Illumina, Inc. (ILMN) Q3 2018 Earnings Report, Transcript and Summary

Hello and welcome to the Third Quarter 2018 Illumina Earnings Teleconference. My name is Michelle and I will be your operator for today’s call. At this time, all participants are in listen-only mode. Later we will conduct a question-and answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Jacquie Ross. Ma'am, you may begin.

Thank you, Michele. Good afternoon, everyone, and welcome to our earnings call for the third 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’ve 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 a brief 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 current 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 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. Good afternoon everyone. Illumina had another strong quarter with record revenue of $853 million, up 20% from the third quarter of 2017. We saw continued momentum across both our sequencing and microarray business, including strong demand for sequencing consumables to support research, translational, and clinical applications across a broad range of customers. In the third quarter of 2018, sequencing consumable revenue of $467 million grew 23% compared to the third quarter of 2017 and included about $14 million of stocking associated with Chinese customers buying ahead of potential tariffs. Year-over-year revenue growth of $87 million reflected growth across our high throughput, mid throughput and low throughput categories as Illumina continues to uniquely support the broadest range of customer applications and throughput requirements. Within the high throughput family, HiSeq consumables continued their expected and steady decline as customers transition to NovaSeq. While HiSeq still represents the majority of high throughput consumable revenue today, NovaSeq continues to grow very quickly with S4 representing the largest revenue contributor across the entire high throughput family of flow cells. That said, we continue to see a good mix of demand across the NovaSeq portfolio that also includes the lower output S2 and S1 flow cells. Consumables for our mid throughput sequencing system, NextSeq, continue to perform extremely well with many customers adopting the system as their primary workhorse for NIPT and oncology applications. As a result, NextSeq pull-through per system was at the high end of the $100,000 to $150,000 per year range. And the low throughput family also grew well with pull-through for both MiSeq and MiniSeq within their respective ranges. Sequencing consumable revenue also benefited from a modest contribution associated with iSeq, in its first full quarter of commercial availability. Finally, library prep also contributed to year-over-year growth with our Nextera suite of products leading the way. We believe our continued focus on delivering differentiated solutions that simplify customer workflows and improve data quality and costs will drive growth in library prep revenue. For example, we launched Nextera Flex in Richmond, a few weeks ago, which we believe will set a new standard for fast turnaround time, coverage uniformity, and content flexibility for exome sequencing. In total, sequencing consumables represented 55% of revenue in the third quarter consistent with last quarter and up 2% from the same quarter a year ago. Moving to sequencing systems, revenue of $138 million was up 12% sequentially with solid performance within the portfolio. As we expected, this was the strongest quarter of the year so far, and in fact, the highest revenue quarter for sequencing system since the fourth quarter of 2015. Consistent with our expectation for a heavily backend loaded year; NovaSeq delivered its highest revenue contribution of the year with stable ASP trends. Everything we're seeing is consistent with our belief that the NovaSeq upgrade cycle will span multiple years and we continue to target 330 to 350 NovaSeq shipments for the full year. NextSeq shipments grew sequentially and year-over-year with a good mix of existing and new to sequencing customers. Within our low throughput system family both MiSeq and MiniSeq shipments were up sequentially with good activity across all our regions and strong adoption by new to sequencing customers, who again, represented over 50% of shipments in the third quarter. iSeq got off to a great start with demand from both existing and new Illumina customers and shipments ahead of forecast. We're hearing great feedback from customers on how easy the iSeq is to use and how it's increasing productivity of labs that can now afford to in-source lower throughput projects. Sequencing services and other revenue of $109 million was up 36% from the same quarter a year ago and roughly flat on a sequential basis as we expected. In total, our sequencing revenue grew 21% in the third quarter of 2018 with strong activity across research, translational, and clinical applications. Across these areas we continue to be encouraged by a myriad of developments that we believe will enable genomics to continue the progression from research to the clinic and over time the standard-of-care. We're optimistic about genomics-based research funding as our technologies have uncovered insights that have been used to improve patients’ lives, especially in cancer. One notable area where we see significant potential is immunotherapy. With over 1,000 clinical studies associated with I/O there's overwhelming interest in using the immune system to combat cancer. But the biomarkers used today to predict responses of class of drugs fail to fully classify patients that will benefit from treatment. One example of our commitment to this area is a recently initiated collaboration with Memorial Sloan Kettering Cancer Center to identify genomic biomarkers that predict response to immunotherapy using whole exome and whole genome sequencing. In addition to our collaboration with BMS on tumor mutational burden, we believe that these studies will provide insights to help stratify patients for the most suitable and impactful therapies and therapy combinations. At a high level, the funding environment for basic and translational research continues to look favorable. In the U.S., for example, we were pleased to see that the total NIH budget for 2019 is increasing $2 billion to $39 billion. Genomics and NGS research continue to be areas of focus, especially in areas like oncology, cardiovascular, and neurodegenerative diseases, to name a few. Population genomics initiatives continue to build momentum in the third quarter. [All of us] [ph] selected three genome centers to begin generating genomic data within the next quarter. And the Healthy Nevada Project announced that its third phase will include more than 250,000 participants, building on the 50,000 participants currently in the program's first two phases. Yale launched a project to sequence 100,000 exomes starting in early 2019 and the U.K.'s National Health Service announced interest in sequencing up to 5 million whole genomes in the next five years. These large scale population studies represent a unique opportunity to better understand genomics, health, and disease and we remain in the earliest stages of rollout. Of particular interest this quarter, Bangladesh launched a cancer-focused Precision Medicine Initiative that will utilize both our sequencing and array technologies. This is notable as it shows precision medicine and associated population genomics initiatives are extending their reach into developing countries. In NIPT, we have submitted four new IDD applications to extend the geographic opportunity for our VeriSeq NIPT product. In the U.S., we continue to see growing average-risk coverage with recent decisions from Florida and Minnesota Medicaid, Blue Cross Blue Shield Tennessee in North Carolina, bringing total average risk coverage to 43%. In RUGD, Rady Children's Hospital here in San Diego received funding from Medi-Cal to launch Project Baby Bear, offering clinical whole-genome sequencing as a first-line diagnostic test for babies in the NICU. This is a strong validation of the value and potential for sequencing to improve the management of babies born with a rare and undiagnosed disease and we applaud the state of California for funding this effort. Further supporting the value of whole genome sequencing for many RUGD patients, CMS released final pricing of about $5,000 for a single genome late last week. This CMS decision is another important milestone to support the progression of clinical whole genomes into standard-of-care for RUGD patients over time. Finally, on the reimbursement front, we continue to see the development of a more supportive landscape that we believe will accelerate the adoption of genomics in the clinic and encourage further innovation in the field. Most recently, Anthem with more than 27 million covered lives, announced that it will reimburse large NGS panels for stage four patients or those with their current metastatic non-small cell lung cancer. Of note, covered panels will be required to include tumor mutational burden, highlighting what we believe could be an emerging trend in panel coverage. Moving to arrays, total microarray revenue of $134 million was down sequentially as expected and up 11% from the third quarter of 2017. Array instrument revenue of $16 million was higher than we expected and the largest revenue contribution since 2011, driven by a large key DTC customer scaling ahead of anticipated holiday demand. This was more than offset by lower microarray service and other revenue on a sequential basis. While there is seasonality, we continue to be impressed with the rate of growth we're seeing among our DTC customers. Consumer genomics has predominantly been a U.S. phenomenon until now, so it was particularly exciting to see a healthy revenue contribution associated with an emerging consumer genomics industry in Asia-Pacific in the third quarter. Moving to regional results, Americas’ revenue grew 14% versus the prior year period, driven by growth across the sequencing business. EMEA delivered another strong quarter with 33% growth from the prior year period, including a strong contribution from Genomics England, which has now sequenced more than 87,000 whole genomes. Other growth drivers included NovaSeq, NIPT, and sequencing consumables more broadly, which combined, more than offset a negative year-over-year FX impact. Greater China grew 17% year-over-year, with strong sequencing consumable growth. During the quarter, MiSeqDx received NMPA approval, our first NGS instrument to receive regulatory clearance in the region and a significant milestone for Illumina as we expand our clinical presence in the growing Chinese market. This timing, given the emergence of targeted therapies and signs of a more supportive Chinese regulatory environment with two PD-1 drug approvals in the past few months. Finally, APJ revenue of $58 million was up 29% from the third quarter of 2017, the strongest quarter in the region since early 2014. Our APJ business is benefiting from strong sequencing activity among regional, commercial sequencing service providers that drove a majority of the year-over-year revenue growth. With that, I'll turn the call over to Sam for a review of our quarterly financials. Sam?

Thanks Francis. As discussed, third quarter revenue grew 20% year-over-year to $853 million, driven by 21% growth in sequencing and 11% growth in microarrays. Consumables and services continue to represent the majority of total revenue, representing 64% and 17% respectively or 81% in total. Consumable revenue was $550 million, up 2% sequentially and 22% year-over-year. Services and other revenue was $143 million, down 9% sequentially and up 21% year-over-year. In the third quarter, our sequencing consumable business once again benefited from a handful of Chinese customers buying ahead of anticipated tariffs. In the second quarter, we noted that $13 million of revenue has accelerated into Q2 due to tariffs. In the third quarter, an additional $14 million of tariff-related purchases was accelerated. Moving to systems, total instrument revenue was $154 million, up 21% sequentially and up 10% year-over-year with a strong performance within our system families. Instrument revenue, therefore, represented 18% of total revenue in the quarter. 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 refer to the results attributable to Illumina shareholders. Non-GAAP gross margin of 71.1% was higher than expected and increased 80 basis points compared to the second quarter, driven by favorable product mix within sequencing consumables. Year-over-year, non-GAAP gross margin increased 230 basis points, primarily due to a higher mix of sequencing consumables. Non-GAAP operating expenses of $356 million were up $8 million from last quarter, largely reflecting higher R&D investments and headcount additions. Non-GAAP operating margin was therefore 29.4%, up from 28.4% last quarter. Excluding Helix, operating margin was 32% compared to 30.6% last quarter. The non-GAAP tax rate of 17.3% was higher on a sequential basis from the 15.9% last quarter due to the incremental investment in Helix creating additional tax benefits in Q2. While it was lower than we expected due to favorable prior year return adjustments recorded this quarter. For the third quarter of 2018, GAAP net income was $199 million or $1.33 per diluted share and non-GAAP net income was $227 million or $1.52 per diluted share. Cash flow from operations was $292 million. DSO of 46 days was higher compared to 43 days last quarter, driven by less favorable revenue linearity. Capital expenditures in Q3 were $64 million and Q3 free cash flow was $228 million. This quarter, we issued $750 million aggregate principal amount of 0% convertible senior notes due 2023. Net proceeds of the issuance were $735 million, of which $103 million was used to repurchase shares. Additionally, our 2019 and 2021 notes became convertible from October 1 to December 31, 2018. We therefore ended the quarter with approximately $3.4 billion in cash, cash equivalents, and short-term investments. As a result of the 2019 and 2021 notes becoming convertible, approximately 1 million shares have been added to our Q3 diluted share count and weighted average share count for the quarter was 149 million. Moving to guidance, we continue to expect full year 2018 revenue to grow approximately 20%. We expect full year non-GAAP gross margin to be up modestly from 2017 and we expect GAAP earnings per share in the range of $5.32 to $5.37 and non-GAAP earnings per share in the range of $5.70 to $5.75. In the fourth quarter specifically, we expect revenue to be flat to slightly up from the third quarter of 2018. We expect sequencing system revenue to be up sequentially. We expect sequencing consumables to be down sequentially, reflecting the approximately $20 million of consumable revenue previously forecasted for the fourth quarter that has already shipped to Chinese customers in Q2 and Q3. And we expect microarrays to be down slightly with growth in consumables more than offset by an expected decline in microarray instruments. We expect non-GAAP gross margin to be at its lowest level of the year due to higher system and arrays mix expected in the fourth quarter. We expect non-GAAP operating expenses on a percent of revenue basis to be up meaningfully from the third quarter and we expect GAAP earnings per share in the range of $1.17 to $1.22 and non-GAAP earnings per share to be $1.30 to $1.35. With that, we'll open up the queue -- the call to Q&A. Operator?

Thank you, sir. We will now begin the questions-and-answer session. [Operator Instructions] The first question in the queue comes from Ross Muken with Evercore ISI. You may begin sir.

Good afternoon guys and congrats. Maybe starting on NovaSeq, helpful with all the color. It seems like a tremendous quarter. It feels like the breadth of application use is continuing to increase and interest in a lot of the clinical states, whether it's rare disease or liquid biopsy, et cetera, are growing. And so maybe can you just provide -- it seems like the -- provide a little color on sort of the types of customers and some of these new to sequencing or new to high-throughput customers that you're seeing because it feels like we're seeing kind of a changing of the guard in terms of the names of organizations or the types of firms that are now looking to acquire high throughput sequencer and sort of what they're doing with it. So, a little color around that. And then as it relates to kind of the Q4 guidance, just sort of the pushes and pulls where you see maybe the most amount of conservatism or the biggest risk within sort of those assumptions. And Sam, I thought the incremental color was helpful. I just want to make sure I know where the kind of key inflection points are, if it's NovaSeq or if it's one of the other pieces.

Sure and thank you, Ross. So, in terms of the NovaSeq, and we said this on previous calls and it's more true today than ever, we are very pleased with the strong interest we're continuing to see in NovaSeq. And we're really pleased with the way this upgrade cycle is playing out. We have planned this to be a multiyear upgrade cycle. And we planned the stage activation of the different parts of the HiSeq base through the use of different flow cells. And frankly, we're really happy with the way it's playing out. We talked about the fact that we continue to see growth from, as you pointed out, a segment of new to high throughput, new to sequencing customers that, frankly, was higher than we expected coming into the NovaSeq upgrade cycle and so we've typically seen between a quarter and a third now NovaSeq customers each quarter being in that new to sequencing, new to high throughput base. And as we look to the base, we are seeing, as you pointed out, some of these customers are not the usual suspects. They are new to sequencing and I'll give you some examples. An example of a customer we got in the last quarter included a new hospital customer that's part of a national collaboration in a European country to move towards clinical whole genome sequencing and is linked with a PMI project in that country. Another example is a new commercial customer we got in Q3 that's developing a universal cancer screening test. And so previously, they've used a service provider that was operating a NextSeq to run their samples. But as this customer is now scaling, they're bringing the work in-house and so they purchased a NovaSeq. And they're using it to detect tumor mutational burdens across the 10 deadliest cancers at the earliest stages in patient blood samples. So, another customer. A third example would be a new customer in Q3 that's using NovaSeq to start sequencing exomes, which allows a unified workflow for many of the sample types that they run. And they're planning to slowly transition from smaller panels to exomes once all the proper validations have happened. And so across those three examples, you can see that the thesis we had going in, which is as we democratize access to high throughput sequencing, we will see customers doing broader sequencing, doing deeper sequencing, and moving from panels to exomes and genomes are starting to play out, certainly, in those examples. And so that's some of the color behind what's driving the uptake for NovaSeq.

With regards to Q4, Ross, maybe let me just give you some color to add to some of my comments on the call. So, obviously, very pleased with the result in Q3. In terms of Q4, we expect, as I mentioned, flat to sequentially modestly up in Q4. And basically, some of the key driver is there when you look at it. First of all, in terms of China tariffs, it's important to highlight a couple of things there because that's an important driver on Q4. We believe that roughly $20 million of orders in Q4 have been accelerated into both Q2 and Q3. Some of that acceleration was actually from Q3 into Q2, but then the balance was really from Q4 into earlier in the year. So, by and large, you have to expect that roughly $20 million less consumables in Q4 that were accelerated into earlier in the year because of some handful of customers -- Chinese customers, buying ahead of tariffs. So, that's an impact on sequencing consumables, which, as I mentioned on the call, will be slightly down in Q4. In terms of instruments, and we saw this in Q3 as we've had -- as we said before, we expected that the second half of the year will be higher in terms of instruments. And we started to see that in Q3 and we expect to see that in Q4 as well as we expect a meaningful ramp in terms of instrument revenue. And then finally, with regards to arrays, we had in Q3 a very strong quarter for array instruments. So, that presents a bit of a quarter-on-quarter from Q3 to Q4, a slight reduction in terms of arrays, primarily because we've had a strong quarter in Q3 in terms of higher array instrument. And as you know, array -- there's some seasonality behind arrays as well. But again, we saw strong performance in Q3. A lot of that was driven by instrument placements ahead of the holiday season.

Thank you. The next question in the queue comes from Tycho Peterson, JP Morgan. Sir, you may begin.

Hey thanks. You guys, obviously, have a ton of momentum that's playing out on strong instrument placements and better than expected pull-through on NovaSeqs; I think at least relative to what people have been modeling originally. That said it's been a while since we've asked on competitive dynamics. So, I'm just wondering you've got one competitor talking about $1,000 platinum grade genomes. You've got another talking about 300, albeit not in the U.S. Another has talked about 60 gigs of throughput. Does any of this change your view, I guess, of competitive dynamics? How should we think about any of this impacting the selling cycle? And maybe can you just talk on levers that you may pull, in particular thoughts on moving down the cost curve given that you've previously talked about $100 genome down the road?

Sure. So, Tycho, obviously with a market this big and this much growth ahead of it and still being in such earlier stages, you'd expect to see it attracts a lot of players. And we've been talking about the players in the space and the segments they play into. We continue to see, as you pointed out, BGI talking about low cost sequencing and running samples for customers in China at a lower cost for -- per genome than outsourcing customers can get elsewhere in the market. And the competitive dynamic there is still largely the same in the sense that if you compare what customers can get with our products compared with what they can get in BGI, there's a big difference in terms of the quality of the data that you get off the instruments, in terms of the reliability of the instruments; if you purchase the instrument yourself. And then there is some -- in some cases, just concern in terms of the privacy of the data or shipping samples to China. In some cases, there are actually restrictions, whether it's national restrictions in some countries about shipping biological samples outside or data restrictions around having the data outside the country. And in some countries like in the U.S., there are restrictions from funding sources. So, some of the funding sources for academic projects don't allow you to ship samples outside the country to China. And if you do, you risk not being able to get future funding from those sources. But the primary competitive dynamic in that case is really about the reliability and the quality of the data you get from our instrument. And those are dimensions that we continue to invest and to raise the bar and become more and more important as we get into the clinical markets. We continue to look at adjacent markets and what's happening there like the long read market and look at the improvements that are happening there in terms of the gradual improvements in accuracy and the price improvements. And that continues to be a complementary market to us, right? If you look at how customers use those technologies, what they'll do is they'll buy a long read instrument or they'll outsource to a long read service provider to do scaffolding, de novo, create the reference genome, and then drive a lot of their production work on to Illumina instruments. And so in some sense, the way the dynamics been playing out over the years is the more species that get sequenced through the long read technologies, the more sequencing that drives to Illumina. And the competitive dynamic there is while they can do the reference genomes our cost advantage means that anything in production you'd want to do on our instruments. And we've publicly stated that we continue to want to drive the price down over the years as we have. And so we expect that separation of the markets to continue to play out going forward. But overall, if you take a step back, the fact that you're seeing multiple players in the market innovate across different dimensions that you're seeing the venture community get interest in the market really does validate just how enormous the opportunity in front of us is and validates that we're really at the early stages of this big opportunity.

Thank you, sir. The next question in the queue comes from Doug Schenkel with Cowen & Company. Your line is open sir, you may begin.

Okay. Thank you and good afternoon. I want to follow-up on the $14 million stocking order in China. First, how much of this is attributable to NovaSeq? Second, are you only seeing this with consumables? And if so, why? Third, how do you confidently know it's stocking and not fundamental demand, given it's happened a couple of quarters in a row? And lastly and probably most importantly, adjusted for the China bulk orders, are you continuing to see an increase in utilization for NovaSeq globally? Thanks, I’ll get back in the queue.

Yes. So, I'll start, Doug, by talking a little bit about the tariffs activity. So, as we mentioned last quarter, we had $13 million in Q2. That was accelerated from later in the year. And we believe that was a mix between Q3 and Q4 that was accelerated into Q2. And then in Q3, as I've just mentioned on the prepared remarks, we had $14 million that was accelerated from Q4. That again is a handful of Chinese customers. Our intel -- our discussions do definitely point to the fact that these are really ahead of the concern around tariffs, a concern that there might be additional tariffs on consumables and so pre-buying ahead of that. In terms of the mix of those, I would say a good proportion -- a large proportion of them is NovaSeq, but they're not entirely all NovaSeq. So, just to clarify, we believe that, as I said, a large proportion of those orders are NovaSeq. But just in terms of tariffs, as a whole, let me give you little bit of backdrop as well and some context. In Q3, we did receive notification that there were tariffs of 5% that were placed on instruments. So, that's been the only tariffs that have been placed on our products. There hasn't been anything that's placed on consumables. So, we know that there's been 5% placed on instruments. That's a modest amount, and there has not been anything else that's been announced on consumables. But obviously, customers in China have still been a little bit cautious and advancing some purchases ahead of potential tariffs. As I've mentioned before, again, sequencing -- investments in sequencing is definitely a commitment and not easily redirected. So, we don't believe that even with tariff, this changes the landscape materially because customers will still have this commitment to sequencing. Our instruments -- our consumables are proprietary. Our consumables only work with our instruments, and so there's definitely, I would say, more of a long-term commitment to sequencing. We believe this is more of a timing driver as opposed to something that changes the landscape, even if tariffs do get placed on our consumables.

Yes. And if I had to add to what Sam just said, I'll take a step back and look at the China market. If you look at our growth in China for the first three quarters of 2018, that's been approximately 30% revenue growth year-on-year. Now, if you take that same period a year ago, it was 25% growth approximately. And so our business in China is bigger than it was last year and it's growing faster than it was last year. And the tariff effect is a small part of that bigger story of what's happening in China.

And one last thing, Doug, on the question that you asked as well. All of the purchases, the $13 million and the $14 million we announced, have been consumables, not instruments.

Thank you. The next question in the queue comes from Dan Leonard with Deutsche Bank. Sir, you may begin.

Thank you. So, as we're thinking about the cadence of the business into 2019, could you comment, is there anything we should be mindful of on the PopSeq front as GeL is rolling off? And anything we should be thinking about in terms of leverage down the P&L? Thanks.

So, if I look at the population sequencing initiatives, it's clear that governments all around the world are recognizing the value of population genomics studies as a fundamental enabler to precision medicine and those initiatives around improving both the quality of the healthcare system and driving cost out. And now we're engaged in several dozen population sequencing initiatives around the world. If we look at, though, 2019, there are a number of things that are going to play out. In the U.K., which already pioneered the area of population sequencing, we expect GeL to complete its 100,000 genomes in the coming months, it may sort of lead into the beginning of next year. They publicly announced they've crossed over 87,000 whole-genome sequencing. And so that will play out over the coming months entering into 2019. And then they've announced that the next phase of GeL will be driven out of the NHS. And so you can expect to see that starting to ramp-up in 2019, and there'll be a ramp-up period, but that's the big transition you'll expect to see from GeL. That's a very exciting transition because in Phase I, GeL talked about 100,000 genomes. And the message coming out from the U.K. is that they have a vision to do 5 million genomes as part of the next phase of the project. Those -- that will take time, though, to play out, but it's a much bigger opportunity that will start in 2019. Similarly now, if you look in the U.S., and you know what's happened over the last few weeks even, is that the -- we've seen progress around the All of Us Precision Medicine Initiative. That was launched in May and the vision was ready to sequence million samples over 10 years and the budget for All of Us was announced. And that was $376 million for 2019, up from $290 million in 2018. And so they've got the budget for 2019 over the last few weeks, All of Us has now selected the three genome centers that they are going to use to do the sequencing and the genotyping. So, they selected Baylor, Broad, and UW to do the sequencing. And so you can start to see that roll out as we get into 2019. You'll also see progress from Yale. They've announced their project, a large genome medicine project for 100,000 patients, with more than $20 million in funding that they've secured and that is expected to start in early 2019. In addition to those are again many, many, many initiatives that we are working on, there's the initiative in France that was supposed to go into pilot in the next few -- by the end of this year, we think it will happen early next year. So, there are many other initiatives that we're working on as well, and so that's the color on some of the big ones.

And with regards to leverage, Dan, obviously, it's early to talk about 2019 and what our projections and thoughts are there. But all I would say is fundamentally, our commitment to leverage hasn't changed. We're still committed to leverage. We will still look for transformational investments and make those. But overall, we're still fundamentally committed to creating leverage in the P&L.

Thank you. The next question comes from Derik se Bruin of Bank of America. Your line is open, you may begin sir.

Hi, good afternoon.

Hi Derik.

So, a couple of short ones, if I may. So, just following up on the stocking question, how many quarters of material of consumables were stocked? And this goes the question of what is the shelf life of these products? I'm just trying to get a sense of when we would potentially see a reorder when they would burn through this. Question -- and then a question on -- we've had some really good NIH funding. I'm just curious, is -- are the grants have been written over the last year or so, how many of those throughput in the NovaSeq? And I guess, if you've seen sort of an upgrade cycle, bolus of instrument sales of NovaSeqs sort of coming through, is that part of your pipeline of sales in the back half of the year for NovaSeq? Thanks.

So, maybe I'll start with the consumable question, Derik and then I'll let Francis answer the question about the research funding grants. With regards to consumables, we -- our shelf-life is usually somewhere in the six-month to nine-month range. So, in terms of placing orders out of -- or for stocking or two ahead of potential tariffs, obviously, they'll keep that in mind in terms of the shelf-life and in terms of the expiration. They cannot exceed the six-month timeframe usually and I would say six months to nine months is probably a good range for it.

Yes. And then if we think about how the grants are playing out, I think obviously we're very, very happy with how funding is developing in terms of the budgets going out. I mean the $2 billion increase in NIH budget was a welcome use in the industry. We also continue to see a shifting of the budget to genomics-based studies across a variety of academic domains. We talked about interesting work that's happening in cardiovascular and neurodegenerative diseases and lots of other chronic conditions to. So, not only is the overall budget envelope going up, but we continue to see a shift of the budget to genomic testing, which is obviously really good news for science and really good news for us as well. In terms of NovaSeqs, we are starting to see -- it used to be -- I don't know if you recall last year, but certainly, with TOPMed here in the U.S., they still wanted the grants they were giving out to be for projects that were running the X. And they wanted the projects to continue to run the X because that's how they've done it before and that's changed. We are not yet at the stage, where they are requiring NovaSeqs as we saw before with the HiSeq X. So, we're in that transition where they're saying, yes, you can and, in fact, the people that do and have better economics you think have a better chance of winning those projects and typically what happens is that the next stages, it just becomes a requirement in terms of applying for those grants.

Thank you. And the next question in the queue comes from Mark Massaro with Canaccord Genuity. Your line is open, you may begin.

Hey thanks for the questions. It seems like with All of Us U.K., Geisinger, liquid biopsy studies, we can quickly count 10 million genomes that will be sequenced. The last four quarters, you've put up 30% sequencing consumables growth on average, recognizing that this quarter was 23%. As we think about next year, is there any particular reason why sequencing consumables should materially step down from current levels? And then related to that -- or I should say, a second part of this question, when we think about Geisinger as a health system doing exome sequencing for their population, Francis, can you give us a sense if you are talking to other clinical health systems or IDNs to do broad-based exome sequencing on people?

Yes. So, if I think about the things that have driven demand that have given us that 23%-plus growth rate in sequencing consumables not just in the quarter but just past the previous quarters, a lot of those secular trends are here to stay. And there's nothing I can point to for the last year and say that was an unusual thing or a temporal thing. They're maybe timing thing. So, for example, GeL was running at full force this week. It's going to scale up and go into the NHS. There may be a transition that plays out. But in terms of almost every trend that I can point to that drove demand this year, whether it's liquid biopsy, population sequencing on the NIPT side, all of those trends are poised to grow going into the future, right? We're going to have more people doing NIPT tests. So, liquid biopsies, today, we saw Guardant360, and not it's really exciting get reimbursement from Palmetto. It got the local coverage decision around the liquid biopsy test for non-small cell lung cancer and that was the first. And so liquid biopsy, you expect there to be more of. So, again, the trends are secular trends. They're going to play out. Trends like the population sequencing trends are going to play out over a multiyear period. So, at this stage, we're not telling you with any particular quarter, it looks certainly not next year, but you're absolutely right. These are durable secular trends. What's the second part of the question? I think that was it.

Exome sequencing with Geisinger to potentially other health businesses?

Yes, we absolutely are. So, the announcement of Geisinger made around doing whole exome sequencing for all the couple millions of patients in their health system has triggered conversations about having the -- your exome or your genome be a part of your health record. So, we're having those conversations. Nothing has been announced yet, but as you can imagine, it definitely triggered interest from other health systems, especially ones where they have capitated patients or they have patients that tend to be in the system for a long time. They are the ones that are leading the conversations right now.

Thank you. The next question comes from Puneet Souda with Leerink Partners. Your line is open.

Yes, hi Francis. Thanks.

Hi Puneet.

Hi thanks. So, I have a bigger question on the next leg of growth here for you, given that the leading labs have picked up NovaSeq in 2017 and the next or the mid-tier labs are picking up NovaSeqs this year. You've highlighted in the past that there are 850-plus customers or so, and I think you said north of 200 or so have taken the delivery of NovaSeq. Just help us understand how do you see the broader potentially lower throughput labs buying into NovaSeq? Do you expect them to buy into NovaSeq? Do you see a relevance of S Prime there? Or do you expect them to move to NextSeq? How do you get those broader labs into the new instrument upgrade cycle?

Sure. I'll start by saying if you take a step back, I think we still have the majority of the upgrade is in front of us in total. So, if you add up the total number of customers or the total number of systems, I don't think we've crossed over the halfway point even off the upgrade cycle. And now I'll talk a little bit of a segment story. If you look at the high throughput -- the large centers, the majority of them have bought a NovaSeq, that's true, but a small minority of them that have completely cut over to a NovaSeq. And so the work in front of us, both in terms of orders, in terms of shipments and in terms of implementations for our customers is really to do that cutover. And that's not been a 2017 story or an 2018 story, that's a 2019-plus story. And we still have, if you look at the smaller labs, still large labs, so core labs, but it's a smaller end of it, there's still lot of them that have yet upgrade to a NovaSeq. And so a lot of the ones that we expect to buy one or two NovaSeqs, that business still in front of us. And some of them are waiting for the S Prime, which will come out in the coming months and that's important for them. Some of them were waiting for the S1, which just came out earlier this year and are in a valuation cycle right now. And so you add up all those different dynamics, and I'd say the majority of that upgrade is still in front of us.

Thank you. The next question in the queue comes from Daniel Brennan with UBS. Your line is open sir, you may begin.

Great. Hey Francis thanks for the questions. I was hoping maybe you can provide a little color on maybe your revenue mix by customer today between research and clinical and translational other. And then specifically as you think about the clinical business, any color how to think about the growth rate of that business going forward. Obviously, there were a few questions already on that, but I'm just wondering if we're at a point where growth is inflecting given the progress on a number of fronts you cited. Thanks.

So, if I look at the breakdown of the business between clinical and translational research, it's continuing to build in the same way we've seen, consistent what we've seen in previous quarters. So, we said previously, if you look at clinical and translational, it's in sort of the mid to high 40s as a percentage of our revenue. That continues to be true. And the drivers of the clinical business are NIPT and certainly in Europe, we're seeing strong growth with the launch of VeriSeq NIPT off our NIPT business. One of the things we are doing there is we're continuing to get clearance for the VeriSeq NIPT product to expand the addressable market for that solution. That's been a lot of the work we've been doing this year. And so you should see that start to play in next year. The other big driver, obviously, of our clinical business is our oncology segment. And there, there are a number of factors. We have the large liquid biopsy customers. We have the clinical commercial customers that are driving a lot of our oncology business. We see a lot of translational business that comes out of the academic cancer centers. The work that's happening there, a lot of it is around immunotherapy and doing the work to identify the predictors of success of immunotherapy. And all of those things are going to continue to build into next year.

Great. And then maybe just one follow-up kind of related to the prior question regarding amongst those high throughput customers that have already upgraded to the NovaSeq and kind of retired their old instruments, can you just discuss kind of what you're seeing from those customers in terms of demand elasticity, maybe kind of how those customers are spending with Illumina on consumables? Thank you.

Yes, it's an important metric for us to track. And one of the things we did, and we touched on it the last earnings call a little bit was what we look at is we look at the total consumable spend of our high throughput customers. And we look at them before they got a NovaSeq and we look at the ones that don't have a NovaSeq yet and we look at the ones that also bought a NovaSeq. And what we shared was that we saw that high throughput customers that had bought a NovaSeq, in aggregate, they were spending more with us than ones that haven't bought a NovaSeq. And that actually intuitively makes sense, right? So, you're seeing the reason people are buying the most powerful sequencer in the world is because they anticipate more demand for it. And the dynamic we've known in the market is that given the research that our customers want to do, if they have a budget, they want to spend that budget doing as high quality research as they can. And so if they can get a more powerful instrument like a NovaSeq to replace a HiSeq, then what they'll do is they'll do a higher powered study. And so they'll put more samples into the study to generate higher quality science. And so they take the power they have, and they'll use as many samples as they can for that study. So, it's not that they will use less samples when they have the NovaSeq. And that's borne out by the numbers that we're seeing.

Thank you. The next question in the queue comes from Dan Arias from Citigroup. Your line is open, you may begin sir.

Good afternoon. Thanks for getting me in here. Francis, maybe on NIPT and the expectations for some good growth in that market next year. I'm just curious whether you think if we do get a big step-up in average risk testing you think that there's a capacity expansion that goes along with that. Do you kind of feel like there's a need to buy boxes? Or do the labs kind of have the infrastructure that they need? Thanks.

Sure. If you think about NIPT going into next year and sort of where the growth will come from, I think there are a couple of vectors that will drive growth for NIPT. In the U.S., I think as you point out, one of the things that will drive growth is the increased adoption and coverage for average risk customers. So, we're continuing to make progress -- incremental progress in terms of the percentage of covered lives in the U.S. that have access to NIPT for average risk pregnancies. In September, for example, we got Florida Medicaid that became the first state Medicaid program to cover NIPT for average risk. We continue to see some of the payers that I talked about that came online the last quarter. And overall now, we're at 43% of covered lives have access to NIPT testing for average risk pregnancies. The big -- there are a couple of big payers, though, that have not yet moved like, for example, United. And for them, we think a move in the guidelines will be important. And if we look at how that's played out over the year, we've made some progress there. So, if you look at ACOG here in the U.S., they've withdrawn their practice bulletin 640, which question the utility of average risk NIPT. And some in the industry feel that's a precursor for them actually endorsing NIPT for average risk pregnancies because the removal of 640 now leaves the more supportive ACOG 163 in -- as their practice bulletin. And that indicates that the sensitivity and specificity of NIPT is very similar to levels previously published for high risk pregnancies. And so we're making progress with ACOG. And as those guidelines come into play, so I think that will continue to be positive in terms of the couple of large bears that have yet to move. So, one big driver of NIPT growth is going to be continued coverage for average risk -- expansion of the coverage for average risk pregnancies here in the U.S. And then internationally, it's the adoption of VeriSeq NIPT and the coverage of NIPT by the national systems. And so if you look at where we are in Europe, 100% of pregnancies in Europe are covered for NIPT in Belgium, in the Netherlands, we have very well-contingent screening in the U.K., France, and Switzerland. And in Germany, we've just seen some progress with the German HDA publishing assessment acknowledging the diagnostic value of NIPT for trisomy 21 and so making incremental progress in terms of Germany adopting NIPT. And then the other big vector is going to be China. We continue to see growth there, closing in on 20 million pregnancies a year in China. Today, we see 3-ish million, 4-ish million NIPT across everybody, all the players in the market being done. And so there's still an untapped opportunity in China. So, those are the things that will drive NIPT growth.

Thank you. The next question comes from Catherine Schulte with Baird. Your line is open ma’am, you may begin.

Hi, thanks for the questions. Francis appreciated your comments on the early interest you're seeing in iSeq. But can you give us some more anecdotal commentary on the types of customers you've seen there and what the typical use cases are?

Sure. I am very excited about the potential for iSeq and the strategic role it will play in our portfolio. If I look at who's buying iSeq, I'd say broadly, there are three types of customers that are buying iSeq today. The first one, and not surprisingly, they are the ones that were out of the gate the fastest. They were a big part of the early orders of iSeq are actually existing Illumina customers. And what they love about iSeq is they're telling us that it is a terrific box to do a quality control step on a library before you fire up a run on a NovaSeq or any of our other machines because you could spend tens of thousands of dollars on a NovaSeq run. And you would want to know before you did that if there was something wrong with the library. And so it's a terrific little instrument that allows you to do a quick QC step before you run a NovaSeq run. And so a lot of customers have understood that and we're seeing orders for iSeq to support that use case. Another set of customers are customers who are much smaller labs. And they do sequencing today, but they don't have either the capital or the sample volume to purchase their own MiSeq or MiniSeq and so they're outsourcing today. And so iSeq is a very accessible instrument for them, and they're excited about bringing some of that sequencing in-house. And we're seeing customers for iSeq that are exactly that, very familiar with sequencing. In fact, they are sequencing customers; they just don't have their own instrument. And then long-term and probably among the most exciting segments is going to be the tens of thousands of labs today that don't do sequencing. And as they start to understand the role that genomics can play in the research that they do, iSeq is a terrific instrument to open up that largely untapped market that those are labs that today may be buying qPCR boxes, for example, but don't do sequencing at all. And we think that this is the perfect instrument to get into that market.

Thank you. The next question in the queue comes from Patrick Donnelly with Goldman Sachs. You may begin sir.

Great. Thanks. Maybe just one on the liquid biopsy market. We recently saw the first dedicated company in that space is a customer of yours become public to a pretty strong reception. Can you just update on us on that market? How we should be thinking about where we are in terms of placements and consumables already being used for trials compared to the opportunity over the next few years as these companies continue to raise funds and invest in developing the market?

Yes, that is a really exciting segment in the oncology market. We are now seeing liquid biopsy being used in various stages of the cancer journey, right? So, we're seeing some very high-profile companies like a GRAIL or a Freenome that are interested in using liquid biopsy as a screening tool for asymptomatic individuals. And so they're going after the population at large, and they're designing tests that have to have really high sensitivity and specificity to be used as a population screen. And the results we're seeing continue to be very encouraging. The results that the GRAIL team shared at ASCO earlier this year are really encouraging in terms of them being able to bring out a test that has the right sensitivity and specificity across cancer types. Then you're seeing companies like Guardant. And what's exciting about what Guardant is doing is they're using liquid biopsy at a different stage of the cancer journey. And they're saying this is for people who already have cancer. And with their Guardant360 test, you're able to identify the molecular profile of the cancer a patient has. And that is especially important for things like lung cancer, where it is really difficult to get samples from a patient and it's hard to get samples that are not degraded. And so to be able to do that from a blood test is really enabling for those patients. Guardant is also looking at using liquid biopsy as a tool to assess the effectiveness of a therapy through MRD to look for recurrence. And so those are all applications that also lend themselves for liquid biopsy rather than tissue biopsy. And what's especially exciting is that some of the companies are now getting into the space and some of the commercial entities that are being created to deliver liquid biopsy tests are not the usual suspects. They're not just a Silicon Valley cloud. The example I gave was not a usual suspect. It was a new company that was created just to deliver a universal cancer screening test. And so we're seeing a lot of investment poured into this area because there's a recognition of the enormous promise of liquid biopsy to do better screens and ultimately, improve outcomes for patients.

Thank you, sir. We have time for one more question. That question comes from Steve Beuchaw from Morgan Stanley. Your line is open, you may begin.

Well, thanks for letting me run the anchor leg of the relay here. I will try to round out the conversation on the different drivers and maybe touch on consumer. Really interesting growth story with the number of samples that have been access there. If you think about over the last year or two consumer as a driver of growth, it's happened in part because there have been a number of players out there that have taken advantage of some of the products you launched at ASHG a couple of years back, taken their price structure down, taken their prices down, taken their promotional intensity with DTC advertising presentation on Amazon higher. Can you talk about over the next year or two how you think the intensity of the push is in consumer relative to the last year or two? Thanks.

Yes, it's a great question and I'm glad we got to touch on the consumer market because it's a very exciting market and it's a large market going forward. And we did -- as we touched on, we did see an inflection in the consumer market play out in 2017. And in 2017, we -- sequence are genotyped more samples that year, so 7 million samples in 2017 than we done in the previous 10 years combined. The space started in 2007 when it launched 23andMe. And we saw that inflection point. And that inflection point last year was driven by -- it was primarily a U.S. story. It was primarily an Ancestry story, and it was primarily driven by a couple of the big players in that space. This year, we've continued to see the growth in the genealogy segment, but we've seen other things play out. One, we've seen just more players emerge in the market. And so we are tracking a large number of companies now that are in the DTC space around the world. And we started to see revenue contribution show up, as I talked about it, for example, from Southeast Asia. And so we're starting to see DTC become a more global story than it, frankly, has ever been and we're definitely at the very early stages of that. Frankly, we're at the early stages of it in the U.S. and we're at the, really, really, early stages of it outside the U.S. We're also seeing a broadening of the drivers for consumer genomics, right? So, if I said the first driver of it was genealogy, the discoveries that have happened have now enabled more reports to be generated for customers. And so some of the pool is now coming from segments that are broader than genealogy. It's health traits, it's wellness, it's nutrition, it's fitness and that's expanded -- and that's the story of 2018. And the revenue from it, we expect to come in future years, but the idea of it really showed up in 2018. We're also excited about the potential for Helix to continue to expand that opportunity and continue to enable innovation for consumers to try out different reports in consumer genomics and figure out where the next growth vector could be. And so those are the dynamics around consumer and genomics that have showed up. We continue to see the growth driven by genealogy. It's now much more of a global story. It's much more diverse in terms of number of customers that are interested in doing it and a number of segments that they are targeting, but very early across the Board.

Thank you. I'll now turn the call back over to Jacquie Ross for any closing remarks.

Thank you. As a reminder, a replay of this call will be available as a webcast in the Investors section of our website. Thank you for joining us today. This concludes our call, and we look forward our next update following the close of the fourth quarter.

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