Illumina, Inc. — Q3 2020 Form 10-Q Summary
Business context and reporting period
Illumina provides sequencing- and array-based genetic analysis solutions for research, clinical, and applied markets. The filing covers the 13-week quarter and nine months ended September 27, 2020, compared with the comparable periods ended September 29, 2019. The company reported one segment, Core Illumina; Helix was deconsolidated in April 2019.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | YTD 2020 | YTD 2019 |
|---|---|---|---|---|
| Total revenue | $794 million | $907 million | $2.286 billion | $2.591 billion |
| Gross profit | $526 million | $648 million | $1.573 billion | $1.805 billion |
| Gross margin | 66.2% | 71.5% | 68.8% | 69.7% |
| Income from operations | $162 million | $308 million | $447 million | $717 million |
| Net income attributable to Illumina | $179 million | $234 million | $399 million | $763 million |
| Diluted EPS | $1.21 | $1.58 | $2.70 | $5.13 |
| Operating cash flow | Not separately provided | Not separately provided | $674 million | $608 million |
Q3 revenue comprised $676 million of product revenue and $118 million of service and other revenue. YTD revenue comprised $1.904 billion of product revenue and $382 million of service and other revenue. Sequencing revenue was $708 million in Q3 and $2.033 billion YTD; microarray revenue was $86 million in Q3 and $253 million YTD.
- Cash and cash equivalents were $1.761 billion at September 27, 2020; short-term investments were $1.563 billion, for total cash, cash equivalents, and short-term investments of approximately $3.3 billion.
- Debt consisted principally of $517 million of 2021 convertible notes and $750 million of 2023 convertible notes. Net carrying value of debt was $1.173 billion, including $507 million classified as current.
- YTD investing cash flow was negative $520 million and financing cash flow was negative $435 million, resulting in a $281 million decrease in cash and cash equivalents.
- YTD capital expenditures were $127 million. The company repurchased 1.4 million shares for approximately $455 million, with approximately $295 million remaining under the authorization.
- YTD operating margin was 19.6%, compared with 27.7% in the prior-year period. The Q3 operating margin was 20.4%, compared with 33.9%.
Material changes versus the prior comparable period
- Q3 and YTD revenue declined 12%, primarily because COVID-19 reduced shipments of sequencing consumables and instruments. YTD instrument revenue decreased 27%, while consumables revenue decreased 6%.
- Service and other revenue declined 27% in Q3 and 19% YTD, reflecting lower development and licensing revenue and lower genotyping and sequencing services.
- Gross margin declined because of lower fixed-cost leverage, higher COVID-19-related freight costs, and lower development and licensing revenue.
- Q3 operating expenses increased 7%; YTD operating expenses increased 3%. Q3 research and development increased 14%, while YTD selling, general and administrative expense increased 7%, including PacBio-related costs and GRAIL transaction expenses.
- Q3 other income benefited from $59 million of unrealized gains on marketable equity securities, partially offset by a $10 million loss in the fair value of PacBio-related derivative assets.
- YTD net income was affected by a $116 million loss on PacBio-related derivative assets, a $62 million valuation allowance against California research and development credits, and a $28 million tax expense associated with the Altera litigation outcome.
- The effective tax rate increased to 28.4% YTD from 11.5%, primarily because of the California credit valuation allowance and Altera-related tax expense.
Guidance, outlook, risks, contingencies, and unusual items
- Management did not provide an outlook for the remainder of 2020, stating that the magnitude and duration of COVID-19 effects could not be predicted.
- COVID-19 continued to pressure demand, customer shipments, sales activity, field support, supply chains, research and development, and operating costs. Management expects continued negative effects but cannot estimate their size or duration.
- On September 20, 2020, Illumina agreed to acquire GRAIL for $8 billion, consisting of $3.5 billion in cash and $4.5 billion in Illumina stock, subject to a collar. Closing was expected in the second half of 2021 and required shareholder and regulatory approvals.
- The GRAIL transaction was expected to require approximately $3.1 billion of cash consideration to GRAIL stockholders, funded with balance-sheet cash, GRAIL cash, and up to $1 billion of new debt or equity. Illumina obtained a commitment for a 364-day, $1 billion senior unsecured bridge facility.
- If the GRAIL transaction was not completed by December 20, 2020, Illumina could be required to make $35 million monthly continuation payments. Under specified termination circumstances, Illumina could owe a $300 million termination fee and make an additional $300 million investment in GRAIL.
- The terminated PacBio acquisition resulted in $132 million of Q1 cash payments, including a $98 million reverse termination fee and $34 million of continuation advances. The reverse termination fee was no longer repayable after September 30, 2020; up to $52 million of continuation advances remained potentially recoverable under specified conditions.
- The 2021 convertible notes became convertible on July 1, 2020 and mature in June 2021. Management stated that available liquidity, operating cash flow, and the bridge commitment were sufficient for near-term needs, including the planned GRAIL acquisition.
- The filing states that there were no off-balance-sheet arrangements and no material changes in market risk disclosures. Ordinary-course litigation includes intellectual property, employment, and contractual matters; the filing does not provide a clear aggregate exposure.
Investor verification checklist
- Verify the effect and duration of COVID-19 on sequencing consumables, instruments, services, supply-chain costs, and customer demand.
- Track GRAIL regulatory proceedings, closing conditions, financing arrangements, continuation payments, potential termination fees, and the effect of stock issuance on ownership and EPS.
- Review the June 2021 maturity and conversion status of the $517 million convertible notes and the company’s refinancing plans.
- Assess whether marketable equity investment gains, PacBio derivative remeasurement losses, and other unusual items are recurring or nonrecurring.
- Reconcile the YTD tax rate, including the $62 million California credit valuation allowance and $28 million Altera-related tax expense.
- Monitor liquidity after share repurchases, acquisitions, strategic investments, capital expenditures, and potential GRAIL funding requirements.