Business Context and Reporting Period
Illumina, Inc. develops and sells genetic analysis systems, instruments, consumables, services, and related technologies for sequencing, genotyping, gene expression, molecular diagnostics, cytogenetics, and in vitro fertilization screening. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012, compared with October 2, 2011. Each comparable period comprised 13 and 39 weeks, respectively.
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | YTD 2012 | YTD 2011 |
|---|---|---|---|---|
| Total revenue | $285.9 million | $235.5 million | $839.3 million | $805.5 million |
| Revenue growth | 21% | 4% | ||
| Gross profit | $195.9 million | $157.1 million | $569.9 million | $538.5 million |
| Gross margin | 68.5% | 66.7% | 67.9% | 66.9% |
| Income from operations | $48.8 million | $36.8 million | $141.4 million | $172.2 million |
| Operating margin | 17.1% | 15.6% | 16.8% | 21.4% |
| Net income | $29.7 million | $20.2 million | $79.4 million | $74.9 million |
| Net margin | 10.4% | 8.6% | 9.5% | 9.3% |
| Diluted EPS | $0.22 | $0.15 | $0.60 | $0.52 |
| Cash flow from operations | $213.0 million | $249.8 million |
Product revenue was $262.4 million in Q3 and $776.9 million year to date; service and other revenue was $23.5 million in Q3 and $62.4 million year to date. Q3 consumables revenue increased 22% to $176.7 million, while instrument revenue increased 15% to $82.4 million. Year-to-date consumables revenue rose 18% to $533.3 million, but instrument revenue declined 20% to $234.2 million.
At September 30, 2012, cash and cash equivalents were $343.1 million and short-term investments were $890.0 million, for total cash, cash equivalents, and short-term investments of approximately $1.2 billion. Total debt carrying value was $833.5 million, consisting principally of the $797.2 million carrying value of the 0.25% convertible senior notes due 2016 and $36.3 million of 0.625% convertible notes due 2014.
Net cash used in investing activities was $168.6 million, including $83.2 million for acquisitions, $51.7 million for capital expenditures, $15.0 million for strategic investments, and $11.3 million for intangible assets. Cash used in financing activities was $4.7 million, including $52.5 million of share repurchases and $38.7 million of proceeds from equity issuance. Cash increased by $40.1 million during the nine-month period.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven primarily by higher sequencing consumables revenue, growth in the installed instrument base, increased consumable usage per HiSeq system, a full quarter of MiSeq shipments, and initial commercial shipments of the HiSeq 2500.
- Gross margin improved because of a favorable shift toward higher-margin consumables and manufacturing efficiencies. The prior-year margin was also reduced by the Genome Analyzer trade-in program, which ended in the fourth quarter of 2011.
- Year-to-date operating income declined 17.9% despite higher revenue and gross profit. Operating expenses increased 17% to $428.5 million, reflecting a $21.4 million in-process research and development impairment charge, $23.4 million of headquarters relocation costs, $18.7 million of Roche tender-offer costs, and $3.4 million of restructuring charges.
- Q3 operating income and net income improved year over year, but the comparison benefited from $37.6 million of prior-year debt-extinguishment losses that were not repeated in 2012.
- BlueGnome was acquired on September 19, 2012, for total estimated consideration of $95.5 million, including $88.0 million of initial cash consideration and $7.5 million of estimated contingent consideration. The purchase price allocation remained preliminary.
- The headquarters relocation was completed during Q3. The related facility exit obligation was $44.9 million at September 30, 2012.
- The company repurchased approximately 569,000 shares for $25.0 million during Q3 under a $250 million authorization. Approximately $192.5 million remained available under the program at quarter-end.
Guidance, Outlook, Risks, and Unusual Items
Management expects sequencing market expansion, a growing installed base, and increased consumable demand to support future growth. Management also expects additional expenses related to Roche’s unsolicited tender offer through the first half of 2013. No specific revenue or earnings guidance was provided in the filing.
- Government and academic research funding remains uncertain, particularly because of potential U.S. budget reductions and sequestration. Management estimated that approximately one-third of total revenue is derived directly or indirectly from NIH funding.
- Management expects microarray demand to remain focused while declining sequencing costs may shift certain whole-genome studies from arrays to sequencing.
- Management stated that current cash, investments, and operating cash flow should fund operating needs for at least the next 12 months, absent unforeseen circumstances.
- Key risks include funding reductions, slower economic conditions, product development and commercialization execution, manufacturing performance, competitive technologies, pricing pressure, foreign exchange exposure, tax-rate variability, and litigation.
- The company recorded a $3.0 million legal contingency loss during the first nine months. The LadaTech patent litigation and Roche-related stockholder lawsuits were settled or dismissed; other ordinary-course claims remain subject to uncertainty.
- The company recorded a $21.4 million IPR&D impairment charge in the second quarter, primarily because resources were redirected and no near-term additional investment was planned for the project.
- Share-based compensation expense was $70.1 million for the first nine months, with approximately $160.5 million of unrecognized compensation cost expected to be recognized over approximately 2.1 years.
Important Facts for Investors to Verify
- Confirm the sustainability of consumables-led growth and whether sequencing instrument shipments continue to expand the installed base.
- Assess the effect of discontinued promotional programs and product mix on future gross margins.
- Track operating expenses and determine whether tender-offer, relocation, restructuring, and impairment-related costs are nonrecurring or recur.
- Review the maturity, conversion terms, dilution potential, and refinancing or settlement requirements of the 2014 and 2016 convertible notes.
- Evaluate BlueGnome integration, contingent consideration of up to $20.0 million, and contingent employee-related payments of up to $20.0 million.
- Monitor NIH and broader research funding, sequestration-related developments, and customer purchasing delays.
- Reconcile future cash generation with acquisitions, capital expenditures, share repurchases, working-capital needs, and remaining facility obligations.
- Review pending litigation accruals and the company’s statement that ultimate losses cannot currently be estimated beyond amounts already recorded.