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ILMN > SEC Filings for ILMN > Form 10-Q on 29-Oct-2012All Recent SEC Filings

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Form 10-Q for ILLUMINA INC


29-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying condensed consolidated financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. This MD&A is organized as follows:

Business Overview and Outlook. High level discussion of our operating results and significant known trends that affect our business.

Results of Operations. Detailed discussion of our revenues and expenses.

Liquidity and Capital Resources. Discussion of key aspects of our statements of cash flows, changes in our financial position, and our financial commitments.

Off-Balance Sheet Arrangements. We have no significant off-balance sheet arrangements.

Critical Accounting Policies and Estimates. Discussion of significant changes since our most recent Annual Report on Form 10-K that we believe are important to understanding the assumptions and judgments underlying our financial statements.

This MD&A discussion contains forward-looking statements that involve risks and uncertainties. Please see "Consideration Regarding Forward-Looking Statements" at the end of this MD&A section for additional factors relating to such statements. This MD&A should be read in conjunction with our condensed consolidated financial statements and accompanying notes included in this report and our Annual Report on Form 10-K for the fiscal year ended January 1, 2012. Operating results are not necessarily indicative of results that may occur in future periods.

Business Overview and Outlook

This overview and outlook provides a high level discussion of our operating results and significant known trends that affect our business. We believe that an understanding of these trends is important to understanding our financial results for the periods being reported herein as well as our future financial performance. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Quarterly Report on Form 10-Q.

About Illumina

We are a leading developer, manufacturer, and marketer of life science tools and integrated systems for the analysis of genetic variation and function. Using our proprietary technologies, we provide a comprehensive line of genetic analysis solutions, with products and services that address a broad range of highly interconnected markets, including sequencing, genotyping, gene expression, and molecular diagnostics. Our customers include leading genomic research centers, academic institutions, government laboratories, and clinical research organizations, as well as pharmaceutical, biotechnology, agrigenomics, consumer genomics companies, and in vitro fertilization clinics,.

Our broad portfolio of instruments, consumables, and analysis tools are designed to simplify and accelerate genetic analysis. This portfolio addresses the full range of genomic complexity, price points, and throughputs, enabling researchers to select the best solution for their scientific challenge. In 2007, through our acquisition of Solexa, Inc., we acquired our proprietary sequencing by synthesis (SBS) technology that is at the heart of our leading-edge sequencing instruments. These systems can be used to efficiently perform a range of nucleic acid (DNA, RNA) analyses on large numbers of samples. For more focused studies, our array-based solutions provide ideal tools to perform genome-wide association studies (GWAS) involving single-nucleotide polymorphism (SNP) genotyping and copy number variation (CNV) analyses, as well as gene expression profiling and other DNA, RNA, and protein studies. In 2010, through our acquisition of Helixis, Inc., we expanded our instrument portfolio to include real-time polymerase chain reaction (PCR), one of the most widely used technologies in life sciences. To further enhance our genetic analysis workflows, in 2011 we acquired Epicentre Technologies Corporation, a leading provider of nucleic acid sample preparation reagents and specialty enzymes for sequencing and microarray applications. In 2012, we acquired BlueGnome Ltd., a provider of cytogenetics and in vitro fertilization screening products.

Our financial results have been, and will continue to be, impacted by several significant trends, which are described below. While these trends are important to understanding and evaluating our financial results, this discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto in Item 1, Part I of this report, and the other transactions, events, and trends discussed in "Risk Factors" in Item 1A, Part II of this report and Item 1A of our Annual Report on Form 10-K for the fiscal year ended January 1, 2012.

Funding Environment

There remains significant uncertainty concerning government and academic research funding worldwide as governments in the United States and Europe, in particular, focus on reducing fiscal deficits while at the same time confronting slow economic growth. We believe this uncertainty will continue into 2013, which could lead to purchasing delays and could negatively impact our business.

While many of our customers receive funding from government agencies to purchase our products or services, we are increasingly less dependent on government funding as exemplified by MiSeq orders, which are weighted more heavily to non-academic customers. However, we estimate that approximately one-third of our total revenue continues to be derived, directly or indirectly, from funding provided by the U.S. National Institute of Health (NIH). In fiscal 2012, the NIH budget increased 1% as compared to fiscal 2011 levels. NIH funding for the next six months will be subject to the continuing resolution that has been agreed upon and signed into law by President Obama. The significance and timing of any reductions to the NIH budget beyond the next six months may be significantly impacted by the sequestration provisions of the Budget Control Act of 2011 and by whether these provisions remain in effect. In addition, the U.S. Department of Health and Human Services (HHS), of which the NIH is a part, has the ability to reallocate funds within its budget to spare the NIH from the full effect of HHS budget reductions. Accordingly, although there is no clarity on sequestration and the NIH budget for 2013 remains uncertain, we continue to believe that a dramatic reduction in NIH funding is unlikely. We further believe that allocations within the NIH budget will continue to favor genetic analysis tools generally and, in particular, next-generation sequencing.

Next-Generation Sequencing

Next-generation sequencing has become a core technology for modern life science research. Over the next several years, expansion of the sequencing market, including an increase in the number of samples available and enhancements in our product portfolio will continue to drive demand for our next-generation sequencing technologies. Our sequencing instrument installed base continued to expand in Q3 2012 with the first commercial shipments of the HiSeq 2500. As a result, we believe that our sequencing consumable revenue will continue to grow in future periods.

MicroArrays

As a complement to next-generation sequencing, we believe microarrays offer a less expensive, faster, and highly accurate technology for use when genetic content is already known. The information content of microarrays is fixed and reproducible. As such, microarrays provide repeatable, standardized assays for certain subsets of nucleotide bases within the overall genome. We believe that focused studies will drive future microarray sales; however, as the cost of sequencing continues to decrease, we believe that researchers will migrate certain whole genome array studies to sequencing over the next few years.

Financial Overview

Financial highlights for the first three quarters of 2012 include the following:

         Net revenue increased by 4.2% during the first three quarters of 2012
          compared to the same period in 2011. Revenue for the first three
          quarters of 2012 was driven by an increase in consumable revenue due to
          the continued growth of our instrument installed base and an increase
          in consumable revenue per HiSeq system.



         Gross profit as a percentage of revenue (gross margin) was 67.9% for
          the first three quarters of 2012, an increase from 66.9% for the first
          three quarters of 2011. The improvement was a result of a shift in
          sales mix from instruments to consumables, which have a higher gross
          margin. We believe our gross margin in future periods will depend on
          several factors, including market conditions that may impact our
          ability to set pricing, product mix, cost structure for manufacturing
          operations, and creation of innovative and high premium products that
          meet or stimulate customer demand.



         Income from operations decreased 17.9% in the first three quarters of
          2012 compared to the same period in 2011 primarily driven by the
          impairment of in-process research and development ("IPR&D") acquired in
          a prior business combination, costs related to the relocation of our
          headquarters, costs incurred to address Roche's unsolicited tender
          offer, and costs related to the restructuring efforts announced in Q4
          2011. We expect to incur additional expenses related to the unsolicited
          tender offer through the first half of 2013.



         Our effective tax rate was 33.2% for the first three quarters of 2012.
          The provision for income taxes is dependent on the mix of earnings in
          tax jurisdictions with different statutory tax rates and the other
          factors discussed in the risk factor "We are subject to risks related
          to taxation in multiple jurisdictions and the possible loss of the tax
          deduction on our outstanding convertible notes" in Item 1A of our
          Annual Report on Form 10-K for the fiscal year ended January 1, 2012.
          For the remainder of 2012 and beyond, we anticipate that our effective
          tax rate will trend lower than the U.S. federal statutory rate as the
          portion of our earnings subject to lower statutory tax rates increases
          and the U.S. research and development tax credit is passed and
          retroactively applied for 2012.

We ended Q3 2012 with cash, cash equivalents, and short-term investments totaling $1.2 billion.


Table of Contents

Results of Operations

To enhance comparability, the following table sets forth our unaudited condensed
consolidated statements of operations for the specified reporting periods stated
as a percentage of total revenue.

                                           Q3 2012    Q3 2011    YTD 2012    YTD 2011
Revenue:
Product revenue                             91.8  %    93.5  %     92.6  %     94.0  %
Service and other revenue                    8.2        6.5         7.4         6.0
Total revenue                              100.0      100.0       100.0       100.0
Cost of revenue:
Cost of product revenue                     26.5       29.2        27.5        29.6
Cost of service and other revenue            3.7        2.8         3.4         2.4
Amortization of acquired intangible assets   1.3        1.3         1.2         1.1
Total cost of revenue                       31.5       33.3        32.1        33.1
Gross profit                                68.5       66.7        67.9        66.9
Operating expense:
Research and development                    18.9       21.4        20.7        18.8
Selling, general and administrative         24.4       28.0        24.6        24.9
Unsolicited tender offer related expense     1.4          -         2.2           -
Restructuring charges                          -          -         0.5           -
Headquarter relocation expense               6.8        2.8         2.8         1.5
Acquisition related (gain) expense, net     (0.1 )     (1.1 )       0.3         0.3
Total operating expense                     51.4       51.1        51.1        45.5
Income from operations                      17.1       15.6        16.8        21.4
Other income (expense):
Interest income                              1.2        0.6         0.9         0.6
Interest expense                            (3.3 )     (3.7 )      (3.4 )      (3.2 )
Other expense, net                           0.3       (0.7 )      (0.2 )      (4.8 )
Total other expense, net                    (1.8 )     (3.8 )      (2.7 )      (7.4 )
Income before income taxes                  15.3       11.8        14.1        14.0
Provision for income taxes                   5.0        3.2         4.6         4.7
Net income                                  10.4  %     8.6  %      9.5  %      9.3  %

Our fiscal year consists of 52 or 53 weeks ending the Sunday closest to December 31, with quarters of 13 or 14 weeks ending the Sunday closest to March 31, June 30, September 30, and December 31. The three and nine month periods ended September 30, 2012 and October 2, 2011 were both 13 and 26 weeks, respectively.

Revenue

(Dollars in                                                 Percentage                                              Percentage
thousands)          Q3 2012       Q3 2011       Change        Change       YTD 2012      YTD 2011       Change        Change
Product revenue   $ 262,418     $ 220,296     $ 42,122          19 %      $ 776,893     $ 756,884     $ 20,009           3 %
Service and other
revenue              23,456        15,203        8,253          54           62,358        48,580       13,778          28
Total revenue     $ 285,874     $ 235,499     $ 50,375          21 %      $ 839,251     $ 805,464     $ 33,787           4 %

Product revenue consists primarily of revenue from the sales of consumables and instruments. Our service and other revenue is primarily generated from instrument service contracts and genotyping and sequencing services.


Table of Contents

Q3 2012 Compared to Q3 2011

Consumables revenue increased $31.8 million, or 22%, to $176.7 million in Q3 2012 compared to $144.9 million in Q3 2011. The increase was attributable to increased sales of sequencing consumables, driven by higher consumable sales per HiSeq system and the growth of our installed base of sequencing instruments.

Instrument revenue increased $10.5 million, or 15%, to $82.4 million in Q3 2012 compared to $71.8 million in Q3 2011, driven by sequencing instrument shipments. We benefited from a full quarter of MiSeq system shipments in the current period compared to a partial quarter of shipments in Q3 2011, and we commenced commercial shipments of the HiSeq 2500 in Q3 2012. Additionally, we believe that Q3 2011 revenue was affected by purchasing delays due to the uncertainty surrounding the levels of academic funding in the United States and Europe and overall economic conditions at that time.

The increase in service and other revenue in Q3 2012 compared to Q3 2011 was driven by the increase in our instrument service contract revenue as a result of our growing installed base.

YTD 2012 Compared to YTD 2011

Consumables revenue increased $81.2 million, or 18%, to $533.3 million in the first three quarters of 2012 compared to $452.1 million in the same period in 2011. The increase was primarily attributable to increased sales of sequencing consumables, driven by higher consumable sales per HiSeq system and the growth of our installed base.

Instrument revenue decreased $58.7 million, or 20%, to $234.2 million in the first three quarters of 2012 compared to $292.9 million in the same period in 2011, driven by a decrease in HiSeq 2000 shipments, partially offset by three full quarters of MiSeq shipments. In the first three quarters of 2011, we shipped a high volume of HiSeq 2000 units, driven by the significant backlog entering the period and demand from the Genome Analyzer trade-in program.

Revenue in the first three quarters of 2011 reflects the impact of discounts provided to customers under our Genome Analyzer trade-in program. The estimated incremental sales incentive provided under this trade-in program was approximately $11.1 million for this period, based on the total discount provided from list price in excess of our average discount on HiSeq 2000 sales during the period. The Genome Analyzer trade-in program was completed in Q4 2011. See "Revenue Recognition" in note "1. Summary of Significant Accounting Policies" in Part I, Item 1, of this Form 10-Q for additional information on the Genome Analyzer trade-in program.

The increase in service and other revenue in the first three quarters of 2012 compared to the same period in 2011 was driven by the increase in our instrument service contract revenue as a result of our growing installed base.

Gross Margin

(Dollars in                                             Percentage                                               Percentage
thousands)      Q3 2012       Q3 2011       Change        Change       YTD 2012      YTD 2011       Change         Change
Gross profit  $ 195,873     $ 157,115     $ 38,758          25 %      $ 569,881     $ 538,512     $  31,369           6 %
Gross margin       68.5 %        66.7 %                                    67.9 %        66.9 %

Q3 2012 Compared to Q3 2011

Gross profit in Q3 2012 increased by $39 million from Q3 2011, driven by the increase in revenue. Gross margin improved in Q3 2012 due in large part to the shift in sales mix from lower margin instruments to higher margin sequencing consumables as well as manufacturing efficiencies.

YTD 2012 Compared to YTD 2011

Gross profit in the first three quarters of 2012 increased in comparison to the same period in 2011 primarily due to higher sales. Gross margin improved in the first three quarters of 2012 due in large part to the shift in sales mix from lower margin instruments to higher margin consumables. Instrument sales from the first three quarters of 2011 were affected by promotional discounts provided to customers on HiSeq 2000 sales, including the Genome Analyzer trade-in program. Based on the estimated amount of incremental sales incentive provided, the Genome Analyzer trade-in program negatively impacted our gross margin by approximately 1.4% in the first three quarters of 2011. The trade-in program was completed in Q4 2011.


Table of Contents

Operating Expense

(Dollars in                                                Percentage                                                Percentage
thousands)        Q3 2012        Q3 2011       Change        Change        YTD 2012      YTD 2011       Change         Change
Research and
development     $   54,056     $  50,399     $  3,657            7  %     $ 174,118     $ 151,400     $  22,718           15 %
Selling,
general and
administrative      69,791        66,031        3,760            6          206,276       200,925         5,351            3
Unsolicited
tender offer
related expense      3,956             -        3,956          100           18,742             -        18,742          100
Restructuring
charges                138             -          138          100            3,434             -         3,434          100
Headquarter
relocation
expense             19,475         6,519       12,956          199           23,445        11,583        11,862          102
Acquisition
related (gain)
expense, net          (357 )      (2,598 )      2,241          (86 )          2,460         2,442            18            1
Total operating
expense         $  147,059     $ 120,351     $ 26,708           22  %     $ 428,475     $ 366,350     $  62,125           17 %

Q3 2012 Compared to Q3 2011

Research and development expense increased by $3.7 million, or 7%, in Q3 2012 from Q3 2011, primarily due to increased investment in projects to develop and commercialize new products and increased facilities expense as the rental fees for our current headquarters are higher than the prior facilities occupied in Q3 2011. These increases were partially offset by a decrease in personnel expenses as a result of a restructuring and reduction in workforce in Q4 2011.

Selling, general and administrative expense increased by $3.8 million, or 6% in Q3 2012 from Q3 2011. The increase is attributable to an increase in professional service fees and increased facilities expense as the rental fees for our current headquarters are higher than the prior facilities occupied in Q3 2011. These increases were partially offset by cost savings resulting from the restructuring plan and reduction in workforce announced in Q4 2011.

During Q1 2012, CKH Acquisition Corporation and Roche Holding Ltd. (together, "Roche") made an unsolicited tender offer to purchase all outstanding shares of our common stock for $51.00 per share. We recorded $4.0 million of expenses incurred in relation to the offer during Q3 2012, consisting primarily of advisory fees. Refer to note "12. Unsolicited Tender Offer" in Part I, Item 1 of this Form 10-Q for further information.

In late 2011, we announced restructuring plans to reduce our global workforce and to consolidate certain facilities. The restructuring effort has been substantially completed.

In Q3 2012, we completed the relocation of our headquarters that started in 2011. During Q3 2012, we incurred $19.5 million in additional headquarter relocation expense, primarily consisting of cease-use loss recorded upon vacating our prior headquarters, double rent expense during the transition to our new facility, and accretion of interest expense on lease exit liability recorded upon vacating our prior headquarters. Headquarter relocation expense recorded in Q3 2011 consisted of accelerated depreciation and rent expense on the new facility during the transition period when we occupied both the current and new facility.

Acquisition related (gain) expense, net, in Q3 2012 consisted of gains related to changes in fair value of contingent consideration partially offset by $0.7 million in acquisition transaction costs. Acquisition related expense, net in Q3 2011 included gains related to changes in fair value of contingent consideration.

YTD 2012 Compared to YTD 2011

Research and development expense increased by $22.7 million, or 15%, in the first three quarters of 2012 from the same period in 2011, primarily due to a $21.4 million impairment loss recognized for IPR&D recorded as a result of a prior acquisition, increased investment in projects to develop and commercialize new products and increased facilities expense as the rental fees for our current headquarters are higher than the facilities occupied in Q3 2011. These increases were partially offset by a decrease in personnel expenses as a result of a restructuring and reduction in workforce in Q4 2011.


Table of Contents

Selling, general and administrative expense increased slightly in the first three quarters of 2012 from the same period in 2011. The increase is driven by increases in professional service fees, facilities expenses, and share-based compensation and other discretionary personnel expenses. These increases are partially offset by cost savings resulted from the restructuring plan and reduction in workforce announced in Q4 2011.

During the first three quarters of 2012, we recorded $18.7 million of expenses incurred in relation to Roche's unsolicited tender offer, consisting primarily of legal, advisory, and other professional fees.

In late 2011, we announced restructuring plans to reduce our global workforce and to consolidate certain facilities. As a result of the restructuring effort, we recorded additional restructuring charges of $3.4 million during the first three quarters of 2012, comprised primarily of severance pay and other employee separation costs.

In Q3 2012, we completed the relocation of our headquarters that started in 2011. During the first three quarters of 2012, we incurred $23.4 million in additional headquarter relocation expense, primarily consisting of cease-use loss associated with vacating our prior headquarters, double rent expense during the transition to our new facility, and accretion of interest expense on the lease exit liability . Headquarter relocation expense recorded in the first three quarters of 2011 consisted of accelerated depreciation and rent expense on the new facility during the transition period of occupying both the current and new facility.

Acquisition related (gain) expense, net in the first three quarters of 2012 consisted of acquisition transaction costs of $0.7 million and changes in fair value of contingent consideration. Acquisition related (gain) expense, net in the first three quarters of 2011 consisted of gains related to changes in fair value of contingent consideration offset by acquired in-process research and development of $5.4 million related to a milestone payment for a prior acquisition.

Other Expense, Net

(Dollars in                                             Percentage                                             Percentage
thousands)        Q3 2012      Q3 2011      Change        Change       YTD 2012      YTD 2011       Change       Change
Interest income  $  3,459     $  1,388     $ 2,071         149  %     $   7,370     $   4,909     $  2,461         50  %
Interest expense   (9,483 )     (8,797 )      (686 )         8          (28,193 )     (25,605 )     (2,588 )       10
Other income
(expense), net        855       (1,564 )     2,419        (155 )         (1,878 )     (38,643 )     36,765        (95 )
Total other
expense, net     $ (5,169 )   $ (8,973 )   $ 3,804         (42 )%     $ (22,701 )   $ (59,339 )   $ 36,638        (62 )%

Q3 2012 Compared to Q3 2011

Interest income increased in Q3 2012 due to an increase in realized gains from our investment portfolio. Interest expense in Q3 2012 remained largely unchanged from Q3 2011, and is primarily comprised of accretion of discount on our convertible senior notes.

Other income (expense), net, in Q3 2012 primarily consisted of foreign exchange gains. Other income (expense), net, in Q3 2011 primarily consisted of a loss on the extinguishment of debt recorded on conversions of our 0.625% convertible senior notes due 2014. The loss on extinguishment of debt was calculated as the difference between the carrying amount of the converted notes and their fair value as of the settlement dates.

YTD 2012 Compared to YTD 2011

Interest income increased in the first three quarters of 2012 due to an increase in realized gains from our investment portfolio. Interest expense in the first three quarters of 2012 remained largely unchanged from the same period in 2011, and is primarily comprised of accretion of the discount on our convertible senior notes.

Other income (expense), net, in first three quarters of 2012 primarily consisted of foreign exchange losses. Other income (expense), net, in the first three quarters of 2011 primarily consisted of a loss on the extinguishment of debt recorded on conversions of our 0.625% convertible senior notes due 2014. The loss on extinguishment of debt was calculated as the difference between the carrying amount of the converted notes and their fair value as of the settlement dates.

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