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Illumina, Inc. (NASDAQ:ILMN)

Q3 2010 Earnings Call

October 26, 2010 5:30 p.m. ET

Executives

Peter Fromen – Senior Director, IR

Christian Henry – SVP, CFO & General Manager, Life Sciences

Jay Flatley – President & CEO

Analysts

Doug Schenkel – Cowen & Company

Ross Muken – Deutsche Bank

Marshall Urist – Morgan Stanley

Isaac Ro - Goldman Sachs

Tycho Peterson – JP Morgan

Derik DeBruin - UBS

Jon Groberg – Macquarie Capital

Quintin Lai – Robert W. Baird

Dan Leonard – Leerink Swann

Bill Quirk – Piper Jaffray

Amit Bhalla – Citi

Unidentified Analyst – Gleacher and Company

Zarak Khurshid – Wedbush Securities

Jonathan Palmer – CLSA

Operator

Good day, Ladies and Gentlemen, and welcome to the Third Quarter Illumina Earnings Conference Call. My name is Derrick, and I’ll be your operator for this call. (Operator Instructions)

I would now like to turn the conference over to Mr. Peter Fromen, Senior Director of Investor Relations. You may proceed.

Peter Fromen

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 released today, and offer our commentary on our commercial activities after which, we will hold 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 site of our website at Illumina.com.

Presenting for Illumina today will be Jay Flatley, President and Chief Executive Officer and Christian Henry, who is our Senior Vice President and 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 at 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 City SMID Cap Conference in Las Vegas on November 16th, the Piper Jaffray Healthcare Conference in New York on November 30th, and the Deutsche Bank MedTools Investor Summit on December 7th and 8th 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 will now turn the call over to Christian.

Christian Henry

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 significant uptake 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 for sequencing systems was at the high end of our projected range of 150 to $200,000 per system. Additionally, across our installed base of Microarray Scanners, annualized consumable pull-through was above our targeted range of 400 to 500K per system. And reached levels last seen in Q1 of 2009.

Our Microarray Consumable business was driven by revenue from our whole genome V chips, which grew more than 50% year over year, and 20% sequentially. This growth was largely due to the Omni 2.5, which became our bestselling 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 from Microarray Instruments 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’d like to note that we recorded a pre-tax amount of $18 million related to non-cash stock-based compensation. This impacted our EPS by a tax-adjusted amount of $0.09 pro forma diluted share for the quarter.

I want to remind you that we now include this expense in our presentation of our pro forma net income and earnings per share. However, in our discussion of gross margins, operating expenses, and operating margins, I will highlight both our GAAP expenses, which includes the stock comp expense, and other non-cash charges, and the 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 includes stock-based compensation of 1.5 million compared to 1.3 million in the prior year period. Excluding this expense in 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 ’09.

The anticipated decline in gross margin was due to the genome analyzer trade-in program associated with the launch of HiSeq. We will continue shipments of systems purchased through the trade-in program for at least the fourth quarter. And as a result, we expect gross margins in the fourth quarter to be in the mid-60’s, 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 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 profits 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 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 re-evaluation of monetary assets outside the U.S. 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 U.S. 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 effect of 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 per 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 productions, 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.

Jay Flatley

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 are 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 Omni 2.5.

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 Omni 2.5, which became our single bestselling microarray in the first full quarter of shipment. As a reminder, the Omni 2.5 is a four-sample BeadChip with 2.5 million markers per sample that enables customers to access rare variant content.

In addition to the Omni 2.5, the Omni-1Quad 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 Omni 2.5 and soon the Omni 5 will enable researchers to explain significantly more of the inheritability of human disease. We currently expect to launch the Omni 5 by the middle of 2011 pending the availability of content from the 1,000 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 HighScanSQ. 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 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 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 ECHO, a low cost, real time PCR technology that Helixis had developed. I’m pleased to report that we successfully integrated the Helixis team and ECHO 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, ECHO 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 $50,000or more. The ECHO 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 HiSeq 2000.

Over 40% of Q3 shipments went to major genome centers, such as DGI and Brogue. 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 programs 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 SVS 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 of 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 the throughput. This system will allow customers access to the latest technology roadmap at a lower entry price. And provide field upgrade ability to 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 GA2X to below $300,000, including the paired end module, which is the current price level of the GA2E system. As a result, we’re going to discontinue the sales of the GA2E, and address the cost sensitive segment of this market with new and refurbished GA2X’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 programs links our internal sequencing surfaces to leading institutions using HiSeq to offer the human full genome sequencing services. We continue 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 turnaround 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 to the most significant product launch in the company’s history. Through disciplined expense management, we’ve 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 Omni 2.5 launch has gone well. And the product is quickly becoming our bestselling microarray.

We’re successfully scaling HiSeq manufacturing to meet demands that have significantly exceeded our expectations.

In general, our markets are very well funded globally. And we see no slowing in the demand for sequenced 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.

Question-and-Answer Session

Operator

(Operator Instructions) I'm showing the first question comes from the line of Doug Schenkel with Cowen & Company. Please proceed.

Doug Schenkel – Cowen & Company

Hi. Good afternoon, and thanks for taking my questions.

Christian Henry

Hi Doug.

Jay Flatley

Hi Dough.

Doug Schenkel – Cowen & Company

So from an outside perspective, it looks like you guys have made plans to increase high-speed 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%. It sounds like you got a 70% increase. Is that the right way to think about it, that you guys have actually make a third decision to expand capacity in response to demand exceeding expectations?

Jay Flatley

Yeah, I say that’s right, although, you know, when we saw the initial uptick, even in the first quarter, we plotted out several quarters of increased production and then we continued to tweak that ramp up as we saw the actual order rate. So those continuances weren’t whole independent of each other. But you’re right, we sort of hit the curve a couple of times already.

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

Doug Schenkel – Cowen & Company

And are you at the point that you’re starting to turn the corner on some of the, I guess, components, the challenges that you’re running into because of the demand for HiSeq demand for HiScan and you know, and how’s this going to change with the launch of the HiSeq 1000.

Jay Flatley

I think the teams are doing a really great job there in Christian’s group of managing the component’s supply chain. We really haven’t had any particular challenges there other than the fact that we didn’t order enough parts for the influx of demand that exceeded the expectation.

So you know, as we saw that demand level, in every month we sort of 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’re going to be handling the backlog. Our backlog was of total HiSeqs now stretches out deliveries longer than is idea. We’d like to begin to ratchet that in here, but it’s going to take us a couple quarters to do it.

Doug Schenkel – Cowen & Company

And one last one on trade ins. Any chance you’d provide enough data 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?

Jay Flatley

Oh, I can 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 you know, we said that we expected somewhere north of 50% initially to be traded in. I think the percentage is substantially higher than that by the time we get all done.

We should say that the Q4 trade-in program, which is the one that offered the best turns for the customers is essentially over now 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 flow, there will be no more.

Doug Schenkel – Cowen & Company

Great. Thanks again, and congrats on a great quarter.

Jay Flatley

Thanks, Doug.

Operator

(Operator Instructions) And your next question comes from the of Ross Muken with Deutsche Bank. Please proceed.

Ross Muken – Deutsche Bank

Good afternoon, guys and congrats.

Jay Flatley

Thanks, Ross.

Ross Muken – Deutsche Bank

So maybe talk a bit about the challenges in dealing with the fast sort of 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, you know, much better sort of cost benefit for them but it’s happening at this incredibly rapid rate. And so while that’s great, you know, it’s certainly something 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.

You know, as you sort of continue to churn away here at all the various product lines and continue to expand them, what’s been sort of the customer feedback and how do you kind of condition the sales force to make sure that this sort of quick turnaround time and the phenomenal R&D pipeline continues to be so well received?

Jay Flatley

Well, it is a challenge for the customer base to absorb these changes if they go too quickly. So you know, one of the things, of course, we attempt to do is package changes together. So we, you know, 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 you know, 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 run on GA even after the HiSeqs were installed for a while so that they could sort of manage their workflow on a project basis to make that transition easy.

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

Ross Muken – Deutsche Bank

Thanks. And maybe just quickly, you know, the cash flow generation here continues to be tremendous. You’re building up the cash balance again. What’s sort of the near-term priority in terms of deployment?

Christian Henry

So Ross, it’s Christian. You know, obviously one of the things we did announce was our share buy-back under the 10D51 programs so that’s just running its course. That’s one use of cash. We do have some CapEx that continues to run along at a reasonable rate, kind of in that 10 to $12 million a quarter. And then, you know, the rest of the cash flow generation, you know, we’re really looking at a lot of different strategic investments, different kinds of tuck-in technologies, etcetera. As you saw on this call, I indicated that we had invested $31 million in varying 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.

Ross Muken – Deutsche Bank

Great. Thanks, guys.

Jay Flatley

Thank you.

Operator

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

Marshall Urist – Morgan Stanley

Yeah, hey guys. Good afternoon and congrats from me on the quarter as well. First one, if I could just maybe ask a question about Microarrays, you know, the 2.5 is doing well. We’d like to get a little bit more detail on what you’re seeing from sort of a customer and project perspective there with, you know, sort of which do you watch and what’s your current expectation on when we’ll start to see some data from these – from the Omni 2.5?

Jay Flatley

Yeah, I think the uptick of the 2.5, as we indicated in the script, will be very strong. There’s adoption in particular in some of the larger centers that had been historic users of large DOT watts technology and so we’re seeing them sort of coming back into the marketplace now. There’s a whole series of pilot studies that are getting kicked off here, and I think, you know, we’ll begin to see the early results from these studies sometimes 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 seal the growth in the marketplace.

Overall, this is happening about like we expected. The Omni 5 is later than we might have hoped because we don’t have access to the content yet from the Falcon Genome Project. We expect to sort of be over that hump by very early next year and be able to get the 5 into the market roughly midyear of 2011.

Marshall Urist – Morgan Stanley

Okay, great. Thanks. And then just one other one, just on the expense leverage, you know, with the – with the HiSeq ramp, you know, you guys are showing some pretty – some pretty dramatic expense leverage here, so is this something that we should be thinking about as sustainable over the next few quarters, and into 2011, or you know, as you’re doing to get through the HiSeq kind of trade in and the steepest part of the curve, are there some other investments in other areas, you know, in R&D or SG&A that we should be looking for? Thanks.

Jay Flatley

Well, I guess the first thing to talk about is the gross margin side. You know, we’ve indicated some reduction in gross margin 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 you know, into the 2011 timeframe, 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, yeah, terrific performance this quarter on percentage of revenue basis. We’ve continued to grow the absolute dollars we are investing in sales and marketing because we need to continue to scale there to meet the demand levels of the increase breadth of the product line.

On the R&D side, you know, we continue to run lots of programs in parallel. There’s no very significant or major investments that we expect to be [inaudible] there, although we’ve always said as we get to these levels of operating profit that we 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.

Marshall Urist – Morgan Stanley

All right, great. Thanks, and congrats again on the quarter.

Operator

Your next question comes from the line of Isaac Ro from Goldman Sachs. Please proceed.

Isaac Ro - Goldman Sachs

I am actually –

Jay Flatley

Welcome aboard Isaac.

Christian Henry

I have a project for you.

Isaac Ro - Goldman Sachs

That terrifies me. Thanks for the offer though. Just real quick on the HiSeq 1000, I think you gave some pricing dynamics but you didn’t necessarily carve out kid of where HiSeq 1000 is going to be priced versus the 2000 and the GA2X. I’m just first off wondering how it’s going to be positioned on the pricing side.

Jay Flatley

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

Isaac Ro - Goldman Sachs

You got it. And then, you know, just look at the low end of the market, obviously there’s a couple of offerings hitting the market at the sort of 150K or lower arena. How important do you think it is to plan that part of the market, you know, heading to 2011?

Jay Flatley

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 certainly a marketplace that we’re looking at, we think is an interesting one, but we don’t have any future product offerings to talk about.

Isaac Ro - Goldman Sachs

Great. And if I could just ask one last quick one, you know, there’s a lot of money going into investment in single molecule technologies over the last few years. I mean, do you view that market as worthy of incremental investment at this point?

Jay Flatley

We don’t actually see the single molecule systems as a market. A single molecule to us 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 difficulty of sequencing a single molecule at a time. And they’ve made tremendous sacrifices in terms of run time, read lengths, cost in principle activity in order to achieve sequencing single molecule. So we think that, you know, 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.

Isaac Ro - Goldman Sachs

Got it. Thanks very much.

Operator

Your next question comes from the line of Tycho Peterson from JP Morgan. Please proceed.

Tycho Peterson – JP Morgan

Hey, good afternoon. You know, starting off the question on HiSeq, you know, as we think about moving beyond the upgrade past era, you know, and then in the first year, can you just talk a little bit about what the mix of, you know, the interest is? I think you talked about 90% of Q3 orders were outside genome centers, so you know, are the areas where you’re seeing interest beyond your expectations in terms of non-traditional customers or I guess, how do we think about the pipeline beyond the upgrades?

Jay Flatley

I wouldn’t say they’re non-traditional. We certainly see them coming from a broader way of market – of types of labs let’s say, down to the very small lab 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 the single lab with a very small number of people can implement a technology like HiSeq and place sort of in the world class sequencing and make major discoveries. And that has the effect of broadening the market.

But we are seeing the demand across all the traditional academics that you might expect, certainly into the ag market place for sequencing. We’re seeing probably some increasing demand in industrial customers. In pharma, we continue to believe that there won’t be large-scale discovery programs running in house, but that all of the research labs in pharma will need access to next gen sequencing. So you know, 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. So we do think it’s a very important and pervasive technology.

Tycho Peterson – JP Morgan

And then with regards to the 1000, you know, was this something that potential customers were asking for? I’m just trying to kind of, you know, think about how big an opportunity that is for you relative to your 2000 business and will it be a small subset of HiSeq placement that ultimately go out with the single-flow?

Jay Flatley

Well, we think it’s pretty substantial, particularly because of the upgrade path, that you can get into the marketplace at a lower price 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 analyzers 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. And so we decided to launch the HiSeq 1000 as a result.

And we think that, you know, from a competitive positioning standpoint, we now have two systems that are the latest-greatest technology and for the very price-sensitive customers, we can deal with them using the new price of the GA2X at the 95G output and the refurbish program for those customers that are very price sensitive. So we think from sort of a price-performance perspective, we’ve got the marketplace really well covered with the launch of the HiSeq 1000.

Tycho Peterson – JP Morgan

Okay. And then on the Helixis business, with regards to the initial echo placement, have you seen any cross showing from some of these – the other market diagnostics, forensics, or food testing or anything?

Jay Flatley

It’s a little too early to tell. When we bout Helixis they came in with a pretty substantial backlog. They had launched principally through distributers internationally and there was a pretty large backlog. So we’re – we very early in the stage of deploying it to our own sales force because we need to ramp up the production to shop backlog before we start taking too many orders. So it’s a little early to sort of comment on what we think the order dynamics are going to look like.

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

And certainly we have a built-in opportunity to sell an echo system in front of our HiSeq technology and the GA technology anywhere we’re selling sequencers was an obvious place to sell echos.

Operator

Your next question comes from the line if Derik DeBruin from UBS. Please proceed.

Derik DeBruin - UBS

Hi. Good afternoon.

Jay Flatley

Hi Derik.

Christian Henry

Hi Derik.

Derik DeBruin - UBS

Hey. So I’ve got a number of short questions that are all related. So how long until the shipment and installation of a HiSeq until it runs full throttle. And then I guess, how many of your platforms do you think are running all out? I’m trying to get a feel for utilization rates just because when I look at the numbers for next year, you know, the consumable pull-through seem to be the biggest variable in terms of potentially getting upside to current expectations.

Jay Flatley

Yeah, installations are going quite quickly now and they’re coming up fast in the field, so you know, 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 in 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 develop new applications or do tech development [ph] on the system.

Derik DeBruin - UBS

Okay. And how many – and so what’s your current guess in terms of – not so much – maybe not so much for HiSeq, but just in terms of your overall install base. How many of those are being used in full capacity?

Jay Flatley

It’s hard to tell. You know, the capacity of these is pretty high as you can imagine, so I’d say most, you know, most of our large genome centers are running at, you know, somewhere in the 80 to 90% range. Most other customers wouldn’t be running at 80 or 90%.

Derik DeBruin - UBS

Okay. And then just one other question, kind of a market dynamic question. When you gave your analyst day back in early January, you made a comment that you felt like there was about 1,500 installed based of next generations sequencers out there. I’m just kind of wondering, you know, do you have enough data on kind of where you see the market right now and how much, you know, where we are right now just given all the swaps that’s gone on and new people buying it?

And I guess I’m trying to get at is to try to get a feel for what is the overall sequencing capacity that’s out there in the field.

Jay Flatley

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

Derik DeBruin - UBS

Okay. Thanks.

Operator

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

Jon Groberg – Macquarie Capital

Hi. Thanks a million for taking my question. Can I – 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 instruments and exactly what will occur here.

Jay Flatley

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

Jon Groberg – Macquarie Capital

And so just thinking about the – at the price point you’re 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?

Jay Flatley

Yeah. It will be a bit lower than the 2000 would be, but you know, I think over time the 2000 is going to get to be a decent margin. So you know, we think the 1000 will be just fine.

Jon Groberg – Macquarie Capital

Okay. And then if I can, just switching to the array business, I mean, we thought a lot about the trade-in program that’s going on obviously in 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 of the other products that you’re introducing on the array side?

Jay Flatley

No. There’s no official trade-in programs on the microarray scanners.

Jon Groberg – Macquarie Capital

Okay. Thanks much.

Jay Flatley

Thank, Jon.

Operator

Your next question comes from a line Quintin Lai from Robert W. Baird. Please proceed.

Quintin Lai – Robert W. Baird

Hi, good afternoon. Congratulations from us as well.

Jay Flatley

Thanks, Quintin.

Quintin Lai – Robert W. Baird

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 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?

Jay Flatley

It’s a combination; with respect of the stimulus, we think there’s probably about 1/3 of the total funds from the stimulus program right now out on the hands of researchers. So we have about 2/3s of that yet ahead of us, which clearly now we’ll – I think we’ve mentioned a bit in a 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 the other economic challenges that the country has had. But the funding environment there is still good.

Probably, single biggest factor that plays in our favor is that next-gen sequencing is a very popular technology. It’s the technology that, I think has advanced the most quickly in the life science 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 is 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 is 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. I think it’s mostly a market broadening effect.

Quintin Lai – Robert W. Baird

Excellent. And then now that your platform has been 510K cleared, any updates on your diagnostics strategy?

Jay Flatley

Yes. Just to be clear, the product that was 510K cleared is the Express and that is now a platform where we’re developing some internal assays and we’re working with a number of outside partners to begin to on the assays on BeadExpress 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 discovered about 40 genes that have fallen out of that sequencing effort as we completed the bio informatics, about half of those novel and we’re beginning to push into the validation stage in the ovarian program. In the gastric program we’re just about to finish up the bio informatic analysis and develop the gene list and then that will go into the validation phases as well.

Quintin Lai – Robert W. Baird

Thanks.

Jay Flatley

Thank, Quintin.

Operator

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

Dan Leonard – Leerink Swann

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

Jay Flatley

We think our best approximation is about $18 million in the quarter. As we have said over the last couple of quarters, it is getting increasingly difficult for us to tease the numbers apart and in particular that is due to the fact that more and more grants now are follow-ons to grants that were already given and they’re being used to buy reagents that might be coupled with other orders that we would have gotten. So I think the ability to actually determine what the contribution is at any given quarter is getting increasingly difficult.

Dan Leonard – Leerink Swann

Okay, thank you. And then my follow up. Can you also quantify, and a range would be fine, how much you’re targeting to expand HiSeq manufacturing capacity in the fourth quarter?

Jay Flatley

No, we aren’t going to give a range for Q4, we did in the script say that we increased 70% in the 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.

Dan Leonard – Leerink Swann

Okay, thank you.

Operator

Your next question comes from a line of Bill Quirk from Piper Jaffray. Please proceed.

Bill Quirk – Piper Jaffray

Thanks. Good afternoon everyone. Not to beat on a dead horse, but to come back to HiSeq manufacturing expansion. Given the couple quarter comments, work down that backlog as well as the timing of the HiSeq 1000 release, is it fair to assume guys that we are going to see manufacturing expansion into the first half of 2011 as well?

Christian Henry

We haven’t, we aren’t going to talk about our plan but obviously one of the things Jay said was we’re working hard to kind of bring down our lead times to more normalized levels. So the fourth quarter, it’s likely that hopefully we’ll be successful and continue 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 – some logistics and materials procurement process in place so it is becoming easier to scale with each quarter. At this time, it probably isn’t appropriate to give the specifics of what we’re going to do in the first part of next year.

Bill Quirk – Piper Jaffray

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 say?

Christian Henry

We have extra space in the facilities that we’re in up in -- and the HiSeq made up in Hayward, so we’ve been utilizing additional square footage to the extent we need to. But we don’t need to go acquire a new building, per se, to be able to achieve our goal.

Bill Quirk – Piper Jaffray

Very good, thank you.

Jay Flatley

The other part of the math, 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 clear, the goal is to get above the incoming order rate and as we do that we are going to start shrinking the lead times which is important to us, but we need to be cautious that we don’t over shoot that too far and build excess capacity that when we come to a more normalized level would result in unabsorbed overhead. There is a delicate balance we’re walking here over the next few quarters.

Bill Quirk – Piper Jaffray

Very good, thanks for the additional color guys.

Operator

The next question comes from a line of Amit Bhalla from Citi. Please proceed.

Amit Bhalla – Citi

Hi, good afternoon. Two questions. First off, housekeeping. 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%, I just wanted to get this number for this quarter?

Jay Flatley

We didn’t update the backlog this quarter, so you didn’t miss it, we just didn’t update it.

Amit Bhalla – Citi

Okay, then the follow-up. In terms of NIH, how sensitive is your business to changes in,NIH funding? I mean, I think I have a feel for it, but I just want to hear it from you like if NIH funding is to move 2,3 or 4% in a certain direction, how much impact do you think that has to your business over the next two years?

Jay Flatley

We’re generally less sensitive than many other companies in the industry and the reason is that the technology that we happen to – we are fortunate to have in our portfolio is the type of technology that is the highest demand. And so in times when the budgets are growing at small numbers there are other compromises that researchers make in order 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 affected by budget changes than other companies would be.

Amit Bhalla – Citi

I’ll sneak a quick one back in about the genome network, the IGN. You mentioned you had several orders this quarter, can you tell us 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.

Jay Flatley

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 that where they don’t know necessarily what they’re going to do next after they sequence the initial bolus of genomes. 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 are doing the sequence thing and then it is recognized 100% when the data is delivered.

Christian Henry

And just to be clear – to recognized on our services line, not in program.

Amit Bhalla – Citi

Okay, great, thanks.

Operator

Your next question comes from a line of [inaudible] from Gleacher and Company. Please proceed.

Unidentified Analyst – Gleacher and Company

Hi, thanks for taking the questions. Going back to the genome network business could you comment on the margins that you expect with the business going forward for it to be profitable and maybe how it compares to the kind of overall margin for your services business?

Jay Flatley

Well certainly, it’s a profitable business for us. It is one that is competitive marketplace, but it is 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 in that may mean that we’ll be aggressive in pricing, but at almost any price point we can imagine we’ll remain profitable.

Unidentified Analyst – Gleacher and Company

Okay, great. And then could you comment on the product strategy for GA2X and QE and the HiSeq 1000 and strength in HiSeq overally?

Jay Flatley

Yeah, we’re essentially discontinuing the GA2E and the GA2X will now be priced under $300,000 including the paradigm modules. So any customer buying that system would be able to get up to 95G 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 a GA2Xs that have come back as part of the trade in programs that we’ll sell as previously used units, so those would be discounted below the $300,000 for that set of customers.

Unidentified Analyst – Gleacher and Company

Great, thank you.

Operator

Your next question comes from a line of Zarak Khurshid from Wedbush Security. Please proceed.

Zarak Khurshid – Wedbush Securities

Good afternoon. Thanks for taking the questions guy. I’ll offer up my third quarter attaboy as well. Just thinking about the utilization of the BGI sequencers, how should we think about that in light of their growing capacity?

Jay Flatley

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% if they can. With any major sequencing center there’s going to be some nature downtime for instrument maintenance and for doing various kinds of rearranging of the units and project management stuff. So it’d be unusual to get over, say, 90% overall utilization, but certainly they’d probably have a certain goal to be at that point or maybe slightly higher.

Zarak Khurshid – Wedbush Securities

Okay, great. And then for the following question, could you describe kind of the strategic investments; were they more diagnostic or tools of nature and how do they actually look for you the company?

Jay Flatley

I think of them as technology investments, they were not specifically diagnostic, although the technology – as much of grouping technology is – could ultimately be used in diagnostic applications. So they’re fundamental technology pieces that could play probably into our product lines.

Zarak Khurshid – Wedbush Securities

Thanks.

Operator

The next question come from line of Paul Knight from CLSA. Please proceed.

Jonathon Palmer – CLSA

Hi guys, this is Jonathon Palmer in for Paul Knight. I was wondering, can you guys give us a quick update on the growth you’re seeing from a geographic basis; Europe and Asia?

Jay Flatley

Yeah, if you look at the third quarter, we had a very strong quarter in America and in Europe. Not quite as strong of a quarter sequentially from Asia relative to the second quarter, but relative the third quarter of last year Asia also had a nice quarter. But if you look in terms of who’s growing fastest right now it’s America followed by Europe then followed by Asia for the third quarter.

Christian Henry

And that follows somewhat of a season pattern. Q3 typical in the U.S. it’s the strongest quarter and it’s not in Asia, pretty typical distribution that we expect.

Jonathon Palmer – CLSA

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

Jay Flatley

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 pay the funds to be able to buy products, which in fact is what’s driving the growth. So I’d say overall the funding environment in Europe is probably not as strong as the United States but it hasn’t really impacted us materially.

Christian Henry

I think that back three or four months ago there was quite a scare about Europe actually tearing back research funding significantly and I think that’s not occurring typically in the U.K. already. They stay flat but it’s not going to be cut back radically, which I think some people were worried about back two months ago.

Jonathon Palmer – CLSA

Great, thanks for color and taking my questions.

Operator

At this time I’m showing no further questions, thank you. I would like to turn the call back over to Mr. Peter Fromen for any closing remarks.

Peter Fromen

Thanks operator. As a reminder, a replay of this call will be available as a webcast in the investors 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 our next update in February following the close of the fourth quarter of the fiscal year.

Operator

Ladies and Gentleman, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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