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Illumina, Inc. (NASDAQ:ILMN)

Piper Jaffray Healthcare Conference

December 3, 2013 9:00 a.m. ET

Executives

Marc Stapley - SVP and CFO

Rebecca Chambers – Senior Director, IR

Analysts

Bill Quirk - Piper Jaffray

Bill Quirk - Piper Jaffray

Okay, thanks everyone for coming and good morning. I’m Bill Quirk. I am managing director at Piper Jaffray, run the diagnostics and tools platform over here. And it’s a great pleasure to introduce to my right Senior Vice President and CFO of Illumina, Marc Stapley to our 25th annual conference. And to Marc’s right is the Senior Director of Investor Relations Rebecca Chambers. I am going to turn the floor over to Marc for a couple of introductory comments and then we’ll go right into Q&A. And as a reminder, since it’s a open session, so please by all means love to hear your questions. Marc?

Marc Stapley

Good morning, Bill. Thank you very much for having us again here. It’s our pleasure to be here today. So 2013 so far has turned out to be a very interesting year for Illumina. We are excited with the way the business has been progressing so far this year and be happy to talk more about what’s been driving that in the Q&A session.

We’ve had some very exciting acquisitions throughout the year. We’ve actually completed now four acquisitions in 2013, so we are very excited with the way that our portfolio is progressing. We just recently announced the reorganization as you know. And that reorganization will really help us to focus the business on the areas of growth that we see going forward. So lots of very exciting things happening.

Question-and-Answer Session

Bill Quirk - Piper Jaffray

Thanks, Marc. And maybe we can take the first half [indiscernible] in terms of the active M&A. Historically Illumina has done some tuck-in deals from time to time. To your point 2013 is more active than we have seen in the past. How do you feel about the portfolio now? Are there other elements – I realize you’re probably not going to elaborate too much on that but nevertheless, how are you feeling overall about the portfolio? Do you still see some rounding out that it could be done?

Marc Stapley

Yes, we are feeling really good about the portfolio in particular. The acquisitions that we’ve completed this year have been really quite diverse in terms of what those acquisitions are from the early stage technology in Moleculo that we acquired for the long read technology to the sample prep capability that we brought with ALL to the back end bioinformatics with NextBio and then in particular our reproductive health portfolio over the last, call it, a year and a quarter has been really built out substantially. It’s now a very comprehensive portfolio via the acquisition of BlueGnome for the IVF testing and Cyto in particular and the acquisition of Verinata to help us address the non-invasive prenatal testing market. So right now really comfortable with the way the portfolio looks. We are always looking for additional opportunities. We view those opportunities in the kind of Moleculo to BlueGnome range. Verinata was more of a unique opportunity but we continue to look at ways to better our portfolio more but mostly I would say we still got a lot of what we needed to do at this point.

Bill Quirk - Piper Jaffray

And staying on Verinata for a moment. I think it’s safe to say that most of us in the audience are probably caught a little bit off-guard with the rapid adoption within the high risk group for prenatal testing. Can you talk a little bit just one, about the ratio of Verinata’s position here relative to three other primary competitors? And then secondly, kind of where this market transitions, the benefit of growing so rapidly in the space is obviously high growth but the downside of course is that the penetration here has come up the curve exceptionally fast. And so if we look out over the next couple of years, the transition almost has to be into the so called average risk market and perhaps you can just talk some of the characteristics there and what I am really getting at, Marc, is price point is going to have to come down?

Marc Stapley

I think we were a little surprised by how quickly this market really did grow and how fast non-invasive prenatal testing penetrated, next-gen sequencing penetrated this market in particular. But if you go back to our original strategy with the Verinata acquisition, it was less about driving verifi sales, in particular more about driving the non-invasive prenatal testing market even further. Things like guidelines for high risk pregnancies have clearly helped to make that market accelerate as well as reimbursement decisions that have been gone really, really well also helping that market to accelerate.

But we think we can help accelerate even further ultimately by taking the non-invasive prenatal test on next-gen sequencing platforms through an FDA approved IVD. Once you get there we think what you do is you enable the average risk market which is a very significant market around the world, and I think you are right. You enable that market at a lower price point. But that’s okay, because if you think about how big that market is, you don’t have to make wild assumptions about the level of penetration in average risk and the ASC [ph] in order to drive that $1 billion plus market for next-gen sequencing, Illumina in particular.

Bill Quirk - Piper Jaffray

And again staying on topic for just a moment. One of the characteristics has been that the tests have evolved fairly rapidly from simply T21 to T13 and 18 gender to micro-dilution et cetera. And so as the tests continue to evolve, does that help you at all with price, or do you think that it’s just going to be this continuous model of prices – pricing is going to come down particularly in the average risk market but nevertheless the actual data generated or produced to results get increased irrespective of price?

Marc Stapley

It’s probably a little of both because once you lock down the IVD test, you kind of lock down what that test is able to report out on. You lock down the pricing with reimbursement decision and so on. And so there is that IVD market that particularly penetrate the average risk. And then there is probably a lab developed test market for those other indications that might be capabilities in the future. And so I think it’s a little bit of both and obviously that’s differentiated by market and by price point as well.

Bill Quirk - Piper Jaffray

And then shifting gears a little bit to the research side of the business. Historically of course sequencing franchise has been driven – there’s really some exceptional performance really across broad geographies. So Marc, I guess, multi-part question here: one, can you just speak quickly to the various geographies and where we are with respect to the health of the research market, be particularly curious about Japan, for example, the stimulus funding?

Marc Stapley

So certainly in the last couple of the years the landscape for the research market has improved. We got past the US sequestration challenges. Europe seems to be in spite of the macroeconomic funding issues that continue, seems to be doing very well for next-gen sequencing particularly in southern pockets in Europe, and to your point about Japan, we have seen stimulus funding in Japan really drives that to a point where it’s coming – becoming closer and closer to 10% of our business, which is well probably was many years ago and should be getting fairly soon in the midst of – so the stimulus funding in Japan is certainly helping to drive next-gen sequencing and the focus on this area in particular.

So I would say, globally around the world we still feel like the funding situation and the amount of total funding pie that’s available that’s going to next-gen sequencing is continuing to grow at a nice steady pace, and also however if you got to think about how our business is diversified as well, the period you were talking about a couple of years ago when our funding – academic funding was driving about 80% -- so government funding was driving about 80% of our business. Today it’s more like if you base on the last quarter it’s more like 55%. So the way we thought this despite our revenue stream from those, those government funded – globally government funded sources to clinical consumer or price agricultural pharma market is really helping to create a little bit of a risk mitigation around funding.

Bill Quirk - Piper Jaffray

And then with respect to the Japanese stimulus, how long of the tail do you think we can see here?

Marc Stapley

It’s probably a little too early to say. I would say we are in the early stages of it right now. But so far the indications are good. And we are excited about the business opportunities that we have in Japan, whether it be pharmaceutical genome centers et cetera and I would say that our platforms in particular seem to be doing very well in the Japanese market. The form factors worked very well. The workflows worked well and so it’s an exciting area for us, but the tail could be fairly long.

Bill Quirk - Piper Jaffray

Questions from the audience? So Marc, just turning back to you sample sources of growth applied to research, you highlighted obviously in the quarter about 45% of listings [ph] were outside of traditional research, or government funded research on the customers. So can you just elaborate a little bit on just some of the catalysts here, I think we’re obviously all familiar with the NIPT market but perhaps if you could elaborate on some of the other sources here just helping fund –

Marc Stapley

Yes, I think it’s numerous different sources. Let me start with the consumer business which is – this is a statement about our global business, not just about HiSeq but the consumer businesses have been growing very well for us this year. The agricultural market is growing very well. If you think about the oncology market which is one area of particular focus that we want to pay attention to in our reorganization. We think that’s very nascent at this point and a very significant market. If you think about all the different stages of cancers and there are different types of cancer, we think that, that market is addressable in many ways and that’s a lot of works in driving some of the focus and attention and HiSeq sales as well so far in 2013.

We are excited about the MiSeq FDA approval. We think that creates markets for us as well. We are excited about the launch of 1T on HiSeq, which we think if we were able to pass the economics of that on to the customer will help to introduce new markets as well at lower price points. So I think it’s a combination of all of those things driving those pharmaceutical customers, those agricultural customers, so customers that are focused on the oncology and as you mentioned the non-invasive prenatal testing and those consumer customers who continue to spend in next-gen sequencing and genotyping.

Bill Quirk - Piper Jaffray

And so specifically on the 1T upgrade, this was announced around SSG, you had a little over a month now, if you perhaps reflect on and no doubt there is some customer feedback on what the 1T can do. And so have you taken additional look at your estimates relative to the number of HiSeq that may be taken out of the field and essentially not upgraded as a long term but turns in for a lack of better term with the new purchase of an upgraded 1T HiSeq?

Marc Stapley

So obviously when we decided to focus on the 1T as the next advancement that we wanted to introduce for HiSeq, it was based on customer feedback on what customers were looking to do and what was more important to customers, including both throughput, cycle time and so on. And so as part of that analysis we obviously estimate what we think will happen with the installed base. If you – just to remind everybody that the 1T capability will apply to subset of all HiSeqs that have been sold primarily related to 2013 shipments in particular.

And so we certainly that many of those customers will take advantage of the 1T capability. They will of course continue to do other applications. They will continue to run the rapid mode as well. So it won’t be a 100% on 1T of course. And then of those other by far the majority of customers who wouldn’t have access to that capability we think a significant proportion of that could very well be interested in the1T capability. It obviously could be very price point driven as well, not just the cycle time, it’s probably a process cycle time but the price points will also help to drive that adoption. And we haven’t yet determined how we’re going to price that particular kit. We will probably follow a similar model that we followed with MiSeq, recently where we doubled the throughput of MiSeq, where our intention is to pass on some of those economics to the customer as well as being able to retain some of the economics of the higher throughput capability.

Bill Quirk - Piper Jaffray

And Marc, if we think about the last time, you went through an update when you tripled the capacity, obviously there was a one quarter disruption in terms of the consumer business. Having said that, overall the vast majority of your customers eventually upgraded over – I remember correctly about a two year cycle. And so what would prevent that – I suppose you alluded to perhaps on the economics side but historically customers haven’t had that much of a problem trying to find funding to acquire your higher end sequences.

Marc Stapley

Yes. I mean you are absolutely right. This is a concern that we have relative to the 1T launch, I think the number of differences between the 1T launch and you alluded to the v3 launch previously a couple years ago stopped. There are more differences than there are similarities. You also talked about the upgrade cycle which was really an upgrade to the 2500. If I go back to the v3 launch in particular, when we launched v3 we tripled the capacity overnight with zero increase in cost thereby reducing the cost of base substantially. It introduced a different level of multi-pricing that was required, there really wasn’t a choice, I mean it replaced what was existing at that time and has affected every instrument in the installed base, in the HiSeq installed base.

And you are right. It did cause that – it was one of the causes of that temporary dislocation, one of three actually. But you are also correct – that came back very, very quickly. If you think back to the consumable portfolio on HiSeq around that period, in Q4 ’11 it was $273,000, it went to $299,000 in Q1 ’12 and then $338,000 in Q2 ’12. So very quickly in the space of maybe a quarter and half came back to your previous levels of quarter. I think that’s what generally happens is even a situation where the entire installed base was turned over in terms of the kits they were using, that very quickly the funding was found, the samples were found, and it very quickly came back to the previous level.

And I think that goes back to our fundamental belief that the demand of sequencing – sequencing of samples, basically samples were out there, the funding is out there and they will culminate, just it’s a question of how long it takes for that to happen. We think with the 1T launch, with all the differences for example it being a subset of instruments and there are still being plenty of choices et cetera, that will have no concern, no effect that we are concerned about other than the positive one.

Bill Quirk - Piper Jaffray

As one of the ramifications of the cost of sequencing coming down dramatically over the past almost decade now, is the array based franchise has kind of flattened out in terms of market growth, certainly the gene expression side of that is on the negative curve. And so can you talk a little about -- obviously it’s a much smaller piece of Illumina now and candidly I think far less of an investor concern now than it used to be but nevertheless as you roll out the 1T, what does it do to your outlook around the array franchise being roughly flat?

Marc Stapley

Yes, the array franchise, while roughly flat, it kind of have a lot of puts and takes in different markets. So while you are right the gene expression market has been declining, the consumer market has been growing. The cyto and PGS market has been growing, our BlueGnome acquisition has helped to contribute to the array business, and that’s where it’s recorded at least by part of it. So it’s a few thing – and this has actually always been the case with the arrays. There are a couple of key drivers on the upside and couple of things that are declining. You saw that a year and half, two years ago with the Axon business, the Axon array in particular which was very successful. And so we think that continues. So my kind outlook for the array business hasn’t really changed in terms of how flat it is but the composition of it probably changes over time as it has done certainly over the last few years.

Bill Quirk - Piper Jaffray

Questions from the audience? Okay. Turning back to some of the applied markets and where the strength is there, behind the scenes that there has obviously been a lot of disruption around reimbursements and you obviously have quite a few clinical customers. And so it hasn’t seemed you really had much if any effect on Illumina and yet we’ve actually seen at least fully by my count in terms of labs that are gone out of business because of these coding changes and codes going away and introduction and candidly the rumble of the rollout of the new code reimbursement. And so Marc, can you talk a little bit about to what extent that still represents a risk if any to Illumina and again you seem to have dodge the board while there has been a hit by that?

Marc Stapley

Yes, so I think you got to go back to how much of our business currently is driven by reimbursement versus how much of it is driven by more traditional sources. And that’s one of the key reasons why we haven’t seen an effect. I also think we’re somewhat immune to that effect, of course, obviously if labs that are customers of ours would go out of business as a result of situations you’ve described, that has a negative effect on us. We are so diversified now at this point that I think you don’t tend to see those impacts in particular. Reimbursement – it’s going to sort itself out over time, it just takes a while to do that. We are focused on those areas where we can help to drive reimbursements, for example, areas like an IVT in particular. And so we are paying more attention to that right now. So you are right, I don’t think we have seen much impact and it’s not one that where we see a lot of risk around at this point.

Bill Quirk - Piper Jaffray

And last about four minutes, I would like to turn the discussion a little bit to competition both current as well as potentially strategic competitors and setting specifically with the right thermal [ph] acquisition and to what extent any large transaction, of course there tends to be disruption particularly within the sales team. And so to what extent has Illumina been able to capitalize on that?

Marc Stapley

Yes, you are right. You do see lot of disruption, I think many of us have seen it and been through it in our careers and it’s been inevitable to an extent, certainly we have been the recipient of that in this case where you’ve had people that are interested in moving on and we had a lot of people show interested in joining Illumina and we have been able to capitalize on that as well to some extent. So and then on the competitive front, not really seen much change. I mean we continue to see the same kind of win ratios that we have seen. We obviously continue to see life in customers in bids and we have been very happy with the way that our platforms have competed and continue to win in those competitive situations.

Bill Quirk - Piper Jaffray

And so in terms of the available personnel, the new personnel that I guess have made themselves available for lack of better term for Illumina, is this a combination of deepening the sales team as well as expanding it from a geographic standpoint, little of both, one way or the other, how would you characterize this?

Marc Stapley

It’s a little of both. I mean it can’t specifically be characterized into one factor or the other. We’ve had a very clear focus this year on building out our sales force in particular and specifically around focusing on MiSeq and the desktop platform. I think we have been very successful about it, of course any time we can acquire a salesperson with the customer relationships, the scientific background, the technology understanding, that’s obviously a benefit to us in terms of how quickly that salesperson is able to come up to speed and ramp and contribute positively.

Bill Quirk - Piper Jaffray

And then just thinking about a couple of upcoming competitive launches both from Oxford Nanopore as well as Qiagen, the switch and seems to that they are taking a very kind of easy workflow approach to sequencing, right, with Qiagen having a couple of sample prep instruments and then some software on the back end, and Oxford’s talking about a pretty quick and easy sample thought process as well. And so Marc, can you talk about to what extent the arms race so to speak in terms of throughput, I think you guys can probably one man [ph] over right but now it appears that you’ve got competitors attacking from the sample prep length? And so to what extent has this had any effect on how you’re prioritizing sequencing R&D, you’ve obviously made a couple of acquisitions to try to help down the south, maybe you can speak to that topic?

Marc Stapley

Yes, I don’t think it’s really changed anything. We have been focused for a long now on how to ease the workflow and focusing on not just the sequencing part of the workflow but the sample preparation, the library preparation and the backend bioinformatics, and that strategy is what’s really driven our acquisitions of ALL and NextBio. It’s driven our focus on BaseSpace. That’s driven our focus on the software prep facilities that we obtained with Epicenter and so on that are doing extremely well. And so we’ve always been addressing our research and development dollars on the entire end-to-end workflow, not just the sequencing and sequencing platform and SBS chemistry.

We view an integrated sequencer as being truly integrated, that you are able to put a sample in, run that through the sequencing process, run the bioinformatics on the back end and get a very usable meaningful report of information of the outlook. And so everything we have been focused on over the last couple of years has been around how you enable that and we think we are a long way down that path both through acquisitions and organic investment. And we are excited about how that might turn out in the future. We always – to your point about competitors, we always assume our competitors are going to be able to deliver what they said they are going to deliver and that focuses our attention from an R&D standpoint.

Bill Quirk - Piper Jaffray

Very good. Well it seems like we have fairly run out of time. Marc, Rebecca, thank you so much.

Marc Stapley

Thank you, Bill.

Rebecca Chambers

Thanks, Bill.

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