Illumina Inc (ILMN) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2006 Illumina, Incorporated Earnings Conference Call.

My name is Melanie and I'll 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 Passamato], Director of Corporate Marketing.

Please proceed, ma'am.

Good afternoon, everyone, and welcome to our fourth quarter conference call.

At the close of market today, we released our financial results for the fourth quarter and for the fiscal year 2006.

During this call, we will review our financial results, provide our financial guidance for fiscal 2007 and provide commentary on commercial activities, 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 Senior 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 activities.

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.

Thank you, Karen.

Good afternoon, everyone, and thank you for joining us today.

I hope that you've had a chance to review our financial results, which were released after the close of market.

Today, we will review our operating results for the fourth quarter and fiscal year, provide you with an overview of the accounting impact of our recently completed acquisition of Solexa, and then I will discuss our financial guidance for 2007.

Jay will discuss our commercial progress in the fourth quarter and lay out our view for 2007.

Before I begin, I'd like to remind everyone that our actual results do not include the impact of Solexa.

However, our 2007 financial guidance will include the consolidated company.

In the fourth quarter we saw strong demand across all of our products lines.

This enabled us to record our 22nd consecutive quarter of revenue growth.

Total revenues were 60.4 million, which represents a year-over-year growth of 163%.

On a sequential basis, total revenue grew more than 13% over Q3 levels.

This was our sixth consecutive quarter of sequential growth greater than 10%.

Revenue from consumables represented more than half of our total revenue during the quarter.

As a percentage, consumables were lower during the quarter when compared to the third quarter, due to an increase in instrumentation and services revenue in the fourth quarter.

We shipped 35 BeadArray readers in the quarter, bringing our cumulative system shipments to 246.

Services and other revenue includes revenue earned from our genotyping services business, as well as revenue related to our instrument maintenance contract.

In the fourth quarter, service and other revenue increased 91% to $11 million.

This is compared to 5.7 million in the fourth quarter of last year.

And as a reminder, the figure from the fourth quarter of last year included a one-time milestone of 1.1 million related to our collaboration with Invetrogen.

In the quarter, we recognized revenue on 17 service contracts, four of which were greater than 1 million in value.

During the quarter, we also processed more than 20,000 samples, and delivered more than 4.1 billion genotypes.

For the year, total revenue grew 150--more than 150% to 184.6 million.

Product revenue grew nearly 170% over 2005 levels.

This growth was due to a nearly four-fold increase in consumable revenue.

This significant growth was also due primarily to the launch of eight new Infinium-based whole-genome genotyping products.

In addition, compared to 2005, instrument revenue grew nearly 100%, as did our revenue from our services business.

At the end of the fourth quarter, our consumable revenue for systems installed was tracking at more than $600,000 per instrument per year.

The geographical breakdown of our revenue in 2006 was approximately 76% in North America, 18% in Europe, and 6% in Asia.

For the year, we saw strong growth across all of our geographies with North America growing the fastest.

The breakdown of customer types in 2006 was approximately 75% academic and 25% corporate.

The trend of customer mix is clearly moving towards corporate buyers as the fourth quarter revenue mix moved to 65% academic and 35% corporate.

Before discussing our operating expenses for the quarter, I'd 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 $4.1 million, or $0.08 per diluted share.

For the year, the total impact was 14.3 million, or $0.29 per diluted share.

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.

And in the discussion that follows, I'll 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 to reconcile these results.

The cost of product and services revenue was 20.1 million for the quarter, compared to 7.2 million in the fourth quarter of '05.

The Q4 '06 costs included stock-based compensation expense of $507,000.

Non-GAAP product and services gross margin was 67.4% for the quarter, compared to 70.1% last quarter and 68.5 in the fourth quarter of '05.

The lower gross margin in the quarter compared to Q3 was primarily attributed to the product mix.

In the quarter, revenue from instrumentation was higher relative to total revenue than in the prior quarter.

Additionally, we sold more instrumentation through our distributors in the fourth quarter, particularly in Asia.

These systems carry lower selling prices to Illumina due to the typical distributor discount.

Also from an instrument perspective, we shipped proportionally more BeadArray readers configured for gene expression, which sell at lower selling prices than our systems for genotyping.

Research and development expenses were 8.8 million in the quarter, compared to 7.5 million in the fourth quarter of '05.

Included in the figure for the fourth quarter is approximately 1.1 million in stock comp expense.

Excluding this expense, research and development costs were in line with prior year levels.

For the year, research and development expense was 33.4 million, compared to 27.8 million in 2005.

The increase is primarily due to 3.9 million in stock compensation expense and the fact that we incurred a full year of research and development costs associated with our acquisition of CyVera Corporation.

SG&A expenses were 14.9 million in the quarter, compared to 8.2 million in the fourth quarter of '05.

Of the $6.7 million increase, 2.5 million was related to stock compensation expense.

The remainder of the increase was related to the expansion of our commercial activities to support our increased revenue growth and increased spending in litigation.

In the fourth quarter, we reported a GAAP net income of 17.1 million, or approximately 28% of revenue.

On a fully diluted basis, this represents earnings of $0.34 per diluted share.

This compares to net income of $326,000, or $0.01 per diluted share, in the fourth quarter of '05.

Excluding the impact of stock compensation expense, we are pleased to report record non-GAAP net income of 21.2 million, or 35% of revenue.

On a fully diluted basis, this represents earnings of $0.42 a share.

Moving to the cash flow statement, in the fourth quarter we generated positive cash flow from operations of approximately 8.4 million.

Additionally, we generated 2.8 million through our employee stock plans.

These inflows were offset by our purchase of $50 million of Solexa common stock in connection with our acquisition and approximately 1.6 million in capital expenditures.

Our net cash and investments position declined by approximately 30--39.1 million during the quarter to 130.8 million.

For the year, we generated 38.6 million in cash flow from operations.

And excluding the effect of our May financing and our investment in Solexa, we generated net positive cash flow of 33.5 million, or $0.66 per diluted share.

Reviewing the balance sheet, we continue to be in a good position with respect to accounts receivable DSO at approximately 60 days.

This compares to DSO of 69 days at the end of the fourth quarter of 2005.

Going forward, we expect DSO to continue to fluctuate from quarter to quarter, based on our geographic mix of revenue.

Inventory grew by $800,000 in the quarter to 20.2 million.

Now, I'd like to walk you through a brief overview of the accounting for the Solexa acquisition.

Upon the close of the transaction, Illumina issued 13.1 million shares of common stock for all of the outstanding common shares of Solexa.

This represented an exchange ratio of .344 shares of Illumina stock issued for each share of Solexa.

We converted Solexa stock options and options--to options to purchase Illumina common stock.

This represented approximately 1.4 million shares.

Finally, we reserved 2.3 million shares for issuance upon conversion of the outstanding Solexa warrants assumed at the close of the merger.

For accounting purposes, this acquisition was valued at approximately $615 million.

In order to determine how to allocate this amount, we engaged a third-party to perform a valuation analysis and related purchase price allocation.

As a result, we expect to add approximately 40 million--49 million in net assets to our balance sheet after the close of the transaction.

Additionally, we expect to capitalize approximately 22.8 million of core technology related to Solexa's intangible assets.

It is our expectation that this amount will be amortized over a period of approximately 10 years.

Additionally, in the first quarter we expect to record a charge of approximately $254.6 million associated with in process research and development.

And finally, we expect to record approximately 289.4 million in goodwill.

Now, I'll review our financial guidance for 2007.

Consistent with our previous calls, 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.

Additionally, the guidance discussed below excludes the effect of the merger-related items, such as the amortization of intangible assets, the in process R&D charge, and the effect of valuing Solexa's assets and liabilities at their fair value as of the date of acquisition.

For fiscal 2007, we expect revenues to grow between 60 and 71%, which would generate total revenue in the range of 295 to 315 million.

The revenue growth is expected to be driven by an increase in the demand for genotyping related products and services, the commercialization of the Illumina genome analyzer, and the launch of our BeadExpress platform.

Product and services gross margin are expected to range around the mid-60s, with gross margins in the first half of the year being lower than in the second half of the year due to the ramp of manufacturing of our sequencing instruments and reagents.

Research and development expense is expected to grow significantly over 2006 levels as we add the research and development capabilities of the Solexa team to our organization.

At this point, we expect R&D expenses to range from $57 to $67 million.

Selling, general, and administrative expenses are expected to grow as we rapidly expand our commercial infrastructure to support the BeadArray sequencing and BeadExpress platforms.

Total SG&A expense is expected to range from $72 to $82 million.

Based on these revenue gross margin expense levels, we expect income from operations to range from approximately 15% to just over 20% of revenue over the course of the year.

Given our tremendous growth and profitability in 2006, we used a significant portion of our tax loss carry-forwards to offset 2006 income.

Therefore, we are now projecting our GAAP income tax rate will increase from approximately 6% of earnings before tax in 2006 to approximately 36% in 2007.

This represents a reduction of our earnings of approximately $0.13 per diluted share.

In 2007, we will be working on various tax planning strategies, and expect to report a lower GAAP tax rate in 2008.

Excluding the impact of the expense associated with stock options and merger related items, we expect total annual non-GAAP net income to range from 52 to 62 million.

This represents fully diluted earnings per share of $0.86 a share, assuming the midpoint of the range, and fully diluted weighted average shares of approximately 66 million.

For the year, we expect stock compensation expense to range between 20 and 25 million, or $0.34 per share, assuming the midpoint of the range.

However, this expense is highly dependent on our underlying stock price.

For the first quarter of 2007, we expect total revenue to range from 64 to 68 million.

Gross margin is expected to be in the mid-60s, declining from last quarter due primarily to the ramp in sequencing manufacturing.

Excluding the expense associated with stock compensation and merger related items, we expect net income to range from 9 to 11 million, resulting in earnings per share of $0.16, assuming the midpoint of the range, and fully diluted weighted average shares of 62 million.

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

Jay?

Thanks, Christian.

Good afternoon, everyone. 2006 was a landmark year for Illumina.

We exited the year with a record backlog while our revenue grew by more than 150%.

We saw non-GAAP gross margins improve over 2005 levels and we not only reached, but generated significant profitability and positive cash flow.

Operationally, we nearly doubled our install based for the second consecutive year, launched eight new products in our Infinium whole genome genotyping product line, quadrupled our BeadChip manufacturing capacity, and added more than 200 new employees.

Perhaps most importantly, we've created the infrastructure that will enable us to continue to take advantage of the exciting growth opportunities in genetic analysis and molecular diagnostics.

Strategically, we've been busy as well.

Since our last conference call, we announced and completed our acquisition of Solexa, Incorporated.

We believe that this merger gives us the opportunity to create a powerful life science franchise by combining the leading technologies in genotyping, next generation sequencing, and gene expression.

By adding Solexa's capability to our own portfolio, we will now compete in the $1 billion sequencing market with what we believe to be the best of breed technology.

I'd now like to walk you through some of the recent progress of Solexa.

In early January, Solexa announced that the early access phase of commercialization had been completed and that the Illumina genome analyzer is now achieving 1 billion bases of high quality sequence in a run.

We're now in full commercialization with a significant backlog and are scaling our manufacturing and commercial capability to meet the market demand.

We believe that the sequencing business will be a significant portion of our total revenue in 2007.

In any acquisition, one of the keys to success is the ability to rapidly integrate the companies.

We've been hard at work on this and we've made tremendous progress.

For example, on day one, which was just this past Monday, we had the organizational structures defined, computer networks connected, integration plans mapped out, and the financial forecasts for 2007 consolidated.

By the end of the first quarter, we expect to have the entire commercial organizations completely integrated, and in April we expect to implement our ERP system in the Hayward, California and in the U.K. sites.

In the process of defining our new organizational structure, we've made some management changes that I'd like to share with you.

First, I want to remind everyone that John West, the former CEO of Solexa, has joined Illumina as Senior Vice President and the General Manager of our sequencing business.

John Stuelpnagel, our COO, will take on the additional responsibility as General Manager of our microarray business.

Tristan Orpin, our Vice President of Sales, has been promoted to Senior Vice President in charge of all commercial operations, responsible for sales, marketing, and technical support across all of our products and geographies.

Christian Henry, our Vice President and Chief Financial Officer, has been promoted to Senior Vice President and Chief Financial Officer, and is assuming the additional responsibility for Investor Relations.

[Matt Passard], our Vice President of Marketing, has moved into the role of Vice President of Sales, the position previously held by Tristan, while [Omead Austegan] will take Matt's place as our Vice President in charge of marketing.

Omead was the Vice President of Marketing at Solexa, and we're enthusiastic about him taking on a broader role within the combined company.

Finally, I'd like to welcome Mr. Blaine Bowman and Mr. Roy Whitfield to our Board of Directors.

Mr. Bowman and Mr. Whitfield are joining from the Solexa Board, and I'm looking forward to working with them to chart the future of our new organization.

Turning back to the array business, I'd like to highlight a few important transactions during the fourth quarter.

In late October, we announced a landmark agreement with Amgen for the purchase and installation of a large genetic analysis system for Infinium genotyping.

Amgen, in collaboration with Brigham & Women's Hospital, will use our Hap300-Duo BeadChip to analyze approximately 28,000 samples as part of the women's genome health study.

In early November, we announced that Erasmus MC, the Netherlands' largest academic medical facility, will use the Hap550 BeadChip to genotype more than 10,000 samples in a longitudinal study of late age disease.

Also in November, we announced an agreement with the Johns Hopkins University School of Medicine in collaboration with researchers at the National Human Genome Center at Howard University to utilize the Hap650Y BeadChip for an asthma study of over 2,000 individuals and their families.

This study will be the largest and most extensive genome wide scan of individuals of African and African American descent to date.

Finally, in December, we announced that we entered into a multimillion agreement with GlaxoSmithKline for the purchase of 1,000 Hap550 BeadChips to be run at a third-party facility and a study to utilize Illumina's fast track genotyping service to process approximately 4,000 disease samples for a pharmacogenetics application.

In addition to our success in genotyping in the fourth quarter, we saw a significant increase in shipments related to our gene expression products.

Shipments for gene expression grew more than 50% sequentially, and were up nearly 150% on a year-over-year basis.

As Christian highlighted earlier, we also saw a significant increase in the number of BeadStations sold for gene expression.

The expression business was highlighted by our announcement in November that, in collaboration with a prominent pharmaceutical company, the Genome Institute of Singapore will utilize the HumanRef-8 expression BeadChip to analyze up to 3,000 samples.

In early January, we also announced two important collaborations in our molecular diagnostics business.

First, we announced an agreement with the Mayo Clinic to co-develop molecular diagnostic tests for the study of complex diseases.

The collaboration will use our BeadArray and BeadExpress instrument platforms.

Under the agreement, Illumina will manufacture and market test worldwide.

The second agreement is with the Children's Hospital of Eastern Ontario, or CHEO.

We're collaborating with CHEO to develop molecular diagnostic tests to screen newborn babies for spinal muscular atrophy and hemoglobinopathies.

These tests will utilize Illumina's VeraCode technology and run on our BeadExpress reader.

Illumina will gain global commercialization rights to assays developed under the collaboration.

Now, I'd like to take a few minutes to discuss our view of the market and some of the new products that you'll see from Illumina in 2007.

As you can see from our guidance, we believe that the markets for our products are strong and will continue to exhibit significant growth throughout 2007.

The market for all genome genotyping continues to gain momentum.

The expected success of genotyping studies is likely to drive incremental demand for additional studies on larger, more diverse populations.

As these initial studies are completed, we expect to see significant growth in the custom genotyping market.

With our Infinium-based iSelect platform, we are well positioned to benefit from the growth in custom genotyping.

Additionally, we're seeing increased interest in new applications, including copy number analysis and methylation.

Understanding the impact of these new features of the genome will aid dramatically in our understanding of complex diseases such as cancer.

We expect the gene typing market to remain competitive.

In spite of this competition, our ability to create a broad and differentiated portfolio of products has allowed us to maintain pricing power in the market.

In fact, our Q4 orders across the Infinium product line were at a higher average selling price than in Q3.

With these macro factors in place, we believe the genotyping market should experience growth in the range of 30 to 50% in 2007.

In the sequencing market, we believe there will be a significant demand for next generation technologies.

As researchers realize the dramatic throughput and cost advantages associated with the Solexa technology, we expect to see a significant ramp in both sequencing instrumentation and consumable sales.

The platform has broad capabilities across many applications, including digital gene expression, micro RNA analysis, and methylation.

In terms of gene expression, the total market is not growing very significantly.

We believe that the momentum we've gained in the second half of 2006 positions us well to continue to gain market share.

The addition of Solexa's digital gene expression capability provides a powerful new approach that is unique in the market.

I should mention that the Illumina genome analyzer is already being used in the field to perform digital gene expression.

In order to support our rapid growth, it's imperative that we continue to create groundbreaking new products.

I'd like to outline a few of these new products that we'll launch in 2007.

First, in early January, we announced the introduction of a high throughput DNA methylation profiling technology capable of surveying up to 1,500 sites across 96 samples simultaneously.

The first standard product in this family is a cancer panel covering 1,500 sites over 800 cancer genes.

Custom content panels will soon be available to meet individual researcher needs.

Additionally, in the first quarter we will begin commercial shipments of our new BeadExpress platform - a powerful system for low to mid multiplex applications.

The system will have important advantages over other technologies in both the research and molecular diagnostics 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've nearly completed our beta program and we're in the process of ramping up our manufacturing capacity.

Initial customer demand has been overwhelmingly positive and we're building a nice backlog for the system.

As a reminder, this platform will be sold directly into the research market and over time targeted to penetrate the molecular diagnostics market.

Finally, in early January, we announced that we're in the late stages of development of the Human 1M, the latest in our line of Infinium-based whole-genome genotyping BeadChips.

The 1M is a single chip format, which includes over 1 million variants providing researchers with unsurpassed power and coverage for whole-genome association and copy number analysis.

The content is based on our Hap550 BeadChip with an additional 450,000 variants added.

We expect broad commercial availability before the end of the second quarter.

Illumina's whole-genome genotyping customers have enjoyed the significant benefit of full upgradeability of their content.

For example, when we launched our Hap550 product, we also launched the Hap240S, allowing existing customers of lower content chips to migrate to the Hap550 content.

We will do that again with the 1M product by launching a 450S, allowing customers currently at the 550 SNP level to upgrade to 1 million variants.

We also expect the 450S to ship before the end of the second quarter.

In summary, 2006 was an incredible year for Illumina.

We achieved breakout revenue growth and industry-leading profitability, which enabled us to acquire a key strategic asset in Solexa.

Our ability to develop, deliver, and support a stream of innovative new products has allowed our customers to radically accelerate their research and development programs.

This work will revolutionize the understanding of the genome and the impact of genetics on disease.

In 2007, we expect our markets to remain healthy and our teams to continue to innovate, pushing forward the boundaries of genetic analysis.

I thank all of our stakeholders for their support.

And we're now ready to accept questions.

(Operator Instructions.) Our first question comes from the line of Ed Tenthoff with Piper Jaffray.

Go ahead.

Great.

Thank you.

And congrats on just a fantastic year.

Thank you.

One quick question for you just with respect to the tax rate guidance that you had said, Christian.

What did you say the tax rate would be in '07?

And also, can you give us some idea of what array revenues were last year and what array revenue growth was?

Sure.

So the GAAP tax rate will be roughly 36% is what we're modeling now.

It might be slightly less than that, but we've modeled it at 36%.

The cash tax rate will be lower than that, of course, in the mid-20s.

The--we didn't give specifics on what the array revenue was, but I did say that it was a four-fold increase roughly over 2005 levels.

And it was really the engine that drove the revenue story this year.

Great.

Well, thanks for that.

I'll get back in the queue.

Okay.

Thank you, Ed.

We're ready for the next question.

Hello?

Operator, do we have another question in the queue?

Our next question comes from the line of Eric Schmidt with Cowen.

Go ahead.

Hi, Eric.

You signed a number of large deals in Q4, Amgen, Erasmus, Hopkins, Singapore, Rotterdam.

Could either of you provide a little bit of color on which of those deals impacted the quarter and sort of to what degree?

I guess I'm also in a backward way trying to get into the directional movement in your backlog.

Sure.

We did do a lot of big deals in the quarter and it really helped our instrument revenue, as you saw.

We had very very strong instrument revenue proportionately in the quarter and it was largely driven by some of these larger deals.

The consumable flow-through will probably run out over the first few quarters and actually over the course of the year in '07.

Jay did mention in the remarks that we actually ended the year with a record backlog.

And so we were pleased that we were able to do record revenue and still at the end of the day have a record backlog, too.

The effect of consumables in the fourth quarter on those large deals was very small.

So most of the revenue we recognized had to do with the system installations.

There's generally a lead time, you know, anywhere from say, four to eight weeks or so before they start to really get up and running.

Okay.

And then can you relate, I guess your backlog back to your manufacturing capacity and any plans for further expansion there?

We continue to ramp our capacity as required and we have the ability to make additional decoding machines as we need to do that.

We're fortunate in that we can add capacity in relatively small increments and we continue to look forward at the demand curves, typically six to nine-months out to determine how much capacity we'd be adding at any given time.

And so, we think we're in pretty good shape at the moment and we have the ability to add capacity if and when we need it.

Okay.

Congratulations.

Quintin Lai with Robert W Baird.

When you announced the deal last year, the Solexa, you kind of gave preliminary guidance of 20 to 35% dilutive to consensus 2007.

And so now as we're doing the math, it looks like instead of being dilutive to EPS, it looks like dilutive to net income expectations.

How much of that is what's really related to the tax rate?

How much of it is due to the earlier than expected close and the higher share count or how much of it is related to maybe the higher stock comp.

Well, you know, Quintin, you've basically hit all of the issues that affect the guidance.

But if you think about it, at the time, I believe The Street estimates were around $1.13 a share and the estimates that we're giving today are about $0.86.

And the $0.86 remember is a midpoint in a range from $0.79 on the low end, up to $0.94 on the high end if you look at it.

And so, $0.86 on $1.13 I think is roughly 24%, so that falls right in the range of the dilution.

On the very low end of what we said.

That's right.

Now, in fact, the tax rate is higher than even we expected in November.

And as I said in my remarks, it's kind of in the range of--it subtracts $0.13 or so, so that's a big driver.

And then the stock compensation expense, you know, we went from an expense just a shade under 14 million in '06 to we're going to be in the low 20s in '07 as we pick up the Solexa stock comp plans.

One of the things I want to focus on for everyone on the phone is that we are going to be focused on the non-GAAP earnings per share and the non-GAAP financial results, because if you really look at it, we believe that they are the clearest indication of how our core business is doing.

As you know, we're going to have a $250 million or so charge in the first quarter and so I just really want to get everyone focused on the non-GAAP EPS as the primary metric for looking at our business in 2007.

That, of course, and our revenue growth.

Jay, with respect to the consumption per reader, you said that in the fourth quarter it was 600,000.

In the third quarter it was 700,000 and yet you said that the ASPs for Infinium went up.

So, is it a volume usage issue or is it dilution from the number of readers that are just solely dedicated to gene expression?

The comment I made about ASPs, Quintin, related to incoming orders and so those may or may not have shipped during the quarter.

And so really it has to do with sort of what the forward-looking backlog represents in terms of ASP, so that wouldn't really be a factor in the calculation of the throughput.

We do expect that throughput number to move around a little bit from quarter to quarter.

Some quarters it moves up and sometimes down, depending upon when systems get installed during the quarter and how fast customers start up.

So we don't sort of put any sort of weight on the fact that it dropped a little bit in the fourth quarter at all.

Our usage rates continue to be very very robust at virtually all of our sites.

And I might point out, sort of standing back from the specifics here, on a more global basis, that we know of no other business and no other company in life sciences that has $600,000 of consumable per installed instrument.

And last question, then I'll jump back into the queue.

The guidance for 2007, are you able to break out a percentage of how much of that is going to come from sequencing?

No, we're not going to give any separate guidance on the businesses.

As you know, the sequencing business for us really just starting up and it's a little too early to provide guidance on any specific level.

Zarak Khurshid with Caris.

Congratulations on a solid quarter.

It looks like gene expression is continuing to accelerate.

Can you characterize the growth in that business?

Are you taking market share from the leader in that field?

And are you benefiting from the announced closure of another large player there?

It's probably a combination of all those factors.

It's certainly gaining market share, because we don't think the market itself is growing at a very fast rate overall.

I think, accounting for sort of our success there, are a couple of key factors.

One, sort of the halo effect from genotyping.

I think customers more and more recognize the underlying power of our technology and the quality of the kinds of chips that we manufacture.

Another key factor is the fact that we launched our rat products, which now completed the portfolio that in combination with human and mouse, address about 90% of the overall market.

So we were, up until four or five months ago, missing that third key leg to our product line and that's helped a lot.

And the third factor is that we've now revved all three of those products to generation 2 products.

And so we've significantly improved the ease of use and the quality of the content on these chips.

So, we do think we're taking market share and we're taking it probably from multiple different players.

I should also mention that we're really excited about what we're going to be able to do in this market going forward, in combination with the Solexa technology, taking advantage of that system's ability to do digital gene expression, actually counting of transcripts.

And in conjunction with our analogue technology I think in combination, those two technologies are going to really provide sort of a new paradigm in the market for gene expression.

Great.

And then a couple of follow-ups, if I may.

With respect to the large DCode and CHOP projects, can you quantify to what extent those projects have been completed and maybe how the curve might look?

Would it be a kind of slow and steady drop-off or sort of a quick shutdown?

And then any updates on the Invitrogen collaboration?

Thanks.

Both of those customers are running pretty much at full capacity and we're shipping them chips almost every week.

The projects that they have on deck now will certainly extend out into 2008 and our expectation is that, at least in the case of CHOP, that they're ambition is to go well beyond the initial contract and continue to bring more samples in.

That will, of course, require additional funding, but they believe, if successful in the first phase, that they'll be able to secure additional funding to keep the project going.

In the case of DCode, we're going to continue to do lots of different types of work with DCode.

And so while the initial project at some point may wrap-up, there's lots of interest in working with us in other areas and taking advantage of what we're doing in methylation and other emerging applications like copy number analysis.

So I don't expect that you're going to see sort of a one quarter drop-off that's going to be reflected at all in our financials.

Great.

And then the Invetragen collaboration?

I'm sorry, yes.

The Invetragen business continues to grow, although at rates that are less than what we had originally anticipated.

So the business is profitable for us.

It's a nice underlying annuity business for our oligo synthesis operation, but I'd have to say we're disappointed at the overall growth in that part of our business.

Maykin Ho with Goldman Sachs.

Even though that you did not break out the components of the revenues, if I kind of look at it just having a little bit of sequencing business and looking at the run rate, for example, in November-December, it looked like you may now have to have a lot of placements in order to reach the revenue target.

Is that an accurate assumption?

Well, we've given a range of guidance that goes up to $315 million, Maykin, and as I mentioned earlier, the sequencing business is in the very early stages now.

We're certainly optimistic about what we think we can do in that business, but given the fact that it's early and there's still some uncertainty there, we think the guidance that we've provided is prudent.

We do expect that we're going to have continued nice growth in our base business and no reason to expect anything's going to change there.

And presumably in the coming quarter the mix would shift more towards the consumables and therefore, gross margin should improve?

Well, that varies sort of quarter to quarter.

So there are sort of two forces at work there.

Probably over sort of a longer averaging you'll see consumables as a percentage of total revenue increase.

However, in any given quarter, you can see the percentage decrease, due to the specific mix between instrument services and consumables.

In fact, we saw that this quarter.

Last quarter we had a very high consumable mix and our gross margins popped up over 70%.

In this quarter, while our consumables were over 50%, they were less than they were last quarter as a percentage and so our gross margins dropped down a little bit.

I think the other thing you should think about Maykin, is that the business will be more interesting to measure this year, because as we ramp the sequencing business, those gross margins will be lower in the first part of the year and improve throughout the year, as we scale up manufacturing, as we learn out and focus on the supply chain, just like we did with our base business.

And so, the mix of instrumentation between the business lines in the quarter will also impact the margin.

And so, I think the guidance we've given of mid-60s gross margins for the year is probably pretty realistic and obviously we're working towards always improving them.

And Jay, if you kind of look at the coming year, what would you say are your first three priorities and how would diagnostics fit into that?

I think first and foremost, Maykin, we're focused heavily on making sure that the Solexa acquisition meets its core objectives.

And that's growing the revenue, getting the system into the market, making sure it's robust and adding additional applications to that.

We set goals internally about the kind of market share we want to achieve there and so we're certainly going to be very focused on delivering on those goals.

The second thing, of course, is to make sure that in no way does our base business falter as a result of our focus on Solexa.

And so we've got John Stuelpnagel now running our microarray business and he's been full-time focused on that.

And John West, full-time focused on the sequencing part of our business.

And so I'd say that that's probably second high-level goal.

The third one was probably to continue to innovate in the whole genome line.

So, we think that it's going to be really important to continue to develop new products, to bring those to market very fast and that includes even things like the BeadExpress platform, which is a whole new business.

One thing we're seeing here early on is the ability to cross-sell products and we have many customers that have come to us already and said, okay, I want to talk to you about sequencers, about deep stations for doing genotyping expression, and about BeadExpress for doing low multiplex applications.

And so we're going to have the ability to put those together in packages that we think is sort of a unique part of our offering overall.

Molecular diagnostics in '07 will not be a contributor to our revenues.

It certainly will begin to be in '08.

So our focus on the diagnostics side this year is very much on the development side to get our first diagnostics products developed, get the assays really robust and then get them submitted into the FDA for hopeful approval in 2008.

Any idea what that product might be?

Well, it's certainly one we're working on very intensely is the decode myocardial infarction panel.

And so that's a collaborative development program we have going with DCode and our goal is to have that into the market by 2008.

[OPERATOR INSTRUCTIONS] Follow-up from Ed Tenthoff of Piper Jaffray.

Just a quick question.

With respect to the gross margins in the fourth quarter, I know that you attributed that to instruments, but just to be clear, was there pricing pressure as a result of competitors and how did the pricing of your products stack up?

And then maybe as a quick second question, is there kind of a ceiling to how much service revenues you guys can ultimately do?

That was a really really strong quarter.

What's kind of your annual run rate there?

On the pricing side, Ted, the price to do genotyping has gone down dramatically over the last five years and we've been instrumental in causing that price decrease.

And that's why we think the market is exploding at the rate it is.

And so there's clearly, sort of at the backdrop level, a decrease price curve going on in genotyping and we're pushing that as well as all the rest of the competitors in the marketplace.

In terms of the quarter specifically, the ASPs that we saw in the quarter were approximately what we expected, so we don't think that there was any huge impact due to ASPs that were anything other than what our plan was.

The single biggest factor had to do with a greater proportion of instruments and what Christian mentioned in his remarks, that we sold more of them through distributors where we discount the instrument to them and then they mark them up and sell them to the end-user and they take that distribution margin.

And the second factor is that we sold more units just for Expression.

Which previously, we hadn't sold a lot of instruments that were dedicated just to Expression and we're starting to see more of that.

And those instruments are configured with a little less horsepower, so they're priced a little lower than our genotyping systems are.

In terms of services, I wouldn't say there's a natural cap to what we can do in services.

There are some companies and some academic institutions that are always going to want to outsource and we did have a very strong quarter.

And we go into the first quarter with a strong backlog as well in services.

So, if you would have asked us a couple of years ago, we spent some time speculating as to whether the service business would really be a significant part of the market in 2007 and our view over the last two years certainly has been that it will continue to be a very significant part of the business and we intend also to provide some sequencing services as well.

Great.

That's really helpful.

Thanks, Jay.

[OPERATOR INSTRUCTIONS] Quintin Lai with Robert W Baird.

Thanks for taking the follow-up.

With respect to some of the new offerings from some of your competitors in genotyping, are you seeing any changes in the sales cycle for new contracts that are deciding between you and your competitor?

No, I don't think so, Quintin.

The sales dynamics are pretty much the same as they've been for the last 18 months or so.

Okay.

And then second question, for Christian.

CapEx and free cash flow expectations for 2007?

CapEx will be roughly equivalent to what we did this year.

This year we did 15.1 million in CapEx and I suspect we'll do between 15 and 20.

We're still getting to know--although we put forecast and budgets together for Solexa and we've spent a lot of time focusing on it, you know, we're still getting to understand their scale-up activities in detail to figure out the capital requirement there.

But I think 15 to 20 is a good number.

As you look at what we did this year, we did more than a fourfold increase in our capacity and I think that cost us on the order of $12 million or something like that.

I mean, we're very efficient in our use of capital.

And I would expect the same to be at Solexa.

From a free cash flow perspective, I actually didn't put the numbers in front of me and so I don't have that.

We do expect to be nicely cash flow positive for the year.

Given $50 million of income and $15 to $20 million CapEx run rate, we should be nicely cash flow positive.

Follow-up from Zarak Khurshid with Caris.

You touched on the distribution in Asian geographies.

Any thoughts on going direct in different global geographies in the future?

Thanks.

We'll continue to go increasingly direct.

Early in the company's history we had more distributors than we do now and as the markets develop, we tend to go increasingly direct in those countries.

For example, we've moved from a pure distribution model in China to a hybrid model where we now have direct sales people there as well as a distributor, because of the level of support and sales work that we provide, it shrunk the distributor discount significantly.

And so over time, we will wind up becoming direct in China.

And so we're doing that in a number of different geographies there.

But we do have distributors in places like South Korea, in sort of the Vietnam Thailand area, in Taiwan, in India, Malaysia, places like that, Australia.

Actually, in Australia we just now moved to a hybrid model as well.

So that's becoming increasingly direct as a percentage.

[OPERATOR INSTRUCTIONS] There are no further questions in queue at this time.

I would now like to turn the call back over to Management for any closing remarks.

Thank you all very much for joining us today.

This concludes our conference call for the fourth quarter of 2006 and we look forward to updating you next in April.

Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference.

This does conclude the presentation.

You may now disconnect.