Illumina, Inc. — Form 10-Q Summary
Business context and reporting period
Illumina develops and sells sequencing- and array-based technologies, instruments, consumables, analysis tools, and related services for research, clinical, applied, pharmaceutical, biotechnology, agricultural, and consumer genomics markets. This filing covers the three and six months ended July 2, 2017, compared with the periods ended July 3, 2016. Each period comprised 13 and 26 weeks, respectively.
Following the February 28, 2017 financing of GRAIL, Illumina reduced its ownership and voting interest, lost control, and deconsolidated GRAIL. GRAIL is now accounted for as a cost-method investment. Core Illumina remains the principal operating segment; Helix remains a consolidated variable interest entity.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $662 million | $600 million | $1.261 billion | $1.172 billion |
| Gross profit | $434 million | $424 million | $802 million | $821 million |
| Gross margin | 65.5% | 70.6% | 63.6% | 70.0% |
| Operating income | $143 million | $162 million | $195 million | $283 million |
| Operating margin | 21.6% | 27.0% | 15.5% | 24.2% |
| Net income attributable to Illumina stockholders | $128 million | $120 million | $495 million | $210 million |
| Diluted EPS | $0.87 | $0.82 | $3.35 | $1.43 |
- Q2 revenue increased 10%, led by product revenue growth of 6% and service and other revenue growth of 32%. Six-month revenue increased 8%.
- Q2 consumables revenue was $402 million, instrument revenue was $136 million, and service and other revenue was $119 million. For the first half, consumables revenue increased 7%, while instrument revenue declined 3% because lower HiSeq and HiSeq X shipments more than offset NovaSeq shipments.
- Research and development expense increased 4% in Q2 and 10% for the first half. Selling, general and administrative expense increased 14% in Q2 and 11% for the first half.
- Six-month net income included a $453 million pretax gain from GRAIL deconsolidation, including a $159 million remeasurement component. The gain materially increased reported earnings and other income.
- Cash provided by operating activities was $346 million for the first half of 2017 versus $341 million in the prior-year period. Investing activities provided $198 million, primarily reflecting $278 million of proceeds from the GRAIL transaction, partly offset by $152 million of capital expenditures. Financing activities used $62 million.
- Cash and cash equivalents were $1.219 billion at July 2, 2017, compared with $735 million at January 1, 2017. Cash, cash equivalents, and short-term investments totaled approximately $1.9 billion, including approximately $799 million held by foreign subsidiaries.
- Total debt consisted primarily of $633 million of 2019 convertible notes and $517 million of 2021 convertible notes. Long-term debt was $1.169 billion at July 2, 2017. The notes were not convertible at quarter-end.
- Total assets were $4.858 billion and total Illumina stockholders’ equity was $2.715 billion at July 2, 2017.
Material changes versus the prior comparable period
- Revenue growth was driven by sequencing consumables, genotyping services, instrument service contracts, and the NovaSeq launch. The larger installed base supported recurring consumables and service revenue.
- Gross margin declined substantially because of an $18 million acquired-intangible impairment, lower-margin array services mix, inventory reserves associated with product transitions, and lower initial instrument margins for NovaSeq.
- Operating margin declined as gross margin contracted and operating expenses increased. Q2 also reflected legal contingency activity related to patent litigation; the prior-year period included a reversal of previously recorded patent litigation expense.
- Reported first-half earnings benefited from the GRAIL deconsolidation gain. The related discrete tax impact was approximately $150 million.
- Illumina adopted ASU 2016-09, recording a $45 million net increase to retained earnings, primarily from share-based compensation tax benefits. The adoption also affected cash-flow classification.
- Capital spending increased to $152 million from $121 million, primarily for facilities and manufacturing, research, and development equipment.
- Illumina repurchased $101 million of stock in the first half, completing the prior authorization. A new $250 million authorization remained available at quarter-end; no repurchases occurred during Q2.
Guidance, outlook, commentary, risks, and unusual items
- Management expects revenue to continue increasing in 2017 and expects research and development and selling, general and administrative expenses to continue growing.
- Management expects current cash, short-term investments, and operating cash flow to fund near-term operating and capital requirements for at least the next 12 months.
- Management believes sequencing consumables growth will continue as the installed base expands. It expects some research customers to migrate array studies to sequencing, while applied-market demand supports array growth.
- Future gross margin will depend on pricing, product and customer mix, new-product transitions, excess and obsolete inventory, manufacturing scale, royalties, and support obligations.
- Key risks include successful commercialization of instruments and consumables, manufacturing execution, competition and technological change, integration of acquired technologies, adverse economic conditions, tax-rate variability, and unpredictable intellectual-property, employment, and contractual litigation.
- Pending litigation outcomes are described as inherently unpredictable; the company cannot provide a meaningful estimate of reasonably possible losses for matters where no liability has been accrued.
- Helix redeemable noncontrolling interests were $80 million at quarter-end and may be redeemable for cash after January 1, 2021, subject to specified conditions. Illumina also had $86 million remaining on a venture-capital fund commitment.
- The company had no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and no substantial changes in market risk.
Important facts for investors to verify
- Separate recurring operating performance from the $453 million GRAIL deconsolidation gain when assessing earnings quality.
- Track whether NovaSeq adoption improves instrument margins and whether consumables growth offsets product-transition costs and lower-margin service mix.
- Review the sustainability of the 63.6% first-half gross margin and 15.5% operating margin.
- Reconcile operating cash flow with reported earnings, particularly the effect of the GRAIL gain and other non-cash adjustments.
- Monitor the $1.169 billion long-term debt balance, 2019 and 2021 note maturities, and conversion conditions.
- Assess exposure to litigation, Helix redemption obligations, foreign-held liquidity, strategic investments, and the remaining capital commitment.
- Confirm the impact of forthcoming revenue, financial-instrument, lease, and credit-loss accounting standards on reported results and disclosures.