Illumina, Inc. (ILMN) Q2 2018 Earnings Report, Transcript and Summary

Welcome to the Q2 2018 Illumina Earnings Conference Call. My name is Darrell, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. Please note that this conference is being recorded. I’ll now turn the call over to Jacquie Ross. Jacquie, you may begin.

Thank you, Darrell. Good afternoon, everyone. And welcome to our earnings call for the second quarter of fiscal year 2018. 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 Francis deSouza, President and Chief Executive Officer; and Sam Samad, Chief Financial Officer. Francis will provide an update on the state of our business and Sam will review our 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 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 currently available information, 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 those documents that Illumina files with the Securities and Exchange Commission, including Illumina’s most recent forms 10-Q and 10-K. With that, I will now turn the call over to Francis.

Thank you, Jacquie. And good afternoon, everyone. The second quarter represented another strong performance for Illumina with record revenue of $830 million, up 25% from the second quarter of 2017. Before we get into the detail, I'd like to thank the global Illumina team for the solid execution in the first half of 2018. Genomic information is more valuable and actionable than ever before and it is to the team’s credit that we continue to move quickly, embrace new opportunities and find innovative ways to support our customers. As a result, our business is growing as we enable a broad range of drivers, spanning applications, systems and geographies. In the last five years, we estimate that over 225 petabytes of sequence data have been generated on Illumina platforms alone. That volume of sequence data is roughly equivalent to 2.5 human genomes sequence of 30x coverage. Despite this impressive repository of sequence data, to-date we have only ascribed significance to less than 1% of the variance catalog in the human genome. So it's clear that the vast majority of opportunity remains ahead of us, not only in terms of sequencing volumes, but even more importantly in terms of advancing our understanding of the genome and our ability to positively impact human life. I will now update you on our business in the second quarter. Reflecting stronger than expected demand, second quarter sequencing consumable revenue of $455 million grew 35% from the same quarter a year ago. This includes about $13 million of stocking associated with Chinese customers buying ahead of potential tariffs. Excluding this, growth was 31%. Second quarter sequencing consumable growth was broad-based with customers in research, translational and clinical settings, all contributing significantly. We're seeing robust growth as our customers leverage genomics to drive discoveries, connect data to insight and routinely apply genomic tests in clinical and applied markets, whether it is to uncover new insights in Parkinson's or diabetes or to establish the utility of circulating tumor DNA for early cancer diagnosis, our customers are increasing using sequencing as the primary tool to advance our understanding of the genome and improve patient outcomes. Highlighting this breath of drivers across our sequencing business, we saw consumable growth across all three sequencing system categories; high throughput, which includes NovaSeq and HiSeq; mid throughput, which is NextSeq; and low throughput, which includes MiniSeq, MiSeq, iSeq. NovaSeq consumables grew $40 million sequentially, with continued strong adoption of S4 and S2 and a healthy ramp in the S1 flow cell launched in February. As we expected, NovaSeq growth was partially offset by lower HiSeq consumables, although the HiSeq 4000 consumables remained an area of strength. Overall, sequencing consumable use is ramping faster than we expected. In total, high throughput consumables grew more than 35% from the same quarter a year ago. It is now approaching $1 billion annual run rate and a sizable majority of HiSeq customers, who have added at least one NovaSeq system, have increased their total spend on consumables. As a result, our full year expectation for NovaSeq-related revenue is exceeding the internal forecast we set at the start of year. It was also a strong quarter for NextSeq consumables with growing demand across VeriSeq NIPT, oncology research, translational activity and clinical oncology testing. Mid throughput consumables grew more than 50% from the same quarter a year ago, demonstrating that the NextSeq continues to be an important sequencing workforce supporting a broad range of applications. Pull-through persistence exceeded the high-end of our $100,000 to a $150,000 guidance range. We saw a sequential and year-over-year growth in our lower throughput sequencing consumables which support our MiSeq and MiniSeq systems with pull-through within their expected ranges. Today, these systems represent more than 10% of our sequencing consumable business. Finally, library prep grew 25% from the same quarter a year ago, driven by our core library prep portfolio, including traction with our new Nextera DNA Flex offering, which continues to receive positive customer feedback. Our library prep portfolio is now approaching 15% of our sequencing consumable business. Sequencing system revenue grew 10% sequentially to a $123 million, up as we expected from a seasonally lighter first quarter. We continue to be pleased with the broad appeal of NovaSeq. Globally, more than 200 different labs have received a NovaSeq system with demand driven by capacity expansion, HiSeq conversion and new to high throughput customers. The broad appeal and utility of the NovaSeq system is further reflected by the mix of flow cells customers are using, with most ordering a combination of two or more of the available flow cells. Overall growth in NovaSeq consumables spanning S1, S2 and S4 has been faster than we anticipated and the feedback consistent performance continued to be positive. We expect NovaSeq shipments in the 330 to 350 unit range for this year. Moving to the rest of our sequencing system portfolio, NextSeq shipments grew sequentially with a good mix of capacity expansion and new to NextSeq customers. Combined low throughput systems placements increased sequentially and year-over-year with strong adoption by new to sequencing customers who represented over 50% of shipments from this group in the second quarter. I'm pleased to share that we started shipping iSeq to customers in late Q2. Early order activity has been robust with a good mix of new and existing customers in both academic and commercial settings. As a standard Illumina practice, we will ramp production in the coming months. Sequencing services and other revenue had another strong quarter, up 10% sequentially and 38% year-over-year to $106 million. Roughly half of this total dollar amount is associated with traditional maintenance contracts. The rest is primarily associated with our sequencing services labs which support Genomics England in addition to some NIPT and rugged customers. Genomics England had a particularly strong quarter as it targets completion of its $100,000 genome project later this year. Additionally, we also reported the contribution from our oncology partners, Bristol-Myers Squibb and Loxo Oncology. Both programs completed their first full quarter of work and are progressing well in their co-development and commercialization objectives. There has been a good collaboration between our teams and that of our partners demonstrating ongoing commitments to our shared vision of bringing transformative insights for targeted and immunotherapies to patients. We are particularly encouraged by positive feedback from key opinion leaders on an early version of the TruSight Oncology 500 assay. Moving to arrays, microarray revenue grew 25% year-over-year to $140 million, with growth not only in the direct-to-consumer or DTC but also in global research applications spanning genotyping and epigenetics. Growth was strong in all regions, including China where the launch of the Asian Screening Array helped drive a large number of iScan installations in Q2 which indicates future growth for arrays in the region has sites scale their operations. We also secured our largest single order for the Infinium MethylationEPIC BeadChip as we drive larger epigenome wide association studies in the translational research market. While sequentially microarray revenue was down associated with DTC functionality, we foresee robust demand for arrays as DTC broadens across geographies, applications and providers as precision medicine initiatives expand and research and applied uses for arrays increase. Moving to regional results, Americas revenue grew 19% versus the prior year period, driven by growth in sequencing consumables and microarrays. EMEA continues to be an exciting market for Illumina and now represents about a quarter of our total revenue. EMEA revenue grew 36% from the same quarter a year ago with a strong contribution associated with the Genomics England program that has now sequenced more than 70,000 co-genomes. We also saw initial NovaSeq purchases from the Wellcome Sanger Institute as they prepare for their first 50,000 samples that will be sequenced as part of the UK Biobank program. Total Asia Pacific revenue grew 32% year-over-year with another strong quarter from greater China, which delivered shipment growth of 42% from last year and 45% sequentially. Even excluding the $13 million stocking order, China reported record shipments in Q2. Illumina has a number of very strong sequencing service provider partners in China and their growth continues to be driven by NIPT and research based sequencing in a variety of areas including oncology and reproductive health. Outside of China, the rest of Asia Pacific and Japan or APJ was driven in large part by increasing volumes at our service provider customers and ramping ahead of precision medicine initiatives. In addition to robust sequencing consumable growth, APJ also reported strong array growth, driven by a small but rapidly growing DTC customer offering that test serviced across Asia that is based on our screening array. Before I hand the call over to Sam, I'd like to formally welcome the Edico team that moved to Illumina headquarters at the beginning of June and is already proving to be an integral part of the product development group. Together, we are now focused on delivering the most complete offering of accelerated secondary analysis solutions for all our customers. We're confident that our proprietary FPGA acceleration will improve time to answer on workflows across research, translational and clinical applications and look forward to updating you on the team's progress in the quarters ahead. With that, I'll hand the call over to Sam for a review of our quarterly financials. Sam?

Thanks, Francis. As discussed, second quarter revenue grew 25% year-over-year to $830 million, driven largely by growth in sequencing consumables that once again exceeded forecast. We also saw a strong performance in both microarray and sequencing services and the contribution associated with our oncology collaborations. Additionally, benefit from foreign exchange rates contributed 2% to the year-over-year growth. Total instrument revenue in the second quarter was a $127 million, down 7% year-over-year and up 8% sequentially, instrument revenue therefore represented 15% of total revenue in the quarter. Consumable revenue was $540 million, up 7% sequentially and 34% year-over-year. Services and other revenue was a $157 million, basically flat sequentially and up 32% year-over-year. In 2008, instruments represented 33% in consumables and other represented 67% of our revenue. In the second quarter of 2018, consumables and services represented 84% of total revenue, highlighting how the mix of our business has evolved. Moving to gross margin and operating expenses, I will highlight non-GAAP results that include stock-based compensation. I encourage you to review the GAAP reconciliation of these non-GAAP measures, which can be found in today's release and the supplementary data available on our website. Please note that all subsequent references to net income and earnings per share are referred to the results attributable to Illumina shareholders. Non GAAP gross margin of 70.3% was higher than expected and increased 50 basis points compared to the first quarter and 330 basis points compared to last year. The increases were primarily due to higher mix of sequencing consumables, which represented 55% of revenue in the second quarter of 2018, and compares to 53% in the first quarter of 2018 and to 51% in the second quarter of 2017. Non-GAAP operating expenses of $348 million were up $32 million from last quarter, largely reflecting higher R&D investments, headcount additions and increased variable compensation expense. Keep in mind the first quarter operating expenses were lower-than-expected due to the timing of certain investments and headcount additions, in addition to a favorable judgment on patent suit. Non GAAP operating margin was therefore 28.4%, down from 29.5% last quarter. Excluding Helix, operating margin was 30.6% compared to 31.9% last quarter. The non-GAAP tax rate of 15.9% compares to 12.9% last quarter and to 25.1% in the second quarter of 2017. Positively impacting the Q2 ‘18 tax rate was an additional benefit related to our Helix investment and a favorable 2017 foreign tax return adjustment. Excluding the Helix benefit, non GAAP tax rate would have been 16.9%. For the second quarter of 2018, GAAP net income was $209 million or $1.41 per diluted share and non-GAAP net income was $212 million or $1.43 per diluted share. The impact of foreign exchange increased Q2 non-GAAP EPS by approximately $0.03 relative to last year. Cash flow from operations was $295 million. Improved revenue linearity led to a record DSO of 43 days compared to 47 days last quarter. Capital expenditures in Q2 were $77 million and Q2 free cash flow was $218 million. We ended the quarter with approximately $2.5 billion in cash, cash equivalents and short-term investments. Moving to guidance, total company revenue is now expected to grow at approximately 20% in 2018 to $3.3 billion. This represents an increase of a $124 million compared to the midpoint of our previous 15% to 16% guidance range. Compared to our previous guidance, the new growth expectation reflects higher sequencing consumables reported in the first half and an increase in the sequencing consumable forecast for the rest of 2018, notably associated with NovaSeq. We continue to expect full year non-GAAP gross margin to be up modestly from 2017. Non-GAAP operating expenses as a percentage of revenue are now expected to be slightly lower in 2018 versus the 43.5% reported in 2017. This is primarily due to a higher revenue outlook and slower growth in headcount than anticipated. Reflecting another more modest Helix benefit in the second quarter and the favorable taxe return adjustment, we now expect our non-GAAP tax rate to be between 16% and 17% for the full year. On a go forward basis, you should expect a tax rate of approximately 19%. We continue to monitor the tariff situation closely in China. As noted earlier, three of our larger customers initiated some stocking purchases in the second quarter and we expect to see additional stocking activity, albeit to a lesser extent in the third quarter. Beyond possible near-term variability in the timing of orders like we saw in the second quarter, we are confident that customers will continue to see the benefit of partnering with Illumina to deliver their own genomics-based services and products. GAAP EPS is now expected to be between $5.10 and $5.20 and non-GAAP EPS is now expected to be between $5.35 and $5.45. This increase primarily reflects the higher revenue projection for the full year, improved gross margin and a more favorable non-GAAP tax rate than previously projected. For the full year, we are still expecting about $0.25 of Helix dilution. This excludes the previously mentioned tax benefit that resulted from our latest investment rounds in Helix that positively impacted Q1 and to a lesser extent Q2. We continue to expect share count for the full year to be approximately 148 million. For the third quarter, specifically, we expect revenue to be flat to slightly up from Q2. Keep in mind the $13 million stocking order that effectively pulled revenue from later periods into the second quarter. As a result, we expect a more modest sequential increase in sequencing consumables, and we expect sequencing system revenue growth. Offsetting these positive revenue impacts in part, we expect the raise to be down meaningfully on a sequential basis. This is primarily driven by seasonality in DTC and in fact, we expect Q3 to be the lowest revenue quarter of the year. And after the positive benefit we saw in Q1 and Q2 of this year, you should expect FX to have less of an impact in the back half. We expect non-GAAP gross margin to be down modestly on a sequential basis to reflect the impact of mix. And we expect non-GAAP operating expenses to increase sequentially on a percentage of revenue basis, given our expected hiring and investment plans. With that, I'll hand the call back to Francis.

Thank you, Sam. This was a very strong quarter for Illumina. And looking ahead, the opportunity for genomics continues to grow. With so much left to learn about the genome, research remains an important driver of our business. In fact, four of our 10 largest sequencing consumable customers in the second quarter are primarily focused on research, either directly or as a CRO. And their combined demand grew faster than the overall sequencing consumable growth rate in the quarter. The consumer genomics market continues to extend its reach with some promising developments in China, Korea and Japan this quarter, in addition to continued momentum in our DTC array customers and Helix. In oncology, we saw Guardant Health receive the first -- the final Medicare Coverage policy for an NGS-based liquid biopsy assay for certain non-small cell lung cancer patients. We are seeing growing interest in tumor mutational burden or TMB which is emerging as one of the best NGS-based predictors of response to cancer immunotherapies. Germany is expected to be the first company to formalize reimbursement for TMB once the national study is completed in the fall. And we’ve been seeing strong interest in our NextSeq system as a result. We continue to see the NIPT opportunity growing with expansion into new geographies and broadening coverage. NIPT was acknowledged as beneficial, as a primary screening tool for trisomy 21 in Germany during the quarter, opening the discussion for potential reimbursement in 2019. And in the US, we are watching to see whether ACOG will further revise its guidelines regarding use of NIPT for average-risk pregnancies, following the withdrawal of Committee Opinion 640 that was issued in 2015. This growing interest in population genomics initiatives highlighting the governments all over the world are recognizing the value of genomic studies to enable precision medicine that could improve the quality and efficiency of healthcare systems. In the second quarter alone, we saw all of us begin enrollments in the United States, a large UK Biobank study awarded and announcements from Genome Canada and the Australian government among others. While these programs typically take several years to ramp from initial interest to begin sequencing at scale, they represent exciting multi-year opportunities for us and our customers. We will now open the call to questions. Operator?

[Operator Instructions] And our first question comes from Derik de Bruin from Bank of America Merrill Lynch. Go ahead with your question, Derik.

Just a little bit clarity on the 13 million stocking order. Is it across all the different sequencing categories, all the different sequencing instruments? And I’m just wondering if it was more heavily weighted to NovaSeq or if it was tied to -- just -- or was it spread across, just a little bit more color on what’s going on in the after-market?

Sure. The $13 million stocking order was primarily focused on NovaSeq, however, was a little bit of NextSeq in there too.

And moving on to our next question we got Ross Muken from Evercore. Go ahead with your question Ross.

So maybe if we think about all the various areas of application or end market where we’re seeing a sort of dramatic uptick on the NovaSeq side, where are you seeing the most sort of surprising level of interesting growth? And if we think about kind of the mix today, clinical research and some of the more translational areas, what is that looking like on kind of the incremental basis as we think about where the growth upside from utilization is coming from, as to how that’s exchanging?

Yes, sure. There are a number of things that we expected to play out with NovaSeq that we’re seeing and there are definitely a couple of surprises. One thing that we did expect to play out was that NovaSeq would fundamentally unlock some elasticity in the market. And one of the things that we were looking for was validation that customers who purchased a NovaSeq in addition to their other high throughput systems were anyhow buying more consumables from us, that would validate a theory that they would open up bigger cohorts, more access to sample and that’s certainly how it’s playing out. So that was sort of a core driver of NovaSeq and that’s playing out well. Obviously, we are seeing a lot of whole genome work being done on NovaSeq as we expected some of the big service provider customers of ours have been on the commercial side, certainly have been some of these earliest adopters and some of the fastest to ramp up the NovaSeq installation. So we expected to see that and that’s playing out. What maybe we didn’t expect that we saw was quite the number of new to high throughput customers that emerged in both the NovaSeq pipeline and then as NovaSeq customers. And so, that’s been a pretty robust consistent number of quarter-after-quarter now. And so that frankly was an upside surprise for us. And as we talked about the NovaSeq consumable pull through has been also an upside surprise for us that customers are more quickly unlocking more samples and are more quickly ramping up their NovaSeq utilization. And so all that has sort of added up to as a theme that our NovaSeq revenues for the year, across consumables and instruments, is going to be greater than we expected for the year.

And our next question comes from Tycho Peterson from J.P. Morgan. Go ahead with your question.

I want to ask about some of the benefits you guys had. Can you quantify the tariff pull forward but I think we'll probably get questions about maybe some of the milestones around Bristol and Loxo and then GeL which was going to tail off a bit in the back half of the year potentially? So as we think about the guidance range for the back half of the year a couple of things, can you talk about picks and those are headwinds and what you are baking in for additional tariff impact? Is there anything embedded for some of the newer products like Edico and the new closed sales? And then how much of a headwind or GeL and maybe some of these companion diagnostic deal milestones that won't necessarily repeat?

Yes, so there definitely have been some collaboration income or collaboration revenues I should say that we realized in Q2. We expect that to continue in the back half of the year as well Tycho for our earlier guidance, albeit probably to a smaller or lesser extent than what we saw in Q2. We saw a good quarter from GeL. We expect to see continued GeL revenues as well as they ramp up to achieve the 100,000 genome milestone that they have. So overall -- and in terms of the tariff question that you had, as we talked about in our prior prepared remarks, we saw $13 million stocking orders that we saw in Q2. We do expect some timing shift with regard to potential order placements of consumables ahead of potential tariffs in the back half of the year but that’s not material. So there isn’t really anything material to talk about in terms of major shift because of tariffs. So we saw that in Q2, we expect to see maybe a little bit of it in Q3 but nothing really that material to impact sales. And then with regards to I think your last point was around the NovaSeq consumable, the S1, S2, S4 flow cells that we have, as we talked about in our prepared remarks as well, part of our guidance raise is driven by the fact that we expect increased consumables revenues from NovaSeq. So it’s reflected in our guidance range.

Yes, that’s right, and if I would add, if you think about GeL, clearly GeL is working to wrap the 100,000 genome project and we are in the tip of that but GeL is also looking now to transition to the second stage of their journey where they are actually building in genomic testing into the NHS and really moving into clinical standard-of-care or things like rugged. And so, obviously there will be a transition. But if we think long-term, that could actually unlock a bigger revenue opportunity long-term than the trajectory we’re on now with them.

And our next question comes from Doug Schenkel with Cowen & Company. Go ahead with your question Doug. Doug, are you still there? I think Douglas dropped off. We will move on to Patrick Donnelly from Goldman Sachs. Go ahead with your question.

Great, thanks. Maybe just one on China. I know you mentioned kind of the oncology and we reproductive health markets kind of shaping up there. Can you just also talk through, I know consumer genomics has started to pick up, seeing some -- is getting state-of-the-market in China, which markets you’re most excited about over the next six to 12 months there?

Yes. So China continues to be as you can imagine a very exciting market for us. It is already our second largest country in market. And as we look at the drivers, we feel very good about the prospects for continued growth in China, driven on the one hand I think what you talked about which is our NIPT business, still have headroom in front of it there, obviously oncology and oncology testing in the very early stages are penetrating that market. But there are number of other markets that are emerging and one that's definitely interesting is the direct-to-consumer opportunity. And the launch of the Global Screening Array has helped drive up opportunities for DTC for us in China. It’s already led to a number of iScan patients in China and they were a number of companies that we’re seeing now or ramping up their DTC capabilities there, including WeGene who was going to utilize our microarray technology to provide complete ancestry analysis service to 56 major ethnic groups in China. And other company in China as an example is working on an EWAS study in the second half of 2018, with the intention to launch a DTC based study on offering on methylation. And so, we’re definitely seeing the emergence of the DTC segments, although still at very early stages in China.

And our next question comes from Doug Schenkel from Cowen & Company. Doug, go ahead.

So with consumables revenue per NovaSeq has continued to ramp HiSeq and HiSeq X utilization instruct a bit but it’s probably been a bit more durable than many of us expected, relatively HiSeq and HiSeq X retirements don’t seem to have scaled a whole lot even as you place more and more NovaSeqs. So with that in mind, over the balance of the year, what’s your expectation for NovaSeqs impacting or your HiSeq installed base of instruments and the use of these instruments that remain in the field? And looking beyond this year, once more projects are completed, do you expect the pace of retirements to increase in the amount of spend for the HiSeq and X to drop? Thank you.

Sure, Doug. So I will start by validating the number of points that you made. One, we are pleased in the ramp-up that we’re seeing in terms of the utilization of NovaSeq instruments that are out in the field, and we’re pleased with what we’re seeing in terms of pull through of NovaSeq, although it’s too early to call that definitive range but we are pleased with what we are seeing so far. We are also seeing though in some cases that there are customers that have validated workflows on a HiSeq that will continue to run on HiSeq for a while before they transition on to NovaSeq. And that’s part of the design that we laid out in terms of having this multi-year transition into NovaSeq. And so the dynamics that will play out over the coming quarters and years is we will start to see some of those clinical customers validate their workflows on NovaSeq and transition over to NovaSeq. We will also see some of the larger HiSeq X fleets start the cut over to NovaSeq. So they have begun that journey but we are still in the early stages of people being to complete cutover onto NovaSeq. And so that’s still in front of us and that will drive the demand for NovaSeqs going forward. I don’t expect to see any sharp acceleration in that transition. I expect it to see more measured over the years and that is how we’ve laid it out, it’s also how we staged the flow cells. So coming out with S2 at the beginning, then S4 in the fall of last year and then S1 in Q1 of this year and each of those flow cells is intended to catalyze different segments of the HiSeq base, right. So S4 is really targeting the high throughput genome centers and looking to prompt in the coming quarters a cutover from X that’s one that’s obviously the lower end of that segment to move customers that might have been still on the 2500 for example. And so that's how we staged the rollout of the flow cells and that’s how we expect it to play.

Yes, I’ll just add a couple of quick comments Doug as well just for completeness. We have always said this is going to be a multi-year upgrade cycle and that’s how it’s playing out. And with regards to customers, they are transitioning at their own pace. And we are more than happy to see customers transition as they see the need to. So that’s how it’s going to play out.

And our next question comes from Sung Ji Nam from BTIG.

Just not to deliver the point on tariff but I was wondering in terms of the stocking activity. Is that just out of abundance of caution and also are you seeing that outside of China as well?

Yes. The stocking activity that we saw in Q2 was purely related to China and for a handful of customers in China. And as Francis mentioned earlier, mostly on NovaSeq, some orders of NextSeq as well. So at this point we are seeing that in China only. And truth of the matter is we are still monitoring developments on the tariffs point and what's going to happen. So we are still looking forward to see what's -- how this is going to play out. As I said, we don't expect major shifts in terms of ordering and placement activity. We see this to be fairly immaterial in terms of our overall sales. And the last thing I’ll say on this is, sequencing technology is a big investment and one that is not easily redirected. Our customers take this seriously. And so, as we look forward and as we stay and stay close to the whole tariff situation, obviously we are going to continue to watch it closely and we are going to also do what's best for our customers as we look forward.

Yes, so just add to what Sam said, look, ultimately demand in China is driven by the customer demand and the strength of our technology. And we continue to expect both to be strong and sort of drive the business for us there.

And our next question comes from Dan Arias from Citi Group. Go ahead with your question Dan.

Looking at you, Francis, if maybe you could provide the revenue or the system growth number for oncology during the quarter, as we sort of track momentum there? And then maybe more broadly but along those lines, I know it's hard for you guys to pinpoint applications sometimes. But as we’re sort of contemplating this inflection, now it seems like it’s taking place. I’m wondering if you could just sort of help us as to what percentage of revenues may be roughly speaking are now coming from clinical work, how much falls into that bucket at this point?

Yes. So we don’t actually break out the revenue down to the level of systems placed in the oncology market. But what I can say at a very top level is that the percentage of our overall revenues that come from the clinical market, last year was about 45% and that continues to be strong. And so, you’ve seen that grow now over the last few years as both oncology and NIPT have driven the growth of both consumables and system placements into those clinical markets. Some of the things that are playing out in the clinical market, we continue to see strong translational demand for our products. And then more recently as we announced companion diagnostic deals with Bristol-Myers Squibb and Loxo, that’s starting to generate revenue, and we expect that to continue. And then one exciting development for the future is the emergence of tumor mutation burden as a biomarker predictive of the effectiveness of immunotherapies, and that could be an exciting driver to add fuel to the oncology market for us.

And our next question comes from Bill Quirk from Piper Jaffray. Bill, you can go ahead with your questions.

First off, Francis, I really appreciate the color around both Genome England as well as Sanger’s efforts around population sequencing. Can you talk to some of the other country programs and help us think about the pacing of some of these programs and the associated spend? And I have a follow-up. Thank you.

Yes, sure. There is no doubt that these population sequencing initiatives are really exciting both for the market and for Illumina. These programs, they deepen what we know about the genome, they have the potential to enable precision medicine at a national scale. And perhaps equally importantly, these initiatives, they educate the population about genomics and the value of genomic information in our life. So they are hugely exciting initiatives and it’s fantastic to see the momentum that these are gaining around the world. Now having said that, these are large initiatives and they can take years to scale, we brought up GeL, GeL started in late 2014 and it’s really only now that it’s at scale as it’s looking to complete the 100,000 genomes. So hugely exciting for a number of reasons and we’re doing a lot work as you can imagine to support the initiatives, to support the customer tenders, to support the pilots. But it’s not something that we’re counting on as a dramatic revenue driver in 2019.

And our next question comes from Jack Meehan from Barclays. Go ahead, Jack.

I was hoping you could elaborate on some of the early traction you're seeing with the iSeq launch and just elaborate on what your expectations are in terms of placements, what are some of the customers you're seeing look to adopt the technology? Then finally, your thinking evolved at all around how this could be used as a clinical tool?

Yes. Sure. I’m particularly excited about iSeq and the role it plays strategically in our portfolio. When we envisioned iSeq and then we started talking to market about iSeq one of the things we said is that there are tens of thousands of labs, smaller labs that today don’t do any sequencing. And so, we see the opportunity there to use iSeq to bring sequencing to those labs. And we talked about the fact that we expect iSeq customers to fall in three buckets. We said, look, some of the early iSeq customers will be existing Illumina customers. And the used cases they will be drawn to is to use iSeq as a QC tool before they run their libraries on the bigger machine. So if you think about a run on -- NovaSeq for example, that run is tens of thousands of dollars. And so, customers are excited about having iSeq to QC the library before they run it on NovaSeq. I am sure enough as we look at the early orders for iSeq and we look at the pipeline, there are definitely customers that fall into that bucket. They are exciting about having it as a companion to their higher throughput instruments. The second bucket though we said is, there maybe labs that are familiar with sequencing but don’t have a sequencer because they are outsourcing their sequencing. They are doing that for a couple of reasons. One, they may not have access to the capital necessary to go buy even a MiSeq, but certainly add a NextSeq or a NovaSeq or they just don’t have the regular flow of samples. And so iSeq is a really exciting tool for those customers. And again, if you look at the orders we have got and the pipeline we are building, there is definitely a set of customers that are familiar with sequencing but don’t have a sequencer today. And then third is probably most exciting, they are going to be the customers that don’t do any sequencing today, that maybe use at the PCR machine or some other tools that iSeq can help address. And again as we look at who is buying iSeq, we are definitely seeing a number of customers that are new to Illumina and in some cases new to sequencing in total. When you start to think about the applications that we are hearing from our customers in addition to the companion QC tool, we are hearing customers that are looking to use the iSeq for things like pathogen detection, for microbial whole-genome sequencing and/or targeted RNA. Those are probably the used cases we hear the most at this point.

And our next question comes from Puneet Souda from Leerink Partners. Go ahead.

I have a broader more longer-term question. I know with Seq consumables, you have obviously seen a great pick up here in consumables and the guide is reflecting that. So I was wondering when you look at it on a multi-year replacement cycle that you have pointed out for NovaSeq, historically for HiSeq we have seen utilization ramp-up and reach a certain level of peak. But in case of NovaSeq, should we assume the utilization and/or the pull-through to continue to ramp-up longer term, assuming that potential flow cells will come to the table faster than potential new instrument launches?

Yes, if I think about it NovaSeq -- and you are right the trend we saw before, the consumables started to build and then hit a peak and then once we hit a steady state we were able to talk to the market about a range that you could use to model pull-throughs. We are still at the stage where the NovaSeq pull-through is continuing to go up. In fact, actually, in the last quarter the pull-through of NovaSeqs hit the new high. And so we are still at the stage where it's building and frankly more than maybe we’d initially expected even. At this stage though it’s still volatile. And so, we are not yet at the stage where we are able to give you a range if you can use in the model. And the scenario you brought up is sort of a realistic scenario which is customers are using multiple flow cells and they are mixing and matching the flow cells that they are using for the applications they want to run. And NovaSeq is a more versatile tool than something like a HiSeq X, which is clearly a whole-genome machine. And so, I think that creates more utilization opportunities for customers than a HiSeq X.

And our next question comes from Amanda Murphy from William Blair. You can go ahead with your question.

Sorry for the follow-up on the population sequencing commentary that you’ve made. Just seems like some of these projects -- obviously there’s been an increase in countries and other entities coming online. It seems like there’s some conversation around the rate methodology I guess between genotyping and sequencing. And I guess I’m specifically thinking about all of those where they discussed price point and what they might do over the long-term. My question is, do you have -- obviously you’re having conversations with the customer base in that vein, do you have the kind of the current instrumentation perhaps format that you need to sort to get these guys over the humps in terms of doing broader whole-genome sequencing, meaning the S4 and et cetera or is there an evolution that we should expect before some of them turn to big whole-genome type project?

Sure, Amanda. So I will start by saying, there are now dozens of pop seq opportunities that we are working with around the world and they are all a little bit different, something that draws some common trends across some pretty different opportunities in terms of size and scale. I will start by saying that one common thread across the majority of them now is that they are connected to a healthcare system directly even more so than when saw when GeL pioneered population sequencing in 2014. And so, a vast majority of those opportunities now are either directly connected to the healthcare system or actually driven by the healthcare system. The other trend we’re seeing is that the majority of them are around whole-genomes. All of it started as sort of thinking about a two stepper where they would start with genotyping and then in a future stage they would go to sequencing and what’s happened now is they have accelerated their sequencing. And so, now they're talking about doing both simultaneously. So even all of us, while it was initially genotyping and then going to sequencing has really brought the sequencing forward. And I think the overall -- the work that’s happened at GeL has read and helpful for the rest of the world in terms of seeing how to be done and seeing the utility of doing whole-genome sequencing. In terms of our platform’s readiness, S4 is absolutely appropriate for the large scale population sequencing efforts that we’re talking about and I think it can carry us for a while. Obviously in the longer term as we think about the scale of how these -- how big these initiatives could be as they’re getting embedded across multiple applications in the healthcare system, you’ll need a bigger boat, but for now S4 is absolutely the right answer.

And our next question comes from Dan Leonard from Deutsche Bank. Go ahead, Dan.

So I was hoping you could elaborate on your DTC assumptions and the visibility you have there. And specifically, I was surprised on the Q3 comments that you would expect sequential weakening, given the amount of promotional activity on prime day, the adoption of WeGene in the overall earlier stage of penetration in Asia and some of the other demand drivers? Thank you.

Yes. Sure, Dan I’ll speak to it. We haven't given any expectations for the full year in terms of DTC or microarrays, so we haven’t updated our assumptions there. But the seasonality that we talked about is really not uncommon. We see that seasonality every year where we have a strong Q1 and then to some extent a lesser Q2. Q3 is typically the -- I’d say the weakest quarter of the year for DTC and hence why we have indicated that for microarrays in total it’s going to be a weaker quarter. And then we see potential improvements in Q4. That’s the usual seasonality that we see with microarrays and DTC. And this year, we don’t expect anything different.

And our next question comes from Steve Beuchaw from Morgan Stanley.

Really coming back just to the Nova consumables question from a couple of other angles. One is, when we think about Nova consumables and the efficiency that it provides to labs, they treat people more for their money right, it’s pretty straightforward. And so, I wonder is it right to think about the sample volumes really picking up at a pace that’s materially more than the 30 plus percent rates that we are seeing in the revenues. And is that something that you would see in BaseSpace from the operations out there in San Diego? Do you see revenues -- I am sorry, samples actually growing quite a bit faster than revenues? And then I wonder if you could circle back on the same topic to sample access, when I think back to 2014-2015 when we had the interest at X emerging, there was at some point difficulty getting to samples, enough samples to keep them running at capacity. But this time around it seems like the access to samples is going along very, very fast. Is the key there that it’s not just whole-genomes this time or is there some other key to the explosion of access to samples?

Yes, what we are hearing from our customers and what we are seeing in the pull-through, what we are seeing in the instrumentation data is that customers are running their NovaSeqs hard and that’s showing up in the utilization numbers that we talked about, that’s showing up in the pull-through numbers and the highs that we are hitting in terms of pull-through on NovaSeqs. And what is playing out falls into a number of buckets. One, you are absolutely right. We are seeing larger cohorts being run and where they are being run the second driver we are seeing is there is an appetite for doing a broader sequencing, things like going for exomes instead of panels with the biobank we’re going for genomes instead of exomes is that being playing out. And then some of the other drivers of people to purchase NovaSeq include applications in oncology like looking for rare events associated with cell-free tumor DNA in the blood. And for their -- for those applications what NovaSeq allows you to do is it allows you to go very deep. And so those customers for example find NovaSeq very attractive and they run them harder finding they could most other machines. And it’s very useful for them in terms of being able to understand the biology. And so what NovaSeq is doing is it’s fundamentally enabling new paradigms for experiment design there in a way that couldn’t be done without the power of NovaSeq and without access to the economics of NovaSeq. And so, all of those are playing out. And what’s interesting about the NovaSeq dynamic if I compare it with the X dynamic is and I think you wanted a point there which is with the X it was really targeting whole-genomes. And so, that was via application and if you were interested in data application or if you wanted to move from exomes to genome, the X is a terrific machine for you. But with NovaSeq, we enable a much broader set of scenarios. And so, if you want to do exomes where you’re doing panels you wouldn’t have been able to do that, in the X you can do that here. If you want to do a very deep targeted sequencing, again that for me is uniquely for NovaSeq and not for the X. And so, it’s that breath of application that you pointed out that means that our customers can access a much broader set of samples, a much broader set of applications, a much broader set of experiment designs and that helps them to getting access to samples.

And our next question comes from Mark Massaro from Canaccord. Can you go ahead with your question, Mark?

Yes, thank you. Francis, can you speak to the inflection in new research studies for instance in single cell sequencing? And then related to your comments about exome sequencing, I know Geisinger indicated plans to offer whole-exome sequencing to their 3 million members. Do you expect that to play out later this year and do you expect other systems to potentially follow suit?

Yes. Absolutely, so as I touched on the last answer, NovaSeq is enabling the fundamentally different types of experiments, much, much larger experiments. I know for example if you talk to the people that are working on the single cell atlas for example, they will talk about the fact that if you want to catalog all the different types of cells in the human body and there are 37 trillion-ish cells in the human body, you need to design experiment that are in the tens of millions of cell, and that’s got to be the design. And they have been talking to us for a while saying that they needed a machine that ended up being something like the NovaSeq they said and you need a machine that’s as powerful as NovaSeq with the economics of a NovaSeq to even design and run that experiment. And so, we’re enabling, whether it’s much bigger cohorts like the single cell atlas will have access to or much deeper sequencing, these are experiments that can now be designed and run in a way that couldn’t be done without the NovaSeq. So absolutely NovaSeq is driving new experiment or design paradigms that unlock the necessity associated in the market.

Geisinger.

And then in terms of what we’re seeing from the health systems, I think Geisinger is definitely a pioneer in terms of going first, but I fully expect over time your genomic record to be a fundamental part of your overall health record. And so it will take time to go from where we are to get there but Geisinger is not going to be the only one I believe that starts to do that in the coming quarters. In terms of the base at which I played out, and frankly I think we won’t stop at the exome, I think it will be the whole-genome, that’s part of your health record but that will take time to play out and that will take pioneers like Geisinger and the other ones that are thinking about doing that to lead the way.

And our next question comes from Catherine Schulte from Baird. Go ahead Catherine.

We’ve seen varying levels of year end budget clashes over the last few years. But Sam can you just walk us through what kind of assumptions do you have in guidance at this point for fourth quarter research spending patterns? And then Francis, any other commentary you’re hearing from research customers around the current funding environment?

Yes. So we're basically expecting what we usually expect around our research spending pattern. There’s nothing that's really different from the prior trends that we're seeing. So in other words without getting into too many details around guidance and what's built into that, nothing really unusual in terms of budget reduction or anything that impacts our research portion of our revenues. Our research actually has been showing strong growth for us, the research component of our revenues, clinical has been showing growth for us as well and we expect that to continue. So nothing built in around any unusual budget crunch at the end of the year.

And in terms of the overall research funding environments, if we look around the globe, the research funding environment has never been frankly this good. If you look at what's happened with the NIH budgets here in the US, if you look at the question about how [great] this will play out but if you look at the funding playing out both in the UK and Europe and if you look at what's happening in terms of overall research funding in China, you add it all up to a more robust research funding environment.

And our next question comes from Derik de Bruin from Bank of America Merrill Lynch.

Just you're now staying with 1.2 billion in net cash, I'm just curious as to -- can you talk about sort of like thinking about capital deployment and obviously you bought Edico, I'm just wondering just put in a broader context I mean your cash flow generation is remarkable at this point.

Yes. Thanks, Derik. I'll speak briefly to it. So anything that lowers the barrier for the adoption of genomics is one of the key I would say foundational elements of our capital deployment strategy. So if it's technology that we can buy rather than build that helps our customers with the end-to-end workflow around sequencing that lowers the barriers to the adoption of genomics, that's really going to be critical to us and very fundamental in terms of how we deploy capital towards M&A. So that's I would say one key component of capital deployment. We're going to look for potential technologies that make sense to buy rather than build for many reasons. Edico was a great example of that, as you saw. And then the other drivers of capital deployment or the other I would say priorities offsetting equity dilution as we’ve talked about time and time again, we continue to look at potential share repurchases opportunistically to offset equity dilution. And then keep in mind we have two tranches of convertible debt that come due in 2019 and 2021. And so, that should be in the backdrop of your thoughts around also as we think about available cash.

And our final question comes from Bill Quirk from Piper Jaffray.

Given the Landmark CMS decision around oncology, NGS oncology reimbursement earlier this year, we’ve noticed an increase in activity at the clinical level, specifically in hospitals. And Francis, can you speak to the interest within systems and I am thinking specifically around the community level hospitals rather than the academic medical centers? Thank you.

Sure. We definitely agree that we are seeing sort of continued building of the interest in oncology testing. Definitely there's building interest from the translational perspective, a lot of that tends to happen at the academic cancer centers, the larger cancer centers. But we are starting to see interest from some of the smaller hospitals too. I think at this stage, probably the way that might play out is more of it will be driven by outsourced sequencing and so maybe some of that demand will be showing up first in some of the outsourced labs. But over time and certainly as you look at our NextSeq countdown in the portfolio, we think those would be great instruments to put into community hospitals for -- to run oncology panels for example. And so, we think that, that interest continues to build. It’s still -- the vast majority of that market, however, is still in front of us and we expect for that to show up in the mid and low throughput part of our portfolio.

And that concludes our question-and-answer session. I would like to turn the call back to Jacquie Ross for closing comments.

Thank you. As a reminder, a replay of this call will be available at the webcast in the Investor section of our website as well as to the dialing 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.

And thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.