Illumina, Inc. 2018 Q2 Form 10-Q Summary
Business Context and Reporting Period
Illumina is a global provider of DNA sequencing and array-based technologies serving research, clinical, and applied markets. The filing covers the three and six months ended July 1, 2018, compared with the periods ended July 2, 2017. Each comparative period comprised 13 and 26 weeks, respectively.
Reportable segments were Core Illumina and consolidated variable interest entities, principally Helix. GRAIL was deconsolidated in February 2017.
Financial Performance and Position
| Metric | Q2 2018 | Q2 2017 | YTD 2018 | YTD 2017 |
|---|---|---|---|---|
| Total revenue | $830 million | $662 million | $1.612 billion | $1.261 billion |
| Product revenue | $673 million | $543 million | $1.301 billion | $1.034 billion |
| Service and other revenue | $157 million | $119 million | $311 million | $227 million |
| Gross profit | $575 million | $434 million | $1.113 billion | $802 million |
| Gross margin | 69.3% | 65.5% | 69.0% | 63.6% |
| Income from operations | $227 million | $143 million | $445 million | $195 million |
| Operating margin | 27.4% | 21.6% | 27.6% | 15.5% |
| Net income attributable to Illumina | $209 million | $128 million | $417 million | $495 million |
| Diluted EPS | $1.41 | $0.87 | $2.82 | $3.35 |
Consumables were the primary growth driver, with Q2 revenue of $540 million, up 34%, and first-half revenue of $1.045 billion, up 33%. Sequencing consumables increased by $117 million in Q2 and $217 million year to date. Q2 instrument revenue declined 7% to $127 million, primarily because of fewer NovaSeq and HiSeq shipments.
Research and development expense increased 16% in Q2 to $151 million and 5% year to date to $288 million. Selling, general and administrative expense increased 22% in Q2 to $197 million and 14% year to date to $380 million.
Net cash provided by operating activities was $550 million in the first half of 2018, compared with $346 million in the first half of 2017. Investing activities used $525 million, including $100 million for the acquisition of Edico Genome and $167 million of capital expenditures. Financing activities provided $97 million, including $92 million of contributions from noncontrolling interest owners. Cash and cash equivalents increased by $119 million to $1.344 billion.
| Balance sheet metric | July 1, 2018 | December 31, 2017 |
|---|---|---|
| Cash and cash equivalents | $1.344 billion | $1.225 billion |
| Short-term investments | $1.168 billion | $920 million |
| Total assets | $5.851 billion | $5.257 billion |
| Current liabilities | $1.217 billion | $746 million |
| Total debt carrying amount | $1.348 billion | $1.192 billion |
| Total stockholders’ equity | $3.351 billion | $2.749 billion |
Cash, cash equivalents, and short-term investments totaled approximately $2.5 billion at July 1, 2018, including approximately $655 million held by foreign subsidiaries. Approximately $171 million of cash held by Helix was restricted to Helix obligations. Management stated that available liquidity and expected operating cash flow were sufficient for near-term capital and operating needs for at least 12 months.
Material Changes Versus the Prior Comparable Period
- First-half revenue increased 28%, driven primarily by sequencing consumables, services, and instruments.
- First-half gross margin expanded to 69.0% from 63.6%, primarily because consumables represented a larger portion of revenue and because the prior-year period included an $18 million acquired-intangible impairment and inventory reserves related to product transitions.
- First-half operating margin increased to 27.6% from 15.5% as revenue and gross margin improved faster than operating expenses.
- First-half net income attributable to Illumina declined to $417 million from $495 million because the prior-year period included a $453 million pretax gain from GRAIL deconsolidation.
- The first-half effective tax rate declined to 12.3% from 27.4%, reflecting lower-tax jurisdictions and a discrete benefit related to recognition of prior-year Helix losses.
- Cash flow from operations increased, while investing cash flow shifted from a $198 million source in the prior-year period to a $525 million use, reflecting securities purchases, the Edico Genome acquisition, and higher capital expenditures.
- On May 14, 2018, Illumina acquired Edico Genome for $100 million in cash, recording $56 million of goodwill and $46 million of identifiable intangible assets.
- The 2019 convertible notes, with $633 million principal outstanding, were reclassified to current liabilities because they become convertible within 12 months. The notes mature June 15, 2019; the $517 million 2021 notes mature June 15, 2021.
Guidance, Outlook, Risks, and Unusual Items
- Management expected revenue to continue increasing in 2018 but did not provide a specific numerical revenue or earnings forecast in the filing.
- Operating expenses were expected to continue increasing in absolute dollars as Illumina invested in research, commercialization, facilities, and personnel.
- Future margins depend on pricing, product and sales mix, manufacturing costs, inventory reserves, royalties, and product support obligations.
- The company identified risks related to product development and launches, manufacturing capacity and suppliers, customer order timing and mix, competition, acquisitions, technology commercialization, taxation, litigation, and macroeconomic conditions.
- Pending litigation and claims arise in the ordinary course, including intellectual property, employment, and contractual matters. The company stated that ultimate outcomes and potential losses could not be meaningfully estimated for matters without recorded liabilities.
- Illumina had $217 million of redeemable noncontrolling interests related to Helix. Certain investors may require cash redemption after January 1, 2021, subject to specified conditions.
- The company expected the new lease standard, effective in the first quarter of 2019, to materially increase reported assets and liabilities through recognition of operating lease right-of-use assets and liabilities.
- Management noted that a Ninth Circuit decision concerning stock compensation and cost-sharing charges could result in a discrete tax detriment of less than $30 million and a modest ongoing tax impact, although the outcome remained uncertain.
- The filing stated that there were no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and no substantial changes in market risk.
Important Facts for Investors to Verify
- Whether sequencing consumables growth and the installed instrument base continue to support revenue and margin expansion.
- The timing and funding of the $633 million 2019 convertible-note maturity or conversion eligibility beginning March 15, 2019.
- The integration, commercialization prospects, and financial contribution of Edico Genome.
- The availability and location of cash, including foreign-held cash and Helix-restricted cash, relative to corporate liquidity needs.
- The effect of U.S. tax reform, the stock-compensation cost-sharing litigation, and future tax-rate changes.
- The potential cash redemption obligation associated with Helix’s redeemable noncontrolling interests.
- The balance and execution of share-repurchase authorizations; the filing stated that $250 million remained available as of July 1, 2018.
- The impact of the forthcoming lease accounting standard and any material developments in pending litigation.