Illumina, Inc. — Q1 2018 Form 10-Q Summary
Business context and reporting period
Illumina is a global provider of sequencing- and array-based genomic analysis systems, consumables, services, and related tools. The report covers the 13-week quarter ended April 1, 2018, compared with the 13-week quarter ended April 2, 2017. The company reports Core Illumina and consolidated variable interest entities, primarily Helix following GRAIL’s 2017 deconsolidation.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $782 million | $598 million | 31% |
| Product revenue | $628 million | $491 million | 28% |
| Service and other revenue | $154 million | $107 million | 44% |
| Gross profit | $538 million | $368 million | 46% |
| Gross margin | 68.8% | 61.5% | +7.3 percentage points |
| Income from operations | $218 million | $52 million | 318% |
| Operating margin | 27.8% | 8.7% | +19.1 percentage points |
| Net income attributable to Illumina | $208 million | $367 million | (43%) |
| Diluted EPS | $1.41 | $2.48 | (43%) |
| Net cash from operating activities | $255 million | $168 million | 52% |
Revenue growth was led by sequencing consumables, which increased by $99 million, higher NovaSeq instrument shipments, and increased genotyping and sequencing services. Consumables revenue was $504 million, instruments were $118 million, and other product revenue was $6 million.
Operating expenses were $320 million versus $316 million. Research and development expense declined 6% to $137 million, while selling, general and administrative expense increased 7% to $183 million. The effective tax rate was 10.6%, compared with 30.8% in the prior-year quarter.
At April 1, 2018, cash and cash equivalents were $1.560 billion and short-term investments were $813 million. Total current assets were $3.194 billion against current liabilities of $1.180 billion. Debt consisted primarily of $633 million of 2019 convertible notes and $517 million of 2021 convertible notes; $620 million was classified as current, primarily because the 2019 notes became convertible within twelve months. Management stated that available liquidity and operating cash flow were sufficient for near-term needs, including at least the next twelve months.
Capital expenditures were $90 million. Cash increased by $335 million during the quarter, to $1.560 billion. Financing cash flow was positive $67 million, including $61 million of contributions from noncontrolling interest owners. No shares were repurchased during the quarter; $100 million remained available under the repurchase authorization.
Material changes versus the prior comparable period
- Revenue increased 31%, primarily from sequencing consumables, NovaSeq shipments, and service revenue.
- Gross margin expanded substantially because of favorable service margins, a greater consumables mix, and the absence of prior-year impairment and product-transition inventory charges.
- Operating margin improved to 27.8%, partly because GRAIL was deconsolidated in February 2017, reducing consolidated operating expenses in the 2018 comparison.
- Net income and EPS declined because Q1 2017 included a $453 million pretax gain on GRAIL deconsolidation, which was recorded in other income.
- Operating cash flow improved by $87 million, while investing cash flow declined to $12 million from $163 million because the prior year included $278 million of proceeds from the sale of GRAIL securities.
- The company adopted Revenue from Contracts with Customers, Topic 606, using the modified retrospective method. The cumulative effect and Q1 2018 impact were not material.
- Construction of a build-to-suit property was completed; $132 million was reclassified from construction in progress and a build-to-suit lease liability to building assets and financing-lease obligations.
Guidance, outlook, risks, contingencies, and unusual items
Management expects revenue to continue increasing in 2018 but does not provide a quantified full-year revenue or earnings forecast in the filing. Management expects research and development and selling, general and administrative expenses to continue growing. Future margins may be affected by pricing, product and sales mix, new product transitions, inventory reserves, royalties, manufacturing costs, and support obligations.
Management expects future effective tax rates to trend below the 21% U.S. federal statutory rate because some earnings are generated in lower-tax jurisdictions. The accounting treatment for GILTI under U.S. Tax Reform had not yet been elected, and tax estimates remained subject to revision.
Helix was consolidated and had $121 million of cash unavailable to satisfy Illumina obligations. Certain Helix investors may require cash redemption of their interests after January 1, 2021, subject to specified conditions; redeemable noncontrolling interests were $215 million. Illumina also had an $80 million remaining capital commitment to a venture capital fund.
Convertible notes due in 2019 and 2021 were not convertible as of April 1, 2018. The company states that pending litigation involves intellectual property, employment, and contractual matters, but it cannot predict ultimate outcomes or reasonably estimate potential losses for matters without accrued liabilities. The filing reports no material changes to previously disclosed risk factors and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether NovaSeq placements translate into sustained growth in the installed base and recurring sequencing consumables revenue.
- The durability of the 68.8% gross margin as product mix, pricing, and product transitions evolve.
- The maturity, conversion status, and refinancing or repayment plan for the $633 million of 2019 convertible notes.
- The effect of U.S. Tax Reform, GILTI accounting, and foreign earnings on future tax rates and cash taxes.
- The potential cash redemption obligation related to Helix’s $215 million of redeemable noncontrolling interests.
- Progress, funding requirements, and operating losses associated with Helix and other strategic investments.
- Potential outcomes and financial exposure from pending litigation and other contingencies.