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Defective Sequencing Reagents to Cost Illumina up to $23M in 2009; Company Says Problem is Solved

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By Julia Karow

This article was originally published Oct. 28.

Illumina reported last week that a defect in its paired-end sequencing reagent kits — along with stimulus funding-related order delays and a decline of whole-genome genotyping studies — caused a shortfall in its third-quarter revenues.

Revenues for the three months ended Sept. 30 totaled $158 million, $4 million less than what the company had forecast as a minimum, though they grew 5 percent over the same period in 2008.

The faulty reagent kits, a problem that Illumina said it first discovered in September and has since rectified, cost the company an estimated $6 million to $8 million in lost revenue in the third quarter. The issue is expected to decrease revenues in the fourth quarter by up to another $15 million.

Product revenues totaled $150 million, 7 percent growth over the third quarter of last year that was led by "significant growth" in sequencing products, according to Christian Henry, Illumina's senior vice president of corporate development and CFO. He made his remarks during a conference call to discuss the company's third-quarter earnings last week. Along with the growth in sequencing came a decline in the company's microarray business, in particular regarding products for genome-wide association studies, as customers await new content from the 1000 Genomes Project.

Of the product revenues, $87 million came from consumables, a 4 percent decline compared to the year-ago period. Sequencing consumables more than doubled on a year-over-year-basis, although they stayed flat compared to the second quarter of this year due to the defective reagent kits.

Array consumables, which Henry said still make up more than half of Illumina's consumable revenues, declined both year-over-year and compared to the second quarter because of a "weakness in sales of whole-genome genotyping chips."

Instrument revenues totaled $61 million for the quarter, up 30 percent from the year-ago period and a record for the company. Illumina shipped "another record number" of Genome Analyzers during the quarter, according to Henry, "as demand for the system continues to exceed our expectations," and also saw growth in sales of its iScan system.

The average sales price for the Genome Analyzer declined slightly in the third quarter compared to the second, "as we closed more multi-system deals, where we typically provide a larger discount," he said.

According to Illumina President and CEO Jay Flatley, more than three quarters of Genome Analyzers in the field had been upgraded to the GAIIx configuration by the end of September. The update, which Illumina introduced in the first quarter, has enabled "multiple customers" to generate more than 55 gigabases per run, he said, and the company is "on track" to enable the instrument to produce 95 gigabases per run "around the end of the year."

He said the reagent quality issue had no "material impact" on throughput improvements for the GA. "We were slowed down a little bit in our testing and our R&D, but we think that is going to be measured in weeks, not months."

Last week, the company launched a new library amplification instrument, called cBot, to replace its cluster station in order to make the Genome Analyzer more user-friendly (see In Sequence 10/27/2009). Along with the cBot, it also launched version 4 of its cluster generation kits, pre-packaged reagent kits "which use a higher-fidelity enzyme to deliver greater accuracy during amplification" and "help eliminate reagent prep errors and sources of contamination," Flatley said.

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According to Flatley, Illumina currently holds "well over 50 percent share of the next-gen sequencing market" which he said "remains robust, and continues to be the most exciting opportunity in the life sciences research area."

Services and other revenues, which include sequencing and genotyping services as well as instrument maintenance contracts, declined 20 percent from last year, to $8 million. As noted in previous quarters, this was due to a decline in GWAS as well as due to the fact that more Illumina-certified customers now provide genotyping services.

Defective Reagent Kits

During the call, Flatley shed further light on the company's problems with the quality of its paired-end sequencing reagent kits.

He said that in early September, some customers started to notice high error rates on the second read of paired-end runs. After identifying paired-end sequencing reagent kits as the cause of the problem, Illumina stopped shipping the kits in late September.

In the weeks that followed, the company traced the problem to one of three raw materials used in the kits and put together new kits. "We have been testing the new kits extensively, both internally and at various customer sites, and believe that these new reagent batches are performing to specifications," Flatley said. In addition, the company has "enhanced quality control procedures to ensure that no additional defective kits are produced or shipped" and is now "testing every lot to be produced" so the problem will not recur.

Illumina started shipping the new kits last week, and expects to "rapidly clear our backlog," according to Flatley. "We are confident about the reagents we are now shipping."

He said that the problem only affected a fraction of customers' runs, but "in our large [customer] production sites, we considered that to be an unacceptable situation," so Illumina asked those customers to halt their runs to be able to address the problem. "We don't think there has been an impact in the majority of customers," he said. To those customers who were affected, the company will provide warranty replacement kits.

Because the company did not ship any paired-end cluster kits during the first few weeks of October, its fourth-quarter revenues "may be negatively impacted by as much as $15 million," Flatley noted.

Stimulus Gets off to a Slow Start

Flatley also commented on the impact of National Institutes of Health stimulus funding on Illumina's revenues, now and in the future.

Because customers only received limited amounts of stimulus funding during the third quarter, the company has so far recognized only "a non-material amount of revenue" from these funds. The fact that many stimulus awards were only made in late September also meant that approximately $8 million to $10 million worth of orders that Illumina had expected to receive during the third quarter did not come in.

Even with awards being made now, "there still remains significant uncertainty as to when these awards will convert to orders and will be recognized as revenue," Flatley said, noting that the company has already received some orders in the fourth quarter that related to stimulus funding. "On the positive side, we no longer expect to see stimulus-related spending delays impact our business," he noted.

Asked by a financial analyst whether any customers had placed large orders for Genome Analyzers, Flatley said that if the company receives an order "that we think is substantial and material," it will release such information "at the appropriate time."

Based on stimulus awards made to date, he said, Illumina has estimated that it could gain up to $100 million in revenues. "We might not get all of that because obviously, there is some competition for those funds, but there are opportunities of that magnitude," he said. These revenue opportunities may grow further next year as NIH makes additional stimulus awards. "We clearly expect a positive effect in 2010," Flatley said.

For the fourth quarter, Illumina expects a minimum of $165 million in revenues, which includes $10 million less in stimulus-related revenues than it had originally anticipated for that quarter.

For all of 2009, the company now expects at least $651 million in revenues, guidance well below the $690 million to $720 million that it forecast for the year back in July.

Illumina ended the year with $238.5 million in cash and cash equivalents, and $521.4 million in short-term investments.

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