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Illumina Inc. (NASDAQ:ILMN)

Q1 2008 Earnings Call

April 22, 2008 5:00 pm ET

Executives

Peter Fromen - Sr. Director IR

Jay Flatley - President and CEO

Christian Henry - SVP and CFO

Analyst

Ross Muken - Deutsche Bank

Doug Schenkel - Cowen & Company

Bill Quirk - Piper Jaffray

Derik De Bruin - UBS

Quintin Lai - Robert W. Baird

John Sullivan - Leerink Swann

Un Kwon - Pacific Growth Equity

Tycho Peterson - JPMorgan

Tony Butler - Lehman Brothers

Davis Field - Goldman Sachs

Matthew Scalo - Canaccord Adams

Jonathan Groberg - Merrill Lynch

Operator

Good day, ladies and gentlemen and welcome to the first quarter 2008 Illumina Inc Earnings Call. My name is Erica and I will be your coordinator for today. At this time all participants are in a listen-only-mode. We will be facilitating a question-and-answer session towards end of this conference.

(Operator Instructions) I will now like to turn the presentation over to your host for today’s call, Mr. Peter Fromen, Senior Director, Investor Relations. Please proceed, sir.

Peter Fromen

Thank you, operator. Good afternoon everyone and welcome to our first quarter 2008 earnings call. During the call we will review our financial results released today after the close of the market, offer commentary on our commercial activities and provide financial guidance for the second quarter and fiscal 2008, after which we will host a Q&A session. If you have not had a chance to review the release, it can be accessed in the investor relations section of our website at illumina.com

Presenting for Illumina today will be Jay Flatley, our President and Chief Executive Officer and Christian Henry, our Senior Vice President and Chief Financial Officer. This call is being recorded and the audio portion will be archived in the investor section of our website.

During the call we will be discussing our financial guidance and plans for future activity. Our intent is for those forward-looking statements to be protected under the Private Securities Litigation Reform Act of 1995. Forward-looking statements made during this call are subject to risks and uncertainties. Actual events or results may differ materially from those projected or discussed. All forward-looking statements are based upon current information available and Illumina assumes no obligation to update these statements. To better understand these risk factors, we refer you to the documents that Illumina files with the Securities and Exchange Commission including forms 10-Q and 10-K.

Before I turn the call over to Christian, I wanted to remind you of the investor conferences in which we will be participating over the next couple of months.

On May 6th we will present at the Deutsche Bank Healthcare Conference in Boston, and the following week on May 13th we will present at the Banc of America Healthcare Conference in Las Vegas. Moving to June, we will participate in the Goldman Sachs Healthcare Conference from 9th to the 12th in Dana Point, California. 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 relation section of the website.

With that now I will turn the call to Christian.

Christian Henry

Good afternoon, everyone and thank you for joining us today. During today's call I will review our first quarter financial results and outline our guidance for the second quarter and the remainder of 2008. Jay will then talk about our commercial progress and provide an update on the state of our business and markets.

In Q1, we recorded our 27th consecutive quarter of revenue growth, with total revenues of $121.9 million. This represents 69% growth year-over-year and approximately 8% sequentially. Product revenue was a $110.7 million and grew 81% over the first quarter of last year, and 9% sequentially.

Sequencing instrumentation and genotyping consumables contributed about equally to both year-over-year and sequential product revenue growth. We generated $63.2 million of consumables revenue in the quarter compared to $38.8 million in the first quarter of 2007, and $56.2 million last quarter. This represents year-over-year growth of 63%, and sequential growth of 12%.

Strong demand for Infinium family of BeadChips led to the growth in consumables during the quarter, although we did see a notable up-tick in the contribution from sequencing kits to the overall increase. The up-tick of the Genome Analyzer in the launch this quarter of the Genome Analyzer II continued to drive growth of our total systems installed base.

Instrument revenue for the quarter was $44.5 million compared to $19.6 million in Q1 of '07, and $41.8 million last quarter. This represented year-over-year growth of 127% and sequential growth of 6%. Services and other revenues, which includes revenue earned from genotyping and sequencing service offerings as well as revenue related to our insurance maintenance contracts with $11.2 million compared to $10.9 million in Q1 of the prior year.

Before moving on to gross margins and operating expenses for the quarter, I would like to talk about the effects of FAS 123R, which requires us to record the expense associated with stock options in our income statement. The total impact of stock compensation expense for the quarter was a pretax amount of approximately $10.9 million or tax adjusted amount of approximately $0.11 per pro forma diluted share.

As prescribed by the standard, the expense is allocated to each P&L line with the amount attributable to each expense category separately identified in the financial tables accompanying today’s earning release. In the discussion that follows, I will highlight both our GAAP expenses, which includes the effect of 123R and the corresponding non-GAAP figures. I encourage you to review the GAAP reconciliation of non-GAAP measures, also included in today’s release.

Total cost of revenue for the quarter was $46.1 million compared to $25.1 million in the first quarter of 2007. The Q1’08 costs includes stock-based comp of $1.4 million compared $0.9 million in the prior year period. Non-GAAP gross margin, which excludes stock, compensation expense was 63.3% of revenue for the quarter compared to 65.5% last quarter, and 67.4% in the first quarter of 2007.

The year-over-year decline in gross margin was driven primarily by the shift in product mix towards instrumentation, and the fact that the lower gross margin sequencing products are a larger percentage of revenue. As I mentioned in past quarters, instruments generally carry lower gross margin and represented approximately 36% of total revenue compared to 27% in the first quarter of 2007.

The declining gross margin relative to the fourth quarter was due to several factors. The largest contributor to the decline was the unfavorable overhead absorption in an oligo manufacturing process. The unfavorable absorption was due to the timing of the manufacture of oligos related to our HD BeadChips and due to lower volumes associated to our oligo collaboration. Despite these unfavorable variances, we continue to maintain our gross margin guidance in the mid-60s for the full year.

Research and Development expenses were $20.6 million for the quarter, compared to $16 million in the first quarter of '07 including $3.3 million and $1.9 million respectively of stock compensation expense. The absolute increase in R&D dollars compared to the first quarter of ‘07 was attributable to the inclusion of Solexa’s R&D expenses for an additional month during the first quarter of '08.

Excluding stock-comp expenses, R&D expenses were $17.3 million or 14.2% of revenue compared to $13.9 million or 19.2% of revenue in the prior year period. SG&A expenses were $33.8 million for the quarter compared to $23.6 million in the first quarter of 2007, including stock compensation expense of $6.1 million and $4.8 million respectively.

Excluding the impact of FAS 123R, SG&A was $27.7 million or 22.7% of revenue, compared to $18.8 million or 26% of revenue in the prior year period. The decline in SG&A expense as a percent of revenue for the first quarter relative to last year confirms the significant commercial leverage that we have been able to achieve with the acquisition of Solexa.

Our non-GAAP operating profit in the quarter was $32.2 million or 26.5% of revenue. This compares to $15.9 million or 22% of revenue in the first quarter of last year and represents year-over-year operating profit growth of 102%. And this is in spite of the inclusion of one additional month of Solexa expenses in the first quarter of ‘08 compared to the prior year. While we are extremely happy with the success of the integration today, we believe that we still have the capability to recognize additional synergies as we align the sequencing and microarray businesses under the Life Sciences Business Unit.

We reported GAAP net income of $13.4 million in the first quarter or $0.21 per diluted share compared to a GAAP net loss of $298 million or $5.58 per basic and diluted share in the prior year period. The GAAP net loss in the first quarter of last year was attributable primarily to the write-off of $303 million of acquired in-process research and development expense related to the Solexa acquisition.

Excluding the impact of the stock compensation expense the amortization of intangibles and net of certain tax benefits, we are pleased to report a non-GAAP net income of $22.5 million or $0.37 per diluted share compared to $12.7 million or $0.22 per diluted share in the first quarter of ‘07. This represents year-over-year net income growth of 77%.

Looking at the cash flow statement and balance sheet and excluding the $90.5 million in payments associated with the litigation settlements made in the first quarter, we generated $27.8 million in cash flow from operations compared to $14.6 million in the prior year period. Our strong operating cash flow performance during the quarter was due to our ability to maintain accounts receivable DSO and inventory balances near Q4 ‘07 levels.

During the quarter we used approximately $7 million in cash for capital expenditures primarily to expand BeadChip manufacturing capacity and bring up our new decoding technology online. Deprecation and amortization expenses for the quarter were approximately $6.2 million, and on a free cash flow basis we generated $21 million or $0.34 per diluted share, compared to $11.4 million or $0.20 per diluted share in the first quarter of last year. We ended the first quarter with $329 million in cash and investments.

During the quarter, we recorded an unrealized loss of $2.4 million due to the temporary impairment of certain auction rate securities. Given recent negative conditions in the global credit markets, we have reclassified the balance of our high grade AAA auction rate securities, totaled $53.5 million from short to long-term investments. Additionally, we reclassified our convertible senior notes to current liabilities as the stock-based conversion rate was met during the first quarter. However, given the current trading price of the bond, we do not believe conversion of the notes to be likely.

I will now update you on our financial guidance for the second quarter of fiscal 2008. Consistent with our previous calls the following guidance excludes the impact of certain non-cash charges including the amortization of intangibles, legal settlement payments and the impact of stock-based compensation related to FAS 123R. For additional details, please refer to the table in our earnings release that reconciles our non-GAAP guidance to the related GAAP figures.

We expect fiscal 2008 revenues between $515 million and $535 million, representing growth between 40% and 46%. This growth rate is at or above the high end of our long-term operating model. This represents an increase of $12.5 million over the mid range of our 2008 guidance that we provided last quarter.

As I mentioned earlier in my remarks, we expect gross margins for the year to range in the mid 60s, and to be lower in the first half of the year compared to the second half. We expect non-GAAP earnings per share between $1.55 and $1.68 with pro forma fully diluted weighted average shares outstanding of approximately $62 million. This represents an increase of $0.09 over the midpoint of our previous EPS guidance.

As a reminder, going forward we will provide a pro forma fully diluted share number that will exclude the double dilution associated with the accounting treatment for our convertible debt outstanding, and the corresponding call option overlay. The call option that Illumina owns offsets all dilution associated with the net share settlement of the note, over its conversion price of $43.66.

We will include the ongoing economic impact associated with the net share settlement of the warrants issued in conjunction with the call option overlay, which have a strike price of $62.87. The first quarter number is included in the reconciliation to GAAP figures that accompanies toady’s press release. Again, as I mentioned last quarter, please feel free to follow-up with myself or Peter after today’s call and we can walk through the details of the calculation.

For the second quarter, we expect revenues to range between $127 million and $132 million, which represent year-over-year growth of 50% to 56%, well above our long-term operating model. Excluding the impact of stock compensation expense and the amortization of intangible assets, we expect second quarter non-GAAP earnings per share to range from $0.37 to $0.40, assuming pro forma fully diluted shares of approximately $61.5 million.

We anticipate a non-GAAP annualized tax rate of approximately 36% for 2008. We expect the tax rate to be higher in the first half of the year, and lower in the second half, as we recognize some benefit from the shipment of products out of Singapore in the fourth quarter.

Over the next few years, as we generate more international income and continue to build out the Singapore manufacturing facility, we expect a further decline in our consolidated corporate rate. We expect a free tax annual stock comp expense to be approximately $45 million or $0.46 per tax adjusted pro forma fully diluted share. As we've emphasized in the past, this expense is highly dependent on our underlying stock price.

Now, 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 began the Q&A. Jay?

Jay Flatley

Good afternoon, everyone. I'm pleased to report that we're off to a very strong start in 2008 with revenue growth of 69% over the first quarter of last year, well ahead of our internal expectations. We grew operating profit by 102% and generated $21 million in free cash flow. However, I'm most pleased by how well our teams met the execution challenges we faced during Q1. During the quarter, we successfully transitioned our three most important product lines to their newest generation, the Infinium HD BeadChips, the iScan BeadChip Scanner and the Genome Analyzer II.

In January, we announced the launch of the Infinium HD BeadChip family which is the most significant new development in Illumina's Microarray business since the introduction of our original Infinium BeadChip. Towards the end of the quarter, we began shipment of the first product in the family, the Human610-Quad. As a reminder, the 610-Quad combines the content from our Hap550 and our HumanCNV370 Chips to allow interrogation of more than 620,000 generic variance across four samples on a single chip.

Our HD technology enables us to continue to improve the economies of whole genome genotyping at the industry as highest quality levels. All indicators point to even higher call rates on the 610-Quad than on our existing Infinium Chips. In May we'll begin shipping the 1M-Duo, the second product in the HD family. The 1M-Duo improves on the content of our flagship Human 1MB Chip with additional disease associated SNPs and increased density of SNPs in coding regions of the genome.

To manage the increased content of the Infinium HD BeadChips, we implemented a new decoding technology in array manufacturing and completed that transition in Q1. The new scanners we brought online result in increase in the rate of which we can decode an individual data point on a BeadChip by over a 100%.

Last quarter I highlighted the 170% improvement that we had made during 2007 in manufacturing capacity. Additional decoding capacity that we've implemented just in Q1 is equivalent to a 66% increase over that level. As a 610-Quad and IM-Duo ramp this quarter to become the majority of our chip production, the efficiency of our new decoding technology will alleviate any capacity constraints.

Last week we launched our next generation analytical scanner called iScan. This system is based on the same Optomechanical architecture as our new decoding systems. We implemented iScan in our service business over a month ago and began shipping the first instruments to customers near the end of the quarter. The iScan system enables a six-fold increase in the throughput of Infinium HD BeadChips compared to our legacy BeadStation platform and a ten-fold improvement on our existing Infinium II BeadChips.

To give you an idea of what this means from a sample perspective, a single scanner with an Autoloader can process 205 samples per day with 610-Quad compared to 32 samples on the BeadStation with the same Autoloader configuration. This translates to 2880 iSelect samples per day on an iScan or one sample every 30 seconds. We expect this dramatic throughput improvement to accelerate completion times of research study and improve our customer's economic equation.

In our based array business during the quarter we continue to see the products we introduced last year drive growth. Once again the 1M BeadChip represented the largest contribution to total BeadChip revenue. The CNV370-Duo, the Hap550-Duo and our customized select format for the next leading products in the portfolio for the quarter. The features of rate portfolio continue to demonstrate the ability to match the appropriate array format that the customer's research demands. This utility is evidenced by the rate in which our customers publish their research in peer-reviewed journals. Already eclipsing last year's total, we seen 57 year-to-date in which customer's have published their research using Illumina genotyping technology.

Yesterday we announced the launch of our HumanHT-12 BeadChip for whole genome gene expression. This product built off our existing expression BeadChips and lowers the total cost per sample to under $100. The HT-12 is the industry's higher throughput and lowest cost solution for whole genome gene expression. The economics of the HT-12 will allow researchers to augment large scale genotyping data with gene expression for more comprehensive genetic analysis. Our existing expression business has continued to grow well ahead of the overall expression market, and outpaced our sequential consolidated top line growth this quarter.

In the lower complexity portion of our business, both the GoldenGate and BeadXpress consumables had a solid quarter. Demand for GoldenGate has been particularly robust within the agricultural market to identify genetic variance that characterize certain plant phenotypes. BeadXpress consumables picked up notably in the quarter, its instrument shipments increased. This completed the transfer and implementation of our BeadXpress manufacturing to our San Diego headquarters and we're significantly scaling production to address continued traction of the platforms in the market.

Turning to the sequencing business, we continue to experience a very robust market environment. This morning we announced the sale of eleven additional Genome Analyzer to the Beijing Genomics Institute or BGI. The sales representative of the ongoing global expansion of the Genome Analyzer footprint bringing BGI's total installed base to 17 units. BJI is now the fourth Genome Center to scale up their capacity of Genome Analyzers to double digits. The significant increase in sequencing capacity will enable the BJI to undertake large scale projects such as the Huang 99 project, the Giant Panda project, and Southern Genome project.

In mid Q1, we began shipping our second generation instrument, the Genome Analyzer II. The GA2 utilizes new optics and camera components to allow more efficient imaging over larger area. This resulted in an increase of system specifications from 1G to over 3G, while simultaneously improving system of robustness. In addition, we added a module to the system that enables real time quality control and will shortly provide real time image processing to accelerate data migration and analysis.

This module which we call iPower, will be of particular interest to the small and medium sized labs with limited data hardware and network resources. I am happy to report that last week we began full commercial shipment of our pyridine module for the Genome analyzer II. Pyridine enabled unable researchers to generate much longer range information across the genome for detection of insertions, deletions and broader structural variation.

Pyridine reached a critical for the sequencing of model organism for which there is no reference, but also for the full characterization of whole human genome sequencing. We expect these system improvements and new software tools to enable routine sequencing of whole human genome study into this year.

In conjunction with the 2008, AGBT meeting, recently held in Marco Island, we announced the sequencing of the first African human genome. Using the Genome Analyzer with 200 and 2000 base pair inserts, we generated over 75 G of data or 25 times coverage of the Genome on 27th sequencing runs in six week. The data detected over 3.7 million snips, 1 million of which were novel. These data in addition to the substantial throughput and accuracy improvement that we have made with the GA2 illustrate the power of the Illumina sequencing platform for whole-genome genome sequencing.

Early this year, an international consortium announced the 1000 Genome Project, which will sequence the genome of at least 1000 people to better understand genetic variation as it relates to human health. This project and other global initiatives to study population diversity and the genetic of disease will surely catalyze the demand for whole-genome sequencing over the next several years. To stand back from all these details of our business, we continue to see overall strength of demand in the markets we serve and little to no impact of reductions in, or the timing of, either government grants of pharmaceutical spending.

I want to take a moment to provide you with an update on the various facilities projects that we have underway. We are on schedule to complete our new 84,000 square foot building at our San Diego headquarters in early Q3. This facility will provide much needed expansion space and the ability to co-locate groups that have been in separate building.

Last month, we broke ground on a new 40,000 square foot facility in the Chesterford Research Park in UK. This site, when completed, will combine four separate facilities that we now operate in the park. Finally, our Singapore manufacturing built-out is right on track, and we expect to begin manufacturing operations in the fourth quarter of this year.

I want to take a few minutes to highlight three new members of our senior management team, who joined the company last month. Joel Macomb joined Illumina from GE Healthcare is our new Senior Vice President of our Life Sciences Business Unit with full operational responsibility for microarray and sequencing businesses. Joe has an extensive background as both an entrepreneur and an operational manager. His most recent role, Joe was President of Interventional Medicine, a $700 million division within GE Healthcare. Prior to that he was President of $600 million Life Sciences Discovery Systems division of GE Healthcare, which was formed following GE’s acquisition of Amersham Biosciences

Also joining the Illumina management team last month was Greg Heath. Greg joins Illumina from Roche Molecular Systems as our Senior Vice President and General Manager of Diagnostics and he will be responsible for managing our emerging diagnostics business and overseeing the development of diagnostic content for the BeadXpress system. Greg has over 20 years of diagnostic experience including launch of the world's first FDA approved microarray. Most recently Greg was Senior Vice President of Global Business at Roche and held positions including Head of Clinical Genomics and Senior Vice President of Global Marketing and Business Development.

The third member joining the team last month was Michael Bouchard as our new VP of finance. Michael reports directly to Christian and he is responsible for Illumina’s financial operation. Mike joins Illumina from Websense, where he was Vice President of Finance. After beginning his career at Deloitte & Touche, Mike has held numerous finance positions at Gateway and Rohm & Haas. I want to welcome Joe, Greg and Mike to the Illumina team and look forward to working with them as we build the foundation for the next leg of Illumina’s growth.

To conclude, we are very pleased with our operating results for Q1 and the disciplined execution require to achieve them. We transition in entirely new BeadChip format and decoding technology in to our array manufacturing process. We reengineered the Genome Analyzer and launched the GAII and we completed development and shipment of iScan, our next generation BeadChip scanner. The hard work by our teams has positioned us well for another exciting year.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Ross Muken from Deutsche Bank. Please proceed.

Ross Muken - Deutsche Bank

Good afternoon, gentlemen. It’s a long day. So, as we look at the quarter I think obviously the growth is pretty astounding that you are able to keep this sort of trajectory, but I guess what's even more astounding sort of the degree to which you continue to innovate, we obviously have several new products that will start hitting the P&L in upcoming quarters.

In each year your key divisions you highlighted that on the call Jay, so where are we sort of in the innovation cycle in these markets and do you still think we are early in both genotyping and sequencing in terms of the -- what you can deliver to the end customer and is that demand still insatiable in terms of driving down cost per data point and them wanting to do more and more projects as it becomes sort of a boarder tool?

Jay Flatley

I guess, there is probably two components to the answer, Ross. One is thinking about this from a technology perspective, and I guess looking at it that way, I’d say that our feeling is our technology is both sequencing and in array business continued to have enormous headroom to get better in terms of density, in terms of the overall throughput, continuing to reduce costs, we are long way from ceiling like, where technology limit or bounded.

The other way to think about is from the market perspective, and sequencing it'svery clear that the demand for sequencing is going to be insatiable as far as we can see, and certainly it'sgoing to be a highly elastic market, so as the prices continue to go down, the kind of organisms, we are going to sequence and the amount of resequencing that's done is going to continue to increase enormously.

In the array business I suspect over the next two to five years, you'll begin to see some transitions there. We definitely expect whole-genome association study to continue for at least two to four more years there, robustly. We think we are going to see follow-on, more focused studies, continue and get ever more rich in terms of converting content into diagnostic products, and we are going to see the emergence of the new markets that we’ve talked about, agricultural markets emerging because of the price for data point now is so low and the emergence of the consumer markets. So, all in all I think it's a very bright opportunity in terms of both technology and the market place.

Ross Muken - Deutsche Bank

And now getting into specific numbers, how should we think about, future growth in the two platforms relative to installments unit plays, versus throughput, because it seems like a lot of the new tools that you’re putting out there continue to drive up the dollar revenue throughput per instrument, and everyone on the investor side seems to always be so focused on the installed base, but would you say it's sort of a balance of increasing this installed base plus increasing revenue dollars per instrument or do you think the opportunity longer term is sort of driving more consumables in sort of your existing installed base and sort of in the larger customers specifically.

Jay Flatley

Okay. I think about our BeadArray product line, the array product line; the consumables per installed BeadStation has been relatively stable over the past year, and this ranges quarter to quarter from 550 to the low 600,000 per installed instrument. And, where we are going to have some new dynamics with those numbers given the launch of iScan, we think that model is about right and we would love to continue to increase that, but on a same store basis, if you look just at the BeadStations, we don’t think and we are not projecting to get much above the kind of rates we are at now, in terms of the consumables per installed instrument.

On the sequencing side, we are still figuring out what the steady status, so we are probably a couple of quarters away from really knowing what the consumables per instrument are going to look like, and feel like the, 150,000 to 200,000 per instrument is still in the right range to be thinking about.

So, clearly we are focused on increasing the installed base of the instruments themselves. One thing that doesn't improve the consumption is the broadening of application. So as we put more and more applications on these platforms, particularly in the sort of lower throughput users, they begin to add different applications and collapse put more applications on them then the averages do go up. iScan is going to change this a little bit because the throughput is so much higher on an iScan. But we think in most of the accounts, if they were to take an iScan they wouldn't have certainly be running it at 100% since it's installed. From the day it's installed so I caution investors to not -- just multiply the throughput of the instrument times the 600,000 right now.

Jay Flatley

And I think the one other thing, would be iScan that's so exciting is that,what we're seeing is, and as Jay pointed out, the iSelect business so that the -- in the agricultural markets are really starting to really pick up steam and having the throughput to do the math of numbers of samples required or available in those markets is really going to be an important advantage I think our system has over competing platforms.

Ross Muken - Deutsche Bank

And would you say in terms of end market, that's been the area you've been most surprised in the uptake than sort of add bio applications?

Jay Flatley

I think it'sgoing great but it's probably not the biggest surprise. I mean our sequencing business is doing great and we've exceeded all our estimates for sequencing since we completed the transaction early on so.

Ross Muken - Deutsche Bank

Yeah. And just lastly, from a diagnostic standpoint, is there any sort of update in terms of when we might sort of hear more elucidated strategies as to sort of what's your plans are on that side of the business?

Jay Flatley

Well, we're not prepared to commit yet when we will sort of lay that out from investors and probably the answer to that question will depend a little bit on what the actual strategy is. Depending upon what that outcome is, we maybe more or less publicly at early on. And so we'll -- we'll probably give you an update at least telling you when we're going to tell you by the end of this year and depending upon what it is, we may actually tell you what the strategy is by the end of this year and depending upon what it is, we may actually tell you what the strategy is this year.

Ross Muken - Deutsche Bank

Great, thanks Jay, and congratulations.

Jay Flatley

Thank you. Thanks, Rob.

Operator

And next question comes from the line of Doug Schenkel from Cowen & Company. Please proceed.

Doug Schenkel - Cowen & Company

Hi guys, good afternoon. Any chance you could quantify the impact of the GAII rollout on revenues this quarter; either we have the place for the new instruments or upgrades either in terms of revenue or on ASPs?

Christian Henry

Well, I think, Doug it is Christian, how are you? The GAII is a significant contributor. That was really the predominant genome analyzer that we shipped during the quarter. So we haven't given folks installed base metrics, and we may or may not at a given point in the future, but it was definitely a significant contributor to the $40 plus million in revenue for the quarter.

Doug Schenkel - Cowen & Company

Alright. First of all let me clarify, I guess what I was trying to get at is, if you could quantify the impact of the increased ASP associated with the GAII versus the first Genome Analyzer?

Christian Henry

Yeah, actually the ASPs were not significantly impacted in the quarter because we had basically a customer transition to go through it to make sure that customers that had genome, original genome analyzers first in their backlog, we actually shipped them the new genome analyzer at consistent pricing and we did that really to make sure that our customers got the latest and greatest product that will help with the service of the product etcetera. So I think that the ASP impact will be felt more in the second quarter than the first quarter in particular.

Doug Schenkel - Cowen & Company

Okay. And if there any downtime associated with transitioning at existing GAII or GAII as part of the upgrade cycle that would slowdown for any period of time that consumable utilization rate?

Christian Henry

Not really. The Genome Analyzer, the original instrument, we have built an upgrade kit for it and that takes about two days, a day and half to install that upgrade kit and then test it. So maybe you'll lose a couple of days but it's not that significant.

Doug Schenkel - Cowen & Company

Okay. And then this is the second quarter where you've had a competitive system in the short-read market. Any specifically to the presence of ABI solid system in the market affect Q1 placements any differently than it affected your placements in Q4?

Christian Henry

If we say that the competitive dynamic in the market has been pretty stable from Q4 to Q1.

Doug Schenkel - Cowen & Company

Okay. And one last question. The gross margin number makes sense to me, given your instrument mix. That being said I just want to make sure there weren't any one time event that we should be thinking about that may have depressed margins further in this quarter that we wouldn't see in subsequent quarters.

Christian Henry

I would say there weren't any major one time events though but there was sort of a collection I think that -- we did a lot of product transition in Q1, and there clearly were some cost associated with all of those transitions that hit the gross margin line. You think about it, the three biggest products we ship, we changed them over totally all in one quarter and so there was a natural inefficiency that occurred because of that.

Doug Schenkel - Cowen & Company

Okay, great. I'll get back in the queue, thanks.

Christian Henry

Thanks Doug.

Operator

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

Bill Quirk - Piper Jaffray

Great, thanks. Good afternoon.

Jay Flatley

Hello.

Bill Quirk - Piper Jaffray

Hey Jay, first question. Thanks very much for the color on the US spending trends. Any comment with respect to Japan or for that matter any other markets out of the US?

Jay Flatley

I guess the only color is that we haven't seen an impact, so hopefully that will continue. Some of the governments are actually beginning to pour significant more money into the sequencing business and we see that as a really interesting long-term trend, but nothing that we've seen that caused us to think negatively about spending rates impacting our orders.

Bill Quirk - Piper Jaffray

Okay, understood, thank you. And then secondly, based on the comments you said in the prepared remarks on capacity, should we assume that we're still somewhat constrained here in the second quarter, obviously it sounds like by the end of the quarter we're going to be beyond that?

Jay Flatley

Well, to some extent, yeah. I'd say that's probably it about right Bill. So, we will be sort of out of the woods by the end of this quarter, but if everybody wanted their chip next week we couldn't supply that.

Bill Quirk - Piper Jaffray

Okay, understood. And then lastly Christian, if we think about the tax rate here, obviously and frankly, was it little higher than we were expecting for the first quarter or we understand that's stepped down particularly in the fourth, what should we be thinking about in terms of the second and third quarter?

Christian Henry

Well, I think it's going to be kind of beneath the levels where we are right now. You give or take a point, it really depends on where our income comes from quite frankly, but until we really get Singapore up and running, I would expect the level to be relatively consistent with where we were this quarter. So give or take a point or two, we need a direction.

Bill Quirk - Piper Jaffray

Understood, thanks a lot, congratulations.

Christian Henry

Thanks Bill.

Operator

Our next question comes from the line Derik De Bruin from UBS. Please proceed.

Derik De Bruin - UBS

Hi, good afternoon.

Jay Flatley

Hi, Derik.

Derik De Bruin - UBS

Hey, so just some questions on Gene expressions, I guess. Obviously your competitor had some problems there. I know you don't play in that same market, could you just talk about I guess the dynamic of gene expression outside of the car market. You are launching new products in this area, just a little bit more color on that business and reason, what type of runway do you have in that?

Christian Henry

Well, that market is not been growing much if at all and so our strategy there to try to push the technology into new markets to increase the growth opportunity and also to attempt to take some share. I think we have been taking some share in that market. And I think we are also creating some new opportunities and certainly what we are doing with sequencing as a (inaudible) expression is helping that and so while that's still not a big portion of the overall sequencing revenue, it's a very nicely grown piece of sequencing.

The new chips that we just launched are very economical and we are really going to position to these sort of add-on to what people are which are also doing in the Genotyping space. So, when we do a large scale of Genotyping study, you can add on the expression information as well and do that with a minimal incremental costs to analyze things like quantitative trade low science, so that in some sense is a new opportunity for using gene expression.

Derik De Bruin - UBS

And I guess when you look at the product development that gene expression are going forward to, do you have plans once you have higher density chips in that area?

Jay Flatley

Well, we don't talk specifically about the new products coming. But I guess I’d say that over time the technology will be by more and more towards sequencing, which when you think about our investments in R&D on expression side, yeah.

Derik De Bruin - UBS

Okay. Then along this line, so what would I mean great typical gene expression experiment I guess, what's the cost right now for doing it by the next-gen sequencing platform first to doing other microarray platform?

Jay Flatley

It depends on what you’re looking for. So if you were to be thinking about doing all the genes using the sequencing platform, you will be very competitive with what you can do today. You've seen microarray, if you are trying to do the entire transcript development and look everywhere on the genome all at once, today it’s certainly much more expensive than doing just a gene based array. But if you were to compare it against say array try to higher across whole-genome, it’s probably close to be competitive with that. Those prices of course our goal is to bring the prices are doing whole transcript analysis down over the next couple of years to make it much more cost efficient as we drive down the overall cost of sequencing.

Derik De Bruin - UBS

Okay and I guess when, well I actually I’ll get back in queue. Thanks.

Jay Flatley

Thanks Derik.

Operator

Our next question comes from the line Quintin Lai from Robert W. Baird. Please proceed.

Quintin Lai - Robert W. Baird

Good afternoon, guys. This is actually [Matt] in for Quintin. Congratulations on the quarter.

Jay Flatley

Thanks.

Matt - Robert W. Baird

Start moving to BeadXpress really quickly. Could we talk a little about where the placements of these instruments are going, are they going to BeadArray customers or customers that maybe haven't been a part of the genotyping or next-gen sequencing?

Jay Flatley

I think it’s a combination. So I’d guess probably a third of them are being sold to existing customers of BeadStations, and two-thirds probably to new customers. And so we compete in the low multiplex market with companies that use math stack and full cytometry as an alternative method, and the positioning of this product is that it has a very wide range of multiplex capabilities all the way from one or couple of markers, up to 384 and it can run a whole host of applications.

And so we have now started moving many of the array based applications over, so we moved our DASL assay over to the platform of Methylation assay and so it is now a platform that you can use to do many different things as well as our own applications. So, it’s position to be low multiplex with very broad applications

Matt - Robert W. Baird

Thank you for that color. Kind of to that point, is there any update on what the annual reagent use per instrument is for the BeadXpress?

Jay Flatley

No, we haven’t given out those numbers yet. So, yeah maybe some point in the future, but we are not prepared to do it today.

Matt - Robert W. Baird

Okay. Thanks, I’ll jump back in the queue.

Jay Flatley

Sure.

Operator

Our next question comes from the line of John Sullivan from Leerink Swann. Please proceed.

John Sullivan - Leerink Swann

Hi, guys, good Afternoon.

Jay Flatley

Yeah.

John Sullivan - Leerink Swann

A couple of quick ones, first of all, what kind of feedback are you getting from sequencer users, regarding using Genome Analyzer for finishing work in their larger sequencing studies.

Jay Flatley

The Genome Analyzer II has been very well received, one thing we did John, was we set up, what we call internally a robustness are someone that focuses on sequencing and the customer experiencing. So, we've been tracking all of the earlier runs that have been done on the system in our customer's hand and what we have found is that the system is performing very, very robustly, nine out of ten runs are successful, not even the little bit better than that. And the quality and the quantity of throughput that's come through has been very powerful. So, I think we are off to a fantastic start with the launch, of the GAII.

John Sullivan - Leerink Swann

Okay, great. And just reiterate the paired-end read solution starting to be shipped with GAII in the recent past, what sort of specific benefit do you think investors should expect regarding the paired-end read solution getting shipped? What kind of work is uniquely well enabled?

Christian Henry

I think, first of all, it's very powerful, for when you are doing human resequencing for example. So, you get better analysis of the structural variation of the Genome, that's probably one of the most interesting or important element. The other thing is that as we start to launch multi-insert type products longer paired-end read, shorter paired-end read and having combinations, de novo sequencing is really a reality at that point on the Genome Analyzer. So I’d expect to see a lot of difference, de novo type projects whether it'sbacteria or mammalian genome quite frankly.

Jay Flatley

We expect John that virtually everybody is going to transition to paired-end sequencing, and that, on a typical set of runs; 95 plus percent of them will be paired-end. So, it will be very few occasions, where you ever want to do a non-paired end run.

John Sullivan - Leerink Swann

Okay. And is it a significant additional revenue opportunity for you, supplying the paired-end solution?

Christian Henry

Yeah, it's a reasonable revenue opportunity. We have an early opportunity here as we take our existing installed base and sell into that, and that will happen over the next quarter or two, I’d guess as Jay said, people are rapidly clamoring for the paired-end modules. So, we will see that. But what you shouldn’t do John is assume that, because it's a paired-end reads that the consumables are a factor of two, just we are doing paired-end, because the paired-end run takes longer.

Jay Flatley

Right.

John Sullivan - Leerink Swann

So I understand, it doesn’t increase the capacity of the system.

Christian Henry

Right, the GAII did do that in some extend so we get throughput of course and we can run in less than 2X, you got a paired-end runs in less than 2X at a time to get on (inaudible) classes.

John Sullivan - Leerink Swann

On GA1?

Christian Henry

Yeah.

John Sullivan - Leerink Swann

Right and then my last question, just shifting gears for a second, can you just comment on progress and strategy, something that came up last call, progress and strategy on lowering the impact of share based option expense?

Christian Henry

Well, we have moved a restricted stock unit as our primary vehicle of compensation expense or equity based compensation for people. So, we did that late last year, and so, that was probably the single biggest thing we’ve done. We’ve also basically evaluated our RSU granting programs sort to speak and reduce those share levels, and the truth is though, it will take a while for us to see the true benefit of that because you have all these options that have been granted over time, and as they are vest, you’ve got to take that expense as they vest, but we have addressed it and I think going forward it's going to look favorable for us.

John Sullivan - Leerink Swann

Okay. And then I suppose relatively then I'll get out, what is headcount today versus maybe a year ago or just give us a sense how quickly the organization is growing?

Christian Henry

I think we ended the quarter with over 1,100 people and a year ago, I don't have that number right at my fingertips, I bet I could probably find it. I would think we're probably in the 600 range.

John Sullivan - Leerink Swann

Thanks very much.

Christian Henry

We added a 170 or so just with the acquisitions.

Jay Flatley

Yeah, thank you.

Operator

Our next question comes from the line of Un Kwon, Pacific Growth Equity, please proceed.

Un Kwon - Pacific Growth Equity

Hi, good afternoon.

Jay Flatley

Hi.

Un Kwon - Pacific Growth Equity

I was wondering could you breakout reverse margins on your sequencing business and the headwind you have to expand that?

Jay Flatley

Well, we don't give any gross margin details by product line on. What we have said about the sequencing business is that, it's early in its life and so we do think we have a lot of opportunity to improve the gross margins and sequencing and that's true on both the instrumentation and on the consumer side of business.

Un Kwon - Pacific Growth Equity

Okay, fair enough, and then I guess, on your recently launched iScan instrument and does that impact gross margins at all or ASPs for that line item?

Jay Flatley

Yeah, the trading program we are going to allow customers, existing customers at BeadStations to trade in those BeadStations for for iScans, and depending upon how old your BeadStation is, you'll get more or less credit for the existing instruments. The upgrades will have some impact on gross margin because we're pricing those to encourage the customers to upgrade and do the faster system, because it gives them more capacity to run the consumables, but those gross margin assumptions are built into the guidance we have for gross margins in the mid 60s.

Un Kwon - Pacific Growth Equity

Okay, great thanks. And I'm just lastly, sort of a big picture question on the market. Given the academic market there, the whole genome, genotyping studies are more maturing you're seeing more publications. Can you provide any anecdotal feedback from pharma or biotech as to how they are looking to implement either whole genome genotyping, and or sequencing and their clinical trials. Are you seeing a take up in interest etcetera?

Jay Flatley

I don't suspect you're going to see sequencing used in clinical trials anytime soon. I do think that pharma is going to be, begin to use genotyping more aggressively, particularly focused on an (inaudible) set of snips and so these are ones that have to do with metabolic uptake and there has been now a standard panel defined by the consortium of the pharma companies along with a number of vendors that I think we'll get some attraction because the pharma companies -- the users will all be submitting the same data sets to the FDA. So there will increased standardization and normalization around the data. And so I expect beginning six to twelve months from now you are going to see some significant uptake by pharma of the [ADNI] product.

Un Kwon - Pacific Growth Equity

Okay, great. I guess is it fair to assume that it would be relatively easy for you to come up with an (inaudible) panel, there is nothing proprietary about the content?

Jay Flatley

Well there are some SNPs that are harder to do from IP perspective, but most don't have any IP restrictions.

Un Kwon - Pacific Growth Equity

Okay great. Thanks very much.

Operator

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

Tycho Peterson - JPMorgan

Good afternoon. Thanks for taking my call. Some of my questions have been answered, but give me the starting, you commented a moment ago about the infrastructure build out in terms of where you are in headcount. Can you give us a sense of what the key priorities here, obviously, it's something the street is paying attention to in terms of where you're going to be spending your time and effort and come to building out service organization? So, maybe some of the metrics that we can try to keep an eye on over the next couple of quarters in terms of the infrastructure build out?

Jay Flatley

I think one of the important area Tycho is to build out of the commercial infrastructure and this is required to have ability to support, the sequencer is in particular very broadly used around the world, and to address all the sales opportunities, frankly that we have around world. And so we've made probably our biggest investment in infrastructure. So we keep infrastructure in a commercial organization. So we now have -- I guess at the end of last quarter we had about 200 people in direct sales, customer support roles and now we probably have about 230 people. We added almost 30 people quarter-to-quarter either technical support or sales.

Tycho Peterson - JPMorgan

Okay, and geographically I mean, are you opening service centers overseas and where have the youngsters have been placed?

Jay Flatley

Yes, it's probably heavily biased towards Asia right now. So Europe was pretty well built out, we were a little under built out in Asia, so we've created a little more infrastructure there. We've gone direct in Australia. As an example, we're building out our Singapore operations, so we had a direct sales operations there for even large dip and obviously we're building up a manufacturing operation in Singapore as well so we'll have distribution of Singapore to Asia, and also potentially to Europe out of our Singapore site. We are also adding some infrastructure in Europe, so we now have a general manager of our European operation who is based in the UK and we have a distribution centre in Eindhoven. We also are largely direct in China now, but we due to some distributors there much likely what we do in Japan.

Tycho Peterson - JPMorgan

Okay. And then on the GAII rollout and Christian, I appreciate your comments earlier about the color around whether these shipment placements are going, I mean it sounds like the majority of the shipments were GAII this quarter. But as we think about kind of the push here, is it mainly working through your existing backlog to try to get those customers to upgrade before the systems go out the door or how do we think about interest essentially from new customers? And is there a large group or small group that may be more price sensitive, that are going to hold off and upgrade for the near term?

Christian Henry

Yeah, I don't think price is really a factor here. The throughput that customers are getting relative to their CE-based products, I mean the value proposition is very compelling and so far it hasn't been price that's been an issue. If you look at where we're pricing systems, this quarter almost 90% of them went outside of Genome Centers this quarter.

So we're getting a lot of new customers buying their first instrument, a lot of customers are buying maybe their second instrument for their scaling up and so it looks as though you're continuing to see just a broad adoption across the market. Geographically, we're seeing a lot of demand in all of the different territories and so it's a pretty broad based adoption here. And in terms of the upgrade cycle, we price the upgrade at a pretty reasonable price that the value of proposition there will be compelling over the next quarter or two, I suspect. We'll start working through that backlog and as those orders come in.

Jay Flatley

You won't see everybody do a wholesale conversion right away even though they see the true value proposition that Christian was just describing. That's just because they might not have those capital dollars available so I think.

Tycho Peterson - JPMorgan

Yeah.

Jay Flatley

The upgrade timing will be spread over three to four quarters if people put in for follow-on grants or just request the money and went to get it.

Tycho Peterson - JPMorgan

Yeah.

Jay Flatley

Even though they would want it, they want, they may not all be able to do it they want. That's right.

Tycho Peterson - JPMorgan

Okay. And then finally on consumer, there's obviously a lot of public press with Navigenics and then 23andMe launching in the UK and some other markets. What is your outlook on that business near-term and it sounds like some of them have at least talked anecdotally about looking at sequencing platforms as well in addition to arrays. Can you comment on how you view that opportunity longer-term to maybe convert that business over to sequencing?

Jay Flatley

Yes. We continue to be real optimistic about the consumer opportunity. It again is going to be a market that's incredibly elastic and so as 23andMe is able to bring down price over time. I think the market size is going to really grow significantly, because it's really their business, we're not prepared to report on volumes or anything like that yet. But if you're a subscriber to 23andMe or a customer of 23andMe, you would see that they have already done at least three to four updates of the content on the side and so they're continuing to work very hard to increase the value proposition of what they bring to customers, both in the gene journals, as they called them and also in the tools for studying ancestry.

So I think it's a very exciting opportunity. As to sequencing, yeah I think there may be some consumer interest in sequencing, but the numbers of people there are going to be in the tens of people, it's not to be a thousand person market anytime soon just because of the price point. So I don't think it's going to be a timely revenue opportunity for companies like 23andMe and Navigenics into sequencing in the next couple of years.

Tycho Peterson - JPMorgan

Okay. Thank you very much.

Operator

Our next question comes from the line of Tony Butler, Lehman Brothers. Please proceed.

Tony Butler - Lehman Brothers

Thanks very much. Just a brief question that's a little more broader in nature. I was intrigued Christian by your comments, about 90% of the sales were outside of the genome centers, but if we think in terms of penetration at, let's just say, genome centers or an average customer, how do we actually think about saturation? Would an average customer have 10 GA-2s to a 100, how do you think about that in the context of the average customer? Thanks.

Jay Flatley

It's a difficult question to answer in the sense that next generation sequencing, the throughput changes the game so much that that it's difficult to really know what the average customer is going to have. There is no question that there are probably a few different classes of customers, there is your genome centers which could have 10s to 100s of systems theoretically. There is the major institutions that will have maybe the 10s, and then there is the rest of the market, and so I would guess the majority of the market outside the genome centers will have anywhere between say one and three genome analyzers is what I would guess, kind of like the CE market is. The one metric you could use is that, you know in the capillary market there is somewhere in the neighborhood of 15,000 installed systems. So pretty big numbers if you think about the breadth of placements in that market for using that technology.

Tony Butler - Lehman Brothers

Thanks, Jay. That's very helpful. Thank you.

Operator

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

Davis Field - Goldman Sachs

Hi, actually this is [Davis Field] for Lincoln. I had a couple of questions. First, I know that you talked about the geographic distribution, I was wondering if you could provide a little bit more color, in particular, I don't know if you can sweep the numbers, but how much of the sales are coming outside the United states and what affect if any currency may have had on revenues and going forward how we should think about ex-US markets?

Christian Henry

Yes. Our mix stayed pretty stable in terms of the overall geographic mix. It's running in the range of about two-thirds in North America, about 25% Europe and the remainder rest of the world. And that bounces around a little bit for the quarter, but if you do a moving average, that's where the business has been. Currency hasn't been a big effect on us because we sell in most locations in US dollars. Actually basically currency has had no effect, because almost every single one of our contracts around the world right now is still in the US dollars. Now we are moving to local pricing this year and so that will change over time, but for the most part, everything is in US dollars today and so we don't see a lot of currency impact. I guess being in US dollars today probably it hasn't been the best. We have seen a lot of our competitors get a revenue uplift but it's a double-edge sword of course so that's where we are.

Davis Field - Goldman Sachs

Great. And then the second question I have is, so if I heard you right you expect to begin manufacturing operations in the fourth quarter. And I was wondering if you can and you talked a little bit about this, I was just wondering if you could help us think a little bit more about the tax impact of the Singapore manufacturing would have next year?

Christian Henry

Well, I think we will see how it plays itself out. But if you think about it, if we start shipping most of our ex-US demand out of Singapore, that could take several points off of our tax rate. What I would encourage you to do is maybe look at some other companies that have implemented Singapore's strategies, and you can look at their tax rates. But I would say that we can get below, definitely below 35%, as a tax rate. But at this point, they are still models. We have to actually execute and make it happen. But I do think there is significant upside on the tax line by moving to Singapore, and that we'll start to see it beginning in the fourth quarter and I would suspect that as we get through 2009, we should see a ramp that's continuing to improve.

Davis Field - Goldman Sachs

And so Singapore should be, it's exceptional capacity to handle ex-US sales?

Christian Henry

That's what we are gearing up to do. That's right.

Davis Field - Goldman Sachs

Okay. Last question, with the GA-2 and the iScan, I noticed that there was a slight bump in ASP there, in terms of thinking about gross margins as you shift to these new products, how should we be thinking about that?

Christian Henry

Well, I do think the opportunity, you know as we've said the gross margins are expected to be in the mid-60s for the year and we've kind of put that into the guidance. And some of the reasons why we think gross margins is going to get better from these level is price and some is manufacturing efficiency and some is price improvements on the raw material for example as we scale. So the gross margin improvements are going to come from a number of different areas through the business and it's probably not appropriate for us to break each one of them down at least on this call.

Jay Flatley

But I guess, what we've done in terms of the guidance is included all the things that Christian has talked about on the upside, but we've also factored in the fact that we are going to be doing upgrades both on the BeadStation and the GA-2s, and those upgrade kits will carry somewhat lower gross margins.

Davis Field - Goldman Sachs

That's right.

Jay Flatley

And that's all factored into the overall numbers that we've given.

Davis Field - Goldman Sachs

Great, thanks.

Operator

Our next question comes from the line of Matthew Scalo from Canaccord Adams. Please proceed.

Matthew Scalo - Canaccord Adams

Hey guys. Good quarter. Just a couple of quick questions here, have you guys reached 400 speed stations installed?

Jay Flatley

We haven't updated the installed base recently, so…

Matthew Scalo - Canaccord Adams

Okay. It'sgreater than 300?

Jay Flatley

Yeah.

Matthew Scalo - Canaccord Adams

I think that was good.

Jay Flatley

Yeah. My last update included that…

Matthew Scalo - Canaccord Adams

Okay. Christian you mentioned kind of the integration of sequencing and microarrays underneath the LifeSciences group. Can you give me a little bit more color as far as what processes need to be accomplished, kind of timelines maybe cost associated with it they are material on any annual savings?

Jay Flatley

Yeah. This is Jay. I'll take that question. So as we look at our business, one thing we've recognized is that the kind of technical work we are doing in the microarray business and the kind of technical work we're doing in the sequencing business is very closely related in terms of the molecular biology, the underlying chemistry, how we're engineering our systems and one way we can get a lot of synergy is by making sure that we do a better job of designing our systems to be more compatible.

So if we're designing a set of electronics into one instrument that we're using that same set of electronics in another instrument that maybe designed in a different facility. And having these business units more tightly coupled and under one Senior VP of Development will allow us to get that level of integration and improve sort of the underlying consistency in product development and that's a key goal and you'll see that over the next couple of years, I think begin to look like a much more unified product line coming from us.

Christian Henry

I think, fundamentally there is probably more revenue synergies that we're really focused on. And from a cost perspective, there is cost avoidance in the sense that as we get more integrated, the R&D team can operate project, anywhere in the world, at any time. We've been focused really significantly on that but it's really that the new product opportunities that we see and the ability to kind of have one unified R&D team around the world that can operate in really tight coordination with each other.

Matthew Scalo - Canaccord Adams

Okay. And then Jay did I understand you correctly when you said that we shouldn't expect an increase in annual revenue per system with the iScan say in the first year?

Jay Flatley

Yes the way this is going to work if you think about it. The BeadStation is effectively being obsolete, so we are not manufacturing the BeadStations any longer. So any, a customer who would have ordered a BeadStation to do some set of projects that they had, will now take delivery of an iScan. And so just because we are shipping them on iScan as opposed to BeadStation, we were shipping the BeadStation in February and we are now shipping the iScan in May. That inherently doesn't increase the chips that are going to run directly, and it gives them higher capacity to run more chips. But there is not a direct connection between what projects they run around, the old technology versus the new.

Now we are, we will have some impact is in the very large centers who have capacity constraints, so certainly as they begin to change out their BeadStations and upgrade them to iScans, the average per operating scanner will be higher, but then we have to get in some tricky accounting of how we count the installed base because we are actually taking units out of the field.

Matthew Scalo - Canaccord Adams

Right.

Jay Flatley

And so what we want to do is to caution people to just not assume that the consumables are going to start ramping up radically just because we are shipping iScan.

Matthew Scalo - Canaccord Adams

Right. Okay thanks guys.

Operator

Our last question comes from the line of Jonathan Groberg from Merrill Lynch. Please proceed.

Jonathan Groberg - Merrill Lynch

Phew I made it. Thanks guys.

Jay Flatley

Hey Jonathan.

Christian Henry

Hey Jon.

Jonathan Groberg - Merrill Lynch

So, just maybe three quick questions, the first question you often showed graphs in your presentations about growth curves, I heard a comment early one about gene expression. Kind of where you feel you are at on that growth curve. Can you maybe, give your qualitative view on the genotyping side where you are at on that growth curve?

Jay Flatley

Sure. There are couple of ways to think about that, but if you use the baseball analogy, maybe we are in the fourth innings of genotyping. It is a market that I think is very well established, the kind of science that's being done is very well known and consistent. What you continue to see however is the emergence of new ways, or new sub-applications in genotyping, things like Copy Number Variation, now becoming a very big application which two years ago no one was talking about CNV.

You see the opportunity to do IP genomic applications like methylation and we see the emergence of the really big markets we think, which are going to be end consumer and ag/bio. We have talked a little bit about that. So I think genotyping as a market is going to be going on forever, and our view is that it is going to be decades before sequencing is going to replace genotyping in most applications.

And overtime, we are going to be moving to the point where genotyping is done routinely when babies are born and that's going to be done. We don’t know whether that's five years from now or eight years from now but as we sort of get over the institutional hurdles for that to be implemented, it makes great medical sense people to have their genotype as part of the medical record from very early in life. So I think if you think about it that way, the market is enormous.

Jonathan Groberg - Merrill Lynch

Beyond maybe those new applications from a research site, lets say kind of third to fourth inning and I know you don't break down the different businesses per se, but are you trying to see kind of plateauing of the growth rate and potentially declining over the next, still growing but the rate perhaps declining?

Jay Flatley

I don’t think, I would say we've seen that. I mean, clearly our percentage growth rate for the company are declining just because of they are bigger numbers.

Jonathan Groberg - Merrill Lynch

Yeah.

Jay Flatley

That’s the law of large numbers for us, but I think the market continues to be very healthy. There are very large projects underway. There is some very large projects being proposed and as prices come down, people begin to speculate about doing things that we never would thought of doing two or three years ago and so, I don't think we are seeing growth rate decline yet.

Jonathan Groberg - Merrill Lynch

And then just final question on this line, when you mentioned 23andMe and not wanting to talk about their business obviously. But should that business grow, are you providing the chips at lower price points to them, will that have any deleterious impact on your margin, should that business really take off?

Jay Flatley

Margins are really a mix of various customers in various stages of their business and we give to any customer volume discount schedules, and if they order greater numbers of chips, the price isless. And that’s true for any customers, not just 23andMe. And then that's of course all relate against the backdrop of generally decreasing prices in this market, which is the phenomenon that has really fueled the overall growth of the space, and so both those factors will contribute over time to reduce cost for 23andMe, and that will be passed on customers as well lower prices. And of course what we are doing on the flip side is making the chips more economical to manufacturers so that the gross margin dollars that we create are at least as big or bigger.

Jonathan Groberg - Merrill Lynch

But so the contract to 23andMe is not significantly different from anyone else in terms of the break points and the volume etc?

Jay Flatley

At the same sort of structure.

Jonathan Groberg - Merrill Lynch

Okay, and then final question on the sequencing side, one having, I never speculate early on in the cycle here, but one I was just curious if you expect that business to exhibit any type of seasonality as you get, as you know again maybe larger here in that business. And then two; I've heard a lot of competitors talking about desire to get into the reagent side, you're seeing as a big opportunity, a big growth opportunity obviously the next-gen sequencing and wanting to be a bigger player on the reagent side.

So I'm some curious on two fronts what's happening with reagents. One; if you have, what you can kind of do to bar competition and two, one of the things that has happened in the past, is people diluting reagents and I'm wondering now again this is gotten to be a larger installed base if we are seeing anyone trying to reduce their cost by trying to dilute the reagents there?

Jay Flatley

I think that’s very unlikely that the way we ship our reagents over time, it's even more of this is in pre-mixed component that if its diluted, which is not going to work, and we are also making improvements to our chemistry at such a fast rate that the set of reagents that a customer get next week it's going to be very different than what they are going to get five or six months from now. And so for our third party to spend a lot of energy trying to design reagents that fit into our system it's going to be very difficult. And I think, it will, in the long run prove to probably be futile because of the rate of change of the technology.

Jonathan Groberg - Merrill Lynch

Thanks.

Jay Flatley

Thanks John.

Operator

I will now like to turn the call back over to Peter Fromen for closing remarks. Please proceed.

Peter Fromen

Thanks, operator. As a reminder a replay of this call will be available in webcast format in the investor section of our website as well as through the dial in instructions contained in today’s earning release. Thanks for joining us today. This concludes our call and we look forward to our next update following the close of the second quarter.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: Illumina Inc. Q1 2008 Earnings Call Transcript
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