Illumina Inc (ILMN) 2009 Q4 法說會逐字稿

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

I will be your operator for today.

(Operator Instructions).

I would now turn the call over to Mr.

Peter Fromen, Senior Director of Investor Relations.

Please proceed.

Thank you, operator.

Good afternoon, everyone, and welcome to the fourth 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 2010, after which we will host a question and-answer session.

If you have not 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 of Corporate Development 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 than all forward-looking statements regarding financial guidance made during today's call 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's assumes no obligation to update these statements.

To better understanding the risks and uncertainties that could cause results to differ, 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 to let you know that we will participate in the Cowen Healthcare Conference in Boston during the week of March 8 and at the Barclays Healthcare Conference in Miami the week of March 22.

For those of you unable to attend in 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 will now turn the call over to Christian.

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

During today's call, I will review our fourth quarter of 2009 financial results and discuss our financial guidance for 2010.

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

In the fourth quarter, we recorded 181 million of total revenue.

This represented growth of 12% over fourth quarter of last year.

Product revenue was 168 million, growing 10% over the prior year period, led by significant growth in our sequencing products.

Our Microarray business declined year over year, but we did recognize sequential growth over the third quarter, led largely by growth in our whole-genome genotyping products.

In January, based on management's preliminary review, we announced fourth quarter revenue of approximately 176 million.

At the time of our announcement, we had excluded from revenue one multi-unit sequencing instrument shipment where we had not made a final determination on revenue recognition.

Subsequent to our pre-announcement, it was determined that this shipment should be recognized as revenue and was the primary factor in actual results exceeding 176 million.

Consumable revenue for the fourth quarter was 105 million compared to 99 million in Q4 of 2008.

This represents year-over-year growth of 6% and was driven by very strong growth in sequencing consumables, offset by a declining in Microarray Consumables.

Last quarter, we informed of an sequencing reagent quality issue in which we expected to have an impact on the fourth quarter revenue.

Originally, we indicated a potential impact on sequencing consumables of up to 15 million.

Although difficult to quantify precisely, we now estimate the impact to revenue was approximately 4 to 5 million.

Nonetheless, annualized consumable fall through on the Genome Analyzer was still within our projected range of $150,000 to $200,000 per system.

Despite lower revenues on the year-over-year basis, Microarray Consumables represent more than half of our total consumables revenue.

The decline relative to last year was primarily attributable to lower sales of whole-genome genotyping arrays, but was partially offset by growth in focused content arrays.

However, on a sequential basis, we did see growth in whole-genome arrays which drove annualized consumable pull through on iScan and the BeadArray reader to nearly $500,000 per system.

Total instrument revenue for the quarter was 61 million compared to 51 million in the fourth quarter of last year, representing year-over-year growth of 19%.

We recognized record Genome Analyzer shipments as demand for next-generation sequencing continues to grow rapidly.

Although total instrument revenue was roughly flat with the third quarter, we saw strong growth in sequencing instrumentation, which was partially offset by lower sales of array instruments during the quarter.

Services and Other revenue, which include genotyping and sequencing services, as well as instrument maintenance contracts, was 13 million compared to 8 million in Q4 of last year.

The main driver of this growth was the increase in service maintenance contracts associated with our growing installed base of sequencing systems.

The Services business also grew nicely in the fourth quarter relative to 2008.

We expect Services and Other revenue to grow sequentially in the first quarter of 2010, as a number of large whole-genome and targeted sequencing projects are in process.

Overall demand was very strong in the fourth quarter, resulting in the largest backlog in the history of the Company.

We exited 2009 with a backlog of approximately 228 million.

A portion of this backlog is associated with the large order we received from Beijing Genome Institute.

Even excluding the BGI order, our backlog is at record levels.

Typically, our backlog at any given time will ship to customers within four quarters.

The timing of the shipments depends on several factors, including a given customer's requested shipping schedule, which may span multiple quarters, and whether their product is catalog or custom.

Before discussing our gross margin and operating expenses for the quarter, I'd like to note that we reported a pre-tax amount of $16 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-based compensation expense and other non-cash charges, and the corresponding non-GAAP figures.

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

Total cost of revenue for the quarter was 55 million compared to 57 million in Q4 of 2008.

The Q4 2009 cost includes stock-based compensation expense of 1.3 million compared to 1.1 million in the prior year period.

Excluding this expense and 1.7 million associated with the amortization of intangibles, non-GAAP gross margin was 71.2%.

This compares to 69.5% last quarter and 66.7% in the fourth quarter of 2008, a year-over-year improvement of over 400 basis points.

Relative to the fourth quarter of 2008, in Q4 we experienced a favorable mix of sequencing consumables, improved gross margin on the Genome Analyzer and favorable absorption.

From a sequential perspective, gross margin increased by over 160 basis points from the third quarter, primarily due to higher mix of Microarray consumables revenue, as well as a lower warranty reserve for sequencing consumables.

It should be noted that last quarter we took a $2 million reserve to address the quality issues that arose within our [Read2] sequencing kits.

Pricing in our markets continues to be stable.

We saw increased ASPs across all of our major instrument platforms during the quarter, both sequentially and year-over-year.

With our overall Microarray product line, slightly lower ASPs per sample were partially offset by substantially higher volumes within the Focus Content and whole-genome genotyping array as compared to the third quarter.

I will now discuss our operating expenses for the fourth quarter.

It should be noted that due to our accounting calendar, the fourth quarter contained an additional week compared to the fourth quarter of 2008 as well as the third quarter of 2009.

Research and development expenses were 40 million in the quarter compared to 28 million in the comparable period of 2008, and included 5.6 million and 3.8 million, respectively, in non-cash stock-based compensation expense.

Excluding stock compensation expense and $900,000 of accrued contingent compensation associated with the Avantome acquisition in both periods, research and development expenses were 34 million or 18.8% of revenue compared to 24 million or 14.7% of revenue in the prior year period.

Relative to the third quarter of '09, non-GAAP R&D expense grew by approximately 5 million.

Included in the 5 million was approximately 1.5 million in non-recurring project expenses, the majority of which related to the HiSeq 2000 project.

Additionally, expenses associated with the 14th week were approximately 900K.

In Q1, we anticipate research and development expenses to be flat to slightly higher as we absorb new benefit rates and increase our investments in informatics, quality and process engineering.

SG&A expenses were 49 million compared to 39 million in the fourth quarter of 2008, including stock compensation expense of 9.6 million and 6.9 million, respectively.

Excluding these non-cash expenses, SG&A was 40 million or 22.1% of revenue compared to 32 million or 20.1% of revenue in the prior year period.

Relative to the third quarter, non-GAAP SG&A expenses increased approximately 6 million and were driven by increased headcount, legal expenses and outside services.

The sequential comparison is also affected by a reduction in the year-to-date accrual of variable compensation expense in the third quarter.

In the first quarter, we expect SG&A expenses to be up slightly over Q4 levels as a result of increased headcount, benefit rates and legal expenses.

In the fourth quarter, we also recorded a 10 million charge to in-process research and the development associated with our acquisition of Avantome.

GAAP operating profit for the fourth quarter was 26 million.

Excluding non-cash expenses outlined earlier and in-process R&D expense of 10 million, our non-GAAP operating profit for the quarter was 55 million or 30.3% of revenue compared to 51 million or 32% of revenue in the fourth quarter of last year.

GAAP interest and other expense in the fourth quarter included approximately 5.3 million in non-cash interest expense associated with our outstanding convertible debt.

Excluding this amount, pro forma interest and other income was 1.9 million, which includes approximately 700K in securities gains and about 100K of negative foreign currency effect due to the revaluation of the monetary assets outside of the United States.

Our non-GAAP tax rate for the quarter was 33.4 compared to 36.4% last quarter.

This decrease was due to an upward rate adjustment in Q3 to account for higher than expected annual income from sequencing products in the first three quarters of the year.

It should be noted that our fourth quarter 2008 tax expense included a $2.2 million benefit from the retroactive extension of the US R&D tax credit.

We reported GAAP net income of 12 million or $0.09 per diluted share compared to net income of 26 million or $0.20 per share -- diluted share in the prior year period.

Excluding the impact of non-cash stock compensation expense, in-process R&D expense associated with our acquisition of Avantome, non-cash interest expense and the other items identified in our press release, and net of pro forma tax expense, non-GAAP net income was 38 million or $0.29 per pro forma diluted share compared to 39 million or $0.31per pro forma diluted share in the fourth quarter of '08.

During the fourth quarter, we generated 61 million in cash flow from operations.

We used approximately 6 million for capital expenditures, resulting in approximately $55 million of free cash flow.

This compares to 36 million in the fourth quarter of last year.

Q4 free cash flow benefited from strong collections during the quarter, which also helped lower our DSO to 80 days, down from 94 days in the third quarter.

Inventory balances increased to approximately 93 million in preparation for the launch of HiSeq.

Depreciation and amortization expenses for the quarter were approximately 8 million.

During the quarter, we completed both of our outstanding share repurchase programs and bought back over 6 million shares of common stock for approximately 175 million.

We ended the quarter with approximately 694 million in cash and investments.

I will now provide financial guidance for 2010.

As a reminder, going forward we will only provide annual guidance and we will now include non-cash stock-based compensation expense in our earnings per share guidance in addition to our discussion of net income and the corresponding per share amounts in our earnings release and conference calls.

Consistent with our previous calls, guidance will exclude certain non-cash charges, including the charges associated with the adoption of accounting guidance related to convertible debt, the amortization of intangibles and acquisition related charges.

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

As I highlighted earlier, we exited 2009 with a strong backlog which included a significant order to BGI.

Before we discuss the specific guidance, I would like to expand on the accounting treatment for this order.

We expect to begin shipping HiSeq 2000 systems to BGI in the first quarter, and we intend to ship systems in each of the four quarters of 2010.

We anticipate using operating lease accounting for the hardware purchase.

This will require us to recognize revenue related to these instruments over a period of three years, with the majority of that revenue recorded in 2011 and 2012.

Additionally, consistent with operating lease accounting, the cost will be capitalized into fixed asset and depreciated over the term.

At the end of the term title to the instrumentation will be transferred to BGI As BGI uses the system, they will place orders for reagents, which will be shipped and recognized as revenue under our normal terms.

We expect total revenues to grow by approximately 20% for 2010.

However, with the timing of manufacturing scale up of the HiSeq 2000 and the other significant launches scheduled for later in the year ,we expect revenue for 2010 to be back-end loaded with higher growth in the second half of the year compared to the first.

Quarterly revenue growth is subject to risks associated with our ability to meet demand and recognize revenue connected with new products.

We expect gross margin percentage to be in the mid to high 60s; and relative to 2009, it is expected to be impacted by new product mix over the course of the year.

We expect gross margin percentages to be higher in the first half of the year and then decline somewhat as the mix shifts to newer products and trading programs are recorded for the HiSeq systems.

As a result of revenues growing faster in the second half of 2010, we expect operating expenses as a percentage of revenue to be higher in the first half of the year compared with the second half.

We expect non-GAAP earnings per fully diluted pro forma share to be between $0.90 and $1.

We anticipate the full year pro forma tax rate will be approximately 34%, and we will incur stock compensation expense of approximately 73 million, or a tax adjusted amount of $0.36 per fully diluted pro forma share.

We expect the full year weighted average diluted shares outstanding for the measurement of pro forma amounts to be approximately 132 million.

At this point, I'd like to turn the call over to Jay for some remarks on our commercial activity during the quarter before we begin the question and answer session.

Jay?

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

I'm very pleased with our fourth quarter results.

Revenue grew sequentially by 14% and by 12% year-over-year.

We generated strong order growth in nearly every part of our business, leading to record total orders, and exited the year with by far the largest backlog we've ever carried as a Company.

We improved non-GAAP gross margin to over 71%, delivered non-GAAP operating margins above 30%, and generated 55 million in free cash flow.

During the quarter, we recovered from the quality issues with our Read2 Cluster kits and limited the negative impact in Q4 revenue to approximately $4 million to $5 million.

We began to see the flow of stimulus funds in the quarter, as we booked about $16 million in orders directly associated with ARRA grants.

We also believe that we saw orders materialize in the fourth quarter that had previously had been delayed due to anticipation of potential stimulus funding.

From a regional perspective, Europe had its best quarter of the year, and we saw an improvement in the funding environment in Japan.

Perhaps most importantly, we recorded strong growth in our whole-genome genotyping products that serve the GWAS market.

We are very encouraged by the Q4 trend in GWAS, but with only one quarter of recovery, we are retaining a cautious outlook for the next several quarters.

We remain confident that the future growth will be fueled by the next general generation of arrays that contain rare variant content.

Looking more broadly at the Microarray business, we saw an overall rebound with strong sequential growth.

The 660W-Quad BeadChip was our best selling array in Q4 and narrowly outperformed the human Omni1-Quad, whose fourth quarter revenue exceeded Q2 and Q3 combined.

In addition to strong array shipments during the quarter, we generated the highest quarter level for the array business in the Company's history.

Order growth was strong across the portfolio with several notable highlights.

Orders from Microarray systems were a record, with strong demand for iScan, BeadXpress and automation systems to outfit high throughput labs.

We had record order orders for Expression Arrays, growing 28% over Q4 of last year, driven by key account wins with our human [HG12] BeadChips.

We had outstanding order growth for Focus Content arrays, with strength in agbio from our bovine and ovine products, as well as targeted human panels.

And total Infinium orders, which comprise all of our BeadChip-based gene typing products, reached the second highest level in Company history.

The samples represented by these Infinium orders was well over half a million, by far the largest number ordered in a single quarter.

In addition to this positive order trend, we also launched two new products following the quarter close.

In the second week of January, we launched the OmniExpress.

Based on Illumina's third generation array technology, the OmniExpress is a 12 sample array with 700,000 variants per sample.

The content is a subset of the Omni1-Quad and incorporates optimized markers from all three phases of the HapMap project.

The OmniExpress has a list price at $250 per sample, and will begin shipping this quarter.

Just as with the Omni1-Quad, researchers can begin new genome-wide association studies using OmniExpress, and later run supplemental Omni arrays with new 1,000 genomes content to increase power.

This new content will be the basis for the Omni 2.5 and the Omni 5, which we expect to launch later this year as part of our previously announced Infinium road map.

In conjunction with the Plant and Animal Genome conference held in San Diego during the second week of January, we launched our next-generation high density bovine BeadChip, the Bovine HD.

This array utilizes the same substrait in third-generation array technology as OmniExpress and enables researchers to interrogate over 700,000 bovine-related markers across 12 samples on one array.

Similar to the BovineSNP50, the majority of the content utilized on the array was discovered through sequencing projects conducted on the Genome Analyzer.

Developed in collaboration with major agricultural and livestock organizations in Europe and North America, the Bovine HD array contains markers from more than 20 different breeds and will enable researchers to cover the diversity in bovine populations spread across numerous geographies.

Turning to our sequencing business, we once again recognized record shipments of genome analyzers during the quarter, as we continued to see very robust demand.

The reagent issue in Q4 required us to allocate internal sequencing resources away from other projects, specifically the development of our 95G kits that we had targeted to release by year end.

Earlier this month, we released our fully commercial 50G kits after a successful early access program.

Internally, we have generated runs on the GA in excess of 95G, and have recently rolled out the 95G kits to early access customers with an expectation of full commercial launch in the second quarter.

The progress that we've made on the Genome Analyzer since its launch has greatly exceeded our early expectations of the technology.

We come from a platform barely capable of generating one G of data per run at the time we acquired Solexa, to the point where the genome analyzers in the field will soon be capable of generating nearly 100 G of data per run, all in about three years.

Researchers have demonstrated sequencing runs on the GA in pure reviewed literature with consensus accuracy read of 99.999% and raw read accuracy critical for cancer and de nova sequencing of up to 99.5%.

This unparallel combination of throughput and accuracy has allowed us to extend our market leading position in next generation sequencing and capture critical mine share in the scientific community, as evidenced by over 560 pure reviewed publications 18 times more than its closest competitor.

As many of you are already aware, at the recent JPMorgan conference we unveiled the HiSeq 2000, the next generation of Illumina's sequencing technology.

This system has the potential to radically transform the way sequencing experiments are conceived and performed.

At launch, HiSeq is capable of generating 200-G of quality filtered data in a single run, enabling researchers to sequence two human genomes simultaneously at 30x coverage.

This capability is idea for cancer research as it enables the ability to pair a cancer tumor sample and (inaudible) normal in a single run.

HiSeq is an entirely new platform engineered from the ground up, and delivers on the original vision of combining Illumina and and Solexa's strength in SBS chemistry with state-of-the-art optical and system design.

HiSeq is a dual flow cell system that imagines both surfaces of each flow cell using four cameras of simultaneously gathered data from all four basis of DNA.

By integrating line scanning technology and maximizing the camera duty cycles, HiSeq is capable of generating unprecedented throughput of over 25G per day, all with the quality of SBS chemistry on which the next gen sequencing community has standardized.

At this level of throughput, customers can now sequence whole human genomes for less than $10,000.

HiSeq also incorporated a broad development initiative to improve the user experience across our systems, and was first launched on the cBOT, our next generation cluster system.

We have greatly simplified the way users (inaudible) our flow cells and reagents, reducing hands-on time to start a run to about two minutes.

Similar to cBOT, HiSeq utilizes an easy to use touch screen interface and enables remote monitoring of the run.

In total, sample prep on the cBOT and the run setup on HiSeq require less than 20 minutes of total hands-on time.

We have also made tremendous efficiency enhancement to the data flow and processing.

A realtime processing project has dramatically improved our ability to process images that come off the sequencer.

In 2008, the Genome Analyzer generated 14 terabytes of data per run that had to be written to a disk drive.

Through RTA, we have now reduced that 100 gigabytes per run, so the system requires now only a desktop computer.

Similarly, we've reduced the alignment and mapping protocols for single genome from 3 terabytes down to 600 gigabytes, and once summarized the genome is reduced to about 50 gigabytes.

The enormous amount of data that HiSeq generates made these improvements critical and essential for a large scale analysis of genomes.

At the same time we announced HiSeq 2000, we also announced that BGI had ordered 128 systems, which we believe is the largest single order ever for next generation sequencing systems.

Installation is expected to begin in the first quarter and will be completed by the fourth quarter of this year.

Once all systems are installed, BGI will be the largest genome center in the word, with the capacity to generate data equivalent to that of 11,000 genomes per year.

Early feedback on HiSeq from our customers has been very positive.

We are in the process of running initial customer samples now, and expect to share some of that data at the upcoming AGBT meeting.

At our R&D Day following the JPMorgan conference, we announced another new sequencing product, the Genome Analyzer 2E.

The 2E is based on the architecture of the GA, and capable of generating up to 40G of data per run.

With a list price of $250,000, the GA 2E will target labs with lower capital equipment budgets that want access to next-generation sequencing.

Ultimately, we believe there's a very large opportunity to continue to segment the sequencing market and address the broad set of requirements in molecular biological labs around the world.

In summary, we had a great fourth quarter and saw strength broadly across our business.

We generated record operating cash flow of $175 million in 2009, and returned that same amount to our shareholders by repurchasing 6 million shares of our stock.

The market for next generation sequencing continues to show unprecedented strenth, and the array market is improving as we gain better visibility within the US.

We exited 2009 with the largest backlog in the Company's history, and enter 2010 with what we believe to be the most exciting and innovative product portfolio in genetic analysis.

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

(Operator Instructions).

Our first question comes from the line of Ross Muken of Deutsche Bank.

Please proceed.

Good afternoon.

So Jay, you made the comment that sort of the early feedback on the HiSeq was positive, not surprising given the tremendous sort of innovation there.

In terms of the type of customer that is initially seeming most interested in some of that feedback that you got, is it the sort of large genome centers, is it the core labs?

How small of a lab can you see that eventually making its way into?

And then also on the back of that, in terms of the BGI announcement, what was the response from some of the other genome centers who typically historically were kind of in the lead from a kind of -- ability to generate data perspective?

Now with BGI sort of having a fairly significant advantage, what was the thought process there from the customers?

Yes, as I mentioned, Ross, we think that the acceptance of HiSeq is going to be pretty broad.

Customers across the spectrum of lab sizes have all reacted very positively to this technology.

They recognize the degree of innovation in the system.

Certainly those customers that are in the large Genome centers are looking at ways of potentially doing trade in programs to migrate their installed base over to HiSeq over some period of time, and we are discussing those types of programs with the larger centers.

But I would say that the interest in the system is really quite broad across the entire range of the customer base.

With respect to the BGI order, I think it was a shock to lots of people in terms of the magnitude of that order, and we anticipate that many of the large centers around the world are going to go back and look for ways to try to up their investment if possible to attempt to maintain competitiveness in terms of the total overall output that they are capable of generating.

That is obviously going to take some time to do, and we are anxious to see what the result of that is here over the next couple of quarters.

And on the array business, you saw some encouraging signs in GWAS in the quarter after two relatively weak ones.

As you looked at sort of what was driving that recovery and you sort of had some time to reflect, what was sort of the key types of projects people were focused on, and was it a certain type of customer that was coming back there?

And then in terms of the early feedback on the 2.5 and the 5 and the OmniExpress broadly, what did you hear, as well, from the customer base?

I'd say if you look at the Microarray business broadly, we saw strength really across the whole spectrum.

So we did see significant demand for our Focus chips.

We saw a number of our brand new targeted chips we saw very interesting demand for.

We had great response in the bovine side of the business as well.

We did see the Omni1-Quad begin very rapid sort of ascension in the hierarchy of our chip, and was just behind the 660W.

I believe we actually exceeded the 660W on an order basis but not on a revenue basis for the quarter.

So clearly, that means customers are moving toward higher content on the arrays, which sort of presages what we expect them to do as we move into this next round of whole-genome GWAS.

With respect to the 2.5 and the 5.0, those products are not shipping yet.

Customers, I'd say, are eagerly awaiting their availability.

We continue to work with the consortium in the 1,000 Genome Project to get that content solidified.

We do have the content in hand now for the 2.5, and we are beginning development process of that chip.

We don't have all the content yet for the 5 million marker chip, and at that will be coming here over the quarter to two, when we'll have all the content for the 5M chip.

But I think customers have responded positively to the road map.

As we've mentioned, the economics of starting now are pretty compelling for customers.

(Operator Instructions).

Our next question comes from the line of Tycho Peterson of JPMorgan.

Please proceed.

Hey, good afternoon.

Hey, Tycho.

Jay, can you talk a little bit about the go-to market strategy for both GA 2E and then iScan HQ later this year?

I'm sorry.

It was echoing over here.

What was the second part of the question?

Just the go-to market strategy for both the new iScan and then the GA 2E in terms of kind of going after some of those lower volume customers and how you approach them?

Are you referring to what we used to call Harmonia, the new --

Yes, exactly.

Okay.

Starting first, the sequencing, our plan all along in that marketplace has been to have different systems address different portions of the marketplace, and the market divides a couple different axis, certainly price and capital being one part of that; throughput being another; application potentially being the third.

And where the 2E fits is in the labs where perhaps they are a little bit more capital constrained and they don't need the phenomenal throughput that we provide on a product like HiSeq.

And so the 2E fits under where the GA 2X has been.

It will be very accessible to a broader range of labs.

And 40G, even looking back to where we were a couple of months ago, is still high throughput.

And so they're going to be able to do lots of great science very economically with that product.

If you look at what we used to call Harmonia, that product which we will begin to ship in the second quarter is positioned with customers who want to begin to transfer applications over to sequencing but are significant array users.

So this will be a sequencing module that can add on to the iScan and allow customers, perhaps, who do a whole-genome genotyping study and want to do dense sequencing in local regions of the genome, or for customers who are perhaps today using our Expression arrays and want to begin to migrate their Expression use over to sequencing.

So we are really looking at that product as one that will target customers that are principally array users today but want to, over time, to migrate towards sequencing.

Okay.

That's helpful.

In your commentary, Jay, you talked about the strength you saw in Europe then and the funding in Japan.

Can you talk a little bit about your visibility into those two markets?

The news out of Europe this morning wasn't so encouraging.

So if you could just talk a little bit about how you are viewing those markets over the coming year, that would be helpful.

I'm not sure I saw the news from Europe this morning --

Just the macro, on that kind of the default.

Yes.

Europe for us was very strong in the fourth quarter.

We think that there was some sign of sort of funds being released from what were sort of economic paralysis for a while during the earlier part of the year.

I think we did very well across a number of very important tenders for sequencing products in Europe.

Overall, we feel really good about our European organization in terms of their ability to address the market needs there.

So we're, I guess, cautiously optimistic about how Europe will perform in 2010.

We did have particularly weak European business in Q2 and Q3.

If you contrast that, our business in the US was more steady, I'd say, during 2009, and actually met the original plan for the year in the US.

So the US performed consistently.

Europe had a dip in the middle and a very strong finish.

Our next question comes from the line of Marshall Urist of Morgan Stanley.

Please proceed.

Hey, good evening.

Thanks for taking the questions.

First one, I just wanted to -- was hoping you could give us a little bit more insight into the HiSeq manufacturing scale up and kind of when you think you will be at full capacity and how we should think about how that is going to impact revenue progression over the year?

And then to follow-up on another question, I was wondering if you would be able to hazard a more specific estimate of sort of what percentage of the installed base do you think could potentially upgrade to HiSeq?

We are ramping pretty aggressively on the production side of it, so we had actually put the HiSeq into production in the fourth quarter.

So we have a number of units -- quite a number of units in the final test process in our Hayward facility right now.

We continue to believe we will begin shipping those units over the next month or two.

So we are feeling pretty good about meeting the original ramp-up plan that we had in Q1.

I'd say we will reach full volume production in the second quarter of that system, and feel pretty good about the supply chain and all the pieces that need to come together to get our Q2 numbers achieved.

I'd say we'd probably be -- absent some unbelievably unanticipated demand -- we'll in the third quarter probably be able to begin to supply most of the orders that come in in a timely way, and that is also the quarter where we will begin to actually perform the trade ins that we are in some discussions with on customers now.

In terms of what percentage of the installed base will trade up ultimately to HiSeq it's pretty early to tell on that.

So there's a fair amount of interest on people's part to talk what would be required to do that trade in, but of course it requires access to additional capital.

Our hope is a lot of them, rather than trading in, will just buy a new HiSeq and put it alongside a GA.

So there will be a full mix over the next couple quarters of how people actually place orders there, and in another quarter we'll probably know a little more definitely how we expect it to roll out.

Okay, great.

And then just one more on the backlog with respect to the Microarray business, and particularly around the genome wide arrays.

Is there similar strength in that part of the backlog as well, and how does that -- so that we view more optimistic kind of thinking about the sustainability of the gains that you saw?

Or is that part of the reason why you are taking a more cautious view over the next couple of quarters?

Thanks.

We're not going to get too granular on the backlog, but you can deduce from some of the comments that we made that the order rates were quite strong across the array business, and in most cases in our array market we don't ship all of the order right after we get it because often there's a delivery schedule for the arrays that go out over several quarters.

Some of them are customer arrays that take up to a quarter to actually manufacture the first chip.

And so you could expect whatever backlog we developed there to be shippable over some number of quarters.

And so that's sort of how we expect that to roll out.

In terms of our caution, we are just being careful to not draw too many global conclusion from one data point where we had a strong Q4.

And Q4 is historically a strong order quarter for us.

Q1 is typically a less strong order quarter, and typically, in fact, generally the weakest quarter of any fiscal year for us.

And so we are just remaining cautious about it until we see a couple of quarters of positive results.

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

Please proceed.

Hey.

Good afternoon, guys.

Good afternoon, Mr.

Schenkel.

Well, it's been butchered worse than that in the past.

Let me start with one on -- well, I guess a couple on sequencing.

Any early indicators that the segmentation approach is working?

Maybe it's just a little too early, but I'd be interested to hear if you've seen anything in terms of just new customer flows or more if it's more interest from certain customers, more international interest -- just any signals that this strategy is going to work?

Yes, it's just too early to tell, Doug.

I mean, it's only been a couple of weeks since we announced these products, and so it will take at least a full quarter until we could draw any conclusions, we think, from how the strategy will roll out.

Okay.

But is that kind of what you would expect over the next couple of months, couple of quarters, that if this is working you are going to see interest in sequencing from labs that may not have otherwise reached out to you?

Yes, that's certainly the hope, that either labs that didn't think they could get into sequencing at all before or were very anxious to do and just didn't get the money.

Because if you recall, I think in programs like stimulus, there were such an enormous number of grants that the actual number -- percentage of grants that were awarded was pretty small compared to the ones that were submitted.

And so there may be fall out from that where customers could now afford $250,000 where they couldn't afford $500,000.

Okay, and then maybe just another follow-up along those lines.

You guys talked about the robust backlog you had coming out of the end of last year.

Has there been any, I would say, abnormal rate of converting the backlog in the early going into new orders just because maybe customers want to slow down and evaluate all the different options you guys have out there at this point?

By converting backlog, you mean -- hold up -- try to hold shipment?

Is that what you mean?

Yes, or maybe put differently, if there's somebody who was pretty close to actually placing an order for a shipment, have you seen any signs that it's taking them a little bit longer to actually move forward with an order, or they are delaying an order because now they are not looking at not just one sequencing option, but they're looking at multiple sequencing options?

Yes, I do think there is definitely some of that going on in the field right now, and we expected that.

This surprised all of our customers, and so they've all taken the time -- or are taking the time -- to evaluate their plan and decide whether to go ahead with the G0 that they would have ordered anyway, or whether they are going to go buy HiSeq instead.

And so yes, we do expect that; it was built into our plan.

And Doug, this is Christian.

Just to clarify, the actual backlogs that we've quoted are actual non-cancelable orders that we have in-house on the books that we ship every day again, so just to kind of make that distinction there.

So the backlog is good to go.

It's just a matter of when it's going to happen, and what we are talking about is really new orders, and there may be some effect on the pacing of new orders just driven by the fact that you have a bunch of new instruments out there.

But ultimately that is something that you would expect to work through over the next quarter or so?

For the most part, I think that is right.

We have, obviously, customers who have orders in the backlog who are now engaged in discussing with us whether they would do a trade in or not.

And so in some cases that is something we may decide to do, in some cases it's not.

And so -- but as I've said before, that's all been taken into account in our planning process.

Okay.

Thanks a lot guys.

Thanks, Doug.

Our next question comes from the line of Bill Quirk of Piper Jaffray.

Please proceed.

Thanks.

Good afternoon, guys.

Hi, Bill.

Good afternoon.

A couple of questions for Christian.

If we think about the gross margin guidance here for 2010, and I guess I'm thinking about why it should decline in light of the last couple of strong quarters, is this simply just the expectation, guys, about the mix of products?

In other words, heavier on the instrumentation side?

Yes, so Bill, it's a couple of things.

Obviously, instrumentation -- the product mix in any given quarter is going to have a big impact, but it's compounded by the fact that we have new products that are getting launched like the HiSeq 2000, which have lower gross margins when they are initially launched and then margins get better over time as we get better at manufacturing, get better at getting purchase price variances, et cetera, et cetera.

So that's probably a big element that is driving the margin.

The other piece here is we are trying to factor the trade in programs and see -- as these trade in programs roll themselves out, it's difficult to predict exactly who is going to take advantage of those programs; and consequently, we've taken some pretty conservative assumptions, that many customers will take advantage of those, which will have some negative impact on gross margin.

And so if you look at the first part of the year, we are expecting gross margins to be higher than the second part because of the timing of when, for example, HiSeq will actually start shipping in quantity.

And as Jay pointed out, we won't be fully ramped in manufacturing until at least the second quarter.

So those are the factors that we have.

And then, of course, it's the mix between instruments and arrays, as always has been for us.

Okay, understood.

And then a second accounting question.

In terms of the operating lease structure for BGI, I assume that you guys aren't out actively promoting operating leases in terms of instrument deals.

Having said that, do you have any hurdle rate?

I assume if there's other large deals potentially from the other genome centers out there that this may come into the mix again?

Yes, I think we are not actively pursuing operating leases.

I would agree with you there.

I think the way we think about it is that we are always evaluating each deal on its own merit.

And so we'll take a look at large deals, and depending on the nuance of the situation, we'll figure out what the best alternative is for that situation.

But at the end of the day, the deals have to be accretive for us, and we are very focused on that, and the BGI is going to be accretive to our operating margin.

And so it was one of those deals that made a lot of sense for us to do.

Our next question comes from the line of Jon Groberg of MacQuarie Capital.

Please proceed.

Thanks for taking the question.

Jay, just -- I guess two questions around some new products and all these initiatives that have come out.

One is, as you've gone out now and talked to your customers specifically -- and this might just be a little bit different way of asking a question that has been asked -- but if you go and talk to your customers specifically, how do you think -- or what are they saying in terms of how they may go about adopting the new product, the HiSeq kind of timing?

What does that do to kind of potential GA cells in the meantime?

Just maybe talk about how do you think that plays out through the year?

And then the second question was just going to be on the R&D line, you guys have had a phenomenal last -- a long time, I guess -- the last two months, specifically, introducing new products.

Is there any kind of taking off the pedal off the gas on the R&D, or is that just a continued -- continuing to invest kind of at the levels you've been investing at?

Yes.

Well, as I mentioned earlier, it's a little early to draw global conclusions about the actual way HiSeq will be adopted, but we have certainly customers that have GAs now that are thinking about what it would take to convert their entire installed base over to HiSeq.

So in the larger centers, they are contemplating transactions with us that may result in them converting fully over.

That might take six to twelve months for it to actually be implemented.

We have other customers that are hoping to buy HiSeqs to augment what they have in GAs -- and they may not buy that HiSeq this quarter, they may buy it next quarter -- and we have some single unit customers that may just stick with what they are doing and continue to buy GAs because they are going to be cheaper.

And so exactly how that sorts out is not clear yet.

And we've got models that look at potential variations around our set of assumptions in each of those specific cases, and I think it will take us a quarter or two to really understand how it is going to roll out.

In terms of R&D, we are not taking our foot off the gas in terms of new products.

As I mentioned in my script, we do have a lot of very innovative new things in the pipeline, and we are continuing to work very hard on that.

Having said that, in the last couple of quarters of this year, R&D as a percentage of revenue has been higher than what we generally would have anticipated.

Most of that has been a denominator problem in the equation, because our revenue has been less than what we might have otherwise hoped.

So we're going to be a little bit cautious in how rapidly we add to R&D, particularly in the first couple of quarters in 2010.

We are making some investments in the quality organization in bioinformatics, in the process engineering, to make sure that we have an adequate support structure around the actual teams that are developing the products to make sure that we minimize the chances of any problems that coming up and need our internal processes or quality of our product (inaudible).

If I may just follow-up quickly on the first part, as you've had these conversation and as you are modeling, has -- and obviously it's early on into January -- but since you made the announcement, has it created any positive effect of customers saying, well, we need to sit back evaluate what we are going to do?

Or has it not impacted really the GA side that much at all?

Yes, I definitely think there is some pause effect, and we anticipated a little bit of a pause because it was a surprise to every customer and they need to take the time to make the right conclusion.

We're asking if they can get more money, so there will be a little bit of slowdown of GA orders, we think, and we planned for that.

We think that may lend a little bit of volatility into the Q1, and maybe as we get into Q2 in terms of exactly when orders come in.

But we are very confident in the year overall, and as I've said, we made our plans to support that kind of anticipated small period of uncertainty.

We don't think customers are going to sit around for a quarter here.

They are probably going to take weeks to maybe a month or so to figure it out.

Our next question comes from the line of Quintin Lai of Robert W.

Baird.

Hey, good afternoon.

It's actually Matt in for Quinton.

Just a quick question.

Going back to the long-term operating model you guys last showed last month at the analyst day, the op margin kind of guidance range of 24 to 30, is that inclusive of stock-based comp.

or would I have to back that out as well?

You would have to back that out.

That's basically on a pro forma basis.

Okay.

Thanks.

Thank you.

Our next question comes from the line of Derik De Bruin of UBS Securities.

Please proceed.

Hi, this is actually Dan in for Derrick.

Thanks for taking the questions.

On the HiSeq, just curious about whether the majority of the orders -- or the potential orders thus far -- have been for multiple unit?

And then for those orders that are multi-system, whether the pricing discounts that you've been able to offer thus far have been in line with the early days of the GA?

Well, the initial orders that we are taking are all multiple unit orders.

So the early sales we've constrained to customers who want to order a couple of units, and that's because we will have limited supply and we want -- as we ramp-up this brand new system in the marketplace, we want to minimize the number of sites we have to support the new technology in.

So most of the orders we'll get here in this quarter will be multiple unit orders.

I'm sorry, the second part of the question was?

Pricing.

Yes, and the discounting on these systems, I'd call it little to none in the way of discounts.

I mean, it is a brand new technology.

It's a technology customers want to get access to.

And so we are not finding the need to discount the technology.

Okay, great.

And then quickly on manufacturing -- apologies if I missed this -- but have you begun manufacturing the sequencing products in Singapore?

Not in Singapore.

So we don't today we don't make any of our instrumentation in Singapore.

We will begin in 2010 moving a few sub-assemblies over to Singapore, but we don't have any plan right now to move full system manufacturing to Singapore in 2010.

Our next question comes from the line of Isaac Ro of Leerink Swann.

Please proceed.

Hi, guys, thanks for taking the question.

First off, just want to make sure I caught you guys right saying that new 95G chemistry for GA2 might be available in early access during second quarter?

And if that's right, just can I presume that hat is chemistry that is only really going to be available for GA 2X, and so just wondering how would that compare on a per-genome cost for reagents versus GA 2E?

Yes, the 95 kits are going to early access right now, and so that program is rolling out.

We expect full commercial availability, assuming the early access goes the way we expect -- full access of those kits in the second quarter of the year.

So we're, call it a quarter and a half behind, maybe two quarters behind where we had hoped to be because of the reagent problem that we had in the allocation of internal systems to solving that problem rather than working on 95G.

With respect to where those kits will operate, that chemistry and the protocols will also work on the 2E.

And in fact, that is what takes the 2E performance up to the 40G range, so that 40G number is equivalent chemistry to the 95G number on the 2X.

Got it.

Thank you.

And then just maybe secondly, if you adjust, Christian, for the arrays -- if you adjust for the extra week in the quarter, could you maybe give us a sense of what the growth in arrays was?

Yes, I don't think the extra week really had that significant an impact on our revenue -- probably no impact, actually -- given the fact that we had the holiday period.

So I don't really think we should break it out.

Okay, fair enough.

Thanks so much.

Actually, the other thing, Isaac, is we were shut down the last week of the year.

So was I.

Fair enough.

That shut down is something we do every year, by the way.

Not something we did this year uniquely.

Our next question comes from the line of May-Kin Ho of Goldman Sachs.

Please proceed.

Hi.

In the last couple of weeks, one of your competitors introduced something that could compete against HiSeq 2000.

Can you comment on that?

Well, we don't comment a lot about competitors' systems, May-Kin, but I think that what we have done with HiSeq is really a step function change in the sequencing curves.

We focused across a broad spectrum of performance characteristics of this system, and obviously from the throughput to the inherent quality of the data to usability, user interface and price performance.

And so we feel really, really good about our competitive position in the marketplace.

And on the stimulus, you mentioned it was about $16 million in the fourth quarter.

Some of that is benefit from price delays.

So how should we think about that going forward?

Well, we think that, as we mentioned before, the total pot of money from the first half of the funds that have been released through NIH is somewhere in the range of about $100 million that's accessible to the kind of technologies that we supply.

We anticipate that we are going to have only a limited ability to know exactly which orders came from stimulus going forward and which didn't going forward.

So I think it's going to be hard for us to have precision around what a stimulus order was, say, for out into the second quarter -- what was from stimulus and what wasn't.

So all we could say at this point is that we think that total pot for us is about 100 million.

That will be mostly over 2010 and 2011, and then we expect and hope that in the second tranch of funds that come through the NIH that there's some additional opportunities for us.

And I guess in the new budget proposal, the extra money for NIH?

I'm sorry, extra money for?

NIH.

Yes.

In the baseline budget, recommendation was positive.

I think it probably wasn't as positive as people might have hoped, but it was overall more positive than it has historically been in the past five or six years.

Thank you.

Our next question comes from the line of Tycho Peterson of JPMorgan.

Please proceed.

Hey, thanks for taking the follow-up.

A question on BeadXpress.

Can you talk as to whether you've incorporated the EraGen chemistry at this point, and then how are you looking at porting over the rest of the EraGen menu in respiratory viral and some of the other products?

And then also maybe your appetite for additional content -- acquiring additional content for BeadXpress?

Sure.

The EraGen assay is -- the key advantage of that is it's a single tube assay and very, very fast, so much faster even than our improved Golden Gate assay for BeadXpress.

So over time, we will migrate most if not all of the tests that are going to be running on BeadXpress over to use the EraGen technology.

They are actually doing a lot of the work porting their existing products over to BeadXpress, and so we are not directly in control of that part of it.

All of the new products that Illumina is developing -- most of the new products that we are developing will be based on the EraGen assay.

And so the panel that we talked about, for example, at R&D day will largely use the EraGen assay as the platform.

Okay, and then do you loo -- I mean, are you looking to partner and bring on additional content to expand that menu?

Yes, we are, and we are working on a couple of fronts there.

Clearly, we can supply that assay to third parties who want to build applications on top of the platform, and in some cases even remarket it, so that's one way that it will get out to the market.

And then we continue to look for partnerships to bring content into Illumina in areas that are consistent with our strategy and products that we might want to market.

Okay, and then just one follow-up on sequencing.

With the introduction of the GA 2E, are you starting to see interest from the ag markets and some of the other non-traditional markets for sequencing as you move down the cost spectrum?

Well, we have had a fair amount of interest from the ag markets already on the high end.

And in fact, some of the biggest players in the ag market are very focused on the ultra-high throughput because their sequencing is very challenging genome and they have a tremendous number of species that they want to sequence.

So high throughput and cost is actually critically important for the large players in the ag market.

Probably what you will begin to see -- I think perhaps what you were alluding to -- is in maybe some of the smaller research labs doing work on perhaps less -- some of the less important crops or animals, if you get down to -- I think there were species that a customer might be working on that 2E could be a very important product for that market.

Particularly if it gets into screening and targeting sequencing, the 2E could become a very important product.

Thank you.

Our next question comes from the line of Dan Leonard of First Analysis.

Please proceed.

Thank you.

Jay, has the second data released from the 1000 Genomes Project occurred yet?

And if it hasn't, does that impact your thinking on 2010 array growth?

I've lost track exactly of how many there have been in total, but there's one major one yet to go that we don't have, and that's -- that will be the one that will fill in the remainder of the markers that we need for the 5M.

We expect that to happen sometime in the next quarter, and if that happens, I think we'll be on track.

If it gets delayed beyond a quarter from now, then it probably would begin to impact the 5M part of the product line a little bit in terms of how fast it would ramp.

In terms of the overall market, we are hoping that many customers get started with either the OmniExpress or the Omni-Quad.

Certainly lots of customers, we hope, will get started with the 2.5, even if the follow-on 5 million chip slipped a couple of months, that they might start with the 2.5 and then run the supplemental.

So we don't think that is going to have a huge impact on our business in the back half of 2010, but it might have a little bit.

Okay, thank you.

And then Christian, did you quantify how much of the operating expense jump in the quarter was due to that extra week?

No, not specifically.

I mean, we said roughly about 900K of the R&D growth was, but we didn't quantify it for the SG&A.

Okay, thank you.

Thank you.

That's all the time we have for questions today.

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

Thanks for joining us today.

This concludes our call, and we look forward to our next call in April following the close of the first quarter.

Thank you for your participation in today's call.

This concludes the presentation.

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