Illumina, Inc. — Q2 2013 Form 10-Q Summary
Business context and reporting period
Illumina develops and sells genetic analysis instruments, consumables, services, and related technologies serving sequencing, genotyping, gene expression, reproductive health, diagnostics, research, and applied markets. The filing covers the 13-week quarter and 26-week year-to-date period ended June 30, 2013, compared with the periods ended July 1, 2012.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | YTD 2013 | YTD 2012 |
|---|---|---|---|---|
| Total revenue | $346.1 million | $280.6 million | $677.1 million | $553.4 million |
| Revenue growth | 23% | 22% | ||
| Gross profit | $223.4 million | $193.0 million | $442.7 million | $374.0 million |
| Gross margin | 64.6% | 68.8% | 65.4% | 67.6% |
| Income from operations | $60.0 million | $43.0 million | $14.9 million | $92.6 million |
| Net income | $35.9 million | $23.4 million | $13.3 million | $49.6 million |
| Diluted earnings per share | $0.26 | $0.18 | $0.10 | $0.37 |
| Operating cash flow | $176.4 million | $161.8 million |
Q2 product revenue was $313.5 million, including consumables revenue of $215.4 million and instrument revenue of $94.8 million. Service and other revenue increased 50% to $32.6 million. Management attributed growth primarily to higher sequencing consumables sales from the expanding HiSeq and MiSeq installed base, higher HiSeq shipments, and increased sequencing services and service-contract revenue.
At June 30, 2013, cash and cash equivalents were $783.6 million and short-term investments were $345.9 million, for total cash and short-term investments of approximately $1.13 billion. Total assets were $2.82 billion. Debt consisted principally of $822.2 million carrying value of the 0.25% convertible senior notes due 2016 and $29.7 million current carrying value of the 0.625% convertible notes due 2014. Stockholders’ equity was $1.39 billion.
Material changes versus the prior comparable period
- Revenue increased 23% in Q2 and 22% year to date, led by sequencing-related consumables, instruments, and services.
- Gross margin declined 420 basis points in Q2 and 220 basis points year to date. Drivers included higher amortization of acquired intangible assets, Syntrix-related royalties and legal charges, acquisitions, and a less favorable mix toward instruments and services; operational efficiencies and higher instrument margins partially offset the decline.
- Year-to-date operating income fell to $14.9 million from $92.6 million, primarily because of $115.4 million of operating legal-contingency charges related to the Syntrix patent matter and higher selling, general and administrative expense.
- Year-to-date net income declined despite revenue growth, reflecting the Syntrix accrual, higher operating expenses, and related tax effects. The first-half effective tax rate was negative 639.2%, principally because the Syntrix contingency was nondeductible until paid.
- Research and development expense increased 7% year to date, while selling, general and administrative expense increased 27%. The prior-year period included a $21.4 million in-process research and development impairment charge that did not recur.
- Cash and cash equivalents increased $349.6 million during the first half. Net cash provided by investing activities was $182.5 million, including proceeds from maturities and sales of securities that exceeded purchases and the $345.2 million net cash spent on acquisitions.
Guidance, outlook, commentary, risks, and unusual items
- Management stated that it expects revenue to continue growing in 2013 and that operating expenses will continue to increase as the company invests in products, commercialization, and expansion.
- Approximately 40% of Q2 revenue came from applied-market customers, and management estimated that less than 30% of total revenue was derived directly or indirectly from NIH funding. NIH funding was subject to sequestration and ongoing budget uncertainty.
- Management expects sequencing-market expansion, a growing installed base, and increased consumables demand to support future growth. It also expects some migration from microarrays to sequencing, partly offset by demand from applied, consumer, and translational markets.
- Syntrix received a final amended judgment of $115.1 million, plus an ongoing royalty of 8% on accused sales from March 15, 2013 through patent expiration in September 2019. Illumina accrued $122.7 million at June 30, 2013, is contesting the judgment, and filed a post-trial motion with plans to appeal if necessary. The company may be required to secure the judgment during the appeals process.
- Illumina acquired Verinata Health in February 2013 for an aggregate purchase price of $396.3 million, including contingent consideration of up to $100 million based on milestones. The acquisition added $221.2 million of goodwill and $176.5 million of identifiable intangible assets on a preliminary basis.
- On July 1, 2013, after quarter-end, Illumina acquired Advanced Liquid Logic for up to $96.0 million in cash. On July 18, 2013, it paid $125.0 million to settle warrants covering approximately 3.0 million shares.
- Management stated that existing cash, investments, and expected operating cash flow should fund near-term needs for at least 12 months, including potential Syntrix-related requirements and the Advanced Liquid Logic acquisition.
- The IRS began an initial information-gathering audit of the company’s fiscal 2011 corporate income tax return. Management reported no material changes to previously disclosed risk factors and no significant off-balance-sheet arrangements.
Most important facts for investors to verify
- Whether the Syntrix judgment is vacated, reduced, upheld, or settled, and the resulting cash payment, collateral, royalties, and future earnings impact.
- The sustainability of revenue growth from HiSeq and MiSeq instruments, sequencing consumables, and service revenue.
- Whether gross margins recover as legal charges, acquisition amortization, and mix effects moderate.
- The integration, regulatory progress, milestone payments, and commercial performance of Verinata and other acquired businesses.
- Liquidity after Syntrix-related funding requirements, the Advanced Liquid Logic acquisition, warrant settlement, capital expenditures, acquisitions, and share repurchases.
- The outcome of the IRS audit and the future effective tax rate, particularly the treatment of nondeductible legal contingencies and foreign earnings.