Illumina, Inc.
Q1 2016 Earnings Call Transcript

Published: 4 May 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Illumina, Inc. Q1 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this call is being recorded. I would now like to turn the conference over to Rebecca Chambers. Please go ahead.

[Rebecca Chambers:]

Thank you, operator, and good afternoon, everyone. Welcome to our earnings call for the first quarter of fiscal year 2016. During the call today, we will review the financial results released after the close of the market and offer commentary on our commercial activity, after which we will host a question-and-answer session. If you have not had a chance to review the earnings release, it can be found in the Investor Relations section of our website at illumina.com. Participating for Illumina today will be Jay Flatley, Chairman and Chief Executive Officer; Francis deSouza, President; and Marc Stapley, Executive Vice President, Chief Financial Officer and Chief Administrative Officer. Jay will focus on our Q1 results, Francis will provide the outlook for our business, and Marc will review our financial results and updated guidance. This call is being recorded and the audio portion will be archived in the Investors section of our website. It is our intent that all forward-looking statements regarding our expected financial results and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based on current information available and Illumina assumes no obligation to update these statements. To better understand the risks and uncertainties that could cause actual results to differ, we refer you to the documents that Illumina filed with the Securities and Exchange Commission, including Illumina's most recent Forms 10-Q and 10-K. Before I turn the call over to Jay, I would like to let you know that our Q1 earnings presentation will be available on the Investors section of our website shortly. We plan to reference this document during today's call. With that, I will now turn the call over to Jay.

[Jay T. Flatley:]

Thanks, Rebecca, and good afternoon, everyone. As we shared a few weeks ago, first quarter revenue was $572 million, an increase of 6% over the prior year period and lower than the guidance we provided in January. Our analysis subsequent to the pre-announcement has identified two key contributors to the shortfall

[Francis A. deSouza:]

Thanks, Jay, and good afternoon everyone. Today, I plan to provide further details on our outlook and action plan. Europe revenue declined 2% year-over-year in Q1, missing our projections, and we are forecasting low-to-mid single-digit growth for the full-year. Revenue from the Americas grew 14% representing a slightly slower start than we anticipated for the reasons Jay outlined, but we remain confident in the region's full-year projection of mid-teens growth. Asia Pacific revenue declined 5% as forecasted due primarily to a large HiSeq X comparable. During the quarter, we began to see customer purchasing patterns in Japan improved as research funds are now being released. It's too early to call this a resurgence, but the signs are certainly more positive. Our Asia Pacific region is also forecasting mid-teens growth for the year. The Q1 challenges are responsible for a minimal change in full-year outlook. With the benefit of two additional weeks of analysis since our pre-announcement, we are more confident that Q1 was a result of operational challenges and not market demand. By far, the largest driver of our lowered guidance is our lack of visibility in Europe, as evidenced by the drop in the region's full-year forecast three months after we completed our budget. We're taking steps to enhance visibility and improve our execution in the region. In the meantime, we have incorporated the reduced outlook from Europe into our projection. We're focusing on three areas to deliver on our full-year. First, we're making improvements to our sales process. To address the variability in instrument orders and shipments during the last months of the quarter, we're focusing the sales team on early closure of instrument orders. In addition, large instrument contracts including those for HiSeq X have become more complex, particularly in Europe. And so we are simplifying and standardizing deals. Finally, we're building out our manufacturing capacity for arrays, so that we're able to clear the back orders, and meet the increasing demand. Second, we are committed to improving the execution and outlook in Europe. As we mentioned a few weeks ago, we recently brought in an interim sales leader in Europe, who has already established accountability and ownership for the revised forecast and is driving to the updated expectations. He has already put in place greater discipline around opportunity management, accuracy of our CRM data and quoting. In addition, we're making good progress in our search for a permanent general manager with large global company experience to ensure that our European organization realizes its full potential. The last step in our plan is focused on expense management. Last year we added close to 900 employees, 500,000 square feet of real estate commitments and a new global ERP system. While these investments were necessary to support both the growth we have experienced and our ongoing market opportunities, we recognize the need to meaningfully slow down the pace of investment in 2016, given our updated outlook. We do not expect to have broad changes to our product portfolio or development pipeline but do have other opportunities to delay initiatives that are less impactful to the long-term outlook. We're working on a 2016 re-plan, and have incorporated those improvements into our guidance for the remainder of the year. As a result excluding GRAIL and Helix, our operating margin target for the year is expected to be 34.5%. While disappointing our Q1 results have not dampened our conviction and our market opportunity or our ability to deliver innovative technology to capture those markets. I am personally committed and excited to move this organization to realize our mission, benefit patients and deliver shareholder value. I will now turn the call over to Marc, who will provide a detailed overview of our first quarter results.

[Marc A. Stapley:]

Thanks, Francis. While revenue for the quarter missed our guidance, orders of over $700 million significantly beat our expectations. We built more than 100 million in sequencing consumable backlog, most of which is expected to be delivered this year. As a reminder, we typically see higher sequencing consumable orders in the first quarter, ahead of annual list price increases. Instrument revenue declined 20% year-over-year to $118 million, given the large HiSeq X shipments in the first quarter last year, which accounts for more than $30 million of decline. Consumable revenue was of $361 million, an increase of 17% compared to the first quarter of 2015. Sequencing consumable revenue grew 24% over Q1 of last year to approximately $300 million. Services and other revenue, which includes genotyping and sequencing services as well as instrument maintenance contracts, grew approximately 12% versus Q1 2015 to $89 million. This improvement was driven by extended maintenance contracts associated with the largest sequencing installed base and genotyping services, partially offset by a decline in NIPT service revenue, given the shift to in-house testing as expected. Going forward, we expect (14

[Operator:]

Thank you. Our first question comes from the line of Tycho Peterson of JPMorgan. Your line is now open. Your line is now open.

[Tycho W. Peterson:]

Hey, thanks. Sorry to hone in on the Europe issues, but I just would love to hear from you a little bit more about the steps you're taking to improve your forecasting ability. Obviously, you had issues in Europe in 3Q last year as well. So if you could just talk a little bit about how you intend to improve visibility there? And really what gives you the confidence that the problems are going to be fixed by 3Q since the back half estimates are essentially unchanged to get to the midpoint of the new guidance range.

[Francis A. deSouza:]

Sure, Tycho. This is Francis. There are a number of things we are doing. We started by moving one of our strong leaders from the U.S., who ran Western region, Scott Thomas out to Europe. And he was out there at the beginning of this quarter and has already started rolling out a much more disciplined sales process. And that starts all the way from capturing the opportunities and tracking the opportunities as well as managing our visibility into the opportunities that are in various stages of the process. He is also instituted, a process that frankly we use in the U.S., around managing the pipeline for some of our lower-end instruments. And so that alone has started to give us better visibility into when deals are expected to close over the course of this quarter and allowed us to add urgency and also manage more for a weekly close process, rather than a close process that's so heavily tailored towards the end of the quarter. That does a few things; one, it gives us much better visibility into what we're working for the course of the quarter, it helps drive urgency into the team, and it helps make sure that we understand whether we have the pipe to get the deals we need. Additionally, Tycho, the execution challenges that we've talked about in Europe, much of that related to this deferral challenge that I talked about in the script, where we had a surprisingly large amount of revenue that was not recognizable, and part of the discipline we need in the team is to pull in the orders to make sure that we don't have a lot of systems that don't get shipped in time to be recognized as revenue, or there are small contractual issues at the end of the quarter that wind up having a revenue recognition question and therefore can't be counted. And that's all the discipline of making sure that those deals get closed earlier in the quarter, and Scott is going to make a big difference there as well, we believe.

[Tycho W. Peterson:]

Okay.

[Marc A. Stapley:]

Tycho, I would just add one point to your question about confidence in the outlook for the rest of the year. As I mentioned in the script, or Francis mentioned, we've got Europe in our outlook currently at the revised number that they've committed to and provided recently, which is a lot lower than it was previously. And so that gives us an opportunity to get these changes and improvements baked in, and start to get some positive impacts from them.

[Tycho W. Peterson:]

Okay. That's helpful. And then just on the other side, on spending, I know you talked about maybe pulling back on some of the hiring. Can you just get us comfortable that – I mean, you're such an innovation-driven company that you're not necessarily going to be kind of pushing off stuff that could impact the pipeline and really, future growth.

[Jay T. Flatley:]

Sure. I mean, that's an important tradeoff for us to analyze, and we're in the process of doing that right now. And, of course, the most important programs that are the largest revenue generators, the ones with the highest ROI, will continue to be fully staffed and fully funded. What we'll be looking for are other areas outside of the core product development activity. For example, we may re-staff some of our research at a bit slower rate, because we moved a lot of those people over into GRAIL, and much of that research work has an effect three years to five years from now. So those are the kinds of things we can slow down for some short number of quarters until we get back to the revenue growth rates that we believe we should be at. And clearly, we're going to do that in some of the other support organizations as well, without impacting customer support and the core product development activity. So we're pretty confident we can make a big impact without hitting the core.

[Francis A. deSouza:]

Yeah. Another example of something we're doing there, Tycho, is look, we've already kicked off an initiative to drive more focus and prioritization. And one of the things that we'd identified was that look, there's this terrific strategic planning process that kicks off the project that we want to focus on for the future and leads to the new products we put out. One element that we hadn't focused on historically is to look at all the initiatives we have underway and see what we could stop doing. So we had already kicked off an effort to look at all the things we had going on and prune that portfolio, if you like. So that's an effort we already had underway. We're accelerating that to sort of complete over the course of this quarter, and expect to roll that out starting over the next quarter.

[Operator:]

Thank you. And our next question comes from the line of Doug Schenkel of Cowen & Co. Your line is now open.

[Doug Schenkel:]

Good afternoon. I guess, first, just a – I guess a couple quick ones, and then maybe a slightly longer answer question after that. So the first one is, maybe as a follow-up to Tycho, regarding your guidance for the year, some seem to be focused on what seems to be some back-end loading of the guidance. Does your guidance reflect an assumption that demand gets better, or execution gets a lot better in the second half? Or is your guidance simply reflecting that comparisons get a lot more favorable in the second half, keeping in mind first half growth last year was around 30% and second half growth was 17%? It doesn't seem like you're baking in a whole lot more for the second half than the first half. It seems like it's more comps driven. Is that fair?

[Jay T. Flatley:]

Hello.

[Marc A. Stapley:]

Doug. Yes, can you hear me? It's Marc.

[Operator:]

We're back guys. Sorry, we lost the call there for a minute.

[Doug Schenkel:]

Okay.

[Jay T. Flatley:]

Doug, I lost you about two-thirds the way through your question, I think.

[Doug Schenkel:]

Yeah. It's really just your guidance for the year and the pacing doesn't seem to reflect a whole lot in the way of herculean assumptions for an improvement in the second half in terms of demand or execution. It seems on the surface to be more a function of just changes in year-over-year comparisons, first half to second half, is that fair?

[Jay T. Flatley:]

Well, there's a couple of elements, comparisons are better or easier in the back half, for sure. We're not anticipating any radical changes in the European outlook, because we've actually factored in the disappointing European outlook into the guidance numbers that we've given, and obviously we'll be working to do better than those numbers and are working hard to achieve that. But the single biggest factor that gives us a lot of confidence in the back half is the backlog, the strength of the backlog, the incoming order rate that we had in Q1 and the pipeline that we see for business in the Americas and Asia-Pacific in the back half. So that's what really gives us confidence in the increasing revenue rates in the back half of the year.

[Francis A. deSouza:]

Yeah. I'd say very strongly that the numbers we've put out for the rest of the year were driven from a bottoms-up look at what the regions were forecasting, based on what they had in the pipeline and had visibility into. And so that's what gives us the confidence.

[Doug Schenkel:]

Okay. Another area of focus has been clinical growth, you grew 20% in the quarter, oncology growth was 9%. These on the surface jump out as being light. That being said, what you didn't point out was that clinical growth was up against a tough compare. I think you grew 60% in Q1 of last year, the oncology comp I think is 37% growth. Can you just share any data on backlog, or really anything else, that will help address concerns about a moderation in clinical demand?

[Jay T. Flatley:]

Yeah. I think, as we tried to indicate in the script, we didn't see any fundamental demand factors in our business. We did very deep analysis, as you might imagine, over the last few weeks and so that did not pop out from anywhere. The clinical comparisons were very difficult against Q1 last year for sure, as you pointed out. And so I think that's the single biggest driver in the numbers that we saw in Q1. So we continue to feel very positive about the clinical adoption rates going through the year, and a lot of the key inflections in our markets, whether it's average risk (29

[Doug Schenkel:]

Okay. And one last one. Q1 was not your best quarter, and it's been a tough two out of three. That said, you made it really clear in your prepared remarks that nothing occurred in the quarter that heightened concern about overcapacity, competitive dynamics, the clinical outlook or market potential, but one of the big debates in the investment community is about Illumina's long-term growth outlook. Given some recent developments, and clearly the moderation in revenue growth over the last few quarters, we didn't hear anything in your remarks that would suggest there is a change in how you think about the market opportunity or your ability to drive growth via innovation. Could you just help us with some commentary in terms of how you're thinking about things on the longer-term growth potential, and why we shouldn't think differently about Illumina, given what we've seen over the last few quarters?

[Jay T. Flatley:]

Sure. Hey, if anything (30

[Doug Schenkel:]

Okay. Thank you.

[Jay T. Flatley:]

Yeah.

[Operator:]

Thank you. Our next question comes from the line of Derik De Bruin of Bank of America. Your line is now, open.

[Derik De Bruin:]

Hi, good afternoon.

[Jay T. Flatley:]

Hi, Derik.

[Derik De Bruin:]

Hey, just one short question which is stock option expense for the full year and then a longer question which is sort of following up on Doug's question I think, we've had a lot of incomings from investors questioning the outlook and just the numbers. But I think, in particular, we had a lot of questions on GRAIL and Helix and the fact that those are dilutive to earnings right now and when they would start to potentially be more accretive, I guess. The question been is like when are potentially we going to see some return on those investments and it's more of a question about valuation support for the stock, relative to some of the other names in the MedTech space, that are trading at similar types of top-line growth levels right now. So basically give us some clarity or some indication when do you think you're going to see some benefits from – be able to get some benefits from Helix and GRAIL?

[Jay T. Flatley:]

What was the stock comp question exactly?

[Derik De Bruin:]

What is the update for the full year, is there – what's the number for the full year.

[Jay T. Flatley:]

So, Marc, do you want to cover...

[Marc A. Stapley:]

Yeah. Derik, let me talk to that one really quickly. I'm not giving that specific number at this point, but we're on a path here that isn't going to accelerate that substantially through the second half. There are going to be some upticks, part of which is related to Helix and GRAIL and part of which is related to core Illumina. But it's not going to be that vastly different from what you've seen so far.

[Jay T. Flatley:]

With respect to GRAIL and Helix, Derik, those are incredibly important, strategic bets for our company. We think they both represents, on their own, massive markets, as we've talked, about in cancer screening, gigantic opportunity, probably the single biggest market segment that we can imagine. We continue to believe that there is going to be a strong market for consumer genomics, but it's going to take some work to create the ecosystem to really unleash that, and that's the goal of Helix. And as a company, it is critically important that we take a long-term view and that $0.05 a share in a quarter, even $0.10 a share in a quarter, compared to the opportunities that these two ventures portend for us in the next five years, is insignificant. And so, we're not prepared today to talk about when these are going to turn profitable, and begin to contribute to the bottom-line, but GRAIL, as we mentioned, is a long-term bet and they're not going to be seeing product on the market for some time. Helix will be quicker and so once we get into 2017, we'll begin to get the earliest indications of revenue ramp, but I certainly wouldn't expect that to be a profitable enterprises in 2017.

[Derik De Bruin:]

Great. I'll get back in the queue. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Dan Arias of Citigroup. Your line is now open.

[Daniel Arias:]

Yeah. Hi, good afternoon, guys.

[Jay T. Flatley:]

Hi, Dan.

[Daniel Arias:]

Jay or Francis, just to go back to Europe, as you've digested the issue a little bit, have you found that the shortfall on the HiSeq side was due more to installs that didn't materialize on the clinical or on the non-clinical side of things? And then if I could just ask a follow-up for Marc. Marc, what are you forecasting instrument revenues to be down year-over-year at this point? Thank you.

[Jay T. Flatley:]

Yeah. There was nothing in the European numbers that was market specific. And so these were revenue recognition issues of various sorts as I highlighted in the script. None of those were particularly related to specific markets within the clinical sector or the research sector.

[Francis A. deSouza:]

Right, they are two very different issues, right. If we look at Q1 HiSeq story and that was the HiSeq story across regions and we talked about the fact that a lot of that was the HiSeq shortfall (35

[Daniel Arias:]

Okay. So, Francis, if I could just sort of crystallize from both your thoughts on the issue itself in Europe, is it your estimation that what took place in Europe was pretty much 100% personnel-related?

[Francis A. deSouza:]

I think personnel and then the knock-on effect on the process we're running in Europe. I feel like, we have – and you're not going to put all this on one person and we have definitely good people on the team. What we are seeing is that we don't run as disciplined a process in Europe as we do in the other regions, and already we're starting to see in the last few weeks an improvement in the visibility of the pipeline through this quarter and we're seeing more urgency in our sales process. So that we believe were the biggest drivers in what we're seeing in Europe.

[Marc A. Stapley:]

And Dan, on the instrument revenue, yeah, we are not bifurcating the guide for the year into the individual component pieces, but I gave some specific commentary, I mean clearly we've given commentary around Q1. I gave some specific commentary around Q2 there as well. So definitely a slower start for the year, driven by the high throughput and then as I mentioned we're seeing uptick towards the second half of the year, but not giving out specific commentary on breaking down the revenue growth by category at this point.

[Daniel Arias:]

Okay. Thanks, so much.

[Operator:]

Thank you. Our next question comes from the line of Jon Groberg of UBS. Your line is now open.

[Jonathan Groberg:]

Thanks a million. So, (37

[Francis A. deSouza:]

Yeah. I maybe wouldn't characterize it exactly like that, Jon, but I think your points are important ones. I've highlighted over the past year or 18 months that much of the market development that has to happen now in sequencing falls on Illumina, that we don't have a lot of other large companies who are spending marketing dollars developing markets and so that is key for us to do, more than it ever has been. And the big markets we're opening up now have each their own unique set of issues, whether it's reimbursement or regulatory or in the case of GRAIL, clinical trial work. And so it does take some time to open up those new markets. Having said that, there is no question that Illumina is so driven by product innovation and in all of our businesses, we analytically see, a cycle that's related to product cycles and that, whenever we launch new platforms, we get a surge of new orders for those instruments and then the following year, the consumables begin to catch up and then that platform begins to level out over time. So, every platform has an S curve associated with it. It is true that we are a larger company now and therefore, each individual S curve has a smaller effect on the total revenue of the company. So, there is no getting around that fact and so we've – we have much greater diversity in our business now, which is a good thing, but each individual product launch probably is less of an impact that it might have been back when we had only one sequencer. For example when we replaced the GA with the HiSeq everybody bought a HiSeq, because it was the only product in the market. That's not quite where we are today.

[Jay T. Flatley:]

Yeah. And as we look to operationalize those dynamics, as I said, there are two dynamics playing out. One is, there is an opportunity for us to get more actively involved in the development of those markets, so we can accelerate the adoption of MGS into the different markets we play in and work with our customers to help them with things like, the trial that we're doing, the STAR trial we're doing in the PGS space, in the IVF world for example. We're also getting more engaged with our customers in the payer community and market access programs, and part as Jay said, what we do to develop the market is actually bring new instruments into the market which can catalyze the market through the access to a lower price point. So, certainly, a set of things we are going to operationalize, developing those markets. Separate from that, there is a change in how you sell at this scale. And that, in addition to sort of tracking the big deals that get a high level of visibility at the executive level, a scalable sales process needs to make sure that we're taking care of the flow business and that we do have really good visibility into the pipeline, how pipelines are progressing, the opportunities and that's what we're putting in place in Europe for example right now.

[Jonathan Groberg:]

And that's helpful. And then, just as a quick follow-up, I think you were minus 5% in Asia Pac where you said you're guiding to mid-teens, I know you had a solid book-to-bill, is there anything else that the kind of – gives you the confidence in that acceleration in Asia Pac for the rest of the year? Thanks.

[Jay T. Flatley:]

Yeah, that's exactly right. So, we did see, as expected a decline in Asia in Q1, but as we look at the forecast for the rest of the year, we do believe we have the opportunities and pipeline to support a mid-teens growth in the year. The things that are driving those are one, there is activity around the Chinese PMI that is causing purchasing to happen. We saw that already start and we expect that to play out. We're continuing to see incremental improvement in Japan for example. And while that is slow and steady, it's slow and steady in the right direction and we're seeing that show up in our pipeline as well.

[Marc A. Stapley:]

And Jon, obviously Japan was a challenge quarter-after-quarter for us last year and so that's reflected in the (42

[Rebecca Chambers:]

Operator, we're ready for the next question.

[Operator:]

And the next question comes from the line of Ross Muken of Evercore. Your line is now open.

[Ross Muken:]

Good afternoon, guys. So, can you just go back to that capacity utilization slide and sort of help us understand exactly sort of what we're looking at and how we should sort of interpret the peaks and dips in terms of how you relate that or if it's at all relatable to how you think about your instrument forecasts or managing at least sort of that (43

[Jay T. Flatley:]

Yeah. Marc, you want to walk through that or you want me to or...

[Marc A. Stapley:]

I just want to, yeah, Ross, guess what, I missed the first part. You were saying in relation to the utilization slide?

[Ross Muken:]

Yeah, I'm just trying to exactly understand how we should interpret sort of the various levels of capacity utilization across the base, and then, how we should think about certain points. Typically, if you think about capacity utilization, it sort of signals capital purchasing depending on what level it is. So how do we interpret what levels for you to signal that you should see an increase in instrumentation demand versus maybe a moderation at a certain level and how you sort of attempt to manage it. I'm just trying to exactly interpret what we are supposed to gain from those.

[Marc A. Stapley:]

Yeah. So I think a couple of things. Firstly, the capacity calculation itself, which is based on the actual mix of types of kit that our customers buy and run. Clearly, that's increasing quarter-over-quarter as a result of both the installed base, a little bit of the change in mix and that's coming up with higher throughput instruments, which I will come back to, when I look at the capacity utilization chart. If you think about the percentages, what you probably – what you don't want to see is a very low percentage of utilization. That would reflect a lot of spare capacity in the market, which would have a read-through, I think, to future instrument purchases. You're obviously not going to see utilizations based on our trajectory of past history and our trajectory of much over 50% on an ongoing basis due to the decentralization of market. Only in a centralized market would you see it much, much higher than this. So, if you look at the data, what you're seeing is – well, you see a couple of inflection points where the utilization tends to stabilize. That happens to coincide, in fact in one case, go down, if you look at 3Q 2014, that coincides with when we put new capacity in the market, so back then was the v4 run kit and that created an instant increase in available capacity, which caused the dip in utilization, you can see that recovered. Same thing as, when we introduced the HiSeq 4000, that had an effect on the growth and utilization because we introduced new capacity into the market, with that instrument as well. And then what you're seeing if you see it normalize without one large order is they have a fairly consistent growth rate, which is exactly what you would want to see, which I believe – we believe reflect that the capacity is not – there is not excess capacity in the market, it's being utilized at a rate that is increasing over time, in spite of the increased volumes or capacities that we're putting out there with the higher throughput instruments and kits, does that safe? (46

[Jay T. Flatley:]

The takeaway of course, from this, Ross, is that, to the concern that there is always extra capacity being generated in the market, I think this analysis and what we've gotten from our base analytics show that that's just not the case. That the average instrumentation utilization, if anything, is on a slightly upward trend, which is exactly what we would hope to see. And expect to see.

[Ross Muken:]

Right. And I guess regionally, would Europe look any different, I'm sure you've probably cut the data at some point.

[Jay T. Flatley:]

Well, Europe would be lower on the averages, the trend line probably isn't too much different, but we clearly see highest utilization in the U.S. Europe tends to be significantly lower on average utilization across almost all the platforms.

[Ross Muken:]

That's helpful. Jay, you started off talking about the various reasons for sort of the HiSeq miss, and you have that nice little pie chart which sort of breaks down the components. I guess, as you stated, typically in a quarter, maybe one or two will happen, but not as many. I mean, as you think about the complexity of your business and what you can sort of manage versus what is just market-oriented and the like – and I guess, what period in the company's history, or what prior experience in all the years you've been doing this, would you sort harken back to and say oh, this reminds me of X, and because of Y, we feel confident. I'm just trying to figure out it – what this most looks like, in terms of any of the few sort of periods of challenge that the company has had. I mean, there hasn't been very many.

[Jay T. Flatley:]

Well, and I think from a sort of magnitude of the challenge, Q3 2011 was the other big one for us, driven by very different factors, that was a collection. It was one of those, again, rare quarters where you had the convergence of a whole bunch of factors all at once, which I think we had this quarter as well. The specific factors that were different than the ones we had in Q1, but it was one of those of sort of convergence effects that sometimes happens, and that's what happened to us in Q1. So I'd say that's the closest analogy, in terms of lots of things going in the wrong direction in one quarter.

[Ross Muken:]

Got it. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Amanda Murphy from William Blair. Your line is now open.

[Amanda L. Murphy:]

Hi, good afternoon. So I just had a follow-up to your answer to Jon's question earlier about sort of the R&D pipeline, and I appreciate your comment about enabling markets and smaller S curves but I'm wondering, if you think about technical – or advancements that could further move the market forward, I was just curious if you can give us some high-level perspective there. So, obviously, you mentioned the innovation at the lower kind of CapEx portion of the market, but is there anything in the works? Obviously, ordered arrays is quite meaningful in terms of the improvement in performance, is there anything like that in the works that you could talk to obviously, with respect to your R&D pipeline (49

[Jay T. Flatley:]

Well, I mean, we can't give you specifics on that of course, but if you think about it, ordered arrays have only been implemented on the very highest end of our product line, HiSeq X and the HiSeq 3,000, HiSeq 4,000. So, we could put ordered arrays on other products in the product line, when and if that becomes important for a throughput and cost reason and is the highest return R&D program for us to invest in. And so, that technology can be applied to the other instruments, we've not done that yet, because we don't think it's the most important factor in increasing the overall revenue from those segments. But we have a broad product line now, and over time, various portions of that product line will age out and they will be replaced by brand new products that we bring into the market, that of course will have dramatic new innovations built into them. And we've been working on the fundamental technologies around this (50

[Francis A. deSouza:]

Yeah. One thing to highlight is, look, in addition to looking to, over time, refresh everything we've got, one of the other things you can expect is, look, we are keenly focused on addressing the biggest impediments to getting NGS adopted in the different segments. Some of that is through our own offerings and you can expect innovations where customers are telling both you and us that there are the biggest bottlenecks. So for example, one of the things we heard early on when we launched the X was that, the informatics around was a problem and a challenge for our customers, and you saw us launch C cloud (51

[Amanda L. Murphy:]

Got it. Super helpful. And then, just I guess a more specific question on one of the reasons that you cited around the HiSeq miss was related to people evaluating the NextSeq. So I was curious, I know that's not that many of them, but was that an NIPT-driven factor, and so, if so, then how should we think about product mix maybe changing, to the extent that average risk gains more traction next year?

[Francis A. deSouza:]

Well, there was an underlying factor where one or a couple perhaps of our NXP (52

[Amanda L. Murphy:]

Got it. Okay. Thanks very much.

[Operator:]

Thank you. Our next question comes from the line of Bill Quirk of Piper Jaffray. Your line is now open.

[Alexander D. Nowak:]

Great. Thanks. Good afternoon, everyone. This is actually Alex Nowak filling in for Bill today. So going back to the first quarter, just trying to understand what happened following the preannouncement that changed the commentary from saying that the Q1 shortfall is predominantly due to customer outsourcing to now being a myriad of different issues that you really had no control over. Just trying to understand, what was the change there?

[Jay T. Flatley:]

So if you go back and look at the exact script, we didn't say primarily outsourcing, we did cite the example of outsourcing as one factor that we knew about at the preannouncement date. You can imagine, in those two weeks before the preannouncement, we were scrambling hard to try to get as much data together as we could and have a preannouncement that was timely. We didn't want to wait another week to do a preannouncement to have more data, and so we've learned a lot in the last two weeks when all of the analytics from the Q1 have really come in and we've been able to digest them, talk to the regions, get the new forecast, understand all of the background detail. And so we've been able to go order by order and look at every one of the circumstances and break it into the pie chart that you see in the deck that we provided. And so there were a lot of different issues, and no singular thing to (54

[Francis A. deSouza:]

Yeah. Lead (54

[Alexander D. Nowak:]

Okay. That's helpful. And then just switching to a little bit longer term...

[Francis A. deSouza:]

In addition to getting the orders that didn't convert into revenue, so those were the two issues that we talked about in the preannounce, and those are the two issues still.

[Alexander D. Nowak:]

Okay. That's helpful. And then on the China Precision Medicine Program, just a two part question, sounds like you're starting to see the program move in the country. I'm just wondering if you could provide some more color on what you're seeing, what you're hearing from customers. And then the second part of the question is, is there any risk that several customers in China are buying instruments, specifically, HiSeq Xs in anticipation for sequencing volume, and just because of the timing of a program ramp, you could have some idle (55

[Jay T. Flatley:]

Well, we are seeing a number of customers gearing up to try to be participants in the PMI, we don't know who will win that ultimately, and I don't think they do either frankly. There's obviously a couple of some very strong candidates to participate, and those are large entities, some of which own instruments already, some of which don't. So we think they will buy in advance to have some installation, and perhaps the pull through will be a little bit lower on those in early stages, but they should get very highly utilized once the program begins to ramp up. So sure, we could have a little bit lower utilization locally on some instruments, but that's not atypical, I mean, people sometimes do that for other programs as well, and we'll take that into account in our forecast and our planning.

[Alexander D. Nowak:]

Okay. Great. Thanks.

[Operator:]

Thank you. And our next question comes from the line of Dan Leonard of Leerink. Your line is now open.

[Dan L. Leonard:]

Thank you. This overlaps a little bit with the last question, but Jay or Francis, I was hoping you could characterize the incremental X customers, I think you grew to 31 in the quarter. And then also the funnel, in terms of are these (56

[Jay T. Flatley:]

Sure. So one of the things we talked about is, we did have the four Xs that came in in Q1. We did see some interest from the – wanting to participate in the Chinese PMI that is driving some of the X interest. We haven't gone public with the customers that have come online in Q1. So I can say that there is definitely demand generated from the Chinese PMI, but we can't talk about specific customers associated with that.

[Rebecca Chambers:]

Yeah. The only one that's public is GENEWIZ.

[Dan L. Leonard:]

Well, I know, at least early in the HiSeq X program, you were careful to deliver instruments to folks that had samples and had projects. Is that still the case or are you more (57

[Jay T. Flatley:]

No, that's still a factor. We still use the access to samples as a criteria for the purchase. And what we've really seen in probably the past year is more of the X customers are metering out their instrument deliveries, we're in the very early phases of X, people converting their entire large existing programs over to the X, if you're abroad or an NHI (58

[Dan L. Leonard:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Steve Beuchaw of Morgan Stanley. Your line is now open.

[Steve C. Beuchaw:]

Hi. Good afternoon. Just a couple of clarifications. Marc, I wonder given the $700 million order figure that you provided, if you could give us just a little bit more context around it. Could you give us any sense for maybe what the backlog growth was exiting Q1 or maybe how the growth in orders compares to what you saw in 2015, just so we can again put it in a little bit more context? And then Jay, I wanted to follow up on a couple of comments you made in the prepared remarks around clinical. First on NIPT, I was a little surprised given that we're here in May of 2016, that you talked about some reimbursement decisions around NIPT getting delayed out to 2017, maybe I'm just overly optimistic there, but I wondered if there might be some hope for the second half of 2016, curious what is it that you're seeing there. And then, just to round it out on clinical, on the clinical cancer side, I just want to make sure I understand the narrative, is it stable reimbursement, new products, drives (59

[Jay T. Flatley:]

Hey, Marc do you want to start?

[Marc A. Stapley:]

Yeah. So I'll start with the orders conservation. Steve, obviously a large part of the orders that we booked in the first quarter were shipped in the first quarter, as you would normally expect. But we built significant backlog, and I quote out specifically sequencing consumable backlog, and that will ship mostly through this year, in fact, almost entirely, there is some that carries over into 2017 and beyond. But most of that is going to ship this year. So the way I would think about that, is it's kind of an advanced ordering of reagent purchases that we're going to get, or we should get anyway throughout the year. So it gives us some confidence, but I wouldn't think of it as necessarily incremental. It is relative to last year and prior year, it is larger than we've traditionally seen. And so it gives us a little bit more of the backlog than we would normally have at this time. And then, I also mentioned that we have about a third of our ending backlog for the quarter, rolling over into the second half which gives us some added confidence. Obviously, that includes a portion of those sequencing consumables that I just talked about. So it's nothing more kind of quantitative than that at this point. But other than the sequencing consumables, I would say pretty pleased with the array business and the consumer driven activity there, which has been another helpful part of building backlog. What it wasn't necessarily was a significant proportion of instrument backlog that's not, it's become much more of a – instruments have become much more of a turn in the quarter type of activity. We don't necessarily come into the quarter with significant levels of backlog like you saw us have in Q1 of 2015, and it's much more normalized now.

[Jay T. Flatley:]

Yeah, I would just add the math on the backlog growth is pretty simple. So it's $700 million plus minus the revenue that we get in. So that growth in the backlog was more than we've typically seen in Q1. So we felt really good about the incoming order rate. With respect to NIPT, what we're seeing is that the large payers, the majors there tend to assess coverage decisions on specific dates. So they are on a cycle, and so if they're not on a cycle to do this in 2016, there is little to no chance they are going to go off cycle to approve this. And so as we've mapped out all those cycles, there still remains a possibility of some of them late in 2016, but the majority of them fall in 2017, which is why we cited that we think that the bolus of these coverage decisions will be made in 2017. With respect to cancer, the narrative really isn't about stable reimbursement, because the vast majority of the cancer tests aren't reimbursed today, even foundation medicine. So most of that market is being driven by labs running these tests for market share reasons. Most of the labs are losing money on the cancer tests. So the reimbursement opportunity in oncology lies ahead of us, and it's something that many of our customers are working on. It's an area that I'll be spending a fair amount of my time on in the next year, and it's related to the standardization challenges that I think exist here. We're in the phase of the oncology market where it's becoming increasingly fragmented with lots and lots of different panel products, and one of the things that Illumina needs to do is to begin to re-converge that market into a more standard set of products and more standard set of processes so that payers can get their heads around, what is a – something they should be paying for, and that's something our TST 15 is attempting to do initially in (01

[Steve C. Beuchaw:]

Thanks so much.

[Operator:]

Thank you. And our next question comes from the line of Dane Leone of BTIG. Your line is now open.

[Dane Leone:]

Hi, thank you. I just had a quick one on how MiniSeq and MiSeq performed. Could you kind of give us color because historically, you commented that there would be some degree of cannibalization in sales, can you just kind of give us a basket idea of collectively how MiniSeq and MiSeq kind of performed as a group this quarter versus maybe last year, which would have only been MiSeq, and kind of how you expect that ramp and MiniSeq specifically to continue over the course of this year?

[Jay T. Flatley:]

If you recall we had projected nominally a 20% to 25% cannibalization rate of MiSeq. We're seeing a rate so far at least that's less than that, and part of it is an interesting phenomenon where the low price point of the MiniSeq opens the door to a new customer, and then as we begin to engage with that customer we use it as an up-selling opportunity to sell them a MiSeq rather than a MiniSeq. And so we're seeing that phenomenon working well for our sales people because they love to sell $100,000 instrument rather than $50,000 one, if they have the option to do so. Having said that, the MiniSeq product did well in its first quarter. We've got a great pipeline there, and we're continuing to be optimistic about MiniSeq. And the data we have today at least indicates a lower cannibalization rate of MiSeq than we would have expected previously.

[Dane Leone:]

Okay. Thanks.

[Operator:]

Thank you. And our final question comes from the line of Jack Meehan of Barclays. Your line is now open.

[Jack Meehan:]

Thanks. Thanks for squeezing me in. Just a follow up one on MiniSeq. Do you have sense at this point for what we should be building in as a range for quarterly replacements? And I know there is the long tail of labs that would like to do sequencing. Have you found this customer class is more responsive to an instrument sale approach versus reagent rental?

[Jay T. Flatley:]

(01

[Rebecca Chambers:]

12 to 15 (01

[Jay T. Flatley:]

Yeah, yes, exactly. So we'll be looking probably three or four quarters out before we actually start quoting what the actual range is running.

[Jack Meehan:]

Got it. That's helpful. And then, just one for modeling out. I know here in May, you're not ready to be talking about 2017, let alone 2018 or 2019, but I think one of the moving pieces of the income statement across the Street is the R&D line item, just given some of the expenses you're planning for both GRAIL and Helix. Can you just give us a framework for what we should be building in, in terms of long-term expenditures in R&D is closer to revenue growth, or do you think some of these new products we should be building in something more than that? Thank you.

[Jay T. Flatley:]

Well, I think, clearly, GRAIL and Helix in many ways are incremental to what we're doing before, and we should be thinking about them as such. These are very important strategic bets that we think are the most important market opportunities for us to be working on. But the base level of R&D and the growth rates you've seen over the past couple of quarters will begin to moderate based on the absolute number, will begin to moderate based on the the absolute (01

[Francis A. deSouza:]

Yeah. One of these we have studied, and if you take out GRAIL and Helix over any three-year time horizon, there is enough leverage in our operating model organically. So we continue to believe that.

[Rebecca Chambers:]

Thanks, Jack.

[Operator:]

Thank you. And I would like to now turn the call back to Rebecca Chambers for closing remarks.

[Rebecca Chambers:]

Thank you operator. As a reminder, a replay of this call will be available as a webcast in the Investors section of our website, as well as through the dial-in instructions contained in today's earnings release. Thank you all for joining us today. This concludes our call and we look forward to our next update following the close of the second fiscal quarter.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.