Illumina Inc (ILMN) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter, 2009 Illumina Incorporated earnings conference call.

I will be your coordinator today.

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

We will conduct a question-and-answer session towards the end of the conference.

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

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

Peter Fromen, Senior Director of Investor Relations, sir, you may proceed.

Thank you, operator.

Good afternoon, everyone, welcome to our second quarter 2009 earnings call.

During the call we will review our financial results released today after the close of the market, offer commentary on our commercial activity and provide financial guidance for the third quarter and fiscal 2009, after which we will host a question-and-answer session.

If you have nod had a chance to review the earnings release it can be found in the Investor Relations section of our Website at Illumina.com.

Presenting for Illumina today will be Jay Flatley, President and Chief Executive Officer and Christian Henry Senior Vice President and Chief Financial Officer.

This call is being recorded and the audio portion will be archived in the investor section of our website.

It is our intent that all forward-looking statements regarding financial guidance and commercial activity made during today's call will be protected under the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are subject to risks and uncertainties, actual events or results may differ materially from those projected or discussed.

All forward-looking statements are based upon current information available and Illumina assumes no obligation to update these statements.

To better understand 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 want you to know we'll be participating in Thomas Weisel Health Care Conference in Boston from September 7th to the 9th The Morgan Stanley Health Care Conference in New York on September 14th through the 15th and the UBS Global Life Sciences Conference also in New York from September 21st to the 24th.

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

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

Good afternoon and thank you for joining us today.

During today's call I will review our Q2 financial results and provide guidance for the third quarter and full year fiscal 2009.

Dave will then discuss our commercial progress and provide update on the state of our business and markets.

We recorded 162 million in total revenue for the second quarter, representing 15% growth over Q2 of last year.

Products revenue was 153 million growing 19% over the prior year period and was led by significant growth in our Sequencing Products.

However, as we disclosed in our conference call earlier this month, this growth was partially offset by a decline in the Micro Array business due to a slow-down in the market for Genome Wide Association studies.

Consumables revenue for the quarter was 97 million compared to 82 million in Q2 of 2008.

This represented year-over-year growth of 18% and was directly attributable to growth and Sequencing Consumables partially offset by lower Micro Array consumables.

The rapidly expanding install base of Genome Analyzers pushed sequence in consumables revenue to record levels growing 174% from the second quarter of last year and 20% sequentially.

Just as in Q1, the annualized consumable pull through on Genome Analyzer during the quarter was above our anticipated range of 150 to 200K per system.

Consumable pull through for the Array business remained in the range of 500K to 600K per system.

We shipped a record number of Genome Analyzers during the quarter which enable us to recognize instant revenue of 54 million, a new high for the company.

This compares to 43 million in the second quarter of 2008, and represents year-over-year growth of 25%.

Services and other revenue which includes Genotyping and Sequencing Services, as well as instrument maintenance contracts was 8 million, compared to 12 million in Q2 of last year.

The year-over-year decline in services was largely due to the overall decline in Genome Wide Association studies but due to the fact that more of Genotyping Service revenue has moved to our CSPro Certified customers.

As mentioned before, services revenue are not expected to grow in line with the product business because of the shift.

From a gross margin perspective however, we are relatively indifferent to this transition as our product gross margins are similar to our internal service business.

Before discussing our gross margins and operating expenses for the quarter, I would like to note that we recorded a pretax amount of $15 million related to non-cash stock-based compensation.

This impacted our EPS by a tax adjusted amount of $0.08 per pro forma diluted share for the quarter.

In my discussion of operating expenses, I will highlight both our GAAP expenses, which includes stock compensation expense, and other non-cash charges, and the corresponding non-GAAP figures.

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

Total cost of revenue for the quarter was 50 million compared to 57 million in the second quarter of 2008.

The Q2 '09 cost include stock-based compensation expense of 1.3 million compared to 1.4 million in the prior-year period.

Excluding this expense and 1.7 million associated with the amortization of intangibles, non-GAAP gross margin was 70.6%.

This compares to 68.3% last quarter and 65% in the second quarter of 2008.

A sequential improvement of over 200 basis points and a year-over-year improvement of over 500 basis points.

Both sequential and year-over-year gross margin gains resulted from significant cost reductions and production efficiencies generated primarily within our Sequencing business.

The key contributors of this gain included, first, we continued to recognize gross margin benefits from our reformulated Sequencing Kits that we launched in the third quarter of last year.

Not only is the gross margin on these kits higher than the prior year, our Sequencing Reagents are becoming a larger component of overall revenue which positively impacts the corporate gross margin.

Second, during this quarter we launched a new software package that substantially reduces the computing power required for processing GA data.

This is enabled us to eliminate significant computer hardware that previously shipped with the system.

And, thirdly, our supply chain and cost reduction initiatives reduced the raw material costs of the system.

Finally, we increased volumes across the Sequencing business and this improved our overhead allocations.

These improvements have resulted in a Sequencing Product line whose profitability is now approximately equal to that of our Array business.

During the quarter the gross margin benefit from our Sequencing Product lines was partially offset by a reduction in consumable volume from our Micro Array consumable.

It should be noted that ASPs in both Sequencing and Micro Arrays were stable in the quarter which also favorably contribute to do the strong gross margin performance.

Research and development expenses were 33 million in the quarter compared to 23 million in the comparable period of 2008.

And included 5 million and 3.4 million respectively in non-cash stock compensation expense.

Excluding stock comp expense, and 0.9 million of accrued contingent compensation associated with Avantome, research and development expenses were 27 million or 16.8% of revenue, compared to 20 million or 14.3% of revenue in the prior-year period, and 25 million or 15.2% of revenue in the first quarter.

The increase in sequential and year-over-year research and develop spending was attributable to increased head count and increased project activity.

SG&A expenses were 42 million compared to 36 million in the second quarter of 2008.

Including stock compensation expense of 8.6 and 7.4 million respectively.

Excluding these non-cash expenses, SG&A was 33 million or 20.6% of revenue, compared to 28 million or 20.1% of revenue in the prior-year period, and 34 million or 20.5% of revenue last quarter.

The sequential decline in SG&A spend was primarily attributable to lower legal expense during the quarter, and the year-over-year increase was the result of added head count.

GAAP operating profit for the second quarter was 36 million.

Excluding non-cash expenses outlined above, our non-GAAP operating profit for the quarter was 54 million or 33.2% of revenue, compared to 43 million or 30.6% of revenue in the second quarter of last year.

This represents year-over-year operating profit growth of 25% versus top-line growth of 15%, indicative of the leverage the business generated during the second quarter.

GAAP interest and other expense in the second quarter included approximately 4.8 million in non-cash interest expense associated with FSPAPB14-1 Accounting for Convertible Debt.

Excluding this amount, pro forma interest and other income was 3.7 million, of which approximately 2 million was due to foreign currency reevaluation of monetary assets held outside of the United States.

This resulted in approximately a $0.01 of FX related gains.

As a reminder, following the end of the first quarter we began the implementation of a hedging program to mitigate the FX impact to monetary balance sheet assets in our major functional currencies.

Our non-GAAP tax rate for the quarter was 31.2%, compared to 32.8% last quarter.

Our effective tax rate is driven primarily by ramping of shipments out of our Singapore facility.

As a matter of fact, this quarter both the quality and the yields of products manufactured in Singapore were again comparable to that of our San Diego factory.

We reported GAAP net income of 25 million or $0.18 per diluted share, compared to 13 million or $0.09 per diluted share in the prior year period, excluding the impact of non-cash stock compensation expense, non-cash interest expense associated with the adoption of FSPAPB14-1 and the other items identified in our press release and net of pro forma tax expense, non-GAAP net income was 39 million or $0.30 per pro forma diluted share compared to 27 million or $0.22 per pro forma diluted share in the second quarter of 2008.

This represents 43% growth in net income on a year-over-year basis.

Moving to cash flow and the balance sheet we generated 39 million in cash flow from operations during the quarter.

We had capital expenditures of roughly 14 million and this resulted in free cash flow of 25 million or $0.19 per pro forma fully diluted share.

This compares to the second quarter of last year when we generated $0.11 of free cash flow per share.

Accounts receivable DSO were 86 days during the second quarter which is up from last quarter, as well as the second quarter of 2008, due to a lower percentage of shipments during the first month in the quarter.

Depreciation and amortization expenses for the quarter were approximately 8 million and we ended the quarter with approximately 790 million in cash and investments.

I'd like to now provide financial guidance for the third quarter and full year of fiscal 2009.

As a reminder, we will exclude the charges associated with the adoption of FSPAPB14-1 which requires us to record incremental non-cash interest expense related to our convertible debt.

Consistent with our previous calls guidance will exclude other certain non-cash charges including stock compensation expense related to FAS 123(R), the amortization of intangibles and acquisition related charges.

For additional details, please refer to the table in our earnings release that reconcile our non-GAAP to GAAP figures.

As we indicated in our preliminary announcement we have reset our expectations for 2009 back to the initial guidance we provided at the beginning of the year.

Currently we expect total revenue for 2009 to be between 690 and 720 million.

This represents growth at the midpoint of approximately 23%.

We expect gross margins for the full year to fall in the upper 60s.

We continue to expect non-GAAP earnings per share to be between $1.13 and $1.23.

This assumes pro forma fully diluted weighted average shares of approximately 133 million.

We expect non-cash stock compensation expense for the year to be approximately 62 million or $0.31 per tax adjusted pro forma diluted share.

As a reminder, the pro forma diluted shares calculation excludes the double dilution resulting from the accounting impact of our convertible debt.

The Q2 impact on shares is included in the reconciliation to GAAP figures that accompanies today's press release.

We continue to expect non-GAAP annualized tax rate of approximately 33% for 2009.

Our actual tax rate will be highly dependent upon the shipments made out of our Singapore manufacturing facility to international locations.

We expect capital expenditures for the full year to be approximately $50 million.

For the third quarter we expect revenues to range between 162 and 172 million.

Which represents year-over-year growth between 8 and 14%.

We expect third quarter non-GAAP earnings per share to range from $0.26 to $0.30, assuming pro forma fully diluted weighted average shares of approximately 135 million.

We expect non-cash stock comp expense for the quarter to be approximately 16 million or $0.08 per tax adjusted pro forma diluted share.

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 session.

Jay?

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

As I reported to you a few weeks ago our top line performance for the second quarter was a disappointment.

Having said that, we were very pleased with our overall operational and financial execution which enabled us to achieve our high end of EPS guidance.

Our revenue shortfall resulted from several factors, the most important of which was a faster than anticipated slow-down in our Array business.

Additionally we believed the stimulus plan had a negative short-term impact on both Sequencing and Micro Array orders as customers wait to learn whether and to what extent they will receive stimulus funding.

Finally, we saw some impact in a few select accounts from reductions in endowment funding.

Operationally, manufacturing cost reductions and significant production efficiencies enabled us to improve gross margins by over 5 percentage points relative to last year.

Prudent management of SG&A expenses resulted in operating margins 2.5% higher to over 33% while maintaining a significant R&D investment to drive innovative new products a number of which we launched in Q2.

In the Micro Array business we reported lower revenue sequentially and year-over-year.

We experienced a more significant impact in the Array business than we had anticipated largely a result of some researchers taking a pause from Genome Wide Association studies to wait for next generation content.

The rapid decrease in cost of Sequencing is enabling discover of rare variation in the Genome, which once incorporated on Arrays will provide dramatically increased power for making due to these associations.

To put this in perspective, at the [Coal] Spring Harvard meeting in May, the 1000 Genome Projects disclosed that they had identified over 11 million new snips from the Sequencing Data generated thus far.

It is highly probable that significantly more snips, structural and copy number variance will be identified when the project nears completion later this year.

This last quarter we launched the Omni 1 Quad, the first commercial Micro Array to include rare varying content from the 1000 Genomes Project.

A four sample chip of over a million markers per sample, the Omni includes updated content for all major classes for genetic variation in addition to 100,000 variants from the 1000 Genome Project.

The Omni Quad began shipping at the end of the quarter and has already come our third highest value Array in shipment dollars.

We are very optimistic about the future of the Array business and believe that the new generation of content will create a second round of association studies that will require increase sample numbers for statistical significance.

Our models of this business expected to be approximately flat for the next several quarters and then begin to accelerate again in 2010.

We continue to improve the capabilities of our low complexity Micro Array Products.

Following the end of the quarter, we launched multi sample indexing or MSI for short, for our Golden Gate assay which enables researchers to run 16 times more samples per reaction as with our standard Golden Gate assay.

For example, if a researcher were using our recently launched 32 sample Universal Bead Chip they can now screen up to 512 samples on the same chip using less reagents.

MSI allows sample pooling with automation and sample tracking through our (inaudible) software.

This enables high volume labs to increase their throughput while substantially reducing per sample cost.

We believe that MSI will be ideal for high throughput customers running low complexity screening validation and quality control applications in commercial agricultural and academic markets.

Our Bead Express Reagents were also a strong performer this quarter.

The Q2 analyzed consumables pull through on the platform exceeded our forecasted maximum of $100,000 as we recognized record shipments and orders of VeraCode Consumable Kits with particularly strong demand coming from the Ag bio market.

We once again shipped a record number of Genome Analyzers in Q2 and continue to see a ramp in consumable with the annualized rate again exceeding $200,000 per system.

We continue to see broad adoption of the Genome Analyzer with over 80% of systems shipped outside the major Genome Centers.

Additionally, we are successfully migrating our install base of Genome Analyzers to the GA-2 X configuration that we launched last quarter and have taken orders for well over 200 upgrade kits.

During the quarter, we launched several new software advancements for the Genome Analyzer.

We released new version of pipeline software which allows us to read more clusters per lean of a flow cell and when combined with GA-2X upgrade increases customer through put by 65%.

This releases is one of the components in our roadmap to generate 95 [gig] basis of throughput per run that we presented in AGBT earlier this year.

We continue to make great progress against this goal.

In fact, internally we're producing runs that exceed 55G using established work flow and expect to achieve 95G by year end with that same work flow.

What's exciting is that the improvements we're making, our software and reagent related related which makes implementation in the field very straight forward.

We also launched a Windows based interface to our Sequencing Pipeline software that simplifies management of the data processing for smaller non-LINUX based labs.

Additionally, we launched a new package we call RTA that enables real time analysis of Sequencing Data during a run.

As Christian mentioned to you earlier, RTA also reduces the compute requirements for the platform and has allowed us to remove the [iPar] computing module from the Genome Analyzer.

This transition has eliminated a significant component of cost improving gross margins on the platform.

Also this quarter, we launched our personal Genome Sequencing Service.

This service will provide whole human Genome Sequencing at 30 times coverage to customers at a price of $48,000.

This service has been enabled by the rapid reduction in the cost of whole Genome Sequencing and our expectation that this trend will continue.

Consumers will be engaged with a physician or medical geneticist throughout the process and data are delivered back to the physician.

The consumer will have the ability to select secondary data analysis through one of your partners to understand their risk for certain diseases, their genetic ancestry and other traits of interest all of which can be discussed with the customer's physician within the Illumina network.

While we don't see this as being a material revenue opportunity initially, as the cost of whole Genome Sequencing declines and the genetic understanding of disease and prevention increases, there is no question that this will become a significant component of how individuals and physicians manage health care going forward.

At the same time that we announced our personal Genome Sequencing we also announced that we will conduct this service in our newly certified CLIA laboratory.

As many of you know, CLIA certification was one of the first steps in the service component of our broader diagnostic strategy.

With respect to other components of our diagnostic strategy we expect to submit the BeadExpress platform for 510-K approval before year end.

In our cancer Sequencing Program we expect to begin data analysis on the first set of Sequenced samples beginning in the third quarter.

Before I conclude I want to update you on what we're seeing with regard to stimulus funding and related commercial activity.

As we mentioned to you earlier this month our revenue guidance now includes the potential impact of stimulus.

We're seeing more than double our normal quote activity and believe that next generation Sequencing will be a material beneficiary of incremental funding both in the Genome Centers and in smaller labs.

We're also seeing significant stimulus activity around customer content Arrays as researchers look to conduct fine mapping and validation work on existing data from Genome Wide Association studies.

While the aggregate revenue potential from the stimulus is challenging to quantify the timing is even more difficult to forecast.

Consequently we provided a much broader range of revenue guidance for the third quarter than is typical.

Depending upon the grant approval process it's possible that we could begin to see some stimulus benefit during the third quarter although we're more likely to recognize material impact during Q4.

Other than the near-term slow down we're seeing in the Genome Wide Association portion of our Array business our markets are healthy and growing rapidly.

We continue to see significant Micro Array opportunities within the AG bio, fine mapping and custom content segments of our business.

Operationally we've continued to make great strides in reducing our costs of manufacturing and approving efficiencies as our business scales.

With a market leader in both next generation Sequencing and Micro Arrays and believe that the overall funding environment for genetic analysis has likely never been better.

The next few quarters will reveal how the market will allocate incremental funding as well as the inter play between next generation Sequencing and Micro Arrays.

Given that we have now achieved parity and profitability between Sequencing and Micro Arrays we're relatively indifferent to the mix of orders between these technologies.

Our rate of innovation and product development has never been more exciting and we expect to continue to drive growth through new market and product opportunities over the next few years.

Thank you for your time, and we will now open the lines for your questions.

(Operator Instructions).

And your first question comes from the line of Ross Muken with Deutsche Bank, you may proceed.

Good afternoon, gentlemen.

Hi, Ross.

Hi, Ross.

Jay, I want to talk, first, about sort of the sequential ramp of revenues as they're sort of expected.

It seems now as if there is a bit of stimulus assumed in the fourth quarter given the delta and acceleration quarter-over-quarter versus 3Q.

Can you kind of go through -- I know you pointed to the areas and quota activity, the level of confidence you have in sort of that uptake, is it going to be a function of just the general markets accelerated, or are there certain pockets or orders or certain grants that hit then that give you a high degree of confidence?

Just try to walk us through the methodology how you solved that initial ramp and the timing aspect is a challenging one.

Yes, it is.

We hope to see some stimulus orders in Q3.

We're not sure what that magnitude might look like, so we've taken a cautious approach to our guidance and given a wide range.

As I mentioned on the call earlier in the month, one particular dilemma is that the government fiscal year ends on September 30th and our quarter ends on September 27th.

There is a significant push from the NIH and from the Federal Government to get stimulus money into this system before the end of the government fiscal year which is September 30.

The degree of our impact in Q3 will depend significantly on the exact timing of how that money gets allocated and when the orders actually start appearing.

If they begin to appear in August and September, we'll have some material revenue from those.

If it at all happens in the last week of September, we would very likely have little to no impact from that revenue.

We're very optimistic that we'll begin to see stimulus impact in Q4, and so you'll see, if you looked at our annual guidance and our Q3 guidance, that we do have some stimulus impact built into the fourth quarter guidance that we're highly confident of and these are orders that are in our pipeline, where we're getting feedback from researchers, that they're being awarded high scores.

We're hearing some of the groups getting scores back on their grants.

So that is a very positive trend and one we're confident in, in the fourth quarter.

I guess my one other sort of follow-up on just sort of the guidance.

You talked about sort of the trajectory of the Array business sort of being flattish after being down this quarter, and then reaction sell rating.

Could you just sort of walk through the milestones and the time line in terms of the completion of the 1000 Genome Project, the time to get sort of content on the chips, and then when you think this new study work starts, and do you think it starts sort of as you roll out obviously with the Omni 1 Quad having success, before we have sort of full content from 1000 Genome Chips or do you think there needs to be some sort of significant magnitude of increase rare content on the chips to really get the market going again?

Yes, as I mentioned before, our expectations is that we're going to have a full range of behaviors from our customers here.

We'll have some customers using Array that we had historically in the product line, 610 and 660 and in some cases 1M duo, we're seeing significant adoption of the Omni so there will be some some numbers of customers that believe there is incredible opportunity to get low hanging fruit off the Omni with the rare variant content that we have on that ship.

So studies will start in some customer labs based on our launch of the Omni Chip and we're seeing that already.

The first bolus of content has already come from the 1000 Genome Program, and we're partnered with a number of the very direct participants of this program to begin to sift through the snips that they are discovering and to determine which ones of those are the most important ones to put on our next version of a chip.

That will take a little bit of time, because we want to get the content right, the researchers wander to get the content right.

And so I suspect over the next couple of quarters there will begin to become some clarity around what that content wants to look like and then there will be some period of time for us to manufacture a chip and get it into the hands of those research groups.

We have already seen some stimulus money put in that we think has a very high chance of being awarded to help subsidize this effort on the part of the research groups so they would buy these chips as they come out with higher percentage of rare variant content.

So I think in the first half of 2010, you will begin to see this array opportunity reaccelerate.

Thank you, Jay, I appreciate all of the comments.

My pleasure.

Your next question comes from the line of Doug Schenkel with Cowen and Company.

You may proceed.

Hi, guys.

Good afternoon.

Hey, Doug , how are

Good, thanks.

So I'm still a bit astounded by your gross margin performance in the quarter given that you did come up short of your earlier revenue expectations.

You did provide a good amount of color in your prepared remarks on this, but I just want to see if I could dig a little bit deeper.

I thought that consumables on iScan and BeadReader had a gross margin with at least a few points higher than Sequencing Consumables.

Is this no longer the case, and beyond that is there any reason to think that the COGS improvement seen in the quarter are not sustainable moving forward?

No, Doug, this is Christian.

We were actually obviously quite pleased with the gross margin in the quarter.

This is really just the evolution of a long list of improvements that we've been making to the whole Sequencing platform over the last basically two years.

And it really all started -- it all started last fall with the new reagent kits that we reformulated.

And so that -- by putting those together we were able to take a lot of costs out and drive those gross margins up, and then we've been able to drive the instrument gross margins up through continually improving the system, and then this quarter we had the major software release that we call RTA, that helped us eliminate a major component of hardware that we used to ship along with every system, and that dramatically reduced the COGS and gave us a big lift.

The other piece to think about is overall ASPs in Sequencing have been pretty consistent.

I know it's a competitive market, but we've been -- we've been able to do a very good job of keeping ASPs where they need to be, and that help drive the margin as well.

So at the end of the day, as Jay pointed out, the Sequencing gross margins now are basically a parity with the Array margins, and going forward, obviously priced ASPs drive a lot of your gross margin from quarter to quarter but we still see opportunities to take further costs out of the instrumentation, as well as the reagents.

I think in particular, Doug, the part that we've sort of over performed on here is on the instrument side.

We always believed that we could take a lot of costs out of the reagents and we did that successfully and put those reagent kits roughly in the range of our Arrays, roughly.

But what we did a great job is on the instrument side.

So the instrumentation, itself, is higher margin than our array instrumentation.

And because it's such a high percentage of the overall Sequencing revenue it has a very positive impact on the overall corporate margin.

Yes, that's right.

Okay.

That is really helpful.

Thanks for that and I'll just ask one more question and get back in the queue.

I think you indicated that you expect (inaudible) sales to be essentially stable I think at least through the third quarter stable relative to Q2 sales levels.

I just want to make sure -- I just want to see if you guys can provide a little bit of color on what makes you confident that there is not going to be a further step down in the near-term given that you attributed a lot of the weakness that you've seen in (inaudible) to researchers basically pulling back in advance of the release of new data and given that a lot of that new data is not coming until later this year or early next year it would be helpful to understand why you think this is going to stabilize in the third quarter.

Thanks a lot.

The most important indicator for us, Doug, is our analysis of our pipeline of orders.

So we have, you know, a pretty good system that can track what the forward-looking order queue looks like, and we now have (inaudible) potential stimulus grant in that order system and so we can look forward and in using any range of success that we've typically experienced in terms of converting prospects and opportunities into and orders we have pretty good visibility that we'll be able to convert enough of this Micro Array business so that we can keep the business flat.

Having said that, all the wide range of guidance we provided is where we have some variability on the specific timing of these orders, because there clearly are some material Micro Array orders that are going to result from stimulus, whether they fall in Q3 or Q4 is hard to tell.

Your next question comes from the line of Quinton Lai with Robert W.

Baird, you may proceed.

Good afternoon.

Hey, Quinton.

With respect to kind of going back to the quarter, could you kind of go back and kind of recap to us when did you begin to see the slow-down, and when you saw the slow-down, was it just across the board, or was it just a couple of large customers that they just kind of abruptly shut down, because it looks like that -- that your consumables still per system is in that 500, 600 range.

So, how did that all kind of blend out to go down sequentially?

I mean, the biggest impact was in our Genome Wide Association business, as we've talked about.

We saw in Q1 our typical pattern of lower orders just on a seasonal basis that we've seen every year for many years in the company's history, and we assumed that that was the normal seasonal pattern that we would expect to see.

As we got into the second quarter, what we found was that the orders were very back-end-loaded more so than normal, and we didn't close as many of the Genome Wide Association study orders as we had expected and we also were a little bit lighter on the instrumentation side, in the quarter.

So in aggregate the Array business was sequentially down from our Q1 result.

Do you have any more color to that, Christian?

No, you kind of covered it.

I do think that since so much of our business now is instrument -- is instrument-heavy in general, you know, we have have had a tendency to have more back end loading in the quarter, and therefore you don't necessarily get total visibility until -- until June.

Okay.

And then kind of a follow-up and again just kind of echoing Doug's question here is that for those accounts that had that, I mean, are -- I guess is the new visibility I guess or the new guidance assuming kind of that some of these machines will continue doing base level of studies and until the weight, or does it take a slew of not just new products, but also custom products to get things back together?

And then also just to add another question on since I only get one follow-up so I'll make it real long.

On the fourth quarter given it is a lot of Sequencing instruments, should we be watching out for a gross margin on that next in the fourth quarter?

Well the first part of the question, we had a couple of key accounts that we mentioned that have -- that did slow down dramatically just in the last three and four months because of endowments.

That was two or three major customers funded through endowments, the first time we saw that, and their order patterns changed pretty significantly.

That probably was the single biggest effect from sort of the overall economic environment and then on top of that we had some customers who decided to hold funding for just pure timing purposes to see what happened with the overall stimulus program, so that was sort of a second order effect.

But I think that, you know, as I mentioned earlier we're going to see customers continue to do these studies, so scientists are not shutting down and going home here.

What we're talking about is on the margin, particularly in some of the very large Genome Center type institutes who are involved in many cases in the thousand Genomes Program, they're going to slow down doing Genome Wide Associations while they wait for this new round of content.

You'll see a baseline of studies absolutely continue in the market.

But, in the margin, 5 or $10 million makes a difference in terms of our quarterly results.

For the second part of your question, Quinton, on the guidance we provided was upper 60's gross margin, for the year at this point, and it will always be dependent on what the product mix is, with any given quarter.

Instrumentation is a little bit lower gross margins than reagents, so you would expect, you need to consider that when you are thinking about your models.

But on balance now, what we're feeling, assuming the pricing environment is in reasonable shape, that upper 60's gross margins for the year is achievable.

Great.

Thank you, guys.

Thanks .

And your next question comes from the line of Marshall Urist with Morgan Stanley, you may proceed.

Your line is now open.

Hello?

Marshall.

Hey, guys.

So I want to ask you guys about guidance and kind of help us understand, your confidence in your sort of insight into the channel through three quarters.

Obviously there was a shortfall this quarter, and how has that changed your thinking about 3Q guidance.

I know you talked about the pipeline, clearly there was a disconnect in 2Q, so have you increased the risk adjust when you think about the pipeline and how you're giving the guidance for the third quarter?

Just help us understand the kind of guidance and how things have changed to what you're thinking about now.

Well, I mean, the guidance we provided has a wide range and that really is a consequence of a higher degree of uncertainty that we have in our revenue numbers and probably than we've ever had before.

We can look in our pipeline and we see a rich pipeline of orders.

So this isn't a question in Q3 about whether the orders are there to be had, it is a question of what's the timing of these orders might look like and whether we're going to see stimulus money get released early or linearly in the quarter.

So the operating assumption we put into the Q3 numbers is we expect to see little to no stimulus upside in the third quarter, and some downside risk from what our plan would have been in the third quarter, due to the potential holdup of orders due to people waiting for stimulus.

So that is the backdrop of our Q3 numbers.

Now, those orders, if we miss Q3 timing wise we expect will fall in Q4.

So the resulting number that you can obviously calculate for Q4 by doing the subtraction includes some assumptions about stimulus actually happening in Q4 and those are results we're pretty confident in, based on our pipeline.

One last follow-up to clarify a couple of things, when we think about the range of Q3 guidance, should we assume that--

Marshall, you cut out, there.

Hey, am I back?

Yes, you're back.

You're back.

Okay.

Sorry.

So the follow-up on couple of other quick guidance points, on is the low end no stimulus and gets us to a range of about stimulus gets us to the high end and then are you saying the entire Array business or (inaudible)?

Thanks.

We're missing about half the question, Marshall.

Hey ,

Yes.

Yes.

Okay.

Sorry.

First half just Q3, is there any stimulus in the low end of guidance, and then, second, on the Micro Array business are you saying the whole thing is flat or (inaudible) is flat.

If we came in at the low end of our guidance, it is very unlikely we would have any stimulus advantage in the quarter.

So the first part is, no, we didn't think we would have any stimulus if we were in the low end of that range.

Second part of the question, will the whole Array business will be flat?

Is that what you're asking.

Yes.

I guess if you add up the numbers and do backward comparisons in aggregate you can see it being flat with where we are right now.

But within that the mix will move around a little bit depending upon the custom orders and the aggregate orders.

Some of these large orders are custom products in many cases require us to wait for content from the customer or in some cases to Sequencing to get the content and take a couple of months to manufacture to make the B pool.

So there is background noise in the custom part of the business.

We continue to feel pretty good about what's happening in the BeadExpress part of the product line, we had really good reagent orders in the quarter, and shipments during the quarter, so we think that's going to be a very strong component of the revenue over the next couple of quarters and continue to grow and remain optimistic about what's going on in the AG business.

Okay.

Great.

Thanks guys, sorry about the cell phone.

No, that's all right.

Your next question comes from Tycho Peterson with JPMorgan, you may proceed.

Thanks for taking the call.

Question I guess on the endowment issues, this is something that came up a lot about six months ago and I think at the time you kind of said only 10 or 15% of revenues and you weren't expecting a big impact.

It sounds like it was fairly concentrated in terms of the numbers of academic labs that were impacted but I guess give us comfort that this doesn't get worse going forward given that it is probably not just three universities that are cutting departments.

How do we think about the next couple of quarters from the endowment perspective?

You're right, it was very narrow in a couple of customers, so we haven't seen it in general.

And in these couple of customers the first time we really saw it was probably three months ago where they began to talk about their funding getting squeezed to some extent.

We've not heard that from most of our other academic customers.

In fact, they're sort of on the flip side because they're so wildly bullish about stimulus so we certainly need to control the balance of their enthusiasm on the other side of the equation.

But, you know, endowments could be caught little more but on the back drop of the market is probably slightly positive toward endowment funding over the last couple of months and who knows what is going to happen over the next 3 to 6 but the overall trends are for endowments coming back a bit.

With regard to [GWASP], given there is some risk, not risk given where your margins are on Arrays and Sequencing, but is there some chance some of hat rich variant work might migrate over to Sequences as customers are reluctant to wait until some of the product cycles next year are -- I understand there are different projects in nature is there a risk that some of those projects may be redesigned over to Sequences in the future?

No, the kind of the distribution of the variants across the Genome are so broad that -- unless you sequence the entire human Genome you're not going to get the same data and the cost of running Genome versus running the Array is so different you, you'll see some institutes say we'll sequence 5 or 10 samples and under stimulus a few hundred, but for most of these disease associations you need collections in the thousands and with rare variants maybe like 3 or 4 or 5,000 samples.

So that is not a practical Sequencing experiment.

Yes, that makes sense.

Lastly on the ASPs, does the quote, the number you provided include the upgrade kits?

How do we think ow ASPs going forward once you finish the upgrade cycle.

The holding of ASPs was on an independent basis.

On the Arrays the ASP per chip have been continuing to inch up some.

That's right.

Okay.

Thank you.

Thanks, Tycho .

The next question comes from the line of Un Kwon of Wedbush Morgan Securities.

Hi, thanks for taking my questions.

Hi.

I was wondering is it possible at all to give us a rough breakdown in your Genotyping business between the [GWasp] Micro Arrays versus your custom flash Ag bio products.

We've never given that break down and we don't plan to change that today.

Okay.

Fair enough.

And then my second question then you had indicated that your Sequencing Array business are on parity with respect to gross margin.

Can you talk a little bit about the operating margin differences between the two businesses?

You know what?

There's really not a lot of difference there, because we use the same sales force, the R&D is completely integrated between Arrays and Sequencing, and the G&A I guess Jay and I are still working on both businesses.

Yes.

So the reality is the operating margin line is roughly the same.

Obviously we may have R&D projects going on in Sequencing at some given time versus Arrays or vice versa, that would make differences but fundamentally it is the same R&D organization, which is one of the key reasons why this acquisition made so much sense is that we can create an incredible synergy not only across the commercial organization but also the R&D organization.

Great.

Thanks.

And your next question comes from the line of Isaac Ro with Leerink Swann.

You may proceed.

Hi, guys, thanks for take the question.

Sure, Isaac.

First off, on the new array content that we're looking at, potentially down the road for out of the 1000 Genomes is it fair to say the overall Array market will benefit from the availability of new content and so that would sort of be perceived as a key driver of renewing the growth rate, and if that's the case can you give us historical presidence on product development cycles?

Well, I think if I'm saying your question correctly, yes, there is going to be an enormous theoretical value in this content.

What has happened is that we have completed many, many whole Genome Association studies with the common variants that were discovered in Sequencing 4 or 5 years ago and that is the business that evolved to be a quite a large Array business in the last few years.

And what was discovered there were many disease associations, over 400 of those.

But the effects of those markers were moderate in term of explaining the heritability of the disease.

We know these diseases have genetic components to them, so the speculation and in fact the high degree of confidence, is that the actual remaining heritability, is buried other places in the Genome in structural variation and that is what the next generation Sequencing Technology is enabling us to discover and one of the major goals of the 1000 Genome Program.

There is a high degree of confidence that is going to be discovered in the 1000 Genome Program, are the remaining the heritability of diseases.

We go through a cycle of putting that content on a chips and product cycles are typically three to six months including design and validation and selection of content and manufacturing of the chips.

And the historical precedent you saw is what happened, three or four years ago when the first whole Genome Arrays came into the market and the rapid adoption of Genome Wide Association, our view is that you'll see that again in the rich Genome Association studies, and in fact it could be the probability it will be much more dramatic, because you need more samples because the variation is more rare.

Statistically you need more sample sets.

And secondly, I think that all it will take is a discovery of a few very key disease associations that explain significant portions of heritability and you will see tremendous amounts of money being poured into the Genotyping market if and when that happens.

That was exactly what was looking for.

And then secondly just to check here on Harmonia since it hasn't been asked.

Are you guys still on track for year end launch.

Number two, is it fair to say from a marketing standpoint that this product is being positioned to coincide with the availability of funding and perhaps a lot of smaller centers who previously couldn't access the technology?

Yes, it is certainly targeted for those smaller centers and those we want to transition over Sequencing for accounts to do principally Array work but do occasional Sequencing and will be positioned as a way that customers can do follow-up targeted studies from Genome Wide Association.

That is exactly the target market can also be used for converting customers who are using Array based expression towards Sequencing, which we think is fundamentally more powerful way to do that.

We will be launching that product somewhere around the end of the year.

We haven't given a specific dates to that but we probably will and update that at our Analysts Day in December.

Okay.

Thank you.

And your next question comes from the line of Dan Leonard with First Analysis, you may proceed.

Hey, good afternoon.

Hey, Dan.

This is a bit redundant but I'm trying to get some comfort here.

So your revenue forecast for the full year if I take the midpoint of your third quarter and midpoint of your full year it looks like you're implying a greater than $40 million sequential growth in the fourth quarter from the third quarter.

And I understand you have a pipeline tracking system but just given the expectation of the pay line on some of these grant buckets is going to be very, very low, how do you come up with that number?

Well, I mean, I'm not giving you the exact formula of how we did it, but there are several individual orders -- individual grants that were submitted that are in the magnitude of that entire delta.

And so if any one of those grants come about, it could make up the entire difference in Q4 assuming we're able to ship those products for revenue.

So the grant opportunity here is large.

We don't know with certainty how many of those will get granted, exactly when they will hit, and so I think we've been very up front with investors about that degree of uncertainty.

But we certainly expect some of them to.

And there is many, many grants that are in the 5 to $10 million range.

Okay.

And there are some individual grants that could be up to 40 by themselves?

Yes.

That's right.

Okay.

And then my follow-up, on that sequential revenue growth you're looking for, it looks like with only $0.05 additional cents of EPS using the mid-points of the guidance, it looks like you're expecting incremental margins on that revenue to be rather low.

Is that the right analysis, and if so, why would you expect those incremental margins to be low?

Well, I think what you're doing is we're just looking at the whole business in totality.

We do expect -- we're continuing to invest in R&D, there is R&D element to it.

Depends on where you think ASPs will land on those particular deals, as deals get larger they typically have some discounting associated with them and you may have some ASP impact as an implication of that, and so we took a -- we took a -- just our best view of where we think ASPs might end up.

As we talked about a few minutes ago, we think gross margins are going to end up in the upper 60s for the year, so if you take up -- if you look at the upper 60s for the year, combined with some investments in R&D and a little bit of SG&A, that's how you can kind of come up with those kind of EPS numbers.

Okay.

Thank you.

And your next question comes from the line of May-Kin Ho of Goldman-Sachs, you may proceed.

Your line is open.

Hello?

May-Kin?

Move on to another question.

We'll go to the next question.

And your next question comes from the line of Zarak Khurshid with Caris & Company.

Hi, guys, sorry for the background noise here.

Thanks again for the color today.

Obviously, Sequencing business continues to take off.

Or, just tracking incredibly well.

How should we think qualitatively about the relative impact about NIH on your Genotyping business, versus the Sequencing business, it sounds like a lot of the grants may be on the Genotyping side but is there potentially backlog building on the Sequencing side that could lead to an inflection or an acceleration in that business, as well NIH monies come through?

Well, we certainly think that Sequencing, next generation Sequencing is going to be more than likely the biggest beneficiary of stimulus funding.

However, you know, we have seen lots and lots of grants put in for Micro Arrays as well.

So we think that there will be substantial Micro Array projects that will get awarded as a part of stimulus.

The one difference you see is that in Sequencing there are many sort of moon-shot project, very bold things that customers may try to do and these are these challenge grants put in for large amounts of money where they're contemplating Sequencing, thousand samplings of particular types.

You have large dollars that potential go with those grants and these are for scientific endeavors that have never been possible before.

So we think there is a reasonable chance some of those are going to get awarded.

In the Micro Array business, not that it is not exciting but it is more of the same, more disease association studies and you may see $2 million grant and $5 million grants in Micro Arrays but you won't see many 20 to $40 million in Micro Array that is the reason the dollar distribution will not be as heavy in Micro Arrays as it is in Sequencing.

Additionally we think the underlying NIH budget, stimulus aside, will begin to increase in a very favorable way both because of the disposition of the Obama Administration and clearly with the kind of talent that they're bringing in now to run the NIH with Francis Collins' nomination to lead the NIH, bodes very well for Sequencing and Arrays and genetics analysis in general.

Sounds good, thanks.

And this does conclude the Q&A portion of the conference, I would now like to turn it back over to Mr.

Peter Fromen for closing remarks.

Sir, you may proceed.

Thank you, operator.

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

Thanks for joining us today.

This concludes our call, we look forward to our next update in October following the close of the third quarter.

Thank you for your participation in today's conference, this concludes the presentation.

You may now disconnect, and have a great day.