Illumina Inc (ILMN) 2010 Q3 法說會逐字稿

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

My name is Derek, and I'll be your operator for this call.

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

Towards the end of the conference, we'll be facilitating a question-and-answer session.

(Operator Instructions).

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

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

Peter Fromen, Senior Director of Investor Relations.

You may proceed.

Thank you, operator.

Good afternoon, everyone, and welcome to our third quarter 2010 earnings call.

During the call, we will review the financial results we've released today, and offer our commentary on our commercial activity, 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 & Chief Executive Officer, and Christian Henry, who is our Senior Vice President & General Manager of Life Sciences, as well as our 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 our expected financial results and commercial activity made during today's call be protected under the Private Securities Litigation Reform Act of 1995.

The 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 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 wanted to let you know that we will participate in the Citi's Mid-Cap Conference in Las Vegas on November 16, the Piper Jaffray Health Care Conference in New York on November 30, and the Deutsche Bank MedTools Investor Summit on December 7 and 8 in Boston.

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, everyone, and thank you for joining us today.

During today's call, I'll review our third quarter financial results, and Jay will provide an update of our commercial progress, and the state of our business and markets.

In the second quarter, we recorded $237 million in total revenue.

This represents growth of 50% over Q3 of last year.

Product revenue was $225 million, representing 49% growth over Q3 of 2009, and was led by a significant uptick of our sequencing products.

Our microarray business also showed very strong growth relative to last year, and was up for the fourth consecutive quarter.

Consumable revenue for the quarter was $133 million, compared to $87 million in Q3 of 2009.

We saw strong demand for both sequencing and microarray consumables, resulting in a year-over-year growth of 53%.

Annualized consumable pull through per sequencing system was at the high end of our projected range of $150,000 to $200,000 per system.

Additionally, across our install base of microarray scanners, annualized consumable pull through was above our targeted range of $400,000 to $500,000 per system, and reached levels last seen in Q1 of 2009.

Our microarray consumable business was driven by revenue from our whole-genome BeadChips, which grew more than 50% year-over-year, and 20% sequentially.

This growth was largely due to the Omni2.5, which became our best-selling array in its first full quarter of shipment.

Total instrument revenue for the quarter was $88 million, up 45% over Q3 of last year, and up 26% over last quarter.

In both cases, the growth in instrument revenue was largely due to the success of the HiSeq 2000.

HiSeq continues to exceed our expectations.

To meet demand, we've significantly increased our production in the third quarter, and expect to continue scaling our capacity into the fourth quarter, which will begin to decrease HiSeq lead times.

In spite of the scaling, we believe it will take several more quarters to reduce the HiSeq backlog to ideal levels.

Revenue per microarray instrument also grew, both on a year-over-year and sequential basis.

Services and other revenue, which includes genotyping and sequencing services, as well as instrument maintenance contracts, was $13 million compared to $8 million in the third quarter of last year.

The primary driver of this year-over-year growth was the increase in maintenance contracts for our growing install base of sequencers.

Before discussing gross margins and operating expenses for the quarter, I would like to note that we recorded a pretax amount of $18 million related to non-cash stock-based compensation.

This impacted our EPS by a tax adjusted amount of $0.09 per pro forma diluted share for the quarter.

I want to remind you that we now include this expense in our presentation of pro forma net income and earnings per share, however, in our discussion of gross margin, operating expenses and operating margin, I will highlight both our GAAP expenses which includes the stock comp expense and other non-cash charges, and of corresponding non-GAAP figures.

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

Total cost of revenue for the quarter was $80 million, compared to $51 million in the third quarter of 2009.

The Q3 costs include stock-based compensation of $1.5 million, compared to $1.3 million in the prior year period.

Excluding this expense and $2.3 million associated with the amortization of intangibles, non-GAAP gross margin was 67.8%.

This compares to 70.3% last quarter, and 69.5% in the third quarter of 2009.

The anticipated decline in gross margin was due to the Genome Analyzer trade-in program associated with the launch of HiSeq.

We will continue shipment of systems purchased through the trading program through at least the fourth quarter, and as a result we expect gross margins in the fourth quarter to be in the mid-60s, and to improve once these trade-in programs are completed.

Research and development expenses for the third quarter were $45 million, compared to $34 million in the comparable period of 2009.

These numbers include $6.5 million and $4.8 million respectively in non-cash stock compensation expense.

Excluding this expense and $0.9 million of accrued contingent compensation in both periods, research and development expenses were $37 million or 15.7% of revenue compared to the prior year R&D expense of $29 million or 18.1% of revenue.

SG&A expenses were $55 million compared to $42 million in the third quarter of 2009, including stock compensation expense of $9.9 million and $8.5 million, respectively.

Excluding the stock compensation expense, SG&A was $45 million or 19% of revenue, compared to $34 million or 21.2% of revenue in the prior year period.

GAAP operating profit for the third quarter was $57 million.

Excluding these expenses outlined earlier, our non-GAAP operating profit for the quarter was $79 million or 33.1% of revenue, compared to $48 million or 30.2% of revenue in the third quarter of last year.

GAAP interest and other expense in the third quarter included approximately $5 million in non-cash interest expense associated with our outstanding convertible debt.

Excluding this amount, pro forma interest and other income was $2.6 million, which includes approximately $1 million of net foreign currency transaction gains due to the revaluation of monetary assets outside the US.

Year-over-year, the aggregate impact of foreign currency exchange rates negatively impacted earnings per share by approximately $0.01.

Our non-GAAP tax rate for the quarter was 35.2% compared to 35.3% last year.

The primary reason for our Q3 tax rate that was higher than our expected annualized rate, is the delay in the passage of the US R&D tax credit, which we continue to expect to be passed, and retroactively applied later this year.

Also contributing to the increase in the effective tax rate over our expected annualized rate was an increase in earnings from higher tax jurisdictions, which we will expect to continue to impact us for the remainder of the year.

We reported GAAP net income of $35 million or $0.24 per diluted share compared to net income of $17 million or $0.12 per diluted share in the prior year period.

Excluding 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 $41 million or $0.30 per pro forma diluted share compared to $23 million or $0.17 per pro forma diluted share in the third quarter of 2009.

During the third quarter, we generated $55 million in cash flow from our operations.

We used approximately $12 million for capital expenditures resulting in $42 million in free cash flow.

This compares to $0.3 million of free cash flow in the third quarter of last year.

Free cash flow benefited from another strong quarter of collections, which yielded a DSO of 65 days, as compared to 94 days in Q3 of last year and 64 days last quarter.

In addition, we used approximately $31 million for strategic investments, and $16 million to repurchase our common stock.

As a result, we ended the quarter with approximately $807 million in cash and investments.

Inventory balances increased to approximately $130 million, primarily due to the scale up of HiSeq manufacturing.

Although inventory balances increased, inventory turns improved slightly relative to the second quarter.

Depreciation and amortization expenses for the quarter were approximately $11 million.

For 2010, we provided guidance on an annual basis with eight periodic updates.

Based on our financial performance for the third quarter, we now believe that we will exceed the annual revenue and earnings guidance provided last quarter.

While we are not specifically updating guidance today, I would like to reiterate that we expect gross margins for the fourth quarter to be in the mid-60s due to the trade-in programs, and that even though we have been successful in ramping the HiSeq production, it will take us several quarters to work down the instrument backlog.

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 Q&A.

Jay?

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

I'm extremely pleased with our operational and financial results for the third quarter.

We delivered exceptional top and bottom line growth.

All regions performed well, with notable growth in the Americas and Europe.

We grew revenue 50% year-over-year, with strong demand for our sequencing products, and solid growth in our microarray business.

Excluding the large BGI order in Q4 of last year, we generated record orders in Q3.

Additionally, we grew our ending backlog for the fourth consecutive quarter, exiting with another record.

We're rapidly scaling both sequencing instrument and reagent manufacturing, and effectively transitioning customers from the Genome Analyzer to the HiSeq 2000.

The HiSeq launch continues to go extremely well.

Customers generating excellent data with throughput levels that consistently exceed the product specifications.

To support the demand for HiSeq, we increased manufacturing output by over 70% in Q3, and plan to further expand capacity in the fourth quarter.

We're seeing continued strength in our microarray business, led by strong growth in whole-genome arrays, highlighted by the Omni2.5.

Combined with good expense management, we were able to deliver a pro forma operating margin over 33%, well above our long-term model of 30%.

Total Q3 microarray revenue grew substantially on a sequential and on a year-over-year basis, with strong performance across consumables and instruments.

This represents the fourth quarter in a row that we've seen sequential growth in our array business.

Array consumable growth was led by our whole-genome array business, with strong uptake of the Omni2.5, which became our single best-selling microarray in its first full quarter of shipment.

As a reminder, the Omni2.5 is a 4-sample BeadChip with 2.5 million markers per sample, that enables customers to access rare, variant content.

In addition to the Omni2.5, the Omni1-Quad and OmniExpress contributed to over 20% sequential growth in our whole-genome array business, and over 50% from Q3 of last year.

The genomic power of the Omni2.5 and soon the Omni5 will enable researchers to explain significantly more of the heritability of human disease.

We currently expect to launch the Omni5 by the middle of 2011, pending the availability of content from the 1000 Genomes Project.

We also saw strength in our focus content arrays during the quarter, including our immuno, metabo, and cancer arrays in the human research market, and our bovine and porcine arrays in the ag market.

Microarray instrumentation also had a strong quarter, with iScan system revenue driving sequential and year-over-year growth.

Microarray instrument orders nearly doubled from Q3 of last year, and we recognized sequential order growth across all major array platforms, iScan, HiScan, and HiScanSQ.

Many customers are upgrading their BeadArray readers to iScan or HiScan to increase capacity and gain access to our next generation of BeadChips.

A large majority of the demand pipeline for iScan and HiScanSQ comes from new customers, attesting to the strength and breadth of our BeadChip product family and the flexibility of the HiScanSQ to perform both microarray and sequencing applications.

As I mentioned last quarter, HiScan uses many of the same components as HiSeq.

Over time, this will drive manufacturing efficiencies, but in the short-term it's led to manufacturing constraints due to the significant demand for the HiSeq 2000.

We plan to significantly ramp HiScan manufacturing during Q4 to support demand for both HiScan and HiScanSQ shipments.

At the beginning of the third quarter, we announced our acquisition of Helixis, and at the same time launched Eco, a low-cost realtime PCR technology that Helixis had developed.

I'm pleased to report that we've successfully integrated the Helixis team, and the Eco launch has gone very well.

To date we've shipped more than 60 units, and are scaling production dramatically in the fourth quarter.

Customers are up and running quickly, and early feedback about the performance of the instrument has been quite positive.

Notably, Eco customers have responded favorably to the High Resolution Melt application, which provides higher quality data without any modification to their existing assays.

High Resolution Melt, or HRM, used to be available only on systems that cost $50,000 or more.

The Eco system provides HRM with superior performance at a list price of $13,900.

Turning now to our sequencing business, we had another outstanding quarter.

Total sequencing revenue grew by more than 50% over Q3 of last year, and orders grew 70% as we continue to see very strong demand for the HiSeq 2000.

Over 40% of Q3 shipments went to major genome centers such as BGI and [Broag].

Excluding genome centers, over 30% of shipments included Genome Analyzer trade-ins, reducing gross margins in the quarter compared to Q2.

As Christian indicated, we expect the trade-in program to negatively impact gross margins through at least the fourth quarter.

The breadth of the market opportunity for HiSeq has continued to exceed our expectations.

Notably, this week we passed through 1,000 peer review publications citing SBS chemistry.

Nearly 90% of the Q3 HiSeq orders came from outside of major genome centers.

By simplifying the sequencing workflow, increasing accuracy, and dramatically lowering the cost per genome, HiSeq is truly redefining the trajectory of sequencing, and expanding the market.

Today we launched HiSeq 1000, the latest extension of HiSeq technology.

The 1000 is a single flow cell version of the 2000, offering the same performance but half of the throughput.

This system will allow customers access to the latest technology road map at a lower entry price, and provide field upgradability to the HiSeq 2000.

We expect to begin shipping HiSeq 1000 toward the end of Q1.

In addition to the launch of the HiSeq 1000, we're repositioning our Genome Analyzer portfolio by lowering the list price of the GAIIx to below $300,000, including the Paired-End Module, which is the current price level of the GAIIe system.

As a result, we're going to discontinue the sales of the GAIIe, and address the cost-sensitive segment of this market with new and refurbished GAIIx's.

We feel that this portfolio structure is the most effective way to provide SBS sequencing technology to the broadest range of customers.

Last quarter, we announced the formation of the Illumina Genome Network.

This program links our internal sequencing services to leading institutions using HiSeq to offer the human whole-genome sequencing services.

With continued enhancements to the HiSeq 2000, and advances in sample preparation and data analysis, we expect the network to provide researchers with the unmatched value proposition of rapid turn-around time, industry standard data quality, and highly competitive project costs.

Interest in the IGM program has been significant, and we've already booked multiple orders.

In summary, Q3 was another great quarter.

We generated very strong year-over-year and sequential revenue growth.

We've been able to maintain solid gross margins through the most significant product launch in the Company's history.

Through disciplined expense management, we delivered operating margins above the high-end of our long-term model, which enabled us to generate $0.30 in earnings per share.

Our whole-genome array business has stabilized, and as we expected, growth has begun to accelerate.

The Omni2.5 launch has gone well, and the product is quickly becoming our best-selling microarray.

We're successfully scaling HiSeq manufacturing to meet demand that has significantly exceeded our initial expectations.

In general, our markets are very well-funded globally, and we see no slowing in the demand for sequence data.

We materially grew our backlog again in the third quarter, which we believe provides us with good visibility going forward.

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

(Operator Instructions)

And I'm showing the first question comes from the line of Doug Schenkel with Cowen and Company.

Please proceed.

Hi, good afternoon and thanks for taking my questions.

Hi, Doug.

Hi, Doug.

So, from an outside perspective, it looks like you guys have made plans to increase HiSeq manufacturing for really a third time.

I think coming into the year, we were expecting you guys to double capacity in the second quarter, then I think during the second quarter you made a decision to increase manufacturing by over 50% and it sounds like you got a 70% increase.

Is that the right way to think about it, that you guys have actually made a third decision to expand capacity in response to demand exceeding expectations?

Yes, I'd say that's right, although when we saw the initial uptake, even in the first quarter, we plotted out several quarters of increased production and then we continued to tweak that ramp as we've seen the actual order rate.

So, those decisions weren't wholly independent of each other.

But you're right, we've sort of tipped the curve a couple of times already.

I think the one things that happened is we've been able to achieve our goals, and so as we achieve our goals we see how we can push ourselves to the next level by improving the efficiency of the work flow and the shop floor for example.

And are you at the point that your starting to turn the corner on some of the component challenges that you're running into because of the demand for HiSeq, the demand for HiScan, and how is this going to change with the launch of the HiSeq 1000.

I think the team has done a great job there in Christian's group of managing the component supply chain.

We really haven't had particular challenges there, other than the fact that we didn't order enough parts for the influx of demand that exceeded the expectations.

So, as we saw that demand level every month, we tweaked the demand for the parts upward and upward, and I think now we're at the point where we're manufacturing enough units that we'll begin to bring the backlog down because our backlog of total HiSeqs now stretches out deliveries longer than is ideal.

We'd like to begin to ratchet that in here but it's going to take us a couple of quarters to do it.

Okay, and one last one.

On trade-ins, any chance you would provide an update on what percentage of the GA install base has been traded in, or maybe just talk about what visibility you have on what percentage of the installed base you would expect to be traded in over the next several quarters.

Well we're not going to give specifics in total, but we did say in the script that 30% of the non-genome centers in the quarter were trade-in units.

And, we said that we expected somewhere north of 50% initially to be traded in.

I think the percentage is probably going to be substantially higher than that by the time we get all done.

We should say the Q4 trade-in program which offered the best terms for the customer is essentially over in terms of accepting any more of those trade-ins.

We do have some remaining in backlog to ship but in terms of incoming order flow and backlog building there will be no more of those.

Great.

Thanks again and congrats on a great quarter.

Thanks, Doug.

Ladies and gentlemen, management asks, if you would, please keep your question -- limit yourself to one question and one follow-up for the sake of time.

And your next question comes from the line of Ross Muken with Deutsche Bank.

Please proceed.

Good afternoon guys and congrats.

Thanks, Ross.

So, maybe talk a bit about the challenges in dealing with the vast turnaround times in terms of the technology evolution year, in the sense that you're coming to the customer base consistently with upgrades, new products, much better cost benefit for them, but it's happening at this incredibly rapid rate.

And so while that's great, it's certainly that's an engineering feat on your part, but something from the customer, I'm sure that they're happy about but certainly need to digest.

As you continue to churn away here at all the various product lines and continue to expand them, what's been the customer feedback, and how have you conditioned the sales force to make sure that this quick turnaround time and this phenomenal R&D pipeline continues to be so well received?

It is a challenge for the customer base to absorb these changes if they go too quickly.

And so, one of the things we attempt to do is to package changes together.

So, we could actually implement a higher rate of change of individual pieces of the system than we do, but we tend to, for example, bundle reagent changes with software changes so that the customer has only one transition point.

And, we work very hard to make it as smooth and seamless for our customers as we can, and we've seen that with the HiSeq transition, that we offered them this trade-in program, we gave them ways to very easily transition from what they were doing on the GA over the HiSeq, we let them continue to run on GAs even after the HiSeqs were installed for a while so that they could manage their work flow on a project basis to make that transition easy.

So, we do everything we can there, but the bottom line of all of it is technology is changing fast and customers are the recipients of the huge advantages of that technology change.

Thanks.

And maybe just quickly, the cash flow generation here continues to be tremendous.

You're building up the cash balance again.

What's the near term priority in terms of deployment?

So, Ross, it's Christian.

Obviously, one of the things we did announce was our share buyback under the 10b5-1 program.

So, that just running it's course.

That's one use of cash.

We do have some CapEx that continues to run along at a reasonable rate in that $10 million to $12 million a quarter.

And then the rest of the cash flow generation, we're really looking at a lot of different strategic investments, different kinds of tuck-in technologies, et cetera.

As you saw on this call, I indicated that we had invested $31 million in various strategic investments that we're really not going to talk about today, but help us build out our portfolio for the long-run.

So when you think about what we're trying to do, we're trying to build out the entire portfolio for the long-run with some of that cash.

Great.

Thanks, guys.

Thank you.

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

Please proceed.

Hi guys, good afternoon and congrats from me on the quarter as well.

First one, I'd just maybe ask a question about microarrays.

The 2.5 is doing well.

Would love to get a little bit more detail on what you're seeing from a customer-end project perspective there with rich GWAS and what's your current expectation on when we'll start to see some data from these -- from the Omni2.5?

I think the uptake of the 2.5, as we indicated in the script, has been really, very strong.

There's adoption in particular in some of the larger centers that had been the historic users of large scale GWAS technology and so we're seeing them coming back into the marketplace now.

There's a whole series of pilot studies that are getting kicked off here and I think we'll begin to see the early results from these studies sometime in Q2, maybe late Q1 into Q2 of next year, and obviously we're hopeful that there's going to be some interesting discoveries come from that, that will continue to fuel the growth in the marketplace.

But overall, this is happening about like we expected.

The Omni5 is later than we might have hoped only because we don't have access to the content yet from the 1000 Genomes Project, but we expect to be over that hump by very early next year and be able to get the 5 into the market roughly midyear of 2011.

Great, thanks.

And then just one other one.

Just on the expense leverage with the HiSeq ramp, you guys are showing some pretty dramatic expense leverage here.

So, is this something that we should be thinking about is sustainable over the next few quarters and into 2011, or as you get through the HiSeq trade-in and the steepest part of the curve, are there some other investments in other areas on R&D or SG&A that we should be looking for?

Thanks.

Well, I guess the first thing to talk about is the gross margin side, and we've indicated some reduction gross margins in Q3 and Q4.

We think because of the rapid or the high level of backlog we have on the HiSeq that it's likely that the trade-ins from a shipment perspective will slop over into the first quarter.

But into the 2011 time frame, we think we're going to begin to have some capability to begin to push gross margins back up.

So, that will certainly be a help to the overall operating margin.

As far as the expenses go, terrific performance this quarter on a percentage of revenue basis.

We've continued to grow the absolute dollars we're investing in sales and marketing because we do need to continue to scale there to meet the demand levels and the increasing breadth of the product line.

On the R&D side, we continue to run lots of programs in parallel.

There's no very significant individual major investment that we expect to be incremental there, although we've always said as we get to these levels of operating profit that we would look for opportunities, if they're out there, to make investments in things that will continue to push the high end growth of the Company, including potential acquisitions.

All right, great.

Thanks and congrats again on the quarter.

Thank you.

Your next question comes from the line of Isaac Ro from Illumina.

Please proceed.

Welcome aboard, Isaac.

Isaac, I have a project for you.

That terrifies me.

Thanks for the offer, though.

Just real quick on just the HiSeq 1000, I think you gave some pricing dynamics but you didn't carve out where HiSeq 1000 is going to be priced versus the 2000 and GAIIx.

So just first off, wondering how it's going to be positioned on the pricing side of things.

That obviously varies a little bit by geography and by size of the order, but you can think of it being roughly in the range of mid 5 to the high 5s in terms of the range of pricing for that system.

Got it.

And then, just looking at the lower end of the market, there's obviously a couple of offerings hitting the market at the sort of 150K or lower arena, how important is it to play in that part of the market heading into 2011.

Well it's certainly a very interesting market segment and particularly, as we begin to see the remaining install base of capillary systems, looking to move over to next generation technology.

So, it's certainly a marketplace that we're looking at, we think is an interesting one, but we don't have any particular product offerings to talk about in that space today.

And if I could ask one last quick one.

There's a lot of money going into -- that's been invested in single molecule technologies over the last few years.

Do you view that market as worthy of incremental investment at this point?

We don't actually see the single molecule systems as a market.

Single molecule to us is a technology.

It's sequencing without amplification.

And to us there's very -- the single molecule systems that have hit the market to date have been very expensive implementations because of the difficultly of sequencing a single molecule at a time, and they make tremendous sacrifices in terms of run time, read lengths, costs, and sensitivity in order to achieve sequencing single molecule.

So, we think that, in some very long-run, single molecule technology may advance to the point where it has a significant place in the market, but today we think doing amplification like we do is a superior approach.

Got it.

Thanks very much.

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

Please proceed.

Hi, good afternoon.

Hi Tycho.

Starting off the question on HiSeq, as we think about moving beyond the upgrade path in the first year, can you just talk a little bit about what the mix of the interest is.

I think you talked about 90% of Q3 orders were outside genome centers.

So, are the areas where you're seeing interest beyond your expectations in terms of nontraditional customers, or how do we think about the pipeline beyond the upgrade?

I wouldn't say they are nontraditional.

We certainly see them coming from a broad array of markets of types of labs, let's say.

Down to the very small labs that you initially would not have expected would want this level of throughput, and we think the drivers there really have to do with ease of use of the technology and the fact that a single lab with a small number of people can implement a technology like HiSeq and play in the world class of sequencing and make major discoveries, and that has the effect of broadening the market.

But we are seeing the demand across all of the traditional academics that you might expect, certainly into the ag marketplace for sequencing.

We're seeing probably some increasing demand in industrial customers.

In pharma, we continue to believe there won't be large scale discovery programs running house, but all of the research labs in pharma will need access to next gen sequencing.

So, I guess our view going forward is that NGS is going to become a pervasive technology in most labs of the world and without it you won't be able to conduct large scale experiments in molecular biology.

And so, we do think it's a very important and pervasive technology.

And then with regards to the 1000, was this something that potential customers were asking for?

I'm just trying to think about how big an opportunity that is for you relative to your 2000 business, and will it be a small subset of HiSeq placements that ultimately go out with the single flow cell.

Well we think it's pretty substantial in particular because of the upgrade path, that you can get into the marketplace at a lower price point and then upgrade into the future.

The driver for the HiSeq 1000 and the fact it really precipitated our announcement of that system was the very rapid conversion away from the Genome Analyzer to the HiSeq platform, and I think that probably went faster than we expected.

The customers decided that the high technology new track was really based on HiSeq technology, and so the orders for the GAs went down faster than we might have expected so we decided to launch the HiSeq 1000 as a result.

And we think that from a competitive positioning standpoint, we now have two systems that are latest, greatest technology and for the very price sensitive customers, we can deal with them using the new price of the GAIIx at the 95G output and the refurbished program for those customers that are very price sensitive.

So we think, from a price performance segment, we've got the marketplace very well covered with the launch of the HiSeq 1000.

Okay.

And then on the Helixis business with regards to the initial Eco placements, have you seen any cross-selling from some of the other markets, diagnostics, or forensics or food testing or anything?

It's a little too early to tell.

When we bought Helixis, they came in with a pretty substantial backlog.

They had launched principally through distributors internationally and there was a pretty large backlog and so we're really very early in the phase of deploying this into our own sales force, but because we need to ramp up the production to ship down the existing backlog before we start taking too many orders.

So, it's a little early to comment on what we think the order dynamics are going to look like.

But one thing we have seen, Tycho, is we have seen business development type interest from food testing and different kinds of markets that are maybe more specialized than your traditional lab, and so we'll see how those kinds of things play themselves out.

And certainly, we have a built-in opportunity to sell an Eco system in front of the HiSeq technology and the GA technology anywhere where we're selling sequencers is an obvious place to sell Ecos.

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

Please proceed.

Hi, good afternoon.

Hi, Derrick.

So, I've a number of short questions all related.

So, how long until the shipment and installation of a HiSeq until it runs full throttle, and then how many of your platforms do you think are running all out?

And I'm trying to get a question -- a feel for utilization rates just because when I look at the numbers for next year, the consumable pull through seems to be the biggest variable in terms of potentially getting upside to current expectations.

The installations are going quite quickly now and they're coming up fast in the field, so from the time we ship it, a customer who wants to put it into production, as opposed to just doing some technology development on the system, could have it in production from four to six weeks from the time we ship it.

That wouldn't be surprising for someone who wanted to go that direction.

Now having said that, there are lots of customers buying these who want to do new applications or do [tech deb] on the system.

And how many -- and so, what's your current guess in terms of -- not so much for HiSeq but just in terms of your overall installed base, how many of those are being used at full capacity?

Hard to tell.

The capacity in these is pretty high.

Yes.

As you can imagine.

So, I would say most of the large genome centers are running at somewhere in the 80% ti 90% range.

Most other customers wouldn't be running at 80% or 90%.

Okay.

And then just one other question, a market dynamic question.

When you gave your Analyst Day back in early January, you made a comment that you felt there was a 1,500 installed base of next generation sequencers out there.

I'm just kind of wondering, do you have an update on where you see that market right now and how much -- where we are right now just given all of the swaps that have gone on and people -- new people buying it.

And I guess I'm trying to get at -- just trying to get a feel for what is the overall sequencing capacity that's out there in the field?

We have what we think is reasonably good data, obviously because we're the largest supplier in the market, but we only update those numbers occasionally and we're not prepared to do that update today.

Okay, thanks.

Your next question comes from the line of Jon Groberg from Macquarie.

Please proceed.

Hi.

Thanks a million for taking the questions.

Just so I'm clear on the HiSeq 1000 again, Jay, is what is the upgrade path?

Is it a hardware upgrade, or -- I'm trying to visualize the instrument and exactly what will occur here?

It is a hardware upgrade but it's a minor hardware upgrade.

The 1000 has a single flow cell so the access panels and interface to the flow cell, that whole area of the instrument has different covers on it, and there's some minor hardware changes inside of the system of parts that have come out if it's a single flow cell system, but it is simple enough that it's a field upgrade.

And so, just thinking about at the price point you are selling it, with the -- is this going to be a lower margin product at first, thinking about the cost of goods sold associated with it?

Yes, it will be a little bit lower than the 2000 would be, but I think over time the 2000 is going to get to be decent margins so we think the 1000 will be just fine.

Okay.

And then if I can, just switching to the array business.

We've thought a lot about the trade-in program that's going along, obviously on sequencing.

You mentioned that you were getting to this point where a lot of people on the array side were wanting to upgrade as well.

Is there a similar trade-in program going if people want a HiScan or some other products that you have introduced on the array side?

No, there's no official trade-in programs on the microarray scanners.

Okay, great.

Thanks a million.

Thanks, Jon.

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

Baird.

Please proceed.

Hi, good afternoon.

Congratulations from us as well.

Thanks, Quintin.

With respect to the stimulus and the impact there, it seems like that, given the strength of your business, you're getting some benefit from that.

When you talk to your customers, what do they see sources of funding over the next couple of years and is it growth -- same-store sales growth, or is it going to be opening up new areas like in the ag bio that's going to be funding the future growth?

It's a combination.

With respect to stimulus, we think there is probably about a third of the total funds from the stimulus program right now are out in the hands of researchers.

So, we have about two-thirds of that yet ahead of us, which clearly now will, as I think we've mentioned in the prior calls, clearly go into 2012 if not through the full year of 2012.

So, that gives a pretty nice set of incremental funding over the next couple of years.

I think if you look at the overall funding environment, the NIH, it's good.

It's not as great as maybe people would have hoped absent all of the other economic challenges that the country has had, but the funding environment there is still good.

The probably single biggest factor that plays in our favor is that next gen sequencing is very popular technology.

It's the technology that advanced most quickly in the Life Sciences market, and is making such major contributions that we are beginning to see funding being pulled from other areas as the market expands.

And one great example of that is in cancer sequencing.

So, as the prices come down and sequencing cancer tumors is now something that's economical and technically viable, we're beginning to see money come from NCI into next gen sequencing where previously there wasn't much.

So I think from that perspective, the market's broadening, ag certainly is a broadening opportunity as well, as is pharma, because pharma, frankly, hasn't been buying sequencers at all for the past eight or ten years.

So, I think it's mostly a market broadening effect.

Excellent.

And now that your platform has been 510(k) cleared, any updates on your diagnostic strategy?

Yes.

Just to be clear, the product that was 510(k) cleared is the Xpress.

And so, that is now a platform where we are developing some internal assays and we're working with a number of outside partners to begin to put their assays on the BeadXpress platform.

Probably the most significant part of our diagnostic strategy is in our cancer discovery activity and just a quick update there, we finished sequencing the 25 matched tumor normals for ovarian and for the gastric program.

In the ovarian program, we've discovered about 40 genes that have fallen out of that sequencing effort as we completed the bioinformatics, about half of those are novel, and we're beginning to move into the validation phase in the ovarian program.

In the gastric program, we're just about to finish up the bioinformatic analysis and develop the gene list, and then that will go into the validation phase as well.

Thanks.

Thanks, Quintin.

Your next question comes from the line of Dan Leonard from Leerink Swann.

Please proceed.

Thank you.

Touching on part of Quintin's question, can you quantify as best you can how much of your business in the quarter came from stimulus money?

Yes, we think our best approximation is about $18 million in the quarter.

As we've said over the last couple of quarters, it's getting increasingly difficult for us to tease the numbers apart, and in particular that's due to the fact that more and more grants now are follow-on to grants already given and they're being used to buy reagents that might be coupled with other orders that we would have gotten.

And so, I think our ability to actually determine what the contribution is in any given quarter is getting increasingly difficult.

Okay, thank you.

And then my follow-up, can you also quantify, and a range would be fine, how much your targeting to expand HiSeq manufacturing capacity in the fourth quarter?

No, we're not going to give a range for Q4.

We did in the script say we increased 70% in Q3 which was a pretty big jump for us.

Obviously, it won't be of that kind of magnitude in Q4, but it will be a material increase again.

Okay, thank you.

Thank you.

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

Please proceed.

Hi.

Good afternoon, everyone.

Hi, Bill.

Just -- I guess not to necessarily beat on a dead horse, but just to come back to the HiSeq manufacturing expansion.

Given the couple of quarter comments to work down the backlog as well as the timing of the HiSeq 1000 release, is it fair to assume guys that we're going to continue to see manufacturing expansion into the first half of 2011 as well?

Well we haven't -- we're not going to talk about our plan, but obviously one of the things that Jay said was we're working hard to kind of bring down our lead times to more normalized levels, so in the fourth quarter it's likely that hopefully we'll be successful in continuing to scale our capacity, and then you get into the first half of next year and if we haven't brought our lead times down enough, we'll continue scaling.

I think we've got a good logistics and materials procurement process in place, so it's becoming easier to scale with each quarter.

But at this time, it's probably not appropriate for us to give the specifics of what we're going to do in the first part of next year.

But is it safe to assume, Christian, that the expansion is going to be within the existing facility, that this doesn't necessarily envision any additional build-out, per se?

Well we have extra space in the facilities that we're in up in -- and with the HiSeq is made up in Hayward.

And so, we've been utilizing additional square footage to the extent we need to, but we don't feed to go acquire a new building per se to be able to achieve our goals.

Very good.

Thank you.

The other part I'm at, just to be clear about how this works, of course, is that for us to begin to bring the backlog down and the shipment times of HiSeqs, to get that shorter, we have to achieve a manufacturing build plan that's materially higher than the incoming order rate.

And so that's clearly the goal, is to get above the incoming order rate, and as we do that we're going to start shrinking the lead times which is important to us, but we need to be cautious that we do not over shoot that too far and build excess capacity that when we come to a more normalized level, would result in unabsorbed overhead.

So, there's a delicate balance we're walking here over the next few quarters.

Very good.

Thanks for the additional color, guys.

Your next question comes from the line of Amit Bhalla from Citi.

Please proceed.

Hi, good afternoon.

Two questions.

First, a housekeeping one.

I wasn't sure if I missed this, but can you tell us what the backlog growth was quarter-over-quarter?

I think last quarter it grew 20% and I just wanted to get that number for this quarter?

We didn't update the backlog this quarter.

So you didn't miss it, we just didn't update it.

Okay.

And then as a follow-up, in terms of NIH, how sensitive is your business to changes in NIH funding?

I think I have a feel for it, but I just want to hear from you, like if NIH funding is to move 2%, 3%, 4% in a certain direction, how much impact do you think that has to your business over the next two years?

We're generally less sensitive than many other companies in the industry, and the reason is that the technology that we happen to -- we're sort of fortunate to have in our portfolio is the type of technology that is in the highest demand.

And so, in times when the budgets are growing in small numbers there's other compromises that researchers make in order to be able to buy the most important equipment they think they need to add to their portfolio of technologies, and so in general, we're somewhat less effected by budget changes than other companies would be.

And if I could just sneak a quick one by -- in about the Genome Network, the IGN.

You mentioned you had several orders this quarter, can you tell us a little bit about where those orders came from and when they translate to revenue how that's going to impact the P&L?

Thanks a lot.

We can't tell you exactly where they came from, but the kind of business that we're seeing in general terms comes from some consortia and from many industrial companies that probably have more one-off type projects, or at least projects where they don't know necessarily what they're going to do next after they sequence the initial bolus of genomes, and so it makes sense for them to look at outsourcing.

In terms of revenue recognition, we recognize the revenue when we actually deliver the data, so it will be in our backlog as we're doing our sequencing and then it's recognized 100% when it's delivered.

And just to be clear its recognized on our services line, not in product revenue.

Okay, great.

Thanks.

Your next question comes from the line of [Fung Ginam] from Gleacher and Company.

Please proceed.

Hi.

Thanks for taking the question.

Going back to the Genome Network business, can you comment on the margins you expect to be -- this business going forward to be profitable and maybe how it compares to kind of the overall margins for your services business?

Well certainly it's a profitable business for us.

It's one that is competitive marketplace but it's one where we think our cost of sequencing are the lowest in the industry.

So, it is a business that generates profit for us.

We do intend to be aggressive in this marketplace and to be the strongest player in the market.

And so, that may mean that we'll be aggressive in pricing but at almost any price point we could imagine we'll remain profitable.

Okay, great.

And then if you could comment on your product strategy for GAIIx and IIe given the HiSeq 1000 and the strength in HiSeq 2000 overall?

Yes, we're essentially discontinuing the GAIIe and the GAIIx will now be priced under $300,000, including the Paired-End Modules.

So, any customer buying that system would be able to get up to 95G of output, and we think that system is a fantastic sequencer, particularly at a price point under $300,000.

And then, for the very low price market segment we will have refurbished GAIIxs that have come back as part of the trade-in programs that we will sell as previously used (Inaudible), and so those would be discounted below the $300,000 for those set of customers.

Great, thank you.

Your next question comes from the line of Zarak Khurshid from Wedbush Securities.

Good afternoon.

Thanks for taking the questions, guys.

I'll offer up my third quarter attaboy as well.

Thank you.

Just thinking about the utilization of the BGI sequencers, how should we think about that in light of their growing capacity?

They don't give us statistics on their utilization rate, but their intent obviously is to fill up their sequencing capacity.

So, they will try to run these as close to 100% as they can.

With any major sequencing center, there's going to be some natural down time for instrument maintenance and for doing various kinds of rearranging of the units and sort of project management stuff.

So, it would be unusual to get over say 90% overall utilization, but certainly they would probably have a goal to be at that point or maybe slightly higher.

Okay, great.

And then for the follow-up question, could you describe kind of the strategic investments, were they more diagnostic or toolsy in nature and how -- how do they actually look for you, the Company?

We think of them as technology investments.

They were not specifically diagnostic, although the technology as much as our existing technology is -- could ultimately be used in diagnostic applications.

So, their fundamental technology pieces that could play broadly into our product lines.

Thanks.

Your next question comes from the line of Paul Knight from CLSA.

Please proceed.

Hi, guys.

This is Jonathan Palmer in for Paul Knight.

Hi.

Hi, Paul.

Could you guys give us an quick update on the growth you're seeing from an geographic basis, Europe and Asia.

So if you look at the third quarter we had very a strong quarter in Americas and in Europe.

Not quite as strong a quarter sequentially from Asia relative to the second quarter, but relative to the third quarter of last year, Asia also had a nice quarter.

But, if you look in terms of who is growing fastest right now, it's Americas, followed by Europe, then followed by Asia for the third quarter.

That follows somewhat the seasonal pattern, that Q3 typically in the US is the strongest quarter and it's not in Asia, so it's pretty typical distribution that we'd expect.

Yes.

And then what are you hearing from European customers in terms of the funding environment right now?

I think overall the funding environment in Europe is generally challenged.

But, as we've been fortunate to have the HiSeq and basically technologies that are in high demand, and so we've been very successful in having our customers be able to obtain the funds to be able to buy the products, which in fact is what's driving the growth.

So, I would say overall the funding environment in Europe is probably not as strong as in the United States, but it hasn't really impacted us materially.

I think that back three or four months ago there was quite a square about Europe actually tearing back research funding significantly, and I think that's not occurring.

That's right.

Particularly in the UK already, I think it may stay flat but it's not going to be cut back radically, which I think some people were worried about back a few months ago.

Great.

Thanks for the color and taking my questions.

At this time I'm showing no further questions in queue.

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

Peter Fromen for any closing remarks.

Thanks, operator.

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

Thank you for joining us today.

This concludes our call, and we look forward to the update in February following the close of the quarter and fiscal year.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a great day.