Illumina, Inc. — Q3 2010 Form 10-Q Summary
Business context and reporting period
Illumina develops and sells sequencing, microarray, genotyping, gene-expression, and related genetic-analysis systems, consumables, and services. The filing covers the 13-week quarter and nine months ended October 3, 2010, compared with the periods ended September 27, 2009. The company reported one operating segment because Diagnostics activity remained limited.
Key financial metrics
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Revenue | $237.3 million | $158.4 million | $641.4 million | $485.8 million |
| Gross profit | $157.1 million | $107.1 million | $435.4 million | $328.3 million |
| Gross margin | 66.2% | 67.6% | 67.9% | 67.6% |
| Operating income | $57.3 million | $29.3 million | $143.0 million | $99.9 million |
| Net income | $35.4 million | $17.1 million | $86.5 million | $60.6 million |
| Diluted EPS | $0.24 | $0.12 | $0.61 | $0.44 |
| Operating cash flow | Not separately provided | Not separately provided | $191.1 million | $110.9 million |
Q3 operating margin was approximately 24.2% versus 18.5% in the prior-year quarter; nine-month operating margin was approximately 22.3% versus 20.6%. Q3 net margin was approximately 14.9% versus 10.8%; nine-month net margin was approximately 13.5% versus 12.5%.
- Q3 product revenue increased 49% to $224.7 million, while service and other revenue increased 57% to $12.6 million.
- Q3 consumable revenue increased 53% to $133.0 million, and instrument revenue increased 45% to $87.8 million. Sequencing demand and the HiSeq 2000 launch were primary drivers.
- Research and development expense increased 30% year over year to $44.8 million; selling, general and administrative expense increased 31% to $55.0 million.
- Cash and cash equivalents were $210.8 million at October 3, 2010, compared with $144.6 million at January 3, 2010. Cash and short-term investments totaled approximately $806.8 million.
- Short-term investments were $596.0 million, primarily government-sponsored entity debt securities, corporate debt securities, and U.S. Treasury securities.
- Inventory increased to $130.0 million from $92.8 million at year-end, partly reflecting manufacturing expansion and anticipated demand.
- The company had $390.0 million principal amount of 0.625% convertible senior notes outstanding, maturing February 15, 2014. The net carrying amount was $306.1 million, and the current portion was $306.1 million.
- Stock-based compensation expense was $51.8 million for the first nine months, or $34.2 million net of tax.
Material changes versus the prior comparable period
- Revenue grew 50% in Q3 and 32% for the first nine months, driven by higher sequencing-system demand, the HiSeq 2000, sequencing consumables, and microarray products.
- Q3 gross margin declined 140 basis points because of HiSeq 2000 discounts under the Genome Analyzer trade-in program, partially offset by stronger consumable margins. Nine-month gross margin increased modestly by 30 basis points.
- Operating expenses grew more slowly than revenue in Q3, improving operating leverage despite increased investment in personnel, research, manufacturing, sales, and infrastructure.
- Net income increased 108% in Q3 and 43% for the first nine months. The Q3 comparison also benefited from the absence of a $1.3 million acquired in-process research and development charge recorded in Q3 2009.
- Operating cash flow increased $80.2 million year over year to $191.1 million. Investing cash use declined to $215.0 million from $272.1 million, although 2010 included $98.2 million of net acquisition spending.
- On April 30, 2010, Illumina acquired Helixis for approximately $86.7 million, including $70.0 million of net cash and $14.1 million of estimated contingent consideration. The acquisition added approximately $58.4 million of goodwill and generated a $2.9 million gain from revaluing Illumina’s prior equity interest.
- The company repurchased 347,112 shares for approximately $16.0 million during the quarter. A July 2010 authorization permits up to $200 million of repurchases; approximately $184.0 million remained available at quarter-end.
Guidance, outlook, commentary, and risks
- Management expected Q4 2010 gross margin to be in the mid-60% range because of continued discounted HiSeq 2000 shipments and anticipated product-mix and pricing pressure.
- Management planned to increase HiSeq 2000 production capacity in Q4 2010 to reduce order-to-shipment times.
- Management expected research and development and selling, general and administrative expenses to increase in absolute dollars as the company expanded its product base, personnel, sales force, and infrastructure.
- Approximately $64.4 million of orders in the first nine months of 2010 were believed to be directly related to American Recovery and Reinvestment Act grants. Management expected related customer spending to continue through 2012, while warning that future customer funding levels could decline.
- The company expected significant income tax payments as net operating loss and federal research and development credit carryforwards were utilized. Management anticipated possible retroactive reinstatement of the federal research credit in Q4 2010, which could reduce the current-year tax provision if enacted.
- Management believed cash, cash equivalents, and operating income would fund operating needs for at least the next 12 months, barring unforeseen circumstances. Liquidity needs include acquisitions, capital expenditures, product commercialization, research and development, facility expansion, and share repurchases.
- Key risks include dependence on successful commercialization and manufacturing of new technologies, competition and pricing pressure, production capacity constraints, customer research funding, international taxation and foreign-exchange exposure, acquisition integration, litigation, and potential dilution from convertible notes, options, and warrants.
- Foreign-currency forward contracts had a total notional amount of approximately $17.7 million and generated losses of $1.6 million in Q3 and $0.7 million year to date.
- Management reported no material changes to disclosed risk factors, off-balance-sheet arrangements, critical accounting policies, market risks, or internal control over financial reporting. Pending ordinary-course litigation was not expected to materially affect financial position or results.
Most important facts for investors to verify
- Whether HiSeq 2000 production capacity and shipment timing improved as planned and whether discounts continued to pressure gross margin.
- The sustainability of sequencing-consumable growth and the contribution of the installed sequencing-system base.
- Inventory growth, customer deposits, deferred revenue, and working-capital requirements as production scales.
- The amount and timing of Helixis contingent consideration, milestone payments, integration costs, and resulting goodwill or intangible-asset performance.
- Convertible-note maturity and potential equity dilution, including the 18.3 million warrants issued in connection with the notes.
- Utilization of tax attributes, enactment of the anticipated federal research credit, and the resulting effective tax rate and cash tax payments.
- Dependence on government-funded research, including the potential normalization or reduction of Recovery Act-related orders.
- Execution of the $200 million share-repurchase authorization relative to acquisition, capital-investment, and liquidity needs.