Illumina, Inc. 2013 Q3 Form 10-Q Summary
Business context and reporting period
Illumina develops, manufactures, and markets genomic analysis systems, instruments, consumables, services, and related software for sequencing, genotyping, gene expression, and genomic diagnostics. The filing covers the 13-week quarter and 39-week year-to-date period ended September 29, 2013, compared with the corresponding periods ended September 30, 2012.
Growth was driven primarily by sequencing instruments and consumables, including the HiSeq and MiSeq platforms, as well as sequencing services. Approximately 45% of Q3 revenue came from applied-market customers, while less than 30% came from U.S. academic or government customers directly or indirectly reliant on NIH funding.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | YTD 2013 | YTD 2012 |
|---|---|---|---|---|
| Total revenue | $356.8 million | $285.9 million | $1,033.9 million | $839.3 million |
| Revenue growth | 25% | — | 23% | — |
| Gross profit | $209.9 million | $195.9 million | $652.6 million | $569.9 million |
| Gross margin | 58.8% | 68.5% | 63.1% | 67.9% |
| Income from operations | $45.5 million | $48.8 million | $60.3 million | $141.4 million |
| Net income | $31.4 million | $29.7 million | $44.6 million | $79.4 million |
| Diluted EPS | $0.22 | $0.22 | $0.32 | $0.60 |
Q3 product revenue increased 21% to $318.6 million, including consumables revenue of $215.6 million and instrument revenue of $99.7 million. Service and other revenue increased 63% to $38.2 million. Year-to-date product revenue increased 19% to $928.3 million, while service and other revenue increased 69% to $105.6 million.
Q3 operating expenses were $164.5 million, up 12% year over year. Research and development expense increased 31% to $71.0 million, and selling, general and administrative expense increased 37% to $95.6 million. Year-to-date operating expenses increased 38% to $592.3 million.
Q3 effective tax rate was 15.6%; the year-to-date rate was negative 14.6%, primarily because the Syntrix legal contingency was nondeductible for tax purposes until paid. Q3 net margin was approximately 8.8%, compared with 10.4% in the prior-year quarter; year-to-date net margin was approximately 4.3%, compared with 9.5%.
Cash flow, liquidity, debt, and balance sheet
- Cash and cash equivalents were $691.8 million at September 29, 2013, compared with $434.0 million at December 30, 2012.
- Short-term investments were $336.2 million, resulting in total cash, cash equivalents, and short-term investments of approximately $1.03 billion.
- Year-to-date operating cash flow was $259.6 million, compared with $213.0 million in the prior-year period.
- Year-to-date investing cash flow was positive $81.2 million, versus negative $168.6 million in the prior-year period. Investing included $437.5 million of net acquisition payments and $51.9 million of capital expenditures.
- Year-to-date financing cash flow was negative $82.3 million, including $125.0 million paid to retire warrants and $50.0 million of share repurchases, partially offset by $80.2 million of proceeds from equity issuances.
- Debt consisted primarily of $920.0 million principal amount of 0.25% convertible senior notes due 2016, carried at $830.7 million, and $29.6 million principal amount of 0.625% convertible notes due 2014, carried at $28.8 million.
- Total assets were $2.82 billion and total stockholders’ equity was $1.37 billion at September 29, 2013.
Management stated that cash, investments, and expected operating cash flow should fund near-term operating, capital, acquisition, and litigation-related needs for at least the next 12 months, including securing the Syntrix judgment and funding the NextBio acquisition.
Material changes versus the prior comparable period
- Revenue growth was strong, but profitability declined because of legal charges, product-line impairments, higher acquired-intangible amortization, and increased investment in personnel and growth initiatives.
- Year-to-date operating income declined 57% to $60.3 million, and year-to-date net income declined 44% to $44.6 million.
- Gross margin fell 970 basis points in Q3 and 480 basis points year to date. The filing attributes the decline primarily to a $25.2 million impairment charge related to discontinued Eco and NuPCR product lines, higher amortization, Syntrix-related royalties and contingencies, acquisitions, and product mix.
- Illumina acquired Verinata Health in February 2013 for aggregate consideration of approximately $396.3 million, including contingent milestone consideration, and acquired Advanced Liquid Logic in July 2013 for $97.2 million. NextBio was acquired on October 28, 2013, after the reporting date.
- Goodwill increased to $667.2 million from $369.3 million at year-end 2012, and intangible assets increased to $297.9 million from $130.2 million, principally reflecting acquisitions.
- The company recorded $127.0 million of accrued legal contingencies related primarily to the Syntrix patent litigation, including $114.6 million in operating expenses and the remainder in cost of sales.
Guidance, outlook, commentary, risks, and unusual items
- Management expected continued growth in sequencing consumables as the HiSeq and MiSeq installed base expands, while anticipating continued operating-expense growth from research, product development, commercialization, headcount, and global business-process initiatives.
- Management expected future gross margin to depend on pricing, sales and product mix, manufacturing costs, royalties, and the ability to launch differentiated products. No specific numerical revenue or earnings guidance was provided in the filing.
- Illumina discontinued the Eco and NuPCR product lines and recorded a $25.2 million impairment charge, including $22.9 million related to identifiable intangible assets.
- Syntrix obtained a $115.1 million judgment, including damages and prejudgment interest, plus an ongoing 8% royalty on accused BeadChip sales through patent expiration in September 2019. Illumina planned to appeal, but was required to secure the judgment and escrow post-judgment royalties.
- The IRS began an audit of Illumina’s fiscal 2011 corporate tax return; the audit remained in the information-gathering stage.
- Key risks include dependence on successful commercialization of sequencing and array technologies, competition and technological change, manufacturing execution, reduced academic or government funding, acquisition integration, tax-rate variability, impairment judgments, foreign-exchange exposure, and adverse litigation outcomes.
- Management reported no material changes to previously disclosed risk factors, no significant off-balance-sheet arrangements, and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Reconcile reported revenue growth with the contribution from acquisitions and the underlying organic growth of sequencing instruments, consumables, and services.
- Assess whether the lower gross margin reflects primarily nonrecurring items or a sustained change in product mix, pricing, royalties, and cost structure.
- Monitor the Syntrix appeal, required escrow funding, ongoing 8% royalties, and any potential loss beyond the $127.0 million accrual.
- Evaluate acquisition integration, contingent milestone liabilities, goodwill and intangible-asset balances, and the subsequent NextBio acquisition.
- Review the maturity and settlement exposure of the 2014 convertible notes and the remaining warrants, including potential dilution and cash requirements.
- Confirm the sustainability of operating cash flow after litigation payments, acquisitions, capital expenditures, share repurchases, and other financing commitments.