Business Context and Reporting Period
Illumina, Inc. provides sequencing- and array-based genomic solutions to research, clinical, and applied markets. The company also consolidates GRAIL, which develops the Galleri multi-cancer early-detection test and is reported as a separate segment. This Form 10-Q covers the 13-week quarter ended October 2, 2022 and the 39-week year-to-date period; comparable periods ended October 3, 2021.
Financial Performance and Position
| Metric | Q3 2022 | Q3 2021 | YTD 2022 | YTD 2021 |
|---|---|---|---|---|
| Total revenue | $1.115 billion | $1.108 billion | $3.501 billion | $3.327 billion |
| Gross profit | $717 million | $770 million | $2.300 billion | $2.337 billion |
| Gross margin | 64.3% | 69.5% | 65.7% | 70.2% |
| Loss from operations | $(3.657) billion | $(545) million | $(4.052) billion | $(164) million |
| Net income (loss) | $(3.816) billion | $317 million | $(4.265) billion | $650 million |
| Diluted EPS | $(24.26) | $2.08 | $(27.13) | $4.36 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $245 million | $263 million |
- Core Illumina revenue was $1.110 billion in Q3 and $3.487 billion YTD, while GRAIL revenue was $10 million and $32 million, respectively, before intersegment eliminations.
- Q3 product revenue was $963 million and service and other revenue was $152 million. YTD product revenue was $3.039 billion and service and other revenue was $462 million.
- Cash and cash equivalents were $1.000 billion at October 2, 2022, supplemented by $41 million of short-term investments. Approximately $537 million of cash and equivalents was held by foreign subsidiaries.
- YTD cash decreased by $232 million, with $245 million provided by operations, $489 million used in investing, and $44 million provided by financing activities.
- Total debt had a carrying value of approximately $1.741 billion, including $499 million of 2023 term notes and $747 million of 2023 convertible notes classified as current. The company had no borrowings under its $750 million revolving credit facility and was in compliance with its covenants.
- Inventory increased to $559 million from $431 million at January 2, 2022, while current liabilities increased to $2.669 billion from $1.093 billion, largely reflecting current debt classifications and accrued legal contingencies.
Material Changes Versus the Prior Comparable Period
- Revenue increased 1% in Q3 and 5% YTD. YTD growth was primarily driven by sequencing consumables, instruments, and service revenue. Q3 instrument revenue declined because of fewer NovaSeq 6000 shipments.
- Core Illumina YTD revenue increased 5%, but Core Illumina gross margin declined to 69.0% from 70.6%, primarily due to lower fixed-cost leverage, higher freight costs, and the prior-year patent litigation settlement.
- Consolidated gross margin declined because of GRAIL’s gross losses and higher acquired-intangible amortization.
- Q3 and YTD results included a $3.914 billion goodwill impairment charge related to GRAIL. The impairment followed regulatory developments, a significant decline in Illumina’s stock price and market capitalization, and a higher GRAIL discount rate of 22.0%.
- Operating results included a $453 million accrual for a potential European Commission fine related to the GRAIL acquisition. The company also recorded a net YTD loss of $145 million related to the BGI litigation settlement, including a $180 million capitalized license intangible asset.
- Q3 2021 included a $900 million gain on Illumina’s previously held investment in GRAIL and $615 million of GRAIL acquisition-related accelerated share-based compensation; these items did not recur comparably in 2022.
- YTD research and development expense increased 17% to $975 million, while selling, general and administrative expense decreased 48% to $865 million, primarily because of nonrecurring 2021 GRAIL acquisition-related compensation and lower contingent-consideration expense.
Guidance, Outlook, Commentary, and Risks
- Management expected 2022 revenue to be flat to 1% higher than 2021 and expected operating expenses to increase in absolute dollars.
- Management cited COVID-19 effects, inflation, foreign-exchange volatility, supply-chain constraints, customer inventory and capital-spending caution, and the Russia-Ukraine conflict as ongoing pressures.
- Management stated that cash, investments, operating cash flow, and available revolver capacity were expected to fund near-term operating and capital needs for at least the next 12 months.
- The European Commission prohibited the GRAIL acquisition in September 2022 and indicated that a divestiture decision was likely. Illumina appealed the relevant EU decisions and continued to operate GRAIL separately under interim measures and monitoring-trustee oversight.
- The FTC administrative law judge ruled in Illumina’s favor, but FTC complaint counsel appealed to the full FTC. The company could face additional fines, restrictions, divestiture costs, tax liabilities, loss of synergies, and operational disruption.
- The company recorded $2.178 billion of remaining GRAIL goodwill after the impairment. Future changes in GRAIL results, cash flows, market capitalization, discount rates, or regulatory outcomes could result in additional impairment.
- Illumina settled BGI and CGI litigation for a $325 million payment and received a fully paid-up license to specified two-channel technology patents. The permanent injunction against BGI StandardMPS chemistry remained in effect through January 1, 2023.
- RavGen litigation remained unresolved; the filing stated that the possible loss could not currently be estimated.
- Potential future cash taxes could increase by approximately $163 million because of the tax-law requirement to capitalize U.S. research and development costs, if not repealed or modified.
Investor Verification Checklist
- Verify the status, amount, timing, and collectability of any European Commission fine and the potential divestiture or other remedies involving GRAIL.
- Assess whether the $3.914 billion GRAIL impairment adequately reflects current regulatory, market, and operating assumptions and whether further impairment risk remains.
- Monitor the $1.246 billion of debt due in 2023, consisting of $500 million of term notes and $750 million of convertible notes at principal value.
- Reconcile reported operating cash flow with noncash goodwill impairment, legal accruals, contingent-consideration changes, working-capital movements, and capital expenditures.
- Evaluate Core Illumina demand trends, particularly sequencing consumables, NovaSeq shipments, customer capital spending, supply-chain conditions, freight costs, and foreign-exchange effects.
- Review unresolved RavGen claims and other intellectual-property matters for potential losses not yet estimable or accrued.