Business Context and Reporting Period
Illumina, Inc. develops, manufactures, and markets integrated systems, sequencing technologies, microarrays, consumables, and related services for genetic analysis. The Form 10-Q covers the 13-week quarter and 26-week year-to-date period ended July 4, 2010, compared with June 28, 2009. The company reported one operating segment because Diagnostics activity remained limited.
Financial Performance and Position
| Metric | Q2 2010 | Q2 2009 | Change |
|---|---|---|---|
| Total revenue | $212.0 million | $161.6 million | +31% |
| Product revenue | $198.5 million | $153.2 million | +30% |
| Service and other revenue | $13.5 million | $8.4 million | +60% |
| Gross profit | $146.1 million | $111.2 million | +31% |
| Gross margin | 68.9% | 68.8% | +0.1 percentage points |
| Income from operations | $47.4 million | $36.1 million | +31% |
| Net income | $29.8 million | $24.7 million | +21% |
| Diluted earnings per share | $0.21 | $0.18 | +17% |
| Metric | Six Months 2010 | Six Months 2009 | Change |
|---|---|---|---|
| Total revenue | $404.1 million | $327.4 million | +23% |
| Gross profit | $278.3 million | $221.2 million | +26% |
| Gross margin | 68.9% | 67.6% | +1.3 percentage points |
| Income from operations | $85.7 million | $70.6 million | +21% |
| Net income | $51.0 million | $43.5 million | +17% |
| Diluted earnings per share | $0.37 | $0.32 | +16% |
| Operating cash flow | $130.3 million | $90.1 million | +45% |
Q2 operating margin was approximately 22.4% and net margin was approximately 14.1%. Year-to-date operating margin was approximately 21.2% and net margin was approximately 12.6%.
- Sequencing consumable revenue increased $20.5 million in Q2, driven by growth in the installed base and customer production-scale adoption.
- Instrument revenue increased $16.1 million in Q2, primarily from higher sequencing-system sales and the HiSeq 2000 launch.
- Research and development expense increased 32% in Q2 to $43.7 million; selling, general and administrative expense increased 28% to $53.7 million.
- Q2 included $1.3 million of acquired in-process research and development expense related to Avantome milestone payments.
- Cash and cash equivalents were $237.2 million at July 4, 2010, compared with $144.6 million at January 3, 2010. Short-term investments were $548.2 million, producing total cash and short-term investments of approximately $785.4 million.
- Inventory increased to $119.4 million from $92.8 million at year-end, partly reflecting manufacturing and capacity expansion.
- The company had $390.0 million principal amount of 0.625% convertible senior notes outstanding, due February 2014. The net carrying amount of the liability component was $300.7 million, and the current portion reported on the balance sheet was $300.7 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated, led by sequencing instruments and consumables, while microarray consumable revenue was relatively flat for the first six months.
- Year-to-date gross margin improved because of higher-margin sequencing consumables and a greater sequencing-consumables mix. Management cautioned that Q2 margin was likely to face pressure from newer products and trade-in activity.
- Operating expenses grew faster than revenue in Q2, with increases in personnel, laboratory and production supplies, sales infrastructure, and litigation-related outside services.
- The effective tax rate increased to 36.0% in Q2 from 29.5% and to 36.2% year to date from 32.4%, primarily because the federal research and development credit had expired and earnings shifted toward higher-tax jurisdictions.
- Cash flow from operations increased by $40.2 million year to date. Investing cash use included $65.1 million for the Helixis acquisition and additional Avantome consideration, $22.9 million of capital expenditures, and $17.7 million of strategic investments.
- On April 30, 2010, Illumina acquired Helixis for approximately $86.7 million of total consideration, including $70.0 million of net cash and up to $35.0 million of contingent consideration. The transaction added approximately $58.4 million of goodwill and $28.0 million of identifiable intangible assets.
- Illumina exercised its option to sell its remaining auction rate securities at par value on July 1, 2010; no gain or loss was recorded. The securities and related put option were eliminated from short-term investments.
Guidance, Outlook, Risks, and Unusual Items
- Management expected strong demand for next-generation sequencing to continue and planned to increase HiSeq 2000 production by nearly 50% in Q3 2010 to improve shipment schedules.
- The company began shipping the Omni 2.5 microarray in Q2 and planned a future approximately 5.0-million-marker product subject to the timing of new 1000 Genomes Project content.
- Management expected operating expenses to increase in absolute dollars but anticipated revenue growth to exceed expense growth in the second half of 2010.
- Management expected gross margin to decline in the second half of 2010 because of the Genome Analyzer trade-in program, newer products in early value-engineering stages, product mix, and continuing price competition.
- Approximately $46.9 million of orders in the first six months were believed to be directly related to American Recovery and Reinvestment Act grants. Funding timing and future funding levels remain uncertain.
- Management expected significant income tax payments in 2010 and beyond as tax-loss and research-credit carryforwards were substantially utilized.
- The company stated that cash, short-term investments, and operating income should fund operating needs for at least the next 12 months, absent unforeseen circumstances. Future funding needs depend on commercialization, research and development, competition, acquisitions, and facility and equipment requirements.
- Key risks include developing and commercializing new technologies, manufacturing reliable instruments and reagents, dependence on research customers and government funding, pricing competition, product transitions, tax changes, litigation, and potential dilution from convertible notes, warrants, and equity awards.
- Management did not expect pending ordinary-course litigation to have a material adverse effect. No material changes to previously disclosed risk factors, off-balance-sheet arrangements, or critical accounting policies were reported.
Important Facts for Investors to Verify
- Whether HiSeq 2000 production increases and the product transition convert into sustained instrument and consumables growth.
- The extent and timing of gross-margin pressure from trade-ins, newer products, product mix, and pricing competition.
- The sustainability of demand supported by Recovery Act and other government-funded research programs.
- Execution and integration of the Helixis acquisition, including contingent consideration of up to $35 million and commercialization of its PCR technology.
- Tax-rate and cash-tax trends following the expected utilization of tax-loss and research-credit carryforwards.
- Liquidity and refinancing or settlement requirements associated with the $390 million convertible notes due in 2014, as well as potential warrant and equity-award dilution.
- Inventory growth, capital expenditures, manufacturing capacity utilization, and future working-capital needs.