: Just a couple, actually. Both are sort of follow-ups to questions already asked. But the one question earlier on pharma and companion diagnostics, since we've gotten to talking to pharma companies, I thought usually with these companion diagnostic agreements, they're generating paying for most of the developments, sort of a cost-plus model? The way you kind of spoke to it, it sounded like the risk and the long term uncertainty around it is maybe a reason not to do too many of those. I just want to make sure I'm understanding that correctly. Was it more from a resource side or is it more on a cost side that you're talking about the risk on companion diagnostics?

Yes, I didn't mean to imply that Illumina would take the financial risk. What I meant to imply was that there is a financial risk that has to be taken which makes the agreements typically a little more challenging to strike on the one hand. It also, for us, is an opportunity-cost question because with a particular set of resources, even if they're fully funded externally, if the therapeutic fails at the end of that, the return on those resources that we've applied is essentially 0. And we've lost the opportunity to apply those resources somewhere else. So that's -- those are the aspects that make that a bit more challenging for us. Vamil Divan - Crédit Suisse AG, Research Division: Okay, makes sense. And then the second question, just you were talking earlier about the platforms and your kind of maybe very rapid turnarounds as being something for the future. What would you say may be more near-term if you had to think about sort of the areas where your customers are looking for the most advancement? Is it more -- is it on speed? Is it more on the cost side? Is it ease of use? If you just had to sort of qualitatively describe where you're seeing the most interest in improvements, that would be helpful.

I think we've made tremendous improvements in the speed side of the equation, and the 2500 is a great example of how important it was to take the sequencing run from 10 days down to 1 day. I think for the kinds of applications that a HiSeq is used for in the high end, we're in the ballpark of what customers need there. If we cut that in half, it probably wouldn't make much difference to customers. I think the next really big area that customers care a lot about is increasing the level of integration. So that is related to simplicity of Sample Prep, integration of Sample Prep, which inherently reduces human error in the process and allows them to process -- to feed more samples through the pipeline. And probably secondarily, improvements in software to make the analysis more automated. So I think those are 2 areas we're putting a significant amount of investment in and will overall grow the market and allow us to penetrate more deeply into some of these emerging markets.

And your next question comes from the line of Tim Evans with Wells Fargo Securities.

Just wondering where you stand in your build out of your commercial organization. Specifically, should we be thinking about your SG&A as a percentage of revenue trending up further from here?

I don't think it would have to trend up much as a percentage of revenue. So we haven't finalized '14 planning yet and we certainly aren't prepared to give guidance today. But we've increased a bit from where we were last year and we may wind up somewhere between flat and up a little bit probably next year as a percentage of revenue.

Okay. And just a follow-up on the BGI, are those negotiations for the clinical contracts still ongoing?

Yes.

And your next question comes from the line of Zarak Khurshid with Wedbush Securities.

So both on the clinical side, first, can you comment on what you're seeing in terms of interest uptake and specific applications of clinical sequencing with the academic hospital labs?

So by that, do you mean the academic labs in a place like Stanford and MD Anderson?

Right, you got it.

I'd say, it's very broad. Most of them [ph] today are focused on using various panels, some of which begin by taking our 2 side panels and building on them. Some of which are 100% home brewed where they develop the panels on their own. They're typically running a wide-ranging set of panels that are targeted at different diseases. But I'd say the uptake in those kinds of institutions is particularly strong. Much more so than -- and that really is the focal point of the clinical market now as opposed to, say, community hospitals, where we're still probably a ways away from putting sequencers in community hospitals.

Understood. And then curious if you could just provide an update on the NIPD space as a whole. How fast do you think it's growing currently? Any color on U.S. versus ex-U.S.? And where do you think we are in terms of penetration of that high-risk opportunity?

Well, we haven't seen the reported numbers from the other players this quarter as of yet. So we don't know how many tests were run by the players other than Illumina, other than Verinata. So it's still hard to say exactly what the test volumes are doing right now. We do have a bit of a surrogate in terms of reagent purchases but those can be time delayed either forward or backward a bit. So it's a little hard to be specific there. So I think we'll know a lot more in a couple of weeks once we learn what those test volumes look like. Geographically, the market still is largely a U.S. market. But China is coming on quite strong. And last year, there were some speculation that the Chinese test volume was in the order of the U.S. test volume but at much lower price points. So the revenue would have been much less in China. Europe is much slower on the uptake as you would expect.

And your next question comes from the line of Ross Muken with ISI.

So on the M&A front -- you guys have done a great job last year or so in terms of adding tuck-in technologies. What are the areas where you're seeing the greatest amount of activity or maybe greatest amount of focus in terms of where you see sort of exciting technologies? Informatics, Sample Prep? Just sort of -- I'm curious from a directional perspective where you're spending most of your time. Or is it maybe also on the clinical side?

Well, we continue to look quite broadly. I mean, we have a very active M&A program in department now. So I think opportunities can fall across the spectrum, probably a bit biased toward methods for Sample Prep or targeting methods, things of that nature and perhaps Informatics, less so maybe on sort of core instrument areas. But we continue to look at lots of different technologies. Many companies come to see us to talk about potential strategic partnerships or investments. So we get to look at many of them before we make a decision on whether to do anything with them and, of course, the vast majority of them we pass on. So we'll continue to probably do a handful of these tuck-ins a year is probably what you might expect from us.

And what did the experience with Eco sort of teach you? I guess, it's an asset you obviously knew intimately and incredibly well. It's a market that at one point made quite a bit of sense for you guys to be in tangentially. How does sort of -- given the vast set of opportunities you have in sort of the existing business set with sort of the technologies that you're already dominant in, how do you sort of -- how does Eco -- does it change at all sort of your risk tolerance in terms of moving into new boxes or into new verticals? Or was that just sort of a, "Well, we tried -- we made a go of it, it's a tough market and so we've decided to reallocate"?

Well, the reason we got into it to start with, Ross, if I could back up for a minute is because probably about 5 years ago, maybe 6 years ago, strategically, it looked very important for us to have technology capability at the single to a few marker level and that really completed the spectrum of our offering from one snip to the entire genome. And that made a lot of sense where if you look at the markets and how we thought they were going to evolve and where sequencing was at the time, that fit really nicely in our strategic plan and even though it was a competitive market, the potential carry along [ph] sale we thought made a lot of sense for us. And as I described, what happened is as we brought that technology in, while it met our expectations in many ways, what we weren't able to do is to justify continued investment at a sufficient level on that platform to make it a long-term viable business. And at the same time, the sequencing has gotten so much better, cheaper, faster and all the great attributes of our sequencers now that we think PCR is becoming less relevant in many of the markets that we had originally targeted. So clearly, there's some lessons there that we will employ going forward. I don't think it creates any inherent aversion to us tackling another business that might have a box component to it. But I guess what it does do is it makes us look very hard at our core sequencing business to make sure we realize how good it is and whether any new venture we make has to stand up competitively against our opportunities in sequencing.

Ladies and gentlemen, that concludes today's Q&A session. With that, I would now like to turn the conference over to Ms. Rebecca Chambers.

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 fourth fiscal quarter.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.