Illumina, Inc. 2019 Q3 Form 10-Q Summary
Business context and reporting period
Illumina is a global provider of DNA sequencing and array-based technologies serving research, clinical, and applied markets. The filing covers the 13-week quarter and 26-week year-to-date period ended September 29, 2019, compared with the comparable periods ended September 30, 2018. The company reported one segment, Core Illumina, following the April 25, 2019 deconsolidation of Helix.
Financial results and key metrics
| Metric | Q3 2019 | Q3 2018 | YTD 2019 | YTD 2018 |
|---|---|---|---|---|
| Total revenue | $907 million | $853 million | $2,591 million | $2,466 million |
| Product revenue | $746 million | $710 million | $2,117 million | $2,011 million |
| Service and other revenue | $161 million | $143 million | $474 million | $455 million |
| Gross profit | $648 million | $597 million | $1,805 million | $1,710 million |
| Gross margin | 71.5% | 70.0% | 69.7% | 69.4% |
| Income from operations | $308 million | $241 million | $717 million | $686 million |
| Operating margin | 33.9% | 28.2% | 27.7% | 27.8% |
| Net income attributable to Illumina | $234 million | $199 million | $763 million | $616 million |
| Diluted EPS | $1.58 | $1.33 | $5.13 | $4.15 |
Q3 revenue increased 6%, while year-to-date revenue increased 5%. Growth was led by sequencing consumables, partly offset by lower microarray revenue and lower instrument revenue. Sequencing revenue was $805 million in Q3, compared with $719 million in the prior-year quarter; microarray revenue was $102 million, compared with $134 million.
Year-to-date operating cash flow was $608 million, compared with $842 million in the prior-year period. Investing activities provided $849 million, primarily because available-for-sale securities matured or were sold in excess of purchases. Financing activities used $782 million, including $550 million for financing obligations, $261 million for share repurchases, and $30 million for taxes on equity award settlements. Cash and cash equivalents increased to $1.815 billion from $1.144 billion at December 30, 2018.
At September 29, 2019, short-term investments were $1.351 billion, producing cash, cash equivalents, and short-term investments of approximately $3.2 billion. Approximately $618 million of cash and cash equivalents was held by foreign subsidiaries. Debt consisted primarily of $750 million principal amount of 2023 convertible notes and $517 million principal amount of 2021 convertible notes, with a net carrying value of $1.131 billion. The 2019 convertible notes matured in June 2019; $633 million of principal was paid in cash and the excess conversion value was paid in shares.
Material changes versus the prior comparable period
- Revenue increased $54 million, or 6%, in Q3 and $125 million, or 5%, year to date, primarily from sequencing consumables and development and licensing agreements.
- Gross margin improved to 71.5% in Q3 and 69.7% year to date, mainly due to a greater mix of sequencing consumables and development and licensing revenue. Lower average selling prices and lower service volumes partially offset the improvement.
- Q3 operating expenses decreased 4% to $340 million, partly reflecting the absence of Helix expenses after deconsolidation. Year-to-date operating expenses increased 6% to $1.088 billion, including higher Core Illumina research and development, personnel, facilities, and PacBio-related costs.
- Net income attributable to Illumina increased 18% in Q3 and 24% year to date. The year-to-date comparison benefited from a lower effective tax rate of 11.5%, versus 14.6% in 2018.
- Other income was volatile. Year-to-date results included a $39 million gain from Helix deconsolidation, a $15 million gain related to settlement of a GRAIL deconsolidation contingency, and market-value changes in strategic investments.
- The company adopted the lease standard, ASC 842, in the first quarter of 2019, recognizing operating lease right-of-use assets of $555 million and operating lease liabilities of $691 million at quarter-end.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected 2019 revenue to increase compared with 2018 but anticipated continued weakness in the direct-to-consumer market. The filing does not provide a specific full-year revenue or earnings guidance range.
- Management expected operating expenses to continue increasing in absolute dollars during 2019 and stated that future margins would depend on pricing, product and sales mix, new-product launches, manufacturing costs, inventory charges, royalties, and support obligations.
- Illumina had agreed to acquire Pacific Biosciences of California for approximately $1.2 billion in cash, subject to customary closing conditions and antitrust approvals. The agreement was extended to December 31, 2019, with potential further extension to March 31, 2020. Illumina could owe a $98 million termination fee in certain antitrust-related circumstances; PacBio could owe a $43 million fee in specified circumstances.
- Management believed available cash, investments, and operating cash flow were sufficient for at least the next 12 months, including the planned PacBio acquisition.
- A Ninth Circuit decision could adversely affect the effective tax rate. If the relevant outcome became more likely than not, management anticipated a possible discrete tax expense of less than $30 million.
- Remaining performance obligations were $1.009 billion at September 29, 2019, with approximately 63% expected to convert to revenue within twelve months.
- Legal proceedings arise in the ordinary course, including intellectual property, employment, and contractual matters. The filing states that litigation outcomes are inherently unpredictable but identifies no specific material accrued loss.
- Remaining callable commitments to two venture capital funds were $55 million and up to $160 million, with call periods extending through 2026 and 2029.
- The company repurchased $261 million of stock year to date. Approximately $289 million remained authorized at quarter-end.
Investor verification points
- Verify the status, closing conditions, regulatory review, funding, and termination-fee exposure associated with the PacBio acquisition.
- Assess whether sequencing consumables growth can offset continuing weakness in microarray and direct-to-consumer demand.
- Reconcile operating cash flow, including the effects of debt-discount payments, investment gains, Helix deconsolidation, and working-capital use.
- Monitor convertible-note maturities, potential dilution from the 2021 notes, and future share repurchase activity.
- Evaluate the sustainability of the unusually low effective tax rate and the potential tax impact described in the filing.
- Review the accounting and cash-flow effects of ASC 842 lease adoption and the company’s $740 million total operating lease liability.
- Consider volatility in strategic investment valuations and the $28 million Level 3 contingent value right received from Helix.