Illumina Inc (ILMN) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter 2006 Illumina Inc. earnings conference call. My name is Melanie and I will be your coordinator for today. (OPERATOR INSTRUCTIONS). As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Ms. Karen Possemato, Associate Director of Marketing. Please proceed, ma'am.

Good afternoon everyone, and welcome to our third quarter conference call. At the close of market today we released our financial results for the third quarter of 2006. During this call we will review our results, update our financial guidance for fiscal 2006, and provide commentary on commercial activity, after which we will host a Q&A session.

Presenting for Illumina today will be Jay Flatley, our President and Chief Executive Officer, and Christian Henry, our Vice President and Chief Financial Officer. The call is being recorded and the audio will be archived on our website at Illumina.com. During the call we will be updating our financial guidance and discussing plans for future activity. Our intent is for these forward-looking statements to be protected under the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based upon current information available and Illumina assumes no obligation to update these statements. To better understand the risk factors, we refer you to the documents that Illumina files with the Securities and Exchange Commission, including Forms 10-Q and 10-K. With that I will now turn the call over to Christian.

Good afternoon everyone, and thank you for joining us today. I hope that you have all had a chance to review our financial results that were released after the close of market. I would first like to walk you through our operating results for the third quarter, and then I will follow with an update of our financial guidance for the remainder of fiscal 2006. Then I will turn the call over to Jay for a discussion of the Company's progress.

For the third quarter we are pleased to report our 21st consecutive quarter of revenue growth. Total revenues were $53.5 million, which represents a year-over-year growth of 174%. On a sequential basis total revenue grew more than 29% over Q2 levels. On a year-over-year basis Q3 product revenue grew 188% to $46.9 million. Revenue from consumables increased from approximately 50% of total revenue in Q2 to just over 60% of total revenue in Q3. During the quarter we shipped 30 BeadArray readers, bringing our cumulative systems shipments to 211.

Service and other revenue increased 136% for the quarter to $6.4 million, compared to $2.7 million from Q3 of last year. As a reminder, this number includes revenue from our genotyping services business and revenue earned from instrument maintenance contracts.

During the quarter we delivered more than 1.6 billion genotypes as part of 15 service contracts. Before discussing our operating expenses for the quarter, I would like to describe the effect of FAS 123R, which requires us to record the expense associated with stock options in our income statement.

The total impact to the P&L this quarter was approximately $3.8 million. As prescribed by the standard, the expense is allocated to each expense line. We have not restated our historical financials for the impact of expensing these options. In the discussion that follows I will highlight both our GAAP expenses, which includes the effect of FAS 123R, and the corresponding non-GAAP figures. I urge everyone to review the schedule included in our earnings release that reconciles these non-GAAP figures with the GAAP results.

Cost of products and services revenue were $15.9 million for the quarter compared to $6.6 million in Q3 of 2005. The third quarter costs include stock-based compensation expense of 417 K. Non-GAAP product and services gross margin was 70.1% for the quarter compared to 67.9% last quarter and 65.3% in the third quarter of 2005.

The more than 200 basis point increase in gross margin over last quarter was due to favorable product mix in the quarter towards consumables and continued progress in driving down our cost of manufacturing. For example, we are seeing significant reductions in the cost of raw materials due to our increased scale of production.

Finally, our gross margins for consumables were ahead of our expectations as our mix shifted to higher complexity products in the Infinium productline, such as the HumanHap550 and the HumanHap650Y.

Research and development expenses were $7.7 million in the quarter compared to $7.1 million in the third quarter of 2005. Included in the figure for the third quarter is approximately $1.0 million in stock compensation expense. The reduction of total R&D spending on a non-GAAP basis reflects the timing of major development initiatives and favorable variances in research and development supplies.

SG&A expenses were $14.1 million for the quarter, compared to $7.4 million in the third quarter of 2005. Of the $6.7 million increase, $2.3 million was related to stock compensation expense. The remainder of the increase was related to the expansion of our commercial activities to support our revenue growth and the increased spending on litigation.

For the third quarter we reported GAAP net income of $16.2 million, or approximately 30% of revenue. On a fully diluted basis, this represents earnings of $0.32 per diluted share. This compares to a net loss of $1.4 million, or $0.03 per diluted share, in the third quarter of 2005.

Excluding the impact of stock compensation expense, we are pleased to report non-GAAP net income of $19.9 million, or 37% of revenue. On a fully diluted basis, this represents earnings of $0.39 a share.

Turning to the cash-flow statement, we were cash-flow positive during the quarter, generating total cash of approximately $13.2 million. Of this total, $13 million was generated through operations. Included in our cash flow for the quarter were net proceeds of approximately $4.4 million generated through our employee stock plan, and the use of approximately $4.3 million for the purchase of capital equipment. From a free cash flow perspective, the Company generated approximately $8.6 million in free cash flow.

Moving to the balance sheet, we ended the quarter with approximately $170 million in cash and short-term investments. Cash collections were strong during the quarter. As a result, accounts receivable DSO improved for the fourth consecutive quarter to 49 days. This compares to 50 days at the end of the second quarter and 81 days at the end of the third quarter in 2005. Going forward, we expect DSO to continue to fluctuate from quarter to quarter based on our geographic mix of revenue.

Inventory grew by $2.1 million in the quarter to $19.4 million. I will now update our financial guidance for the remainder of the year. Consistent with our previous call, the following guidance excludes the impact of FAS 123R. I will provide an overall estimate of the FAS 123R expense at the end of my remarks. For additional details please refer to the table in our earnings release that reconciles our non-GAAP guidance to the related GAAP figures.

We continue to see strong demand for our products and services and expect a robust growth of the whole-genome genotyping market to continue to drive our revenue growth. Given these market conditions and our year-to-date performance, we now expect annual revenue to be between $178 million and $182 million, which is an increase of $8 million to $12 million over the high end of the increased guidance that we provided last quarter of $160 million to $170 million. Our updated revenue guidance represents growth between 142 and 148% over 2005.

Research and development expense is expected to range between $29 million and $30 million for the year, while SG&A expenses are expected to range between $45 million and $47 million. Total annual net income is now expected to be at least $49 million, or at least $1 per diluted share, assuming fully diluted weighted average shares of approximately 49 million.

We are currently forecasting total stock compensation expense to be at the higher end of our original guidance at approximately $14 million to $15 million for the year. However, this estimate is highly dependent upon changes in our underlying stock price.

For the year, we now expect to generate at least $40 million in cash flow from operations. Additionally, we expect capital spending to be consistent with our original estimates of approximately $15 million to $20 million.

Moving to the fourth quarter, we expect total revenue to range between $54 million and $58 million. Excluding the impact of the expense associated with stock options, net income per share is expected to be at least $16 million, or $0.31 per diluted share, assuming quarterly fully diluted weighted average shares of approximately 52 million.

At this point I would like to turn the call over to Jay for some additional comments before we begin the Q&A session.

Good afternoon everyone. In the third quarter we delivered over plan performance in virtually every aspect of our business. Revenue growth continues to exceed our expectations with growth of 174% over last year and 29% compared to last quarter. Products and services gross margin exceeded 70% for the quarter, and we have demonstrated the ability to drive high bottom line leverage through disciplined expense control.

The execution ability of our teams enabled us to nearly double our non-GAAP net income over last quarter, achieving 37% net income as a percentage of sales. Over the next few minutes I would like to walk you through some of the drivers that are generating these financial results.

Our growth in revenue continues to be driven by strong interest in genotyping. Demand for genotyping product is robust across a broad range of market segments, and across our full range of products. For example, we announced significant deals this quarter in the pharmaceutical, agricultural and academic segments.

Additionally the sequential growth rate for our custom genotyping products is almost identical to that for the Infinium fixed content product. One of the key drivers of the expansion of the genotyping market is our ability to launch flexible, highly differentiated products that address the specific needs of various market segments. This is a key element of our strategy that leverages our fundamental competitive advantages.

For example, at the end of the quarter we announced the HumanHap300-Duo and the HumanHap300-Duo+ product. These are the world's first multi-sample whole-genome genotyping chip. Based on the content of our Hap300, these new products provide our customers with key benefits, including streamlining their workflow, reducing overall labor, and allowing comparison of two samples side-by-side on the same chip. In 2007 you can expect to see us continue to launch innovative new products that leverage the flexibility of our platforms.

As another example of how the market is expanding, we recently announced a commercial agreement to develop a new multi-sample Bovine BeadChip using our iSelect product. Developed in close collaboration with the USDA, the Agricultural Research Service, the University of Missouri Columbia, and the University of Alberta, this product will be used to map quantitative trait loci on more than 10,000 cattle. The results of this study will be used to improve the quality, cost and efficiency of cattle breeding.

Ideal for focused content applications, the iSelect product enables the creation of custom multi-sample arrays for customers who can select up to 60,000 SNP markers per sample, and run 12 samples per chip.

Finally, as you may have seen in our announcement earlier today, one of the top five pharmaceutical companies is broadly adopting Illumina's technology for internal use in their research and development programs. This is a multi-million dollar agreement for the installation of a high throughput genetic analysis system capable of supporting both genotyping and expression applications. The initial project will involve 3,200 samples using our HumanHap650Y BeadChip. This announcement, along with the expanded relationship with GlaxoSmithKline that we announced earlier this quarter, are strong indicators of the adoption of genotyping by the pharmaceutical market segments. Overall we continue to believe that we are in the early phases of the development of the genotyping market, and that it will continue to see rapid market expansion over the next several years.

I would like to now take a moment to review the progress we have made in our gene expression business. In the third quarter there were three important developments that we believe will drive the growth of this expression business. First, we launched our RatRef-12 expression BeadChip. This multi-sample product enables researchers to examine the known rat genome with 12 samples on each chip. This product is particularly important as an enabler for our pharmaceutical strategy, as these customers use rat as an important model system for the study of therapeutic toxicology.

Additionally, as with our other gene expression chips, this product will sell at the market transforming price of $100 per sample. With the addition of the rat expression chips, our product line now addresses about 90% of the potential market opportunity in expression.

Second, as an outgrowth of our development of the rat product we have made substantial improvements in our manufacturing processes, resulting in significant enhancement in data quality over anything we have seen in expression microarray. As a result, we will be shortly launching Version 2 of our human and mouse expression arrays based on these new process improvements. We expect our customers to enjoy a level of data quality that they have not previously experienced.

Lastly, the FDA-led microarray quality control project recently announced their findings related to the compatibility of microarray gene expression platforms. The MAQC project compared a collection of samples across various commercial platforms at an unprecedented scale. The results of this study demonstrated a high level of concordance between platforms, as well as concordance with PCR technology. This result allows researchers to feel confident selecting the platform that provides the best mix of content, ease-of-use and value without worrying about legacy data sets.

I would like to next provide an update on our progress with the BeadExpress system. The BeadExpress platform will be launched as a powerful system for low to mid multiplex applications. The system will have important advantages over other technologies in both the research and molecular diagnostic markets. In fact we plan on using the BeadExpress readers as a key component for deploying diagnostic content in our strategic alliance with deCODE.

We have now completed the manufacture of the Beta unit, which are currently being tested in our San Diego and Connecticut facility. In the fourth quarter we will begin shipping Beta units to customers, and contingent upon the success of our Beta program, we expect to launch the platform around year-end and begin revenue shipments in the first quarter of 2007. Initial customer response has been overwhelmingly positive, and we have already received our first orders for the new system. I look forward to keeping you apprised of our progress as we get closer to launch.

In terms of new applications for our technology, we're very excited about the emerging market in DNA methylation profiler. DNA methylation is a type of chemical modification of DNA that can be inherited without changing the DNA sequence, and has been shown to play a critical role in the regulation of gene expression. The degree of methylation has research and diagnostic implications for cancer development, aging and various other diseases.

There is pent-up demand to increase the speed and scope of methylation studies through next generation technology. Illumina scientists have recently published two papers in genome research demonstrating the application of our BeadArray methylation technology to cancer marker discovery and stem cell research. In the coming quarters Illumina will commercialize a high throughput technology that will enable researchers to interrogate methylation in DNA samples using a modification to our market-proven GoldenGate assay. This assay offers high sensitivity and reproducibility in detecting differential methylation. The first standard product will be a methylation cancer panel with highly informative content for cancer research. Custom methylation will also be made available.

From a commercial perspective we continue to grow our infrastructure. During the quarter our non-GAAP SG&A spend was 22% of revenue, which as a percentage is significantly lower than our long-term models. We now have more than 100 people supporting customers in our sales, marketing and technical support organizations. But as we continue to grow, we expect to continue to make significant investments in this area to make sure that we take full advantage of the commercial opportunities available to us.

On our last conference call I began my remarks by indicating that we expected to continue to generate operating income of at least 20% of revenue per quarter through the remainder of the year. As you can see from our third quarter results and from the guidance we have given, we now believe that we can significantly exceed this figure for 2006.

As we begin to look forward to 2007 we are working hard to ensure that we're making adequate strategic investments in our R&D programs and our commercial infrastructure. Our expectation is that these investments will result in a long-term balance in our business model that will bring operating margins lower than the 37% net operating profit that we achieved during this quarter.

In summary, the third quarter was highlighted by over planned performance in virtually every aspect of our business. Our revenue growth and strong gross margins drove record profitability and nearly 100% sequential quarterly earnings growth. Additionally, we are beginning to see signs of significant adoption of genotyping by pharma customers who should continue to fuel the rapid expansion of that market.

I look forward to laying out our strategy and guidance for 2007 on our next conference call. At this point, we are ready to begin the Q&A session.

(OPERATOR INSTRUCTIONS). Quintin Lai, Robert W. Baird.

Congratulations on a very nice quarter. Could you give us a little bit of update on the consumable trail for your installed readers? It looks like that you saw an acceleration off of Q2 levels, which had an acceleration off of Q1 levels.

Yes, we did. In the script we said that about 60% of our revenue was from consumables in the quarter. So you can do the calculation and divide by our installed base of last quarter. The way we do that is we use the ending installed base of the prior quarter divided by the consumables revenue in this quarter as the metric. And if you do that division, it has significantly increased over last quarter.

Could you kind of -- then in light of the pricing environment that a competitor is using with price cuts, what are you seeing in terms of your prices that you're getting from your customers?

I guess the way we like to measure that is to look at the average selling prices across the entire Infinium part of the productline. If we do that, our ASPs decrease somewhat in third quarter from the second quarter, but were actually higher than the ASPs in the first quarter. We think in aggregate we're being very successful in migrating customers over time to the higher content, more proprietary products which have higher selling prices. We're feeling pretty good about our pricing strategy at the moment.

Last question, and I will jump back into the queue. Congratulations on signing this big pharma contract with them taking it in-house. Previously it seemed like big pharma had used genotyping as more of a service and outsourcing. Do you think that this could be the start of a trend for big pharma to bring it in-house?

We think so. If you look back historically one of the reasons that pharma tended to outsource genotyping was that the projects were aperiodic, and so they didn't have a regular process flow through the genotyping application. I think that is beginning to change as we look forward toward more routine use of genotyping in clinical trial environments. Our expectation is that more and more pharmaceutical companies will bring this technology in-house at a large-scale.

Having said that, there certainly are some pharma companies who just don't want to own the capital equipment and will, for the long-term, adopt a service model. But we think many of them will bring the technology in-house.

Eric Schmidt with Cowen and Company.

My congratulations as well. Can you provide any color on where gross margins are going in Q4? Is the improvement you saw in Q3 sustainable, and can we further build upon that, or what should we look for in that current quarter?

This is Christian. We continue to think about gross margins being in the high 60s to creeping into the 70% range. As we talked about in our written remarks, the gross margin this quarter was driven by a favorable product mix and our ability to improve our manufacturing costs. We think that we will continue to be able to improve our manufacturing costs, but the mix in any particular quarter will probably be the primary driver of the gross margin. That is probably the best way to think about it.

That's helpful. Any comment on backlog directionally?

Yes. Backlog in total dollars stayed about the same from quarter to quarter. In terms of days of backlog, if you did the division of our forward-looking revenue, actually it is a little lower in terms of days of backlog heading into the fourth quarter. That is actually a good thing for us, because our backlog at the end of last quarter was probably a little higher than we would like to see it. And from a capacity standpoint we're in great shape now, and we are out ahead of that curve, and so we think backlog is pretty much at an ideal level for us.

Last question. I appreciate the comments that you made, Jay, about your longer-term SG&A spending line. Could you also talk about where R&D is going out three to five years as a percentage of revenue?

Our longer-term models show R&D as a percentage ranging between 15 and 17%. We have actually dropped below that level now, but that is largely due to the fact that the revenues increased at such a dramatic rate. As I mentioned in my remarks, we are looking strategically at how we can continue to invest in R&D to bring innovative new products to market and continue to improve our competitive position. I suspect that you'll see that creep up over the next couple of years.

Ted Tenthoff with Piper Jaffray.

Thank you very much, and congrats on another very strong quarter here. Maybe a little bit more of a kind of theoretical question with respect to what you're facing in the competitive environment out there. Has competition increased at all because of some of the price cuts? And really what are the key issues that you guys are facing when it comes to winning business these days? Maybe just a little bit of crystal ball projection tax rate into next year.

I will let Christian handle the tax rate and I will handle the first part of the question. I guess if you think about the competitive environment globally, we have been competing on almost every deal in genotyping for the past two years. We continue to compete on virtually every deal.

From that perspective, the landscape hasn't changed a lot. Clearly with some price changes in the market, the way we have continued to win deals is by having differentiated products. We have our HumanHap500 product and the 650Y that today we believe have no competition in the market. And so as customers desire higher performance, better content, higher content on their chips, we're able to charge a premium for those products over the competitive product.

We also have of course taken advantage of the flexibility that our products offer by doing things like the 300-Duo and the Duo+. The Duo of course allows you to run two chips per sample, which helps the workflow for customers, and that is another competitive advantage. And the plus option on the Duo gives customers the ability to add their own custom content. The way we're looking at this market is to continue to serve every market segment with products that are optimized for that segment. We think that puts us in a very strong competitive position.

From a tax perspective, we are probably looking at 10% or so. Our profitability has improved so dramatically that actually we will burn through most of our NOLs I suspect next year. That will be something on next quarter's conference call. We will give you a specific rate and our projection of how fast we will burn through those NOLs. But obviously the profitability has given -- has forced us to use some of our NOLs faster than maybe we were originally thinking. But I think right now 10% is probably a good number to think about.

Paying taxes isn't always a bad thing, so keep it up. Congrats.

Zarak Khurshid with Caris & Company.

Zarak here from Caris & Co. Again, great quarter. I wanted to ask about the guidance raised and the outperformance. Was it more a function of kind of the growing overall business, or more associated with the projects with deCODE and CHOP getting up to a steady-state level quicker than expected?

DeCODE and CHOP took about the number of chips that we expected, so it was a very strong component of revenue in the quarter. The business sort of across the board continues to be very strong. From a bottom line perspective, we exceeded on the top line and the expenses came in about where we had budgeted and the margins came in higher. All those factors contributed to a bottom line that pretty dramatically exceeded what we had projected.

One thing that was interesting in the quarter, and Jay referred to it in his remarks, is that we are seeing not only strong demand across the whole genome genotyping market but the custom genotyping market is really growing at a rapid clip as well. And I think that is where some of the outperformance in the quarter came from. We did a really good job of executing, of delivering products on time to folks, and I think that helped drive some of the revenue growth.

Thanks. That is a good segue into my next question which is what is -- what do we -- today what do you think the size of the market is for genotyping and what are the growth rates that we are seeing?

Our best estimate is that the overall market is in the range of $350 million or so, with about $200 million, maybe a bit more, $200 million or so arraybased. The remainder of the market would be divided up among TaqMan real-time PCR type systems and genotyping done on platforms like sequencers. We continue to see very strong growth in the market. It is hard on a short-term basis to calculate what those numbers are, but they are certainly in the range of 30 to 40%.

And last couple of questions. There is a sequential decrease in R&D, maybe you touched on it, Christian. Could you go over what that was caused by? And additionally, it looks like interest more than doubled sequentially, can you dig into this?

Sure. From an R&D perspective, fluctuations in R&D are really project dependent. And so we talked about in the remarks that the R&D supplies were lower this quarter, so that was the primary driver of why the expense was in fact lower in the quarter.

On the interest income line, I am really actually -- we did our public offering in the middle of the second quarter, so we have the full benefit of those funds. We're actually -- we switched investment managers in the quarter and we are generating significantly better returns than we have done -- then we have been able to do in the past with the same investment level of safety and investment policy. We were pleased with that performance as well.

Alastair Mackay with GARP Research and Securities.

You had mentioned the BeadExpress, that you have already gotten some back orders. Is it possible at this early point to put a number on the number of units that are in the queue right now? And could you talk a little bit about your strategy in terms of setting a selling price and what you envision in terms of the split between the units and the consumables?

Let me take a stab at that. We're not going to give out the exact backlog numbers we have, but I would say that they are single digit orders numbers. However, the pipeline of orders looks pretty rich, and so we've got quite a number of interested customers that are, as soon as we finish the Beta testing, are ready to take a look at the system in a serious way and hopefully place orders.

The system price will be in the range of about $80,000 to $85,000, we think. We haven't done the final pricing, but that is where we expect it to land. In terms of consumables, we expect that the consumption rate will be a lower ratio than what we see on our other products, of course, because these are low to mid multiplex applications. You might expect an annual consumable number to be maybe in the range of $40,000 to $100,000 per system, something like that.

That sounds good. The second question, given the scope of the expansion that you have experienced, are you starting to think about needs in the foreseeable future to expand the fixed plant, the operations in say San Diego, or are you still pretty well set for manufacturing?

This is Christian. We actually have made great progress in our own building about optimizing the space. And one of the great elements of this manufacturing capability that we have is it is very linear and we can add capacity incrementally. We see that we still have enough capacity -- enough space here to add capacity if we need to.

We are starting to become constrained from just putting people -- having people. And so we just took a lease on some space that is just down the street from us here, and we will move some of the G&A functions over there. And then looking forward in the future, we're still planning out our long-term facilities plan with respect to international manufacturing and also where we are going to keep field offices and things like that. Our intent at this point though is to try to optimize the facility here in San Diego and manage accordingly.

May-Kin Ho, Goldman Sachs.

I have two questions. One is a more on macro one. What have you heard from customers so far based on the publication on the microarray quality control project, and what do you think the long-term implication would be?

I think customers were excited to see that data become published certainly. It is a little early for that to flow through into actual orders or bookings, but our hope is that customers now realize that the reliance on legacy data is not critical, and that the concordance between these platforms is good enough that they can rely really, or make their decisions, based on cost points and ease-of-use. We think we have key advantages there.

As I mentioned in my remarks, we're starting to see some real momentum in our expression business. Our orders were up 20% over last quarter in the expression business. And our hope is that we continue to grow that business at a very solid rate. I think that is overall -- that publications overall are good for the industry and really for all the suppliers into the expression space.

What are the competitor salespeople saying about this product?

I think all the competitors have gone on record publicly and said that they think the data show what they claim to show in the publications, and that is good for the industry.

That is good. My next question is really just a clarification. On the 10% tax rate that you mentioned earlier, is that for the fourth quarter?

No, the fourth quarter will be probably around 7% or so is what we have modeled it to be.

For next year you are saying.

That's right, for the 2007 tax rate.

The year after would you expect to be paying almost full tax rate?

Yes, I think -- we haven't modeled that out completely, but I suspect we will be paying a much higher rate at that point. Kind of a corollary to our facilities question, we're looking at opportunities now to manage that tax rate through manufacturing in lower tax jurisdictions.

(OPERATOR INSTRUCTIONS). Un Kwon, Pacific Growth Equities.

I was hoping if you could comment on your HumanHap300K product. Do you think that over time a lot of your single sample customers will switch over to those duo sample chips?

We think all of them will switch to it. It has significant advantages for them and virtually no disadvantages. There are some customers who will wait to finish projects that they have in process, so that they don't change configurations and don't have to do a little bit of training that it takes to show customers or their technicians how to run the new version of the chip, so they will finish the first project. But we expect in the next three, maybe four months that everyone will have converted.

As far as the other products, the 550 and the 650, do you anticipate putting those on single chips as well?

They are today on single chips.

I apologize. Two samples per chip?

We have not announced any future products specifically in this line. I think if you look at the evolution of what we have done with the technology, you can anticipate that we will continue to improve the content on the chips and take advantage of the flexibility dimensions that we have, but we have not indicated specifically how or what we're going to launch in the future.

Okay. I guess lastly, could you comment big picture on what sort of impact you see from the next generation sequencing technologies and how that may complement the genotyping market, and where you see those technologies fitting?

Certainly. We see those technologies as being highly complementary. A few quarters ago investors I think got a bit concerned about whether sequencing, when it got to be $100,000 a genome, was going to impact genotyping. Our view is that it clearly isn't. At the kind of price point today that we can deliver whole-genome genotyping, sequencing technology is many, many years away from achieving those price points. And by that time we will certainly be way below where we are today.

From a genotyping of common variance we don't believe there's going to be any competitive dimensions between next generation sequencing and what we do. However, there will be complementary in that these new sequencing technologies will allow significantly increased rates of discovery for SNPs and other organisms, for doing resequencing in specific targeted areas of the genome, for doing diagnostic sequencing, seeking rare mutations. And to the extent that new content becomes discovered, we would have the ability then to put that content on a chip. We believe that this is going to facilitate an overall expansion of the market for arrays as we industrialize those discoveries onto chips.

Thanks very much. If I may, I just have a gentleman here who would also like to ask a question.

This is [Lenny Acuwitz, Stock Partners]. I was just wondering, you alluded to this in your opening comments to some extent, as we get into new technologies for drug discovery, and I'm thinking primarily of RNA interference or stem cells, is that going to open up whole new markets for what you're doing? And if so, what type of technologies might be needed that don't exist today, or is it something that wouldn't be increasing business opportunities for you guys?

I would put those two different examples you gave in different buckets. For RNA interference, certainly there are many companies working on new applications to study RNAi, and most everyone is doing research on brain product in that category to market.

In terms of stem cells there will be many types of applications that people use to study stem cells. And we've done stem cell work using -- already using many of our different applications, and I think that will continue.

In terms of whether there are new things to be developed, I think looking at methylation, looking at allele-specific expression and other new types of applications, will certainly aid in the analysis of stem cell.

Steve Unger, Bear Stearns.

Just a first question, in terms of the "switch to i" initiative that you guys are doing in gene expression, could you comment on how you are overcoming the issue related to legacy systems, or legacy instruments, and legacy systems in terms of data conversion?

In terms of data conversion, I think the problem is not very big. And the MAQC data, certainly helps guide customers on how to compare these data, and that is we think largely a nonissue now.

In terms of the installed base, clearly there is one company that has a large fraction of the installed base. We employ a number of different strategies to place our systems in expression. The first is that we sell to Core Labs that have many, many users, and so they are driving lots of projects through the system. And with the pricing that we have on our arrays, they are able to recover the cost of bringing in a new scanner very, very quickly because of the cheaper chips.

Additionally, every system that we install for genotyping can be added on with an option package to do gene expression. And so for example, the pharmaceutical deal we announced this morning, while that system is not initially targeted for sort of taking over that pharma company's expression business, over time they certainly will try expression chips, and we will migrate the consumable we hope over to Illumina platform from the competitor's platform.

Is there a price discount for the instrumentation in gene expression?

No, same prices.

Same prices. Okay. In terms of the 30 BeadStation shipments in the quarter, do you know or can you quantify how many of those are related to gene expression?

No, we don't break that out.

Don't break that out. Moving to the revenue per -- it looks like revenue per instrumentation is up significantly. It seems to be ramping higher. Is that related to high throughput automation autoloader so forth, or additional scanners? How does that correlate?

Yes, the autoloader helps a lot. In many of our larger installations the way we spec the amount of equipment the customer needs assumes that they're going to run these scanners around-the-clock. So we install the scanners. They are supported by autoloaders that put the chips in and out unattended. So the throughput of those scanners, or the D cycle if you will, is nearly 100%. As these large installations become a greater fraction of our installed base and use more of the chip, the overall average is going way up.

Should we expect per BeadChip, BeadStation installation a greater instrument price per installation going forward? Is that your expectation?

I wouldn't necessarily say that. There are a fair number of large installations and we expect there will be some going forward, but whether the ratio will change, I don't think so.

They certainly may move around a little bit?

Yes.

Could you comment on the Invitrogen relationship in terms of whether you are seeing improvement there in their selling efforts?

Sure. They are continuing to work very hard there. They've got some good marketing programs that they have brought online. From an overall revenue perspective, our revenues in the third quarter were about flat with second quarter revenues. But they have just recently brought on their European operation into the collaboration, and so that is going to provide some additional upside and some additional profitability as well.

I might also comment that this collaboration is strategically important for us even more globally than the specific revenue we derive from it, because we had this baseline shipment of oligos that we've put through our factory that helped the overall economics of us manufacturing oligos for our own purposes, because we can absorb a lot of the overhead of the operation and of the capital equipment. That allows us to make oligos much less expensively for use on our chips and in our reagent kits. There is huge strategic elements to this deal as well as just the revenue component.

Excellent, okay. Just one last question quickly. What is the ASP for the HapMap-Duo?

We don't quote specific ASPs for each of the chips, but you would really think about that on a per sample basis. On a per sample basis it is priced the same as the 300.

As the 300 on a per sample, with the higher gross margin, obviously.

The cost to make it are a little less, yes.

Thanks. Congratulations on a very strong quarter.

(OPERATOR INSTRUCTIONS). Quintin Lai with Robert W. Baird.

At the New Orleans American Society for Human Genetics meeting there was also some talk on top of methylation. But for ecology research copy number, the -- your chips currently kick back copy number data, but as this emphasis I guess in oncology research continues, do you see a need to increase the capabilities on your current HapMap chips -- Humanhap chips?

The capabilities in terms of adding more copy number content?

Right.

That is certainly one area that going forward we could put additional content on to the chips. But you're right, that our current chips are very effective at detecting copy number, particularly the high-density chips, the 500 and the 650Y because of the density of those chips do a phenomenal job of analyzing copy number. And we have released new software that goes with our system that gives graphical views of the data for the researchers. And we have a feature called bookmarking that automatically detects these regions of copy number variation and points the researchers directly to those areas of the genome. In addition, on genotyping chips like ours you get genotype information, as well as copy number information, which gives you more power in analyzing the data.

Ted Tenthoff, Piper Jaffray.

Actually Quintin just beat me to the question on copy number. But can you talk about other areas in terms of next generation markets and technologies that are emerging in methylation and copy number but are you doing anything in chip-chip or anything along those lines?

We don't talk much about things that are in the research part of the Company at the moment. We have spoken about methylation because it is in our development pipeline today, and we know that we will have product coming to market relatively soon. But I would rather not get into the things that are in our research pipeline.

Zarak Khurshid, Caris & Company.

Jay, what was the tax expense in the quarter, and any updates with the ongoing litigation with Affymetrix?

I will take the tax one. I think our tax rate was --.

Sorry, legal expense.

Well, the legal expense we don't break out the specific amount we spend in any particular quarter, but it has been basically consistent. It fluctuates a little bit from quarter to quarter as the activities go up and down.

In terms of the litigation itself there has been no real updates other than a trial date becoming reset now for the month of March. The trial is scheduled to start early March. That is really all that has happened recently.

Lastly, with respect to the suit between deCODE and the CHOP employees, has there been any change there with the project at CHOP? And maybe if you could give some color where we are just within that project itself?

The CHOP project has ramped up to be -- just as we expect it to. We have seen no change in that project and we don't expect to see much change in that project. This litigation is really between two of our customers and doesn't impact Illumina directly in any way. And our view is that even in the worst-case situation that CHOP is likely to continue to take chips just as they have previously.

(OPERATOR INSTRUCTIONS). There are no further questions at this time. I would now like to turn the call over to management for any closing remarks. Please proceed.

That concludes our call for today. Thank you all for attending, and we look forward to speaking with you on our quarter four call.

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