Illumina Inc (ILMN) 2007 Q2 法說會逐字稿

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

(OPERATOR INSTRUCTIONS)

I would now like to turn the call over to the Mr.

Peter Fromen, Senior Director of Investor Relations.

Please proceed, sir.

Thank you, Operator.

Good afternoon, everyone, and welcome to our second quarter 2007 earnings call.

During this call, we will review our financial results released at the close of market today, update our finance guidance for the third quarter and fiscal 2007, 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 made during this call 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 these 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.

On August 9th, we will participate in the Leerink Swann Life Sciences Roundtable in New York.

Moving into September, we will present at the Thomas Weisel Healthcare Conference in Boston, which will be held from September 5th to the 7th, the Bear Stearns conference in New York scheduled from the 10th to the 11th and then, at the ThinkEquity G5 Growth Conference in San Francisco from September 17th to the 20th.

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.

In addition to these upcoming conferences, on September 12th, directly following the Bear Stearns conference in New York, Illumina management will hold its Inaugural Analysts Day for the investment community, an event we're very excited about.

Formal details of this event will follow in the next couple of weeks.

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

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

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

Today I will review our operating results for the second quarter and discuss our financial guidance for the remainder of 2007.

After that, Jay will then discuss our commercial progress during the quarter.

We continue to see strong demand in our core markets, enabling us to record our 24th consecutive quarter, or 6th full year of quarterly sequential revenue growth.

Total revenues were $84.5 million, which represents growth of 103% over the second quarter of last year.

On a sequential basis, total revenue grew approximately 17% over the first quarter.

This was our 8th consecutive quarter of sequential revenue growth greater than 10%.

Product revenue was $74.3 million, growing 104% over Q2 of last year and 21% sequentially.

This was fueled by growth across all three of our platforms, the BeadArray, BeadXpress and the Genome Analyzer.

It was also driven -- we also saw impressive second quarter growth in our Consumables business, led by strong demand for our Hap550, HumanHap300-Duo, and our custom genotyping arrays, including our iSelect and GoldenGate products.

Total Consumables revenues for the quarter was $45.8 million, up 126% over the second quarter of last year, and 18% sequentially.

Instrument revenue continues to show significant growth, both sequentially and over the prior year period, driven by the strong uptake of both the Illumina Genome Analyzer and the new BeadXpress System that we launched at the end of last quarter.

Additionally, during the second quarter, we had record order levels for our BeadStation System.

Total instrument revenue was $25.4 million, compared to $13.1 million in Q2 of 2006.

This represented year-over-year growth of 94% and 30%, sequentially.

Services and Other Revenue, which includes revenue earned from our genotyping and sequencing service offerings, as well as revenue related to our instrument maintenance contracts, increased 110% to $10.1 million compared to $4.8 million in Q2 of the prior year.

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

The total impact of the P&L this quarter was approximately $7.8 million or a pretax amount of $0.13 per diluted share.

As proscribed by the standard, the expense is allocated to each expense line, with the amount attributable to each expense category separately identified in the financial tables accompanying the earnings release.

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

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

Cost of product and services revenue was $30.1 million for the quarter, compared to $13.6 million in Q2 of 2006.

The Q2 '07 cost includes stock-based compensation of $1.0 million, compared to $400,000 in the comparable period of 2006.

Non-GAAP products and services gross margin, which excludes both stock comp expense and merger-related costs, was 65.7% for the quarter, compared to 67.3% last quarter and 67.9% in the second quarter of '06.

The year-over-year and sequential decline in gross margin was directly attributable to the shift in product mix towards instrumentation, as placements of both the Illumina Genome Analyzer and the BeadXpress are significantly ramping up.

Going forward, we continue to expect gross margins to range in the mid-60% range, as we anticipate our instrument revenue will continue to be a larger relative percentage of our revenue mix when compared to 2006.

Despite the overall gross margin decline, gross margins in our BeadArray product line were approximately 70% for the quarter.

Research and Development (R&D) expenses were $18.2 million in the quarter, compared to $8.6 million in the second quarter of '06.

This includes $2.5 million and $0.9 million, respectively, in stock compensation expense.

The absolute increase in R&D dollars was primarily attributable to the inclusion of Solexa's R&D expense for the first full quarter following the close of the acquisition.

As I mentioned last quarter, we added more than 125 former Solexa employees in R&D, located in both Hayward, California and the Little Chesterford, UK sites.

Despite the significant incremental investment in R&D, our revenue growth and operating synergies allowed us to maintain R&D expense at a similar percentage of revenue to last year.

Excluding stock compensation expense, R&D expenses were $15.7 million or 18.6% of revenue, compared to $7.7 million or 18.5% of revenue in the prior year period.

SG&A expenses were $23.3 million for the quarter, compared to $12.9 million in the second quarter of '06.

Including stock comp expense of $4.3 million and $2.1 million, respectively, SG&A was $19 million or 22.5% of revenue, compared to $10.8 million or 26% of revenue in the prior year period.

Again, the absolute increase in SG&A dollars can be attributed to the expenses associated with Solexa's SG&A activities, as well as the growth in our commercial infrastructure required to support the dramatically increased level of revenue.

However, as we continue to integrate the two companies, we are demonstrating our ability to leverage the combined resources and infrastructure of the merged company.

This leverage is evidenced by the growth in our non-GAAP operating profit of $20.8 million, or 24.6% of revenue, compared to $9.9 million or 23.7% of revenue in the prior year period.

GAAP reported net income for the second quarter was $9.3 million or $0.16 per diluted share, compared to $6.8 million or $0.14 per diluted share in the prior year.

Excluding the impact of acquisition-related changes in stock comp expense, we are pleased to report non-GAAP net income of $16.8 million or $0.29 per diluted share, compared to $10.1 million or $0.21 per diluted share in the second quarter of '06.

Turning to the cash flow statement, we generated $24.5 million in cash flow from operations or approximately $0.42 per fully diluted share during the quarter.

In addition, we used approximately $6.7 million in cash for capital expenditures (CapEx) during the quarter.

CapEx increased over last quarter, primary due to the manufacturing capacity expansion.

Free cash flow during the quarter was $17.8 million or $0.31 per fully diluted share, compared to $9.9 million in the comparable quarter of 2006, or $0.21 per fully diluted share.

One of the key drivers of our significant level of free cash flow is our ability to effectively manage our accounts receivable (AR).

We continue to be in excellent position with respect to AR DSO at approximately 62 days.

This compares to DSO of 51 days at the end of the second quarter of '06, but an improvement from 67 DSO in the first quarter of this year.

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

Inventory grew by $6.6 million in the quarter to $42.9 million.

The primary driver of the inventory growth was the ramp in inventory required for the production of the Genome Analyzer.

I will now update our financial guidance for 2007.

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

I will provide an overall estimate of 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 half of the year, we now expect revenues for FY 2007 to be in the range of $335 to $345 million, compared to previous guidance of $305 to $315 million.

This represents growth of approximately 81 to 87%.

The increase in revenue guidance is attributable both to the continued robustness in the genotyping business and the acceleration of sales of our Genome Analyzer.

For the full year, we expect product and services gross margins to range around the mid-60%'s.

However, we expect gross margins to sequentially decline in the third quarter, as the revenue associated with sequencing instrumentation and consumables, as a percentage of total revenue, is expected to increase.

As we scale our sequencing manufacturing operations and increase our installed base, we expect to see the benefit of increased consumables revenue mix and overhead absorption improve our gross margins to the upper 60%'s over the long-term.

Our continued ramp in growth and our investment in Solexa Technology will result in increases in both R&D and SG&A over 2006 levels.

At this point, we expect R&D expenses to range from $60 to $70 million and SG&A expense to range from $75 to $85 million.

We anticipate a non-GAAP annualized tax rate of approximately 32% for 2007.

We will continue to work on various tax planning strategies, such as international manufacturing, and believe that we can lower our GAAP tax rate over the next few years.

Excluding the impact of expense associated with stock options and merger-related items, we expect non-GAAP net income to range from $60 to $66 million, which increases the lower end of our previous net income guidance by $5.0 million.

This represents fully diluted EPS of approximately $1.05, assuming the midpoint of the range and fully diluted weighted average shares of approximately 60 million.

We expect that annual stock compensation expense will be around $31 million, which represents a pretax amount of approximately $0.52 per fully diluted share.

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

For the third quarter, we expect that total revenue will range from $88 to $92 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 $16 to $18 million, resulting in EPS of $0.26 to $0.30, assuming fully diluted weighted average shares of 60 million.

At this point, I'd like to turn the call over to Jay for some remarks on our commercial activity during the quarter before we begin the Q&A .

Good afternoon, everyone.

After a great start to the year in Q1, we've continued to build on our success with the results we delivered in the second quarter.

We grew revenue 17% over the first quarter and increased non-GAAP operating margin by 90 BPs, 24.6%, despite the full quarter impact of integrating Solexa's cost structure into our existing operations.

We're already beginning to realize the operating synergies between the two companies that were anticipated at the time of the acquisition.

That said, we believe that we're in the earliest stages of realizing the potential opportunity of a fully integrated company and product portfolio.

We generated free cash flow in the quarter of approximately $18 million or $0.31 per diluted share, compared to $0.20 per share in Q1.

Additionally, we received more than $100 million in new orders for products and services during the quarter, resulting in another record backlog, the majority of which is expected to ship over the next six months.

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.

Strong uptake of new products launched over the past six months continued to drive both growth and profitability.

Our HumanHap550 retained its place as our best-selling product.

To date, we've seen Illumina BeadArrays used for whole genome association and copy number variation studies in 30 peer-reviewed journal publications, 27 of which have been published in the first half of 2007.

Just this past week, researchers from Duke University published a study in which they used our HumanHap550 to identify three genetic variants linked to an individual's ability to control HIV viral load.

These exciting discoveries by our customers reflect the quality content and power of Illumina's BeadArray technology.

At the end of the second quarter we began shipments of our Human 1M DNA Analysis BeadChip.

The 1M includes over 1.0 million SNPs in addition to proprietary copy number variation, or CNV content, developed in collaboration with deCode Genetics.

The 1M is unparalleled in the market place in its ability to deliver content that is intelligently distributed across the whole human genome.

Release of the 1M product includes our next generation software for CNV analysis, which we believe will further the market's adoption of this product for high density SNP and CNV analysis.

In past quarters, I've spoken about the flexibility of our BeadArray architecture.

This flexibility allows rapid development of multi-sample products, which increases the value to the customer by reducing handling and the production costs per sample.

Additionally, our semi-custom arrays, which we call the "plus family of products", enable customers to add markers of their choice to our standard products, providing the economic benefit of our fixed content with the flexibility to fine-tune it for their own requirements.

Our customers have responded well to this product flexibility.

In the second half of '06, we launched the HumanHap300-Duo to enable two samples per chip and the product quickly became our second best-selling chip behind the HumanHap550.

Our Infinium iSelect product is also based on this multi-sample capability.

This product allows our customers to select up to 60,000 SNPs per sample, with 12 samples run on a single chip.

iSelect has resulted in significant order flow, including the announcement just yesterday of a multimillion-dollar collaboration with the University of Pennsylvania, the Broad Institute and the CARe Consortium to provide custom iSelect arrays to test more than 120,000 samples associated with cardiovascular disease.

By integrating multi-sample and custom capabilities, we're providing solutions to our customers at each stage of their research, from whole genome association to more refined and targeted fine mapping, a capability that we believe is unique to Illumina.

Again, we're seeing the validation of this strategic approach, as custom content arrays become a significant component of our overall Consumables revenue.

Let me next give you an update on our BeadArray platform.

As a reminder, BeadXpress is our low-to-mid multiplex platform for genotyping, gene expression, and protein-based applications.

It's based on the VeraCode technology that we acquired from CyVera in April of 2005.

We launched the platform at the end of last quarter and have been very pleased with the initial uptake, as orders have exceeded our expectations.

Earlier I mentioned our capability to address customer requirements at each stage of their research.

BeadArray is a continuation of this focus, providing an ideal solution for 1.0 to 384-marker multiplexing as researchers narrow their search for causal or highly correlated disease markers.

This platform will address a growing number of applications in the clinical, agricultural, and industrial markets.

In addition to the direct sale of genotyping products, our Services business has continued to gain traction with customers who seek to outsource genotyping studies.

We expect our Service business to continue as a strong growth driver for us in the future.

As an example, in the last three quarters we've delivered service projects to four of the five largest pharmaceutical companies.

In addition to these traditional research and pharma-oriented customers, we believe that consumer genotyping will ultimately be the largest market and is poised to become a significant opportunity in 2008.

Many of you may have seen the press release related to the funding of 23andMe a privately held consumer genetics company.

We've developed a collaboration with 23andMe to provide genotyping services for the consumer-based market.

We're extremely excited about this opportunity and are happy to be working with 23andMe.

Now I'd like to move on to our sequencing business and walk you through the initial success we've seen and the traction that the business has developed.

In mid-June we announced that we had received orders for over 75 Illumina Genome Analyzers, including 16 systems installed at the Broad Institute.

Additionally, last week we received an order for 20 Genome Analyzers from a single customer.

We're obviously very pleased with the rapid adoption of this platform.

What's particularly interesting is that we're seeing strong demand across a broad market, with more than half of our orders coming from outside the core genome centers.

Driving the adoption of the platform is not only the 100-fold improvement in cost and throughput versus traditional sequencing, but also the breadth of applications that the Genome Analyzer has enabled on a single platform.

As an example, we've already seen customers at Caltech, Stanford and the NIH publish results in a peer-reviewed journal for chromatin immunoprecipitation sequencing (or ChIPSeq) within months of installation.

Increasing the breadth of application on the Genome Analyzer is an important priority.

Just today we announced the commercial launch of two digital gene expression applications for the Genome Analyzer.

These applications enable tag-based expression profiling and small RNA discovery and analysis for both known and novel transcriptomes on our existing sequencing flow cell.

We're extremely excited about this launch, because we believe that sequencing-based expression will provide a powerful compliment to traditional array-based expression analysis.

Beyond digital gene expression, we're also in the late stages of development of patch protocols around new applications, such as ChIPSeq for protein DNA-binding analysis and for paired-end reads that will allow unambiguous assembly of short reads to a reference sequence.

The rapid uptake of the Genome Analyzer has required us to scale the manufacturing infrastructure in our Hayward and Chesterford facilities.

Our teams have done great work ramping up our capabilities and we believe we have the capacity to fulfill the significant demand for the product.

As Christian mentioned, as we continue to scale up, we expect to see gross margins impress as we manage the supply chain and reduce the overhead per unit produced.

Delighting our customers is equally important, so we're diligently focused on expanding our commercial infrastructure to ensure high quality installation, service, and support.

Before I conclude my remarks, I'd like to provide you with an update as to some of our additional operational initiatives.

As we announced last quarter, we're integrating our Wallingford, Connecticut manufacturing site into our existing operations in San Diego.

This process continues to progress as scheduled.

In order to support the absorption of the Wallingford site and the rapid growth of our overall business, we also mentioned to you last quarter that we contracted to lease 83,000 square feet of new space in our existing campus in San Diego.

We broke ground for that facility in May and we're on schedule to meet our target completion date in the fourth quarter of next year.

Finally, we're rapidly moving on our project to build international manufacturing capabilities and expect to be operational in this facility in 2008.

International manufacturing will allow us to manage our aggregate tax exposure, as well as mitigate the risks associated with a single manufacturing facility.

To conclude, as you can imagine, we're quite pleased with our results.

Our core genotyping markets continue to show strength and we believe that continued discoveries based on Illumina's technology will drive adoption across the broader market.

The sequencing business is performing beyond our expectations and holds great promise as we further the technical capabilities of the platform, build on new applications and explore numerous ways in which to integrate the technology with the BeadArray platform.

Thank you for your time and we're now ready to open for questions.

(OPERATOR INSTRUCTIONS) And our first question comes from the line of Ross Muken with Deutsche Bank.

Go ahead.

Hi, guys.

Hey Ross.

A pretty good quarter there.

When we think about the sequencing business, I mean, when you made the Solexa acquisition, the reaction across the board was a bit mixed and clearly it's far exceeded everyone's expectations, as I think, in general, next-gen sequencing has.

Can you sort of gauge for us where the performance of this business has been, relative to sort of your upside case when you actually purchased the asset?

And can you help to understand, in terms of -- you see a customer in the recent week buying 20 instruments, the sort of applications and really where the demand is coming from that was unexpected?

Well, with the 20 units that we just announced in addition to the 75 previously announced, clearly we've had some other orders in the interim between those two announcements and if you aggregate that, we're not going to be quantitative about the number, but we certainly will say qualitatively that that way exceeded what our initial expectations and what our models look like.

The demand certainly is coming from the genome centers at or above what we had anticipated and so we're real pleased with how that segment of the market or our success in penetrating that segment of the market.

But probably the thing that surprised us most is how broadly the system is being accepted outside the genome centers and how rapidly we're progressing there.

Our commercial infrastructure at Illumina certainly aids that because of the number salespeople we have and our ability to support the system broadly in multiple geographies and in smaller accounts.

But the other key factor, I think, in next-gen sequencing is the simplification of the sample prep process and the lower cost and so this enables almost any university laboratory to purchase one system, for example, and have a real impact doing DNA sequencing, where that isn't quite true in the traditional sequencing business where you had to build out a large sample prep infrastructure.

I think that accounts for the rapid broadening of the market.

The other factor is that the technology is so versatile that many customers want to do just pure experimentation with this to see what new applications they might develop and certainly, we're excited to collaborate with those customers and bring those applications into things that are formally launched as products.

And in the last call you talked about customers who purchased all three systems.

Maybe I missed it on this call, but can you talk a bit about how some of these markets are developing in terms of utilizing multiple technologies for a type of application or analysis and sort of where that's going?

It seemed like the BeadXpress did a lot better than you had thought.

So are we seeing the utilization of all three platforms by customers and is this happening at sort of an expedited rate versus obviously what internally you had thought to be the case?

Well, I think the market, in terms of how people are using the systems, is evolving according to the models that we had developed.

Underlying our acquisition, both of the CyVera technology and the Solexa technology, was this concept of providing end-to-end capability for our customers, all the way from sequencing human genomes on a de novo basis, which ultimately we will do with this platform, through large-scale resequencing using our arrays for doing whole genome association analysis.

And then we're seeing customers looking to do what used to be done using fine-mapping studies in custom arrays now wanting to do sequencing of regions where they get hits from whole genome association studies.

That allows them to discover not only the common variants, but the rare variants in those regions of the genome.

Ultimately that, then, progresses down the analysis chain to the BeadXpress platform where customers want to look at reduced number of markers to find, ultimately, the causal or highly correlated markers.

And so that sort of paradigm of research, I think, is playing out about as we expected.

The overall demand in the market is just greater than what we had planned, so we're pleased by that and we always thought that genotyping and sequencing would work hand in hand together and we're seeing that more than ever.

And just quickly, in terms of ramp-up of the sales force and sort of the other personnel that you're adding.

Do you feel like you're at a position here where, for at least the next six months or so, you have enough people on hand to be able to handle this new level of demand that seems to be above some of the expectations that you had and could you sort of characterize how difficult is to sort of add that many individuals to a small company in such a quick amount of time?

We're hiring significantly, Ross, and particularly in the commercial side of the business for tech support and in marketing and in the direct sales force.

That's necessary to support this increase and to support the fact that these sequencers, in many cases, are going to customers outside the genome centers and so our hiring requirements are pretty steep and we're struggling a little bit there.

B ut I think we're doing, overall, fine in terms of bringing on sufficient people.

The challenge, of course, is finding enough quality talent to bring into the Company that meets our standard, but I think we're on track.

We'd probably like to be a little bit ahead of where we are, but we're doing fine.

Great, thanks, Jay and congratulations.

Thank you.

Quintin Lai, Robert W.

Baird & Co.

Hi, congratulations on a nice quarter, guys.

Thanks, Quintin.

You mentioned that you had record sales of BeadStations in the quarter.

So, kind of going along the last question line, are you seeing sales of the BeadStations going along with the Genome Analyzers or is this just new markets that are coming into the large-scale genotyping?

It's some of both.

We're certainly seeing a broadening of the genotyping market, which is what we had predicted over the last couple years that as the costs come down for genotyping the market would broaden.

We are seeing some of our existing customers order follow-on Bead Stations just to increase capacity and we are seeing labs order systems together to basically outfit a new lab or a new effort and so it's coming from all those areas.

And the ones that are adding this additional capacity, any qualitative differentiation between people bringing it on to maybe use the 1M chip or the iSelect, or -- I'm trying to see where we are with respect to some of these large-scale projects.

Are we still seeing some new studies coming on with just whole genome studies or more targeted type projects from the installed base?

It's certainly both.

There are many new whole genome association studies that are beginning and are being mapped out to begin in the future.

So I think we're a long way away from feeling like anybody's finished with doing whole genome association, but every one of those projects typically spawns a custom genotyping or a sequencing project and so we're certainly seeing that as well.

And then just my final question and I'll jump back into the queue.

One of your competitors, Roche, has been not only acquiring 454, but NimbleGen.

Has that changed any of the competitive dynamics when you go head to head, when either selling a BeadStation and/or a Genome Analyzer?

No, not at all.

I mean, we feel like the Genome Analyzer competes extremely well against any other products in the market right now, so I don't think the dynamics have changed at all.

Thank you.

I'll jump back in the queue.

Doug Schenkel, Cowen & Co.

Hi, good afternoon.

Hi Doug.

I have a couple Genome Analyzer questions, as I'm sure you would imagine.

But, before I turn to that, I was wondering if you might be able to share any data or anecdotes on the competitive dynamic that's developing between you with the 1M and Affy with the 6.0?

I guess, specifically, what I'm getting at is are there any competitive situations which you might be able to refer to where you've either won or lost and if you can, what do you think the drivers were?

Is it performance?

Is it coverage?

Is it sample failure?

Is it pricing, or what not?

Well, I guess what I'd say there is that the 1M continues the performance tradition that I think we set with the other products and we believe it performs better than any other product in the market place.

Certainly, from a coverage perspective, we have the ability and on that chip we have SNPs that cover the whole genome in a very even way, with no gaps in the genome.

We have the addition of the proprietary CNV content on top of those SNPs, so we have the ability to do some structural analysis at levels that we think are the best in the market place.

We have great software that goes with that to enable the actual processing of the data and we've also enabled plug-in technology so third parties can also add in their own software if they think they have better algorithms to do the analysis.

So, if you combine all that with the traditional robustness we have in the Infinium assay and the automation we offer, we feel the competitive dynamic is really good for us.

And so I'd encourage you to talk to our competitor, if you want to know about the performance of their chip, but we feel the performance of ours is quite good.

So, with that in mind, given that the performance has been or is good and continues to be relatively good, that the relative pricing or I guess I should say the discount that Affy seems to be applying isn't necessarily changing anything in terms of market position?

No.

We don't think so.

Okay.

Maybe just jumping over to the Genome Analyzer, you guys have clearly had great success at at least a couple labs now, including Broad.

You've already received orders for more Genome Analyzers than most of us expected for the full year.

As the early access program for ABI evolves into a full commercial rollout, I guess over the next six-to-nine months, is it your assumption that customers who already have 15 to 20 Genome Analyzers in place will be out of the market for a bulk of an ABI solid or another competitive instrument?

Or do you think there's room for more than one instrument at the large labs?

Certainly at the large labs we would expect them to test all technologies, all new technologies that come out, including ours and those of our competitors.

I think the large orders will go to that technology that's performing the best at any give point in time.

The imperative today to get on with next generation sequencing is pretty compelling for these labs because of the dramatic increase in throughput and reduction in costs that this technology provides.

So we are sort of grateful to be in the position where we have this technology fully available and can take advantage of the demand coming from these centers.

And the imperative for Illumina is to make sure that we stay ahead and that our system continues to perform as well or better in the market place than any competing technology and that's what we're working on every day.

Okay and my last question and then I'll get back in the queue, regarding the IP dispute.

Are you still expecting that the next phase of the trial will be late October, early November?

That's our best guess at the moment.

We don't have a definitive date, but that looks like the target range.

Okay.

Thanks a lot.

Steve Unger, Bear Stearns.

Hi, good evening, just a follow-up on that last question, just regarding the major genome centers.

Do you have a placement of a Genome Analyzer in each one of the majors that received NIH grant money?

We haven't disclosed exactly what that list is, Steve.

We've given out some information of sites where we do have them, but we haven't sort of broadly talked about where we have them and where we don't.

Okay and then in terms of your manufacturing capacity, I know that we know about orders, but we don't know, necessarily, about how instruments are going to flow in terms of placements.

Could you give --- I'm going to leave it open for your to tell us what you'd like to tell us just regarding the pace of placements or how much manufacturing capacity.

Can you ship 100 of these this year?

What I would say is that we're very rapidly building our manufacturing capacity.

We're very pleased with how well we've been able to ramp that up.

I would also say that customers would be pretty unhappy if they placed orders and had to wait a long time to get a unit.

So, but we are working -- we have a large backlog and we're continuing to work down that backlog at a rate that we think is very acceptable to customers and we're continuing to increase the capacity in anticipation of strong, ongoing demand.

I don't think that we are going to have problems in supplying instruments to customers in the kinds of timeframes they would like them.

Okay, great, and then my final question.

In terms of the annual consumable revenues from the Genome Analyzer, do you have a better sense as to how much annual flow cell revenue you can generate from an individual Genome Analyzer placement?

We certainly don't have enough empirical data, at this point, in time to give any more clarity to that, but the numbers that we've thrown out before of sort of a 40 top 50% range are based on comparables with other technologies and what's historically happened in the sequencing business.

And that's probably our best guess today, but we really don't have enough placements and enough time to average the consumables over for the empirical data to make any sense yet.

Okay.

Steve, the other interesting thing there is that the diversity of customers that we've got with the analyzer makes the ranges a lot different for many different, any particular customers.

So I'm assuming that'll probably normalize itself over the next six months, probably.

And then I guess the final thing is the different applications that are available on the machine will use different consumable rates and so it'll be interesting to see how it plays itself out over the next six months to a year.

Okay, great.

Congratulations on an incredible quarter.

Thanks.

Thank you.

Thanks.

Tycho Peterson, JP Morgan.

Good afternoon.

Hi Tycho.

With the rollout of the paired-end reads, can you just give us a sense of where the early applications there are?

Is it mainly resequencing or how do we think about that?

Yes.

I think it's going to be mainly resequencing to start and ultimately, for de novo purposes.

Our view is that the paired-end technology is so powerful that the vast majority of use of the sequencer will migrate toward paired-end reads over the next six-to-twelve months.

So, if you were to look 12 months out, we might guess that sort of two-thirds of all applications might be done [through] paired-end reads.

Okay and then you've been talking more and more recently about digital gene expression.

I mean, in a similar vein, how do we think about the applications there?

Well, we launched two of them today.

You know we launched the small RNA analysis, which is very powerful for discovery and subsequent analysis of small RNAs ranging from, say, 15 bases up into the 30's, and we also announced the tag-based expression.

And then, in the future, we've talked a bit about whole transcriptome gene expression and that's an application we're still working on, but the two we announced today are packaged up and ready to ship as complete product.

Our view is that, over time, the power of full transcriptome sequencing is going to be significant for multiple reasons.

Certainly the ability to do analysis of expression across the entire genome without knowing the sequence and to do that in a digital way, where you're actually counting how many copies of every transcript appear in the sequence, in the long run, we think is going to revolutionize gene expression.

And so we're very excited about that and are working hard on that application.

Okay, on the consumer applications, you talked a little bit more about this, and just give us a sense of how much visibility you may have on someone like 23andMe.

And is this an exclusive or are there other businesses out there that are going after this particular personal genotyping application and to what extent are you trying to evolve that as a business model for a customer base?

We certainly think it's going to be important to the evolution of this market.

We've often been asked over the last few years how big can the genotyping market be and we always said the market is genotyping everybody and we still believe that.

And I think the advent of consumer genotyping is going to sort of put some meat on those bones, if you will.

In terms of visibility, it's still pretty speculative in terms of what the adoption rate might look like.

There seems to a be huge amount of interest, but it's awfully hard to actually put a forecast down until you're, say, six months into it.

So I think in 08 we'll begin to have actual data about what that order rate might look like, but our anticipation is it's going to be a very large market and it could be a large market pretty quickly.

Okay and then just one final one on the Genome Analyzer.

You've talked about the reference lab opportunity in the past.

Are you placing systems to reference labs at this point or?

By "reference labs" you mean for clinical diagnostics?

Exactly.

No.

That's not a general use of the system today.

We certainly think it will be one in the future.

Diagnostic sequencing is going to be a great opportunity, but today that's not really where we're focused.

I think that application is a few years away from being a significant revenue contributor for us.

Great.

Thank you very much.

Un Kwon-Casado, Pacific Growth Equities.

Hi.

Thanks for taking my call.

Sure.

I was wondering, could you comment on the some of the growth trends you're seeing in your ArrayMatrix product line?

Yes.

We had a very good quarter in the ArrayMatrix product.

I think it was driven by lots of follow-on studies that have been done from whole genome association.

In our forecasting, we had looked at the balance between how many customers use iSelect versus the ArrayMatrix and we probably did better in the ArrayMatrix side than we even expected in our own forecast.

And what that implies is that there are lots of customers who want to study numbers of SNPs that are sort of in the low-thousands range and want to do lots of samples and that's the market that drives the ArrayMatrix product.

At the same time, iSelect has been fantastic for us since we've launched it.

Order rates have been great.

You're seeing huge deals there like the one we announced yesterday for 120,000 samples and that's because we have the ability to put so many SNPs on a stripe on the iSelect.

But we see a real good future in the ArrayMatrix business as far out as we can look.

Okay and going forward, do you see applications or for assays done on the BeadXpress System cannibalizing the ArrayMatrix at all?

Not much.

Right at the break point, around 384, you'll have some customers who may already own a Bead Station who would opt to use that platform at the multiplex level.

If customers bought the Xpress before they bought a Bead Station, they might use BeadXpress System to do that same application, so right in that sort of range of a few hundred customers will have a choice.

But in terms of real cannibalization, I think the net will be not much.

Okay, okay and with respect to your third quarter guidance on the net income line, could you help me understand?

So you booked $9.3 million this quarter and your guidance for next quarter ticked down to $7.1 million to $9.1 million.

Is that largely due to a higher than expected tax rate?

So you're talking -- we only gave guidance on the non-GAAP figures, I believe, Un.

We didn't give guidance on the GAAP tax numbers.

Okay.

In the press release it has the GAAP numbers.

[Inaudible, multiple speakers] table, yes.

So the net income, the EPS guidance is $0.11 to $0.15 per share and given that you booked $0.16 this quarter, I was wondering what's causing the sequential decline.

Well, there are a couple of things going on there.

One is we are expecting a sequential decline in gross margins this quarter.

The biggest driver of that is going to be the product mix.

The second thing that's going on is we are increasing, we're continuing to grow, so our R&D and G&A expenses are going up a little bit.

And then the third is we do, on a GAAP basis, we do have some higher stock comp expense forecasted, primarily due to the fact that the stock has gone up quite a bit since the last time we sat with you guys and gave guidance.

Okay, okay, that's helpful and could you talk a little bit about where you see your tax rate going next year, even qualitatively?

Should we forecast that as you shift manufacturing abroad, that a percentage of your revenue will have a lower GAAP tax rate?

Next year it might.

It'll be interesting to see what happens, because in reality what'll happen is -- we have to basically migrate our intellectual property to that territory.

So when you do that, what happens is you end up -- that territory ends up paying a royalty back to the U.S., which actually increases our tax rate a little bit and so, it'll be difficult to know now.

But our tax rate could conceivably go up a little bit in the next year and then kind of taper -- and then begin to get some benefits a couple years out.

But it's difficult to say exactly, at this point, what the percentage is, because it's so highly dependent on when we start manufacturing, how much revenue is generated in the foreign territory.

As we get into giving for next year, we will try to clarify that for you so we can get a little more precise, but today we're not ready to do that.

Okay, great.

Thanks very much and congratulations on a great quarter.

Thanks, Un.

May-Kin Ho, Goldman Sachs.

Hi Jay.

Most of the detailed questions have been answered already, so I have a broader question.

You are shifting some manufacturing overseas.

Are there any plans to expand sales overseas to leverage the platform that you have?

We're pretty well covered overseas already, May Kin.

In all the major countries we have direct sales activities and we're continuing to add staff there pretty much in proportion to what we've done domestically.

There are a number of countries today where we're using distributors.

These are smaller countries, typically in Asia, such as Taiwan or South Korea, Malaysia, places like that, and because of the complexity of products like the Genome Analyzer, we're considering augmenting those distributors with direct salespeople who can bolster the tech support and the sales efforts of a product that has so many applications.

So we will be adding in those countries.

We're also expanding significantly in place like China, where we have only had a couple direct people and we'll be expanding there significantly, because we see that as a potentially large market.

Yes.

That was really the gist of my question, is Asia and China.

Yes.

Yes.

So we should see that in the next year or two?

We're doing it right now.

So we're already adding significantly in those geographies and in the countries where we're already direct, you would see us add roughly proportionately to what we're doing domestically, but we will be expanding into some of these distributor countries with more direct presence.

So that factor will cause it to be a bit greater than linear with the rest of the business.

And I was also intrigued by what you said in terms of service to the pharma companies, because I looked at the line revenue for services.

It doesn't seem to be increasing that much and obviously the product revenues are increasing quite dramatically.

So I was just wondering what kind of services are you getting or contracts are you getting from them and are there opportunities for expansion there?

Well, we certainly thing the service business is going to continue to grow and what you see in the numbers, it's hard to read much into those numbers over the short-term, because the numbers can vary pretty dramatically based on a one-week shift and when we deliver a particular contract.

And so the fact that it moves around a little bit quarter-to-quarter I wouldn't consider to be particularly significant.

I think if you averaged over, say, a four-quarter moving average, that we expect that to continue to grow.

We also now are adding to the service capability with sequencing services and we're very optimistic about how the sequencing services business will grow, purely incrementally to what we're doing in genotyping.

Thank you.

John Sullivan, Leerink Swann.

Hey guys, good afternoon.

Congratulations.

Thanks, John.

Thanks, John.

I had a couple of quick ones.

First of all, we talked a lot about next generation sequencing proving itself to be useful in some traditional array applications, micro array applications, things like chip analysis, expression, SNP genotyping and methylation.

I'm just wondering, how are you guys thinking, broadly, about this?

Is next generation sequencing going to end up replacing much of the preprinted array business in your mind and if it does, what does that mean to Illumina?

What should investors think of that potential shift?

Well, we certainly study that problem to the extent that it's possible to study it, John, and our conclusion is that the array business will continue to be very strong as far out as we can imagine.

And that's because while sequencing costs are coming down, array costs are coming down as well and there remains a very large gap between what it takes to sequence someone and what it takes to genotype someone and we expect that that gap will continue.

So in terms of whole genome genotyping, we see that going on for a long time.

Applications like Xpression may migrate more to sequencing than genotyping will, because the added power you get from doing sequence-based expression and the quality of the digital data that you get from sequencers versus the analog data that you get from expression-based chips.

But if you were to model our array business out for some five-year period, we wouldn't think there'd be large cannibalization from sequencing, perhaps mostly in the expression side, not so much in the genotyping side.

Okay and then I guess related, you've talked about these businesses being complimentary, these technologies being complimentary.

Have you had customers specifically go from an initial experiment with HumanHap550 to then look at a region with the sequencer and then maybe go to iSelect or go to ArrayMatrix after that?

Have you seen that sort of progression yet?

Well, the studies don't quite move that fast and so we have people planning to do that, but since the sequencer's really been on the market commercially now for less than six months, it's too early for us to actually being reporting that people have done that.

So there clearly are customers moving in that direction.

Sure.

Is that something that you would imagine in terms of workflow for scientists and biologists?

Yes.

It comes down to what they're trying to accomplish.

So, in cases where understanding where variations or where variations may be anticipated to contribute to disease, sequencing may be a better alternative after you've discovered the regions of the genome that are implicated in the disease.

If you're very cost conscious and if your speculation is that it's a common variant problem, then genotyping will be the better solution and the great thing about our position is that we can supply either one.

Sure.

Okay and then my last question.

Thanks so much for taking the call and congrats again.

Has the pharma industry embraced next generation sequencing yet?

Where would you -- how would you characterize their interest and how would you characterize their movement toward adoption of next generation DNA sequencing?

We're not counting on pharma to get re-engaged in using next generation sequencing for actual sequencing.

It may be that some companies do that in some limited way, but we don't expect to see sort of what happened in the early '90's where every pharma company was doing large-scale sequencing to discover targets.

So none of our forecasts include that as a big revenue source.

I think, in the expression side, there is certainly the possibility that pharma could begin to look at next generation sequencing for other applications like expression or methylation analysis or other type studies, but not so much for pure sequencing.

Okay.

Thanks again.

Thanks, John.

John Groberg, Merrill Lynch.

Hey guys.

Hi, John.

Just us.

We're at the bitter end here, finally made it through.

A couple, kind of three kind of categories of questions with a little more detail.

You've talked before about average sales prices (ASP), if we start with some of the chips, that they've been going up.

Was that still true in the quarter or what happened with ASPs?

Yes.

We didn't say specifically what happened this quarter, but they were very good again, so we're very pleased with what happened on ASP per chip.

Okay and then on, if we look at some of these custom chips that you talked about and also some of the services, like the growing services with the consumer genotyping?

Are those margins on the custom chips and the service margins, when you talk about operating margins, similar to the overall Company's operating margins, or a bit lower, as they require a bit more work, perhaps?

Yes.

The custom chip margins will vary a little bit and you can think about this to the extent that we make a bead pool for a custom chip.

You might amortize that bead pool over, pick a number, 10,000 samples, and so that margin would be about sort of at corporate margin levels.

Once you sort of have fully amortized the bead pool, then the cost of the chip goes way down.

So, if somebody were to order an incremental 10,000 on that same chip, that same custom architecture, then the gross margins, at that point, would be much better than corporate margins.

But, in general, you can think of the custom products being at or above the sort of reported margins that we have as a company.

For custom genotyping, I think you'll see that at corporate margin levels as well.

Okay and then on the sequencing manufacturing, right now how long does it take from someone who orders to when they get a shipment of one of those analyzers?

Well, we haven't given out those numbers specifically, but we --.

That's why I'm asking.

Yes, I know.

I realize that.

I guess what we can say is that we're sort of within the delivery window that most customers are satisfied with.

So we're not sort of way, way out there, but we have a healthy backlog at the same time we're ramping the production at a rate that's absorbing that backlog.

So we're pleased with where we are.

And then do you have a target?

Do you want to cut that number in half or what's your target?

Yes, I think we're trying to ramp up manufacturing faster to reduce the backlog overall and that's because we think, as we look forward over the next couple of quarters, time of delivery is going to be an important factor for us.

And so if somebody orders 20 units, we'd like to be able to deliver those in say 30 days, as opposed to some longer period, and so I think our plan is to continue to ramp capacity to be able to respond quickly to customer demand.

Okay and last category of questions here on the analyzer.

What type of feedback are you getting from customers?

I've heard varying levels of feedback and people who haven't bought saying it's a first generation product and waiting for things to improve as well.

So I'm just kind of curious.

You've had over close to over probably 100 orders now, x-number placed.

What type of feedback are you getting from customers?

I think customers, universally, are sort of astonished by the amount of data they can get out of these products and what they get on sort of a per-dollar invested basis is remarkable and so that's what's fueling the dramatic order uptake for this system.

Customers who wait will always get better technology and this market moves fast and we're continuing to evolve the platform over time, as will our competitors and so, like any high technology market, some customers will wait and buy in later in the cycle.

But the fortunate thing for us about the way this market works is that for somebody who bought 20 units, if I'm another genome center and I didn't buy 20 units, I'm going to be long way behind in six months if I'm using traditional technology versus next-gen technology and so I think that creates a buying cycle that works in our favor.

Okay and then the last question on these genome centers.

Are most of them, from what you know, are they running those 24/7, the next generation machine?

Well, they all started with the first few units in what I call not experimental mode but sort of a research mode.

And so what they were doing with the systems is exploring the breadth of applications they could run, exploring the parameters of how you do the sample prep and various concentrations of DNA in the flow cells and looking at the systems, broadly, as a new technology.

And what you will see now, as these customers ramp up with more systems, is that they've put them into production in specific types of applications and that's certainly what you're going to see happen at the Broad and certainly with this additional customer that ordered 20 units.

Certainly they're not going to be just experimenting with 20 units.

Those are destined for production applications.

I would say, today, that we're not yet in most sites in that mode.

People are doing various types of applications and looking at the general ways this technology can be used and that's part of the reason that we're a little early in predicting what the ultimate consumable stream might look like.

But certainly you're going to see, over the next couple of quarters, these systems go into true production environments.

Okay, great.

Thanks a million for sticking around and taking my questions.

Our pleasure.

Thanks, John.

Thanks, John.

Zarak Khurshid, Caris & Co.

Hi Jay, Christian and Peter, great quarter.

Hi Zarak, how are you doing?

Hey, good.

Thanks for taking my question.

I hate to harp on kind of the customer base issue for sequencing.

I just wanted to get a sense, are the large purchasers doing both digital gene expression and resequencing?

Well, the ones that ordered the large number of units have not bought those specifically to do expression.

They probably may be doing some expression on some of those units, but the early production application for those centers is probably a sequencing application, as opposed to an expression application.

Okay, great and than any sense for the average yearly consumable pull-through on the digital gene expression side?

Do you think it's north of $100,000?

It's too early to tell.

We just really released them today as fully packaged applications, so I would say six months from now we'll get a much better idea whether customers put them in true production modes for doing expression and if so, at what scale.

Great and then lastly, can you give us an update on the larger initiatives with CHOP and deCode?

What percent completion are we seeing in those projects?

Both of those projects were targeted to be 18- to-24-month projects and we're about halfway in on those projects at this point.

I think, certainly in the case of CHOP, the initial order and agreement that we had was anticipated in the way it was structured to be extensible and so the hope is that they have sufficient success in the first phase of the project that they get additional funding to continue on doing more samples.

And we'll probably, six or nine months from now, know more about that, whether they get that extension, so I'd say roughly halfway.

Great and then, yes, congratulations on the U of Penn and Broad vascular initiative.

How should we be thinking about pricing on this specific iSelect array and what is the timing like for this study?

Well, in terms of pricing, it's 12 samples per chip and so, if you think about the overall chip price will be, because it's a custom product, slightly higher than what our standard chips might be priced at.

But, on a per-sample basis, because you're dividing by 12, it's very economical for doing 55,000 SNPs.

The product is going into the design phase now, so it'll take several months to get those chips produced and they probably won't contribute significantly to revenue in Q3, but certainly will in Q4.

Great.

Thanks for taking my call.

Our pleasure.

Thanks, Zarak.

Ladies and gentlemen, that does conclude the Q&A session.

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

Please proceed, gentlemen.

Thank you, Operator.

That's all for our call today.

We look forward to hearing or seeing from you again in October.

Thank you much.

Ladies and gentlemen,, thank you for joining today's conference.

The presentation is now concluded.

You may disconnect your lines.

Have a wonderful day.

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