Illumina Inc (ILMN) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Illumina third-quarter 2007 earnings call.

My name is Amanda and I will be your operator for today.

At this time all participants are in listen-only mode.

We will conduct a question-and-answer session toward the end of this conference (OPERATOR INSTRUCTIONS).

As a reminder this conference is being recorded for replay purposes.

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

Peter Fromen, the Senior Director of Investor Relations.

Please proceed, sir.

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

During this call we will review our financial results released at the close of market today, update our financial guidance for the fourth quarter in fiscal 2007, and provide commentary on commercial activities after which we will hold 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.

Due to travel logistic challenges caused by the wildfires in the San Diego area, Christian is joining us via teleconference.

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 activities.

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 Securities and Exchange Commission 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 will be participating over the next couple of months.

On November 5, we will participate in the JP Morgan MidCap conference in Boston.

Later in the month we will present at the Piper Jaffray Healthcare conference in New York held from November 27 to 29.

At the beginning of our next fiscal year, we will present at the JP Morgan Healthcare conference in San Francisco held from January 7 through the 10.

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 will turn the call over to Christian.

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

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

I will review our operating results for the third quarter and discuss our financial guidance for the rest of the year after which Jay will discuss our commercial progress during the quarter.

We continue to see strong demand across our markets enabling us to record our 25th consecutive quarter of sequential revenue growth.

Total revenues were $97.5 million which represents growth of 82% over the third quarter of last year.

On a sequential basis total revenue grew approximately 15% over the second quarter.

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

Product revenue was $90 million growing 92% over Q3 of last year and 21% sequentially fueled by growth across all three of our platforms -- BeadArray, BeadXpress, and the Genome Analyzer.

Within our product revenues we generated $52.7 million of consumables revenue in the quarter.

This represents growth of 61% over the third quarter of last year and 15% sequential over Q2.

Consumables growth was driven by strong demand for our Human1M, HumanHap550 and HumanCNV370-Duo as well as our iSelect Custom Genotyping Arrays.

Instrument revenue continues to show significant growth both sequentially and over the prior year period primarily driven by the strong uptick of the Illumina Genome Analyzer.

Total instrument revenue was $34.1 million compared to $11.1 million in the third quarter of 2006.

This represents year-over-year growth of 206% and 34% sequentially.

BeadStation growth was also impressive during the quarter as we extend the footprint of the platform to meet the demand for Illumina's genotyping technology.

As I mentioned last month at our analysts day, the aggregate installed base of BeadStation has eclipsed 300 units.

Additionally, we began to significantly ramp the shipment rate of our low multiplex BeadXpress system during the quarter.

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 14% to $7.4 million compared to $6.4 million in Q3 of the prior year.

As we have mentioned previously, services revenue can fluctuate from quarter to quarter based on the timing of the completion of contracts.

The decrease in service revenue in Q2 was directly related to the timing of contract completion.

Services revenue is best assessed on a moving average basis.

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

The total impact of the P&L this quarter was approximately $8.7 million or a tax adjusted proforma amount of approximately $0.08 per diluted share.

As prescribed by the standard the expense is allocated to each P&L line with the amounts attributable to each expense category separately identified in the financial tables accompanying today's release.

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

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

Cost of products and services revenue was $37.1 million for the quarter compared to $16.4 million in the third quarter 2006.

The Q3 2007 costs include stock based compensation expense of $1.1 million compared to $400,000 in the comparable period to of 2006.

As we guided in our last call, non-GAAP products and services gross margin which excludes both stock compensation expense and acquisition related costs was down at 63.1% for the quarter compared to 65.7 last quarter and 70.1 in the third quarter 2006.

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

ASPs on BeadChip shipments in the quarter were slightly higher than Q2 and gross margins in the Array business of 69% were down only slightly from the second quarter due to mix effects.

In the fourth quarter, we expect consolidated gross margins to increase modestly over Q3.

Next year we expect instrumentation to continue to be a large percentage of our revenue mix but believe that gross margins will improve as we develop more efficient processes and scale within our sequencing instrument manufacturing.

Research and development expenses were $19.8 million in the quarter compared to $7.7 million in the third quarter of 2006 including $2.6 million and $1.0 million respectively in stock compensation expense.

The absolute increase in R&D dollars compared to Q3 of 2006 was primarily attributable to the inclusion of Solexa's research and development expense.

Excluding stock compensation expense, R&D expenses were $17.1 million or 17.6% of revenue compared to $6.8 million or 12.7% of revenue in the prior year period.

As a percentage of revenue, R&D expense is within the range of our long-term operating model and aligned to support the product opportunities in front of us.

SG&A expenses were $24.3 million for the quarter compared to $14.1 million in the third quarter of 2006.

Excluding stock compensation expense of $4.9 million and $2.4 million respectively, excluding this impact, stock related compensation expenses, SG&A was $19.4 million or 19.9% of revenue compared to $11.7 million or 21.9% 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 investments we made in our commercial infrastructure to support our revenue growth.

In spite of the incremental operating costs associated with the integration of Solexa's business, our non-GAAP operating profit for the quarter was at the higher end of our long-term operating model at 25.7% of revenue or $25.0 million.

This is compared to $19.0 million or 35.5% of revenue in the prior year period.

We continue to make great progress with the integration of the two businesses and are demonstrating our ability to leverage the combined resources and infrastructure of the merged Company.

On a sequential basis, we grew revenue by 15% over Q2 and increased our operating profits by 20% or $4.2 million.

Compared to Q1 we grew revenue in Q3 by 35% and operating profit by 57% or $9.1 million.

This clearly demonstrates the incremental leverage of the merger.

GAAP reported net income for the third quarter was $14.5 million or $0.24 per diluted share compared to $16.2 million or $0.32 per diluted share in the prior period.

Excluding the impact of acquisition related charges and stock compensation expense, we're pleased to report GAAP, non-GAAP net income of $19.9 million or $0.34 per diluted share compared to $19.9 million or $0.39 per diluted share in the third quarter of 2006.

Turning to the cash flow statement, we generated $5.3 million in cash flow from operations compared to $13 million in the prior year period.

The significant decline in cash flow from operations was primarily attributable to the increase in receivables due to the waiting and timing of the revenue recognition towards the latter half of the quarter as well as a higher percentage of European revenues which incur longer collection times.

This lag in timing of shipments during the quarter was attributable to both seasonality and the relative increase of instrumentation in our product revenue.

We used approximately $5.3 million in cash for capital expenditures during the quarter primarily due to manufacturing capacity expansion.

As you would anticipate given our receivables balance, our DSOs increase substantially to 75 days over the previous quarter measure of 62 days.

Going forward we expect DSO to fluctuate from quarter to quarter based on our mix of revenue from a geographic and product perspective.

Partially offsetting the increase in DSO for the third quarter we improved our inventory turns over Q2 from 2.7 to 3.2 growing our balance by only $2.3 million to $45.2 million.

I will now update our financial guidance for the fourth quarter and fiscal 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 123R.

I will provide an overall estimate of the FAS 123R expense at the end of my remarks.

For additional details, please refer to the table in our earnings release that reconciles our non-GAAP guidance with the related GAAP figures.

We expect fourth quarter revenue to be in the range of $100 million to $104 million which implies full-year fiscal 2007 revenue between $354 million and $358 million compared to our previous guidance of $335 million to $345 million.

This represents annual growth of approximately 92% to 94% over 2006.

In the fourth quarter we expect to see product and services gross margins improved modestly over Q3.

For the full year we continue to expect product and services gross margins in the mid-60s.

As we scale up our sequencing manufacturing operations and grow our installed base we expect to see increased consumables and overhead absorption improve our gross margins to the upper sixties over the next six to 18 months.

We expect R&D expenses to range from $64 million to $66 million and SG&A expenses to range from $79 million to $81 million.

Both amounts are at the midpoint of our previous guidance.

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

We will continue to work on various tax planning strategies particularly as we build out our international manufacturing capabilities.

And we 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 fourth-quarter non-GAAP net income to range from $19 million to $21 million resulting in earnings per share of $0.32 to $0.35 assuming fully diluted weighted average shares of $60 million.

This implies full-year 2007 non-GAAP net income of $69 million to $71 million which increases the midpoint of our previous net income guidance by $7 million.

This represents fully diluted earnings per share for the full year of approximately $1.17 to $1.20.

We expect annual stock compensation expense to be approximately $33 million which represents a pro forma tax adjusted amount of approximately $0.42 per fully diluted share.

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

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

Jay?

Good afternoon, everyone.

Given the results that we've reported over the first three quarters it's clear that we're on track to deliver another year of impressive financial results.

In Q3 we received record orders.

We grew revenue by 15% over the second quarter and increased sequential non-GAAP operating profit by over $4 million to $25 million or 25.7% of revenue.

As Christian highlighted, we're generating sequential operating leverage with the integration of the Solexa team and technology and we are extending the overall footprint of Illumina's product platforms throughout our markets.

To date we've made substantial progress in realizing the synergies before between the two companies but we believe that we are in only the earliest stages of what is possible.

Over the past several quarters I've described how the flexibility and scalability of our core technology has allowed us to build a product portfolio that spans the genome from the full sequence down to a handful of markers and target validations.

Our unique platform position will be enhanced with an increasingly broad family of applications and formats as well as becoming increasingly integrated.

At the end of last quarter, we announced that we had begun shipping the Human1M DNA analysis BeadChip, our newest MicroArray product that includes over one million SNPs in addition to proprietary copy number variation content developed in collaboration with deCODE genetics.

This product has rapidly become one of our best selling arrays with revenue in the quarter just behind that of the HumanHap550.

The HumanCNV370-Duo, a two sample chip that we began shipping in Q2, became our best-selling product in Q3 nearly eclipsing the Hap550.

In August, we announced the introduction of the HumanHap 550 duo which provides customers with the same content as the single in a multisample format.

By including two samples per chip with the same content as the Hap550, we've passed value onto our customers by reducing the handling and product cost per sample.

We began shipment of the 550-Duo during the quarter and expect to see the product ramp in Q4 and beyond.

Just last week we announced an agreement with the University of Virginia and the National Institute of Diabetes and Digestive and Kidney Diseases to process more than 6500 samples on the 550-Duo to identify genes associated with elevated risk for type 1 diabetes.

The rate of peer review publications using our technology has continued to accelerate into the back half of the year.

Year-to-date there have been 42 peer review publications for whole genome association, copy number variation and epigenetic studies.

Recently, researchers from the Institute of Cancer Research in the UK published a study in nature genetics in which they used our 550 BeadChip to identify three genetic variants linked to increased risk for colorectal cancer.

And last month researchers at the Feinstein Institute for Medical Research published their findings in the New England Journal of Medicine which uncovered genetic markers linked to the risk or rheumatoid arthritis that previously had not been found using alternative MicroArray technologies.

These exciting discoveries reflect the breadth of coverage, quality and analytical power of Illumina's BeadChip technology as well as our BeadStudio software analysis package.

In addition to our fixed content MicroArrays, our custom arrays performed very well during the quarter growing 71% over Q3 of 2006.

As researchers conduct increasing numbers of genome wide association studies we expect to find mapping and SNP validation work will grow significantly over the foreseeable future placing a premium on custom content and multisample options.

Our iSelect product line which allows up to 60,000 custom SNPs per sample and 12 samples per chip grew 72% from Q2.

Just last month we announced a large fast-track genotyping service agreement with Cancer Research UK in which we will genotype more than 15,000 samples for lung and ovarian cancer using both our HumanHap550 and iSelect BeadChips.

Over 4000 samples will be run on the 550 and more than 11,000 samples will be run as part of the validation work keeping the multisample and custom content flexibility of iSelect.

Shifting to be BeadXpress, we announced last month at our analysts' day that we had received orders for over 40 units and see strong demand in both academic and large pharmaceutical and biotech labs.

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

BeadXpress enables researchers to run up to 96 samples at a time while interrogating one to 384 markers simultaneously.

We announced in Q1 that we were consolidating our Wallingford, Connecticut facility were BeadXpress is manufactured into our San Diego site.

Due to the great effort by our teams, the consolidation is largely complete enabling us to ship our first BeadXpress units from San Diego in the third quarter and to begin ramping up manufacturing significantly.

Moving to our sequencing business, we announced during the quarter we shipped over 100 Genome Analyzers to date including the 14 that were shipped in advance of the Solexa acquisition.

We are obviously pleased with the initial success that we have seen with this platform but still believe that we have only begun to tap the product's potential.

As I have mentioned to you before we're seeing strong demand for the product across a broad range of customers.

More than half the units we shipped have been outside of the major genome centers to small and medium-sized research labs, agbio, biotech and pharmaceutical customers.

We view this as a validation of the inherent flexibility, ease-of-use and application diversity of the Genome Analyzer.

The hundredfold improvement in cost and throughput of next generation sequencing technologies vs.

traditional sequencing has created a new paradigm in the sequencing market.

Next generation systems are starting to democratize sequencing by removing the substantial sample prep infrastructure required to engage in large-scale sequencing and allowing the single researcher with a single unit to produce enough data to complete genome scale projects.

The Genome Analyzer enables this democratization through its simple sample prep, fully automated front end cluster station and high throughput of high-quality aligned data.

Over the next several months we are going to continue to increase the aligned throughput of the Genome Analyzer, the breath of (inaudible) applications available directly through Illumina and the overall performance of the system.

As I've mentioned before increasing the breath of applications on the Genome Analyzer is an important priority.

Our new paired end read technology is in beta testing in a number of customer sites and we are encouraged by those results.

This technology provides much longer range information than individual sequence reads and is key to detecting insertions, deletions and rearrangements in the genome.

Importantly, our technology for paired end reads does not restrict read length as the technologies from other companies do and also has much lower requirements for the amount of input DNA required making it much more amenable to analysis of scarce clinical samples such as those from tumor biopsies.

Last quarter we announced the commercial launch of two digital gene expression kits for the Genome Analyzer.

The first enables tag-based expression profiling and the second enables small RNA discovery and analysis for either none or novel transcriptomes on our existing sequencing flow cells.

We are continuing to develop application specific kits for new applications such as ChIPSeq for protein DNA-binding analysis and soon we expect to enable support for these in our BeadStudio software.

Our teams in Hayward and Chesterford have done a tremendous job ramping up our manufacturing capacity to meet the significant demand of the Genome Analyzer.

In fact, we have increased our sequencing instrument and reagent manufacturing throughput by 2.5 times since Q1.

However, as Christian mentioned, we have a ways to go to achieve the gross margin goals that we have for the Genome Analyzer system.

We have significant opportunity to improve procurement and supply chain logistics, increase manufacturing automation and lower the per unit overhead cost of the instruments.

Additionally, we're diligently focused on expanding our commercial infrastructure to ensure high-quality installation, service and support to assure that our customers' experience with the Genome Analyzer is unparalleled in the market.

I would like to take a moment to recognize a few management changes that we have had during the quarter.

In July, Kevin Harley joined our team as Vice President of Human Resources, a critical position given Illumina's growth trajectory and ongoing demand for top tier talent.

Just this month we promoted Richard Chan to Vice President of Assay Biochemistry and Reagent Manufacturing.

Richard brings a wealth of experience to his new role having managed the development of a number of Illumina's commercial assays in addition to our genotyping services business.

Also this month we are pleased to announce that Tim Orpin has joined Illumina as General Manager of Asia-Pacific and Japan.

Tim brings over 20 years experience in the life sciences industry and has held a number of senior level management positions in the Asia-Pacific region.

Finally, I'd like to thank Arthur Holden for the contributions he has made as Illumina's Senior Vice President of Corporate Market Development.

Arthur resigned from the Company last month to become the CEO of the Severe Adverse Events Consortium.

We wish Arthur much success in his new position.

Before I conclude, I want to take just a moment to update you on the wildfire situation in and around San Diego County.

Undoubtedly, you have seen images in the media of the destruction that's occurred and the impact that it's had on the county's residents, resources and infrastructure.

Our thoughts are with all of our employees, their families and our neighbors who have been impacted by these events.

We wish them our best and hope to see everyone get through this with as little loss as possible.

To date none of Illumina's facilities have been directly affected by the fires.

Our buildings are fully operational and our production lines are operating at near full capacity.

However, many of our employees live in areas impacted by the fires and many have been evacuated from their homes making it difficult for them to get to work.

It's possible that there may be a modest impact on production over the rest of the week depending on the progress in controlling the fires.

If we believe that our guidance becomes impacted by these events, we will provide you an update next week.

To connclude, as you can imagine we're once again quite pleased with our results.

More and more genome wide association studies are being announced and coupled with follow-on validation and [fine] mapping projects.

These further the strength of our core markets.

We're delighted at the uptake of the Genome Analyzer and look to extend the breadth of applications and technological robustness of the platform.

As we look forward, we are as excited as ever about the strength of our markets and the opportunities we have to continue to innovate around our core technologies.

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

(OPERATOR INSTRUCTIONS) Quintin Lai.

Congratulations on the nice quarter.

You may have mentioned it on the call but could you please update us kind of on the year-over-year growth for some of your gene expression and genotyping products?

We don't break down any growth numbers by product line.

So we didn't do that in the script and we're not prepared to give the product line numbers out.

How about qualitatively?

You didn't mentioned gene expression in your prepared remarks only the digital gene expression.

Yes, the expression product line continues to be a solid performer but it's a small part of the business so it's not something that we particularly highlighted this quarter.

Then with respect to the genotyping uses, as you are seeing like for example a new chip product like your CNV go to number one, is that because new customers are coming in and initiating projects or is it existing customers going back and trying to take a look at copy number now off of their old samples and starting to -- extension of existing projects?

I wouldn't say it's customers who have completed studies who are now going back and rerunning it just to get the copy number addition.

What it is, is increased usage by customers who are already using the Hap300 and now get the extension to CNV and obviously get the Duo component of that.

And also new customers who really like that CNV content and where the pricing of the Duo product is highly appealing.

Quintin this is Christian.

One of the things that is really -- the strategy is really paying off is that we have a suite of products in the Infinium line that people can use it like deCODE has been a big user of the Hap300 in the past because that fits their study requirements versus other customers using the 550-Duo and still further customers using the 1M.

So the diversity and the flexibility of the product line I think bodes well for us in terms of satisfying the entire market.

One last question and I will jump back in the queue.

I think that on the analyst day you helped stir up a little bit of buzz about your relationship with 23andMe and I know that a couple of media outlets have also kind of picked it up and ran with it, if you will.

And so I'm just wondering any kind of updates on when we might be able to hear some more official news coming out of that collaboration?

I think you will hear something before the end of the year.

So what I said at the analyst day remains appropriate and [as they plan] to launch their product before year and and I believe you will see that.

And once that happens then we will start talking more publicly about -- so our expectations surrounding that business.

Thank you and all the best to you and your families with the fire.

Ross Muken, Deutsche Bank.

Good afternoon, gentlemen.

As we look at sort of how these markets have developed and obviously you are seeing better-than-expected results across your platforms what sort of key surprises or things have come up either positive or negative in terms of the market development that has been different than sort of what you initially assumed?

And how should we think about that then in terms of going forward in terms of how -- what stage are we in, in terms of the relevant market development?

I think you are probably addressing mostly the sequencing market there.

And probably the thing that surprised us most is the rapid adoption outside of the genome centers.

We initially thought that while that would ultimately happen in the first year or so the genome centers would continue to be really the dominant place to sell these instruments.

And that's not been the case.

We said half of them are sold outside genome centers and this whole idea of customers being able to use a single system in making remarkable progress in sequencing things on a genome scale is something that they could have never done before.

So I think that's partly the reason for this market development and also a reduction in the sample prep.

So that has certainly been an upside surprise to us.

The other thing is that probably we estimate somewhere half of the customers have been using the sequencers for what we would call nontraditional sequencing applications.

So they tried out other things besides just traditional sequencing and probably somewhere between a quarter and a third of the customers are actually using the system for something other than traditional sequencing.

So that's been something we didn't quite anticipate would happen this quickly as well.

And my second question is for Christian.

I just wanted to clarify something.

In terms of the gross margin, the decline obviously as you said was not related to any sort of pricing differential in terms of genotyping chips or any of the other consumables or any sort of market share shift.

It's purely a function of the more sequencers you sell the more deflationary that is to gross margin.

Am I understanding that correctly?

Ross, that's absolutely the biggest driver of gross margin.

We do a detailed analysis of not only gross margin mix between the businesses but also within the different product lines we have different gross margin characteristics.

And so you saw in the quarter we said that we indicated that the array business was at 69% and change gross margin for the quarter versus 70% last quarter -- basically flat but a little bit down.

We did -- we are continually as we increase our feature sets we are evaluating price in each one of the different product lines and pricing the products accordingly.

But you see the price didn't really have a dramatic impact if you look at that business on its own.

So overall it really is the mix between sequencing and the array business.

But of course in any given quarter and this has been the same for the last eight quarters prices per sample have typically been going down.

But we have been able to do things like multisample, add more content to the chips.

Very consistent with our strategy of keeping the ASPs per chip as high as possible.

And then just quickly on the cash flow.

Obviously that kicked down this quarter because of the working cap and the accounts receivable build which I'm assuming is a function of the orders you are taking on some of the instruments.

How should we think about that sort of smoothing out over time?

Well I think if you look at all the other competitors in our industry, we have been so far ahead in terms of DSO kind of in the low 60s that -- you know, as we continue to expand our business globally, I wouldn't expect it to stay at 60 but I would think it would creep up towards 70 a little bit more.

This quarter was particularly challenging for us because we did have more orders at the end of the quarter for instrumentation as you saw how big the instrument revenue number was and those sales cycles are typically [weighted] until the third month.

The other element that we had going on is that we implemented a new ERP system in the quarter and in terms of focusing we had to spend a lot of time making sure that was done appropriately.

The beauty of that is now we're on one system worldwide which will make us more efficient and help our bottom line.

So we took a little bit of pain this quarter but I think we're going to see improvement from here.

One other factor in that equation is that as you recognize, I'm sure, the month of July and August particularly in Europe are very slow months where there's a lot of vacation time and even though our production is pretty linear, what we have found during that time is that customers would often delay their interest in receiving chips because they had a lot of people on vacation.

So what might have been 100% production line might have been operating only at 50% for the month of August.

And so we would shift of the number of chips in August and then shipped more chips in September.

And so that tends to have effect in Q3 to back-end load the shipments.

That's right.

Thanks for the clarification and congratulations on another phenomenal quarter.

Ted Tenthoff, Piper Jaffray.

Great, thank you very much and again my wishes for you you guys and your families.

I'm glad to hear everyone is doing okay.

Two quick questions if I may.

Firstly, what should we read into the service line this quarter.

I know you had some prepared remarks but is this a factor of more companies taking things in-house?

Is this some timing?

What is the current service capacity?

And just a quick housekeeping one.

Anything onetime in the interest income line?

I will take the services question.

I wouldn't read anything into the revenue number for the quarter at all.

That number bounces around quarter to quarter and it really is a function solely of when contracts cross the finish line.

And often -- we get large orders and be ready to execute on a contract and the samples won't arrive or they'll arrive a month late and so you don't start it at the time you thought you would start it.

And there's lots of these sort of timing effects that happen in that service business because we don't have full control over when the samples arrive.

And so you have to look at our service business on a moving average basis.

So I think that the way to think about it and you can create your own formula but it's a moving average of three or four quarters.

We're continuing to receive very large orders in the services business so we don't see any particular trend to doing less outsourcing and we think that business is going to continue to grow.

And over the next several quarters you'll begin to see an increased contribution from the sequencing services business as well as we start really bringing that online.

Christian, do you want to take the interest income?

Sure, you know on the interest income line we did have a little bit of favorable currency fluctuation this quarter.

The euro obviously moved a little bit and our operation in Europe is bigger than it's ever been.

But it wasn't material.

Thanks guys; great quarter.

Doug Schenkel, Cowen and Company.

I'm on a cell phone -- can you hear me all right?

Yes, very well.

Okay, great.

So despite [blowing through] guidance and consensus expectations at least what was published shares were trading off a bit in the aftermarket.

They're starting to come back a little bit so I guess you guys are doing a good job.

But I am speculating.

But one reason could be that the sequential growth rate incorporated to your guidance may look a bit conservative to some.

So I was hoping we could talk about that the little bit.

Is it wrong to assume that you guys are expecting a sequential slowdown in the number of Genome Analyzers you placed in Q4?

Is there something that bumped up your numbers a little ahead of what you expected just based on revenue recognition or are there other factors that led to what looks like certainly a lower conservative growth rate than we have seen in the last several quarters?

We certainly don't expect any reduction in the sequential growth of Genome Analyzers at all.

As I mentioned in my remarks we had record order receipts and we have every indication that markets are continuing to be very very strong.

One thing we do do as a Company is to try to smooth out our revenue so that we're not having huge quarter-to-quarter fluctuation in revenue.

And everyone should recognize that Q1 is typically the softest quarter in our industry and so we have historically been able to smooth right over that and we hope to be able to do that again.

Let me just kind of clarify.

Basically with the holidays coming, we can have some impact on the timing of when we actually deliver instruments whether it's into the fourth quarter or the first quarter.

We're really not trying to manage or smooth the revenue explicitly.

So you guys feel good about the pace of shipments based on what you have seen coming out of Q3 and just in general what's happening with the market and what may be perceived as conservativism may just be a function of timing on revenue recognition?

Would that be fair?

Yes, I think so.

I mean, I think that we, you know we have a pretty solid track record on delivering what we say we are going to do over the last few years here.

And you know we just are -- the market opportunity as Jay pointed out in his remarks is expanding in all directions for us for all of the platforms.

And so I think the opportunity set is there.

But you are right.

The timing of revenues recognized, it varies from quarter to quarter and in particular the fourth quarter with the holidays some folks shut down.

And just managing through that I think is critical.

And if you look at the growth we're looking at it's not too shabby [and] when you look at it on a year-over-year basis.

Absolutely, agreed.

That's very helpful.

Another question on the Genome Analyzer.

Among the customers who have been using the instrument for a quarter or two at this point do you have a sense for whether most are using multiple applications or are they typically using instruments consistently for one or two applications or maybe even just one?

And if so is it fair to assume that in the absence of paired end reads more work is being done on studies which require shorter read lengths and I guess methylation chip, maybe inserting it since it's short length resequencing?

What does that means for the outlook once you get paired end reads out there?

I would say that most of the installed base today is doing -- is sort of running one primary application and maybe a secondary application.

It's not too typical that people are swapping around applications between three or four different things.

What we do see is that after we install an instrument there is a period where customers are experimenting doing many things.

You know, they're using our prepackaged applications and in some cases they are working on novel approaches of their own.

And as we look forward to think with paired end reads I think it's probably definitely going to push the whole genome sequencing market much more so than we would see today using non-paired end read technology and that is the direction that the paired end reads will push the market toward -- whole genome and ultimately de novo sequencing.

Okay and are those -- are we still on schedule for a before year-end introduction of paired end reads?

We expect to, yes.

Last question.

It is an accounting one for Christian.

Given where the stock price has been recently and the potential for implementation by FASB of convert bifurcation is it too early or are we at a point where we should start thinking about share account and interest expense and the effect of that accounting change next year?

Well you know I probably don't want to address it too much today until the rules get finalized.

You know the way the rules are being proposed right now it could have an impact on us in 2008.

But I want to wait until the dust settles before I really gave guidance.

I expect -- based on what I am hearing from our auditors I would expect the rule to get finalized before year-end and therefore I would probably have some remarks for you on our fourth-quarter earnings call.

Okay, thanks a lot guys.

Great quarter and the be safe.

May-Kin Ho, Goldman Sachs.

Hi, Jay.

You mentioned that with the fire there could be some impact and you might have a better assessment next week.

If indeed there is an impact where would it likely be?

Is it the manufacturing side of things or shipment?

Yes, it would be all in BeadChip manufacturing.

So we run our factory as you may recall 24-7 and right now our building is fully operational.

We haven't had any power problems but there is power out in major parts of San Diego.

Most of that is still in the residential areas so we haven't had that impact.

The biggest potential impact is just in our labor force showing up for work.

We have had an extraordinarily large number of employees who have been evacuated from their homes.

And while that's been the case, we've still had a great turnout in terms of people actually getting to work.

What we do worry about is depending upon how the progress of these fires go that we may have less than optimal percentage of our workforce here and that could modestly impact our ability to produce BeadChips.

So far, we don't think it's an impact and our teams here, John Stuelpnagel, our COO and Dave Douglas our VP of Manufacturing have done a phenomenal job of keeping the factory running and doing that at virtually full capacity.

So far we're looking good but we just wanted to put that out there to make sure that if anything negative did happen that we would update you guys next week.

And the Genome Analyzer -- if you kind of think about the backlog would you be okay there?

That's manufactured in Hayward so, it's not impacted by the fires.

Well our best wishes to you and your crew there.

Thank you, May-Kin.

Un Kwon, Pacific Growth Equities.

Good afternoon.

I was wondering first of all qualitatively would you be able to give us an idea of how meaningful iSelect is as a component of your BeadChip volume?

How could I characterized that?

It's certainly an increasing component so we grew very rapidly in the quarter somewhere in the range not quite -- probably 70 to 75% growth in the quarter.

So it's coming on very strong.

To some extent it will over time cannibalize the Goldengate assay although Goldengate continues to be significant component of the business.

It's a growing percentage.

So do you anticipate that to continue into next year?

I think it will.

One thing you should look at is some of the press releases we have put out.

A lot of the news or the deals that are getting done these days have a whole genome association component and then moving straight into kind of an iSelect or custom genotyping project.

This is really where we have a pretty significant competitive advantage over our competitors because they don't really have these kinds of offerings and I think our customers recognize that.

Okay and is it fair to say that the gross margin on this product line is higher than your other products?

Your other BeadChip products?

They're very good.

In most cases they are at the high end of the BeadChip price range (inaudible).

Thanks.

And last quarter you had given an indication of new orders that you recognized.

Are you prepared to give similar metrics this quarter?

By new orders you mean the actual orders that were booked?

Right, that you hadn't yet recognized.

No, we're not going to give those numbers out every time.

We don't want to create effectively a duty to update those.

So all we said this quarter was that we had record orders.

We want to leave it at that.

Okay and just lastly any color on geographic mix?

Europe is becoming a bigger and bigger percentage.

I think one of the things that -- when Jay was answering the question regarding the sequencer business and what surprises -- I think one thing that's interesting to me is that the geographic mix is really global.

And the good news is that we have an infrastructure to support truly global business.

So what we are seeing is an increase in revenue coming out of Europe, out of Asia and you know the US obviously is still continuing to grow.

But we are seeing Europe in particular starting to pick up percentage points.

Matt Scalo, Canaccord Adams.

Hi, guys.

Just wanted to follow up on the iSelect and talk about maybe turnaround times on the custom arrays versus as you pointed out a little bit on the Goldengate assays.

Can you talk about improvements that you have made there over the last quarter or two?

You mean turnaround time?

Correct.

Well typically we would get a customer inquiry once we locked in the transactions.

Then we go into a period where we are designing the [loci] that somebody wants to put on the chip.

Depending upon the customer that could take a week if they have most of it together and they're just going through our design software or sometimes it can take many months depending upon how sophisticated the customer is and how much research has to be done in defining the SNPs.

So that process is highly variable.

Once we have actually got the SNP list then it is typically somewhere between four and eight weeks before we are delivering chips and that will depend on the complexity of the chip that they order.

I assume it's priced as you mentioned prior to kind of protect margins?

Yes; the price is determined upfront based on how many SNPs per strike that they plan to order and how many chips overall because clearly the price per chip goes down for a greater number of samples.

So if somebody commits to 5000 samples, the price would be much lower than if they committed to say 3000 samples on that chip.

(multiple speakers) the other thing I should point out is that we are building some standard versions of these products as well for consortia.

So we talked a bit about what we have done in the bovine area where we've actually manufactured these chips for consortium and have the right to sell them broadly.

So now we are selling the iSelect products that have been made through these groups as catalog sales.

Okay, that's helpful.

Thank you.

Then just the last question.

As far as you mentioned paired end reads in beta right now.

Can we talk a little bit about extending the read length?

Are we at beta stage on moving say from 35 to 50 base pairs?

We are running longer reads internally and in fact some of our customers are going out beyond 35 bases as well.

And the system is certainly capable of doing that.

It's really just a fact of where you begin to make your -- where you want to make your cutoff in terms of error rates.

So we are working on increasing the read length.

However, as we line up the priorities of the system in terms of what the customers need and what's most important to overall productivity, it isn't actually in read length.

It's much more important that we get paired ends to the market.

It is much more important that we focus on improving the overall throughput.

And the actual read length is less significant in that equation.

John Sullivan, Leerink Swann.

Good afternoon.

A couple of just real quick ones here.

Can you speak qualitatively about the priorities in R&D as you look forward?

I'm wondering do you anticipate higher density arrays or do you anticipate arrays with more parallel sample processing or is more a priority for R&D spending at this point applications and improved productivity in the sequencing part of the business?

Where do you anticipate your biggest priorities in R&D to be a going forward basis?

Thanks.

It's a pretty balanced portfolio John.

We talk about the businesses separately in the array business.

We are certainly focused very heavily on creating new applications and we just announced the Micro RNA product and you'll continue to see us announce new ways to use our technology from an application perspective.

At the same time we are continuing to focus on both content and numbers of samples as a way to improve the value to the customer and to increase overall efficiency and reduce our costs.

So that's sort of a broad program that we have going across many fronts.

The portfolio from an R&D perspective is reasonably well balanced between arrays and sequencing.

On the sequencing side, we're focused both on applications and on fundamental technology improvements.

The technology improvements are mostly in two areas -- paired end reads is a critical one and the second is just improving the overall throughput of the system through lots of different approaches some of which we talked about at our analysts' day.

Sure, okay, great.

And then could you just update us on a corporate issues that you brought up a couple of times that you have a lot of open job opportunities for people in sales and application support and things like this surrounding the sequencing business.

Are you seeing more candidates that you like and can you just update us on that issue as you face it?

Yes, I think we're doing pretty well there.

We have had most of the reqs that have been open for more than four to six weeks have gotten filled.

So I would say we're doing okay.

As we look forward we do have a lot of additional reqs that will open up over the next six to nine months.

So we internally -- we're very focused on putting together a talent acquisition program to make sure that we have multiple channels from which to get these candidates both from other companies in the marketplace but also beginning programs that develop that talent internally to make sure that we have enough to fuel the pipeline.

So you feel like especially as you continue to grow the universe of installed base of sequencers that you have the capability to meet the demanding service needs of clients in sequencing?

I think we are okay.

We are little behind the curve four or five months ago.

I think we have gotten better and today I would say we're okay.

I think over the next couple of quarters, we will do better than okay in terms of response times and having enough people available with the large customer sites.

So I think we are in good shape but we are -- our goal is to get better than we are today.

(OPERATOR INSTRUCTIONS) Zarak Khurshid, Caris & Co.

Hi, Jay, Christian and Peter; nice quarter.

Can you break out the sequencing revenue in the quarter and if you could give us the split between sequencing instruments and sequencing consumable revs?

No, we're not going to do that.

Okay, I thought I would try.

You didn't talk about BeadStations being a record level this quarter like last.

Were sales down sequentially and if so could you perhaps quantify that?

I would say BeadStations were about at the same level as we had last quarter (multiple speakers)

It seemed as though there was a little more emphasis on BeadXpress this time around.

On a dollar basis, were those sales greater than the Genome Analyzer this quarter?

No; the average price of the BeadXpress is less than a quarter -- it's about 20% of the price of the Genome Analyzer and so I don't expect anytime in any foreseeable future that BeadXpress will pass the Genome Analyzer.

But the BeadXpress is starting to ramp up pretty significantly.

So shipments went up significantly in Q3 over Q2 as we are building out our manufacturing infrastructure.

We are fully operational now here in San Diego and so we expect to begin to really continue to drive the shipment side it.

We have built up a pretty substantial backlog and we are working to wittle that down now.

Great.

Then a couple of follow-ups.

What will the fully equipped Genome Analyzer with paired end reads sell for -- going forward?

It's going to be in the range of $450,000 to $500,000.

And then I am assuming the upgrade cost for the existing customers would be somewhere in the order of $100,000 or so?

Yes, we have a couple programs that will be working with customers to get them upgraded to paired ends.

Our current view is that most customers are going to do that upgrade, that paired ends are going to be the dominant way people view sequencing on this machine.

And I think in terms of the incoming order received rate it clearly reflects that.

We have probably got close to three-quarters of our installed units already interested or having placed orders.

Does the annual consumable use per instrument also reflect that paired end read ramp in throughput?

I'm not exactly sure what you mean by the question.

But a paired end read takes longer time to run.

[It measures] consumable on a per day basis.

The paired end doesn't in and of itself doesn't have a significant impact.

The biggest impact on consumables is just getting these machines into production and running 24-7.

Go it.

Great.

I realize it's early days but could you quantify the sales cycle currently in sequencing and the timing between order shipment and revenue recognition?

And then lastly where are we with respect to off-shoring of some of the manufacturing?

Thanks.

Okay here are some qualitative measures of that.

So sales cycles are typically running four to eight weeks.

So couple of months is a typical sales cycle on a sequencer.

Delivery times are running in the four to eight weak window, some a little sooner and some a little longer depending upon what the customer wants and how ready their lab is to receive the instrument.

So I think we are doing really well in our ability to produce the units and to deliver the customer expectations.

So we don't have large numbers of customers that are distressed about the long delivery times.

So we're doing pretty well there.

Lastly, with respect to the other larger player in NexGen sequencing entering the marketplace what do you see as the biggest hurdle for you competitively versus them?

Thanks.

Clearly, our competition in the market has a much larger presence than Illumina does and that's probably the single biggest factor.

We have moved very rapidly here.

We think we have the first mover advantage.

We're continuing to push that very rapidly on both the technology dimension but also in a rapid buildup of our infrastructure.

We continue to believe that the ability to couple together our array technology with sequencing technology in increasingly integrated ways is going to be a strategic advantage for the Company and hopefully that will make us a significant player.

Ted Tenthoff, Piper Jaffray.

Thank you.

I just want to follow-up and double check if there has been any update on the patent suit and when the next phase will get started?

The update from the recent hearing was that the next phase of the trial will begin on February 11.

That phase will include invalidity only and so any other open issue will be pushed on to some third phase which is not currently scheduled but is expected to be somewhere in the May to July time frame.

Operator, are there any other questions?

There are no further questions and now I'd like to turn the call back over to Mr.

Peter Fromen for closing remarks.

Thank you, operator.

As reminder a replay of this call will be available in webcast format in the investor section of our website as well as through a dial-in through the dial-in instructions contained in today's earnings release.

Thank you for joining us today.

This concludes our call and we look forward to our next update following the close of the fourth quarter.

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

This concludes the presentation.

You may now disconnect.

Have a good day.