Illumina Inc (ILMN) 2007 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Illumina, Inc.

2007 First Quarter Earnings Conference Call.

[Operator Instructions]

I would now like to turn the presentation over to the Senior Director of Investor Relations, Mr.

Peter Fromen.

Please proceed, sir.

Thank you, Operator.

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

At the close of market today, we released our financial results for the first quarter of 2007.

During this call, we will review our financial results, update our finance guidance for the second quarter and FY07 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 Senior Vice President and Chief Financial Officer.

The call is being recorded and the audio portion will be archived in the investor section of our website at Illumina.com.

During the call we will be discussing our financial guidance and 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 on 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 SEC, including Forms 10-Q and 10-K.

Before I turn the call over to Christian, I wanted to remind you of the investment conferences in which we'll be participating over the next couple of months.

Beginning next week, on May 3rd we will be at the Deutsche Bank Healthcare Conference in Washington, D.C.

and the following week, on May 10th, we will be at the Blair Growth Stock Conference in Chicago.

Moving into June, we will participate in the Goldman Sachs Global Healthcare Conference in Dana Point in California.

For those of you unable to attend any of the upcoming conferences, we encourage you to listen to the webcast presentation, which will be available through the investor section of our website.

With that, I'll now turn the call over to Christian.

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

I hope that you have all 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 first quarter, update you as to the accounting impact of our recently completed acquisition of Solexa and discuss our financial guidance for the remainder of 2007.

Jay will then discuss our commercial progress in the first quarter.

In the first quarter we saw strong demand across all of our product lines.

This enabled us to record our 23rd consecutive quarter of revenue growth.

Total revenues were $72.7 million, which represents a year-over-year growth of 148%.

On a sequential basis, total revenue grew more than 19% over Q4 levels.

This was our 7th consecutive quarter of sequential growth greater than 10%.

Product revenue was $61.3 million, with revenue from consumables representing more than half of our total revenue during the quarter.

This helped drive our gross margins above our internal expectations.

Instrument revenues showed strong growth, both sequentially and over the prior year period.

This was driven primarily by strong demand for the Genome Analyzer and an impressive uptake of the new BeadXpress System that we launched towards the end of the quarter.

In past quarters, we have reported the number of BeadArray readership, as well as the cumulative number of BeadArray readership.

Since we will now have three instrument platforms, we have elected to report total instrument revenue rather than unit placements of each product.

Along with occasional updates on the aggregate installed base of the various products, we believe that this will provide you with visibility into the overall status of our instrument business.

For the first quarter of 2007, total instrument revenues were $19.6 million, compared to $5.8 million for the prior year period and $13.2 million in the fourth quarter of 2006.

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

In the first quarter, service and other revenue increased 104% to $10.8 million, compared to $5.3 million in the first quarter of last year.

Before discussing our gross margins and operating expenses for the quarter, I would like to describe the impact of FAS 123(R), which requires us to record the expense associated with stock options in our income statement.

The total impact of the P&L this quarter was approximately $7.7 million or a pre-tax amount of $0.13 per diluted share.

As prescribed by the standard, the expense is allocated to each expense line.

The increase in our stock compensation expense, when compared to prior quarters, was due primarily to the timing and the value of options granted in the first quarter and the fact that we granted additional options to Solexa employees at the closing of the merger.

In the discussion that follows, I will highlight both of our GAAP expenses, which includes the effect if 123(R) and the corresponding non-GAAP figures.

I encourage you to review the GAAP reconciliation of non-GAAP measures, which is included in today's earnings release.

Costs of product and services revenue was $25.1 million for the quarter compared to $9.3 million in the first quarter of 2006.

The first quarter costs include stock-based compensation expense of $0.9 million compared to $0.25 million in the comparable period of 2006.

Under the purchase accounting rules, we are required to write up the inventory associated with the Solexa acquisition to its fair market value.

The write up totaled approximately $1.0 million, of which $0.6 million was recognized as COG, based on the inventory level sold during the first quarter.

Non-GAAP product and services gross margin, which excludes both stock compensation expense and the charge associated with the inventory write up, was 67.3% for the quarter compared to 67.4% last quarter and 68.3% in the first quarter of 2006.

Although non-GAAP gross margin was ahead of our expectations for the first quarter, we still expect second quarter and full fiscal year gross margins to be in the mid-60's.

The strong gross margin in the quarter was primarily attributed to improving gross margins in our BeadChips and related consumables.

Gross margins in our BeadArray product line, which includes both instruments and consumables, was greater than 70% for the quarter, with the improvement due to higher ASPs across our Infinium product line, lower manufacturing costs per sample, and to a lesser extent, the relative mix of consumables to instrumentation.

In the sequencing product line, gross margins met our expectations as we made significant progress ramping up our capacity to supply both instrumentation and consumables to the market.

It is our expectation that over time gross margins for sequencing instruments and consumables will approximate the related margins in our BeadArray product line.

R&D expenses were $16 million in the quarter, compared to $8.2 million in the first quarter of 2006.

Included in the figure for the first quarter is approximately $1.9 million in stock compensation expense compared to approximately $1.0 million in the prior year and $0.2 million in non-cash expense associated with the write up of Solexa inventory in the purchase accounting.

This inventory was used in our ongoing R&D activities.

Excluding these expenses, R&D costs were $13.9 million, which is an increase of $6.6 million over Q1 '06 levels.

The principle driver of the increase was the inclusion of Solexa's R&D expense for the two months following the merger.

In the transaction, we added more than 125 former Solexa employees in R&D located in both the Hayward, California and Little Chesterford, UK site.

We expect R&D expenses to increase again in the second quarter, as we will incur expense for the sequencing R&D activities for a full quarter rather than two months.

SG&A expenses were $23.6 million in the quarter, compared to $12.1 million in the first quarter of 2006.

Included in SG&A was stock compensation expense of $4.8 million in the first quarter of '07 and $1.9 million in the first quarter of '06.

The increase in SG&A expenses can be attributed to the expense associated with Solexa's SG&A activities, increased costs of litigation and an increase in spending related to the expansion of our commercial infrastructure.

On our last call, we provided preliminary analysis of the accounting related to the Solexa acquisition.

We engaged a third party consultant to perform both the preliminary and final valuation analysis, which is now complete.

The acquisition was valued for accounting purposes at $618.5 million, slightly above the $615 million we reported on our last call.

We added $44.3 million in net assets to our balance sheet as of the close of the merger.

Additionally, we capitalized $24.4 million in intangible assets related to the core technology and customer relationships, compared to our initial estimate of $22.8 million.

We continue to expect to amortize these amounts over their useful lives, which are estimated to be 10 years and 3 years, respectively.

As you saw in our earnings release, we recorded a charge of $303.4 million related to in-process R&D.

This charge was approximately $49 million higher than the previous estimate of $254.6 million.

The primary driver for the increase was a change in our assessment of the useful life of the technology, as we now believe, based on additional analysis, that the technology will be used over a longer life than was previously estimated.

As a result of these changes to the valuation analysis, we recorded goodwill that correspondingly decreased to $246.4 million.

I would also like to discuss the accounting for the verdict in our litigation with Affymetrix.

In March, the first phase of multiphase trial was completed.

In this phase of the trial, the jury ruled in favor of Affymetrix and announced an award of $16.7 million for past damages.

However, since this was only the first phase in a multiphase trial, it is still unclear whether or not it is probable that we would ultimately be required to pay this amount for damages.

Under the accounting rules, the liability can only be recorded if it is probable that we would have to pay the damages and if we were able to estimate the amount of the damages.

Since we have not met the criteria for recording a liability, there was no expense recorded in the first quarter.

For the first quarter, we reported a GAAP net loss of $298.1 million.

On a basic and fully diluted basis, this represents a loss of $5.58 per basic and diluted share.

This compares to a net loss of $104,000 or break even per diluted share in the first quarter of 2006.

Excluding the impact of acquisition-related charges and stock compensation expense, we are pleased to report a non-GAAP net income of $12.7 million or 18% of revenue.

On a fully diluted basis, this represents earnings of $0.22 a share.

Turning to the cash flow statement, in the first quarter we generated cash flow from operations of $14.6 million or approximately $0.25 per fully diluted share.

As part of the acquisition, we received approximately $76.7 million in cash, which is recorded in "Investing Activities" on the cash flow statement.

In addition, we used approximately $3.2 million in cash for capital expenditures during the quarter.

We also successfully completed a $400 million senior convertible notes offering during the quarter, which had a favorable impact on our cash flow from financing activities.

The notes have a coupon of 0.625% and can be converted into our common stock at a price of $43.66 per share.

The net proceeds from the offering were approximately $390.7 million.

We used approximately $202 million of the net proceeds to repurchase 5.8 million shares of our common stock.

In addition, approximately $46.6 million of the proceeds from the transaction were used to fund the net costs of convertible note hedge and warrant transactions that Illumina entered into with the initial purchasers of the notes and/or their affiliates.

Taken together, the convertible note hedge and warrant transactions reduced the potential dilution upon conversion of the notes.

The warrants have an exercise price of $62.87 a share, representing an 80% premium based on the closing price of $34.93 per share on February 12, 2007.

The remaining net proceeds will be used for other general corporate purposes, which may include acquisitions and additional purchases of our common stock.

During the quarter we also repurchased an additional 1.6 million shares of common stock for $49.3 million under our 10b5-1 share repurchase program.

Turning to the balance sheet, we continue to be in excellent position with respect to accounts receivable DSO at approximately 67 days.

This compares to DSO of 67 days at the end of the first quarter in 2006.

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

Inventory grew by $16.2 million in the quarter to $36.3 million.

The primary driver of the inventory growth during the quarter was the addition of the sequencing inventory as a result of the Solexa acquisition.

Now I will update our guidance for 2007.

Consistent with our previous calls, the following guidance excludes the impact of certain non-cash charges, including non-cash changes related to our acquisition of Solexa and the impact of FAS 123(R).

I will provide an overall estimate of the FAS 123(R) 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.

Based on our strong performance in the first quarter, we are increasing the lower end of our revenue guidance for 2007 and now expect revenues to range from $305 million to $315 million.

This represents growth of approximately 65% to 70%.

The revenue growth is expected to be driven by an increase in demand for genotyping-related products and services and the continued commercialization of the Illumina Genome Analyzer and the BeadXpress platform.

Product and services gross margins are expected to range around the mid-60's, which is consistent with prior guidance.

As with historical trends, gross margin will be impacted by the mix of instrumentation sales versus consumable sales in any given quarter.

R&D expense will grow over 2006 levels, as we add the R&D capabilities of the Solexa team to our organization.

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

SG&A expenses are expected to grow as we rapidly expand our commercial infrastructure to support the BeadArray, Genome Analyzer and BeadXpress platforms.

We expect total SG&A expense to range from $72 to $82 million, consistent with our previous guidance.

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 that our GAAP tax rate will increase from 6.0% of earnings in '06 to approximately 36% in '07, which is consistent with our previous guidance.

In 2007, we will continue working on various tax planning strategies and we believe we can lower our GAAP tax rate over the next few years.

Excluding the impact and the expense associated with stock options and merger-related items, we expect total annual non-GAAP net income come to range from $55 to $62 million, which increases the lower end of our previous net income guidance by $3.0 million.

This represents fully diluted earnings per share of approximately $0.94, assuming the midpoint of the range and a fully diluted weighted average share count of approximately 62 million.

For the year, we expect stock compensation expense to be approximately $30 million, which represents a pre-tax amount of approximately $0.48 per fully diluted share.

This represents an increase of approximately $5.0 million over the high end of our guidance provided on our call in February.

The driver for the increase in expense was due to the timing and the value of the options granted in the first quarter and the fact that we granted additional options to Solexa employees at the closing of the merger.

As we've emphasized in the past, this expense is highly dependent on our underlying stock price.

For the second quarter of 2007, we expect total revenue to range from $74 to $78 million.

Gross margin is expected to be in the mid-60's, consistent with our guidance for the year.

Excluding the expense associated with stock compensation and merger-related items, we expect net income to range from $12 million to $14 million, resulting in EPS of $0.19 to $0.23, assuming 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?

Good afternoon, everyone.

I hope, after reviewing our financial results, it's clear that we're off to a great start in 2007, particularly given that this is the first quarter after absorbing a major acquisition.

As Christian indicated, revenue increased nearly 20% over the fourth quarter levels, gross margins were above our expectations and expenses were in line.

This drove profitability above our expectations.

We generated record free cash flow in the quarter of $11.4 million or $0.20 per diluted share.

Additionally, we received nearly $80 million in new orders for products and services during the quarter, which led to another record backlog.

We also had very strong cash flow from operations, even with the activities surrounding the Solexa integration.

Today I'd like to walk you through some of the key drivers of our financial results and provide you with some insight into our plans for the remainder of the year.

In the first quarter, revenue growth was consistent across nearly all product lines.

For example, revenue growth in genotyping consumables was over 130% in the quarter, compared to last year.

In gene expression, revenue was approximately 120%.

And of course, for the first time, revenue was recognized from our next generation sequencing platform, the Illumina Genome Analyzer.

New product introductions were again an important part of our success in the first quarter.

In March, we were excited to launch the third major platform of the Company, the BeadXpress System.

This high throughput platform is based on the VeraCode technology that we acquired through the purchase of CyVera in April of 2005.

The system is ideal for load-them-in multiplex experiments in a number of different application areas, with initial protocols available for genotyping and protein assays.

Initially, the system will be sold into the research market, where scientists will be able to use our standard Golden Gate Genotyping Assay to perform experiments from 1 to 384 multiplexes.

Ultimately, we believe that this system will be an important element of our molecular diagnostics strategy, as the system meets many of the critical requirements for this market, including low-cost, high throughput and high accuracy.

Additionally, the platform will support a growing number of applications and tests, which will increase its utility in the clinical laboratory setting.

Initial demand for the platform has been strong and we're already seeing evidence of the power of this platform strategy.

We commercially launched BeadXpress on March 21st and we've already seen four different customers that have ordered all three Illumina platforms.

One of the key advantages of our BeadArray architecture is its flexibility to create products with multiple samples on a chip.

This is important, as it improves our customers' workflow and lowers our cost of production on a per-sample basis.

In 2006, we took advantage of this flexibility and launched the HumanHap 300 Duo, our multi-sample solution for whole genome genotyping.

This product is unique in that it has two samples on every chip.

Customers have overwhelmingly adopted this format and the product has now ramped up to become our second-highest selling chip in terms of unit volume.

In March, we further extended the duo concept by launching the HumanCNV370-Duo, using the Infinium Assay and developed in with deCODE genetics.

This is the world's first microarray designed to specifically target novel regions of the genome that show copy number variation (or CNV).

CNVs can occur when a region within a chromosome or an entire chromosome is randomly amplified or deleted.

We expect the market for CMV-related products to grow rapidly, as these variations have already been linked to cancers, congenital disorders and other common diseases.

On our last call, I highlighted the introduction of our high throughput DNA methylation product.

The first product we launched with this technology was a standard cancer panel covering 1,500 sites and over 800 cancer genes.

A few weeks ago, we announced the availability of this product with custom content support.

This enables researchers to cost effectively survey up to 1,500 methylation sites of their choice across 96 samples.

A key factor that drove our gross margin above expectations in the quarter was the improvement in the ASP across our Infinium product line.

This ASP improvement was the single most important factor in driving the BeadArray product gross margins to greater than 70%.

During the quarter, the HumanHap 550 BeadChip became our best-selling product, which helped to increase the ASPs.

This illustrates that our strategy of delivering higher content BeadChips at greater value is being well received by our customers.

While we're discussing new products, I'd like to give you a brief update on our next whole genome genotyping product, the Human 1M.

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 Hap 550 BeadChip, with an additional 450,000 added variants.

We're in the late stages of development and we expect to begin commercialization of this groundbreaking product before the end of this quarter.

I'd now like to review some operational activities.

Earlier this month, we announced that we're planning to consolidate the operations of our Wallingford, Connecticut facility, where the BeadXpress System was developed and is manufactured, and transfer those activities to our San Diego facilities.

We plan to wind down activities in Wallingford over the remainder of the year, as we ramp up corresponding activity in San Diego.

As a result of the consolidation, we'll take a charge of approximately $2.0 million during FY07.

We don't expect this charge to have a material impact on our financial guidance for the year.

As we consolidate the Wallingford operation into our San Diego site and continue to build infrastructure to support our rapid growth, the need to expand our facilities here in San Diego is growing.

In January, we announced that we had entered into a lease for an 83,000 square foot facility on our campus in San Diego.

Construction on the new building is scheduled to begin in May and the build out is expected to be complete in the fourth quarter of 2008.

This facility will enable us to continue growing our manufacturing, R&D, and commercial capabilities.

In addition to our build out in San Diego, we're in the process of identifying an additional manufacturing facility in an international location.

This is part of an overall strategy to mitigate our total tax exposure, as we're now a very profitable company and have used most of our net operating loss carryforwards.

We expect to have this new manufacturing facility up and running in 2008.

Over the course of the year, we'll keep you informed as to our progress.

I'd like to now provide you with an update on our litigation with Affymetrix.

As Christian previously mentioned, the jury found for Affymetrix in the first part of this multiphase trial.

The second phase of the trial, which is expected to occur later this year, will address the validity of the patents in question and will be tried to a different jury.

In the third phase of the trial, the judge will hear our defense of inequitable conduct and our counterclaims for torturous interference and unfair competition.

We believe that our defenses of invalidity and unenforceability of the patents asserted by Affymetrix are very strong.

Should we succeed in proving that any of these patents are invalid or unenforceable, it's likely that the judge will order a new trial on damages.

Finally, each phase of the trial is subject to post trial motions to the judge and appeals.

Appeals are expected to occur once all three phases of the trial are complete and judgment has been entered.

We continue to believe that our positions are very strong and we intend to vigorously defend ourselves.

I'd like to now discuss some of the recent progress in our sequencing business.

In early January, we announced that the early access program had been completed and that the Illumina Genome Analyzer had moved into full commercialization.

Over the course of the quarter, we were focused on manufacturing scale-up of both the instrumentation and the related reagents.

We've made significant progress in this area and we'll continue to maintain our focus on scale-up over the next few quarters, as we see very strong demand in all regions of the world for this system.

As we indicated on our last call, it's our expectation that the sequencing products will represent a substantial portion of our total revenue in 2007.

However, it's not only important to scale up the sequencing manufacturing, but it's critical to integrate the two companies effectively.

In the quarter we successfully integrated the commercial organization, including our sales, marketing, and technical support functions.

The integration in this area made it possible to ship, install and importantly, recognize revenue on the Illumina Genome Analyzers during the quarter.

We will continue focusing on building our commercial infrastructure so that we can serve our sequencing customers with the same world class support that our BeadArray customers enjoy.

The integration is going well in other areas of the business as well.

In R&D, the teams in the Hayward, Chesterford, and San Diego sites have been implementing a unified process across the entire R&D organization.

This common approach will enable us to rapidly develop new products and effectively utilize our R&D resources across the entire Company.

Additionally, the teams have been collaborating on improvements to the Genome Analyzer, which will continue to push the technology forward.

On the infrastructure side, we're launching our integrated ERP system later this quarter and we substantially completed the integration of our administrative processes.

During the quarter we announced several new developments that will enable users of the Illumina Genome Analyzer to broaden the application of the system.

Key technical advances of the system included improved methods to routinely generate over a billion bases of high quality raw data per run, as well as methods to achieve high levels of sample multiplexing in a single channel.

We also simplified methods for generating high quality paired end reads and demonstrated increased read lengths to over 50 bases.

We're extremely pleased with the technical progress that we've made around the Genome Analyzer and look forward to enabling new, more robust applications for our customers in the future.

Looking forward to the remainder of the year, we see robust markets for our whole genome genotyping, sequencing and expression products.

With the forthcoming launch of our 1M product, as well as the continued expansion of our custom genotyping products such as iSelect, we believe we're in excellent position to continue to lead this market.

Additionally, we believe that the important discoveries and important papers that are being published using Illumina technology will further catalyze the market.

In sequencing, we've seen significant early demand for our next generation platform.

As we continue to increase the number of applications and demonstrate the power of our system, we expect to see an increase in sequencing revenue over the course of the year.

Before I conclude my remarks today, I'd like to welcome Peter Fromen to our team as our Senior Director of Investor Relations.

Peter has an extensive background in our industry and will bring tremendous value to Illumina.

In closing, we believe Illumina continues to be well positioned to take advantage of the explosive growth opportunities in the field of genetic analysis.

Of course, in order to take advantage of these opportunities, we much remain focused, execute well, and continue to build the infrastructure necessary to support these significant markets.

Thanks for your time and we're now ready to open the call for questions.

[Operator Instructions] And your first question comes from the line of Ross Muken with Deutsche Bank.

Please proceed.

Good afternoon, guys.

Hey Ross, how are you doing?

Congratulations on a great quarter and a good hire.

Yes.

Thank you.

On the Genome Analyzer, can you talk a bit about the types of customers that we're seeing purchase the instrument, the early phase here?

Is it sort of the traditional customers we'd think of for sequencing instruments or is maybe there potentially a broader base?

Well, I think the initial thrust of sales will clearly be biased toward the academic users.

The bulk of the instruments so far have gone to genome centers and we've had a number of customers order multiple systems from us.

But the base is expanding pretty rapidly as we push into full commercialization.

With the full Illumina sales team now we're able to sell these systems worldwide to a quite diverse customer base.

We've gotten orders from many of the different geographies around the world.

We've also started to see some orders from industrial customers come in and additionally, the applications are pretty broad.

So while sequencing is clearly the dominant application, we have a number of customers using the system for digital gene expression and also other applications like chips, so a pretty diverse opportunity, we think, over the next six to nine months.

And on the genotyping front, it seems as if pricing was quite good in the quarter and clearly you had really nice consumable pull-through.

Can you talk a bit about the competitive environment?

Have you seen any changes from your key competitor there that's really altered any of the market dynamics and do you expect pricing to remain fairly robust, as it has been over the course of the year?

Yes.

We haven't seen any dramatic shifts in the competitive dynamics, so I would say that overall things are about as they have been.

Of course, what we see in this market currently and has historically, is that the selling price of any given product tends to decrease over time and that the product life cycles are pretty short, a matter of probably two years or so.

But our strategy has been one, and I think we've successfully executed on this, where we continue to add higher end products into the product mix so that the ASP across the entire family stays stable and in some cases goes up, as it did in this quarter.

So and our goal, certainly, is to try to keep the selling prices at a minimum, stable, and that's certainly what we're working on and we think products like the 1M and others to follow will certainly help that.

Great.

Thanks, Jay.

Quintin Lai, Robert W.

Baird & Co.

Hi, good afternoon and welcome, Peter.

Hi Quintin.

So, with respect to some of you duo chips, you sounded like that it's overwhelmingly the customers are starting to pick up those chips.

Have they been -- the number of samples that they're running, have they increased it now that they -- do they get a throughput advantage using those two-in-one chips?

Well, they certainly get an advantage in their handling, so it takes less labor to run the chips because you're handling one object instead of two.

From a scan time perspective, there's a bit of an advantage as well, but there's no inherent difference in the throughput that's substantial.

It's a little hard to tell where the customers are running more samples than they otherwise would have.

We don't have any direct way to know that, but what happened during the quarter is that people who were traditionally using the single version of the 300 chip are certainly recognizing the value of moving to the duo.

And the backlog and the new orders are tending to move over to the duo pretty quickly.

Okay.

With respect to consumables or revenue per array -- I'm sorry, per reader - could you update us on that number?

Yes, Quintan, we're not going to give the specific numbers, but the throughput hasn't fundamentally changed from what we've seen over the past few quarters, so.

So should we assume that with ASPs going up that maybe the revenue per array may have gone up -- per reader went up?

Like I said, we're not going to really go there, but what I can say is that it's been pretty consistent over the last several quarters and we didn't really see any fundamental change too much, during the quarter.

All right and then in February, you kind of gave us a number of the strong order flow for the Genome Analyzers at 40.

How -- I guess where is that number now?

Yes, we're not going to disclose the volumes on a product-by-product basis every quarter, Quintan.

I think what we are going to do is occasionally update the installed base and so we'll make a decision on exactly when we do that, but we're not disclosing the orders or the shipments on a product line basis right now.

We just decided to disclose the total instrument revenue, which we disclosed in the script.

Then my last question and I'll jump back into the queue, with respect to BeadXpress, the early adopters.

Are they mainly looking at genetic applications or are you starting to see people coming in for proteomic type of work?

I think the initial users will be mostly doing genotyping.

On the proteomic side, it's going to take some application development on the part of the customer, so what we provide them are activated beads and protocols that are essentially examples of how you can build a protein-based application.

But they will need to build that assay themselves and so that will take a little while longer to develop in the market and as a result, most of the initial use will be in genotyping.

As you get ready to try to move down toward molecular diagnostics, do you want to let -- how long do you need this to be field run before you start to think about maybe submitting the instrument to get FDA clearance?

Well, there are a couple things we have to do to get there.

We have to complete our program of ISO certification internally and we need to feel comfortable that the instrument is stable and that the configuration is fixed and early bugs are worked out.

We don't think that will take very long.

Certainly sort of in the next six months I think we'll be prepared to begin thinking about submitting it to the FDA.

Thanks.

Nice quarter.

Thank you.

Thank you, Quintan.

Edward Tenthoff, Piper Jaffray.

Great, thank you very much and I know people have been asking -- and by the way, congratulations on another nice quarter.

Thank you.

I know people have been asking kind of different ways to try to get to the demand side of the new Solexa system.

But maybe you can discuss sort of the capacity side, with respect to how many systems you guys can actually ship this year and how have you expanded that capacity from since you acquired Solexa.

Yes, I don't think we want to be quantitative about the answer, but let me try to be qualitative.

I think the team in Hayward has done a fabulous job of expanding the manufacturing line there and they've ramped it up dramatically just since the time we became engaged with them in the fall of last year.

Our current view is that this is going to be a significant contributor to revenue and we believe that we can manufacture enough systems to meet the demand, even if the demand exceeds our budget.

So we've built enough capacity and we're continuing to invest in inventory to make sure that we can ship these products rapidly when the orders come in.

So I'm feeling pretty good about our ability to produce them.

Yes and of course, Ted, on the scale-up side, when you're scaling a new product line, the things that we're really focused on there is not only the ability to manufacture the instruments on the line but also building the relationships with suppliers.

Which helps us to drive gross margin up.

The time to when we receive parts, things like that.

And so that's what we continue to work on.

We made a lot of progress in the first quarter and I think that's going to be an important element of Q2 and Q3 as well as we really make this thing robust and being able to ship whatever demand is out there.

I think one of the critical areas for us to focus on, Quintan, is the support side of this.

So we're making significant investments in the technical support side, in training, in bringing in more people that understand the sequencing applications.

And also, the bioinformatics challenges associated with installing and in fact, running these systems.

They generate so much data that there's some bioinformatics challenges that we need to make sure customers can deal with and so we're investing very heavily in that side as well.

That makes a lot of sense and if I may, just one quick follow-up question.

This may be a bit of a silly question.

But as you're looking at orders coming in on the genotyping side, since the jury verdict, are you sensing any pause on the part of customers to kind of wait to see how the whole patent suit sorts out?

Can you just give us a little bit of color on sort of the market at this point?

We've not seen any change in the business conditions, Quintan, so we think things are just as they were.

Okay, great, helpful.

Thanks and congrats.

Thanks, Ted.

Eric Schmidt, Cowen & Co.

Good afternoon.

Christian, since you're moving to a new metric in terms of following your instrument placements, could you provide us with the total instrument revenues for Q2 and Q3 of last year as well?

I was going to provide those on the next -- as we got through the year.

I don't have them right in front of me, so maybe I can figure out a way to get that made public somehow.

Okay.

On the ASP increase that you saw for the Infinium product line, can you quantify that?

We haven't historically talked about the actual ASPs.

What I can say is that we've -- since more of our demand has moved up the 550 and then also the 300 Duo, the actual ASP per chip improved pretty --

Materially.

--materially this quarter.

So has the price itself for the 550 changed in any way or is it all a mix issue?

No.

It's mostly a mix issue.

Okay.

Which is exactly -- that's exactly the strategy, is to keep pushing the value proposition up the curve and maintaining or increasing ASP on a per-product basis.

Right.

Got you.

And Jay, can you just comment on the gene expression market share that you've been able to take over the last 12 months - obviously quite considerable - and whether you think you can make further gains there?

Yes, the underlying business is strong and our belief is that we can continue to make gains.

I'd have to say that our market share is still not huge in that market.

We're having good increases in business but off a smaller base and as you know, the prices of our chips are lower than anyone else in the market.

And so from a unit perspective, our share would be a lot higher than it might be on a revenue perspective.

But we're probably the third player in the market today, I would guess.

What do you think the drivers are for your ability to continue to grow your share?

Time is probably the most important one.

I think the quality of the chips is good and we continue to innovate there.

There's a large installed base of competing products and as those scanners become obsolete and changed out and we continue to add more applications, we combine sort of the multi platform strategy.

We deploy expression more broadly, say, on the sequencer where we're pushing into digital expression.

All those factors will help enormously in the overall penetration of the market.

Thanks, congrats on another --

[Inaudible, multiple speakers]

Go ahead.

I would just saying we didn't say much in the script about the specific applications on the Solexa as you would on the Genome Analyzer.

But digital gene expression is one that we think holds enormous promise and really creates a potential to change the way people think about doing expressions.

Right.

Great, congrats on another great quarter.

Thank you.

Thank you.

John Sullivan, Leerink Swann.

Hey guys, good afternoon.

Hi John.

A couple of quick questions, first of all regarding the custom genotyping products business, which we haven't really touched on in this.

Can you just chat about how quickly this part of the array business is growing for you, relative to even just directionally, relative to the overall -- the Infinium products?

And then secondly, regarding custom genotyping, can you talk about maybe the number of snips that you're usually asked to place in a custom project?

Is it 500 or 5,000 or 50,000?

Yes.

Well, we now have two parts of our product line in custom genotyping.

We have the traditional piece that we run on the Array matrix, which is limited to 1,536 snips per bundle.

That business is sort of on, I'd say, flat-ish.

But that's really because that business in part is being replaced by the Infinium iSelect product.

And so those two product lines together really represents the overall custom genotyping business and in aggregate, that business is growing quite nicely.

The iSelect in particular is growing fast because of the ability to put many more than 1,500 snips on one sample area and so we can put 30,000 to 60,000 snips in a single stripe there.

And so what that has done is taken the average number of snips that people are analyzing on a custom basis up significantly.

So we have many cases where people are ordering 30,000 snips or 45,000 snips that they want to analyze on a multi-sample chip.

If I were to guess what the average is today, it's probably 10,000.

Yes.

That's probably about right.

And the other power of the iSelect product is that you get 12 samples on one chip.

So the economics are really excellent for the researcher.

Okay, thanks very much.

And then secondly, I guess kind of relatedly, are you hearing of any clients or have you had the experience yet of clients doing work, first of all, on the former Solexa product line and coming back to you saying, "Okay, here's the product of my sequencing experiment.

Now I need custom chips from you to go on with this work"?

Well, we haven't seen that, yet, to my knowledge.

Some of our salespeople may be seeing that, but we have seen the opposite, in fact, where people have used our whole genome chips and now want to go in and do local analysis and what they really want to do is sequence in some targeted regions.

And so we think, over time, that's going to become a very major application of this system, so that if you got hits in say 30 regions of the genome, that you'd go in across large sample numbers and do targeted sequencing in those regions.

And that is a potential future application of this system that we think will be quite powerful.

Sure.

And my last question.

Thank you very much.

My last question is the regarding the ASPs on the arrays that you've discussed.

Is there an order size change that is having an impact, by any chance, on the ASPs?

Are you doing more smaller orders and is there a different ASP generally associated with smaller orders?

The smaller orders definitely have higher ASPs, but I wouldn't say that the business has had any market shift there, because many of the large customers are, in fact they're all continuing to order from us.

Right.

So we have a nice annuity business there and so I wouldn't say that that's been a factor in the change.

Yes, John, the biggest driver of the ASP change is really the mix within the product line.

Right, understood.

Thanks for taking my questions.

Thanks, John.

May-Kin Ho, Goldman Sachs.

Hi, Jay.

I don't know whether I heard it correctly, on the genome sequences.

Are you doing 50 [bases per read] at this point?

We're doing that internally, May-Kin, so we talked about that read length at a recent Marco Island conference that we were at.

The kits that we have available commercially do not yet go out to 50 base read lengths, but they will.

What kind of error rate are you getting on 50 bases?

I don't know exactly what we quoted at the conference, but the error rates are sort of well within what people would be expecting, sort of under the 1.0% range.

And you mentioned also that you'll be manufacturing outside of the country, at least that's how I interpreted it.

Yes.

I guess starting in 2008, is that right?

That's right.

Then what would the impact be on the tax rate at that point?

So, May-Kin, it's Christian.

We haven't modeled that out exactly, because we're in the process of doing an IP migration.

There's really two steps to this process.

The first is moving your intellectual property offshore to a lower tax jurisdiction and then the second is manufacturing and selling products overseas.

Our expectation is that over time and depending on what jurisdiction we pick, we probably can get the tax rate down into the, say, 26 to 28%, probably closer to 28% range from where we are now.

There's other models out there of companies that have done this and have been successful, kind of down around that 28% range.

It really does depend on how much of your manufacturing is done overseas and how much of your revenue is generated in that lower tax jurisdiction.

So we'll be modeling it and as we finalize where we're going to manufacture, as we start putting the models in place, we'll make sure we keep you updated.

So have you chosen a site at this point?

We're in final negotiations right now and we'd rather not disclose exactly where, just because we want to get through the negotiations first.

But I suspect very soon we'll be able to talk a little bit more broadly about it.

Okay, I understand.

Thank you.

Thanks, May-Kin.

John Groberg, Merrill Lynch.

Good afternoon, congratulations on a good quarter.

Thanks, John.

So you said that you obviously didn't take any charges associated with the damages awarded at the after trial.

I was just curious if you could quantify in the quarter what your costs associated with the litigation in general were.

I assume a part of SG&A?

We don't explicitly break them out.

We never have, but they were very significant during the quarter and they were -- that and adding the Solexa employees were really the two primary drivers for SG&A growth over the fourth quarter.

Okay and then moving on to that, on the sales force integration.

So most of the Solexa employees were run more on R&D and one of the ideas was obviously not only to hire but integrate the sales force and use the sales force that you currently have.

I'm just curious how that is going, how easily they've been able to take up these new products.

Can you just discuss that?

Yes.

It's going very well.

So we had our worldwide sales meeting in early February and we cross-trained the sales force into four teams from both companies on each other's products.

And while you wouldn't say, at this point, that training is 100% complete, the cross training has been done quite effectively and we're able to sell all the product with all the salespeople.

So, organizationally, the integration was 100% completed in February and really now it's just making sure we continue to ramp up the technical skills on the respective sides.

But I'd say, overall, its going quite well.

So you didn't run into specific technical areas of expertise that weren't well suited necessarily for either party?

No, not at all.

I mean, the kind of products that the sequencer is, you know it's a high performance imaging system, which is effectively what we sell.

The assay methods are not that different from what we do in our genotyping and gene expression area.

And in fact, many members of our sales team worked for me at Molecular Dynamics where we were selling high performance capillary sequencers and so many of them know the sequencing market and the sequencing customer base quite well.

Okay, great and then on, I guess, just leading on to one last question.

What has been the initial feedback of some of the new products, that they've actually, outside of the early access programs, but as they've been getting into new customers, both on the sequencing and maybe on the gene express then?

The reaction on the Genome Analyzer has been tremendous.

As I said in the script, we have very strong demand for the product.

The customers love the data that's coming off the instrument.

Its at a magnitude that has been heretofore unheard of and so they're able to get enormous levels of productivity from a single Genome Analyzer compared to what they can get from traditional systems.

So that's created quite a pull in the marketplace for us to get these instruments placed and up and running in a customer's hands.

In the case of BeadXpress, we launched that only in the late part of March, but we had some pent up demand for that system.

We shipped a fair number of systems during the first quarter and we see that demand continuing.

And we think the initial target customer base are all our existing uses of BeadStations that today, when they get down to smaller numbers of markers, move off of them in platforms to other technologies.

And certainly they're a great initial target for us and our sales force is very confident in their ability to sell the system and it's working quite well in the customers' hands.

Just what events are -- you mentioned, for example, working out bugs on the Express, troubleshooting.

I'm just curious.

Has there been anything that has come up on either products?

No, not at all.

It's just that before you put something in the FDA you want to make sure that there aren't any reliability problems that happen after the system's been running for three to six months or some software change you need to make, either by customer request or because it's a bug.

And you just want to sort all that out, because once you get it to the FDA you want to minimize any changes.

And so, no, we don't -- there's been no issues, other than absolutely routine things.

Okay, great.

Thanks.

Thanks, John.

Zarak Khurshid, Caris & Co.

Hi Jay, Hi Christian, welcome, Peter.

Congrats on a nice quarter.

Thank you.

Thank you.

Hi there.

So quickly, what are the ex-U.S.

sales to date or currently and what would it cost to move the manufacturing overseas?

Well, we'll start with the second question first.

Zarak, if you see our infrastructure in manufacturing, we really don't have extensive capital requirements and so when you think about moving manufacturing overseas, depending on what you move its probably maybe a $5.0 to $8.0 million investment, somewhere in that range, at a high level.

And then when you think about the potential for ex-U.S.

sales, I believe our ex-U.S.

sales are probably somewhere in the range of 40% right now or so and probably growing.

The other thing you might think about is that as we move some of this manufacturing over to an international location, what we're in effect doing is expanding there rather than expanding here.

So a lot of that capital investment we would have made here anyway.

That's right.

In building more decoding machines.

We're just shipping them to a different place.

Right.

The truth is there's not a lot of incremental cost.

Yes.

It's just when we decide to make that jump it's probably $5.0 to $8.0 million, I would guess.

I don't have, we don't have exact guidance for you yet, so that's probably a range to think about.

Sure.

Could you guys do something potential in Tijuana?

I know you guys are down there close to the border.

I don't think that's a leading candidate.

Okay.

While we're talking about it, would the ex-U.S.

manufacturing allow you to bypass potential royalties levied against you in the fee litigation?

Yes, we're not making any more comments, Zarak, on the litigation other than what we made in the prepared remarks.

Okay.

So finally, last question.

You did comment on sort of the criteria of probable damage and sort of quantifying the level of damage as being the criteria necessary to establish a settlement reserve.

If we were to see a ruling in the invalidity phase in the summer and that subsequent ongoing royalty rate established, would that satisfy that criteria?

Well, we're going to have to do analysis whenever we have anything that transpires of materiality in the case and that's going to need to be done with our lawyers and our accountants.

And so it wouldn't be appropriate for us to sort of prejudge what those outcomes might be and what the results might be in terms of the accounting treatment.

We'd have to wait until we got there.

Sure.

So it is conceivable that at some point you may have to take that kind of reserve?

Well, it's certainly conceivable, but [inaudible, multiple speakers] --

Okay.

-- would go along.

But its not something that we certainly predict or anticipate.

Sure.

Great.

Thanks for taking the questions.

All right, thank you, Zarak.

Alastair Mackay, Garp Research & Securities.

Hi Jay.

I wonder if you could talk a little bit about how you see the service business evolving as the Company itself evolves and grows bigger, in particular what you might be thinking about the size of that portion and where you see customers?

Is this a place where you generate new customers or is this a place where customers go as their needs change?

It certainly has been a place where customers test out our technology and so particularly, early on, it was quite typical for customers to run a service project with us prior to making a big investment in instrumentation.

That's a bit less of a factor now, because our installed base is so big and the technology is so broadly accepted and well proven.

But we've seen customers using our services for lots of reasons, either because they're doing a one-off study and they don't clearly anticipate follow-on studies.

That might be one reason.

In the case of consortia that may be coming together across various geographies or various research groups, there may not be a logical place to install a system, nor sort of a natural infrastructure that they want to build and so that consortia would opt to use services.

Our current sort of high level view of services is that we expect it to continue.

We expect it to continue to be a material part of our business and as we begin to add sequencing services into the business as well, then we'll have a whole other dimension to that activity that we think could be quite an interesting business going forward.

Okay.

That's good and can I ask you a quick one about BeadXpress?

Now that you've had all of a month or so of having the units on the market, do you have any better sense about what the consumable flow might look like or how you think about that internally?

That's too early to tell.

There isn't a large enough installed base where sort of enough of the application is up and running for us to have any read on that.

Yes.

Okay and then lastly a quick one.

You'd mentioned paired-end reads for the Solexa Genome Analyzer.

Are you currently or are the machines you're shipping capable of doing the paired-end reads or is that something that you see adding in the near future?

It's the latter.

We don't have a released product for paired-end reads, but we're working very hard on it in the R&D area and we're working collaboratively with a couple of customers on it right now.

Any timeline for that or?

No, not prepared to give a timeline yet.

All right.

Thank you.

Thanks, Alastair.

Un Kwon [inaudible], Pacific Growth Equities.

Hi.

Thanks for taking my call.

I was wondering, on the Solexa end, the performance of the technology has ramped up pretty dramatically with the throughput already at a billion based pairs.

Can you comment on sort of ways and sort of what the headroom may be for you to increase the throughput or increase the performance of that instrument, as we track it, going into this year?

Yes, well, I mean, we certainly aren't prepared to give any specifics about our plans there.

But I think what we can say and certainly one of the base for the entire combination of the companies was the fact that we think this technology has a lot of headroom.

And just as our BeadArray technology continues to have headroom in terms of where we can take it in the future and the dimensions of expandability, we certainly see that in the Solexa technology as well.

And so that's true both sort of on an application access where we think we can add more and more applications on the sequencer, which broadens the utility of the product over time and also certainly, from a throughput perspective and a price perspective.

And so our intention is to continue to push the technology and we think, while there's lots of technical challenges to get there, that the technology has enormous headroom to get better.

Okay and so as far as the throughput is concerned, is that going to come on increased read lengths or are you able to increase the density on your chips?

Well, there's lots of ways that we can improve the overall throughput of the system and we're working on all of them.

Okay.

Switching to you're BeadArray products, can you comment on what your current manufacturing capacity is and do you have enough capacity to meet demands throughout this year until you do build out international operations?

Yes, we think so.

We've done, we think, a pretty good job of keeping capacity sort of right where we need it, where we haven't had a lot of excess and we haven't had any problems with customers canceling orders because they couldn't get shipped.

So we've been able to fine tune that and that's really because of this idea we've talked about, that we can add capacity in relatively small increments and so we just plan ahead a couple of quarters and we add capacity as we need it.

I suspect we will need to add more capacity before the end of the year and we have plans to do that in this facility.

And we think that's going to track exactly with where we think the demand side is going to go and if we're off a little bit, we can react in a matter of about three months.

So I think we have good control over it.

Okay.

All right and lastly, just broadly, would you be able to comment at all as to what percentage of your BeadArray installed base is the G versus the GX?

Well, I can say that the majority of them are the G's -- I'm sorry, are the GX's, the fully configured systems.

But we have seen, lately, more units being ordered of the pure expression version, which is the X version.

Yes.

Okay, great.

Well, thanks very much.

Thanks, Un.

Thanks, Un.

Operator, we have time for one more participant in the queue.

Tycho Peterson, JP Morgan.

Thanks for taking the call and congratulations.

Jay, just wondering if you can talk a little bit about the diagnostic strategy?

I know there's kind of a number of moving pieces here with CyVera and then the Solexa platform and I know Roche had talked about 454's being a key part of their diagnostic strategy.

So how I guess we think about kind of the box side versus your strategy between the two businesses and then, I guess, in the near-term, when we'll be getting some data on the CyVera or Illumina East now West platform?

What kind of data on the platform?

Just initial data and when we're going to see some of the initial products ramping from that business in particular.

Diagnostic?

Yes.

Yes.

So the strategy is to pursue a number of diagnostic partnerships in parallel and we've done that and have announced a number of those with deCODE, of course, or GL, with Mayo and working with those organizations.

We're pursuing development of a number of these testing for our lab.

We're working on the assay side in addition, to make sure the assay is extremely robust before we add the content to it.

We anticipate that the first test will be this myocardial infarction test with deCODE and our goal is to try to get that through the FDA in 2008.

We don't think there'll be significant revenue from that in 2008.

It'll take a while to build up the marketing side of that, but we expect that will be the first commercial product.

In terms of sequencing diagnostics, certainly our long-term view is that sequencing will become a very powerful diagnostic tool, particularly in areas where you have highly variant diseases.

So we suspect in diseases where the marker set is exactly known and is invariant, then the Express platform might be the ideal one to use.

We have a relatively small number of markers.

In highly variant diseases, such as cancer perhaps, what you might want to do is do resequencing of a relatively large number of genes and that's going to require something like the Solexa technology and will require the ability to target specific areas of the genome.

And so we think that's clearly a very important future application of the platform; not one that we could do today.

Okay and then as we, I guess, think about some of the emerging market opportunities for Solexa, I mean, is methylation and chip-chip, are those things that could be potential application areas?

They certainly are.

We've announced our array-based methylation and certainly the sequencer over time will give us the ability to discover methylation sites, which will help inform and populate the chips that we subsequently make.

In the area of chip, we already have a number of customers that are using the systems for doing chips and so I would expect to see some publications in the relatively near-term on that application on the system.

Okay and then finally, you just mentioned that you had some industrial customers for Solexa.

Were those kind of one-off or how do we think about that opportunity?

By one-off, do you mean that they won't order any more or do you mean --?

Well, mean, like I said, if you could just give some additional color.

I'm not sure how we would think about that business.

Well, I'd say it's not the biggest part of the order backlog today.

We're certainly biased heavily toward the academics.

If you were to say what would that mix look like out a year from now, I guess it might be 80/20 academic, maybe 75/25.

We think, largely, this will be biased toward the academic markets in the next year.

Okay great.

Thank you very much.

Thanks, Tycho.

And at this time we have no more questions in queue.

Thank you, Operator.

Thanks for joining us today.

This concludes our call and we look forward to our next update in July.

Thank you for attending today's conference.

This concludes the presentation.

You may now disconnect.

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