Our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying 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.


•         Contractual Obligations. Tabular disclosure of known contractual
          obligations as of December 30, 2012.


•         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 "Special Note Regarding Forward-Looking Statements" for additional factors relating to such statements, and see "Risk Factors" in Item 1A of this report for a discussion of certain risk factors applicable to our business, financial condition, and results of operations. 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 Annual Report on Form 10-K.

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 genomic-based 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. 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 2012 and early 2013, we took significant steps to support our goal to be the leader in genomic-based diagnostics by acquiring BlueGnome Ltd. (BlueGnome) in September 2012 and signing a definitive agreement to acquire Verinata Health, Inc. (Verinata) in January 2013. BlueGnome is a leading provider of solutions for the screening of genetic abnormalities associated with developmental delay, cancer, and infertility, and BlueGnome's offerings enhance our ability to establish integrated solutions in reproductive health and cancer. Upon completion of the Verinata acquisition, we will further strengthen our diagnostic focus on reproductive health by having access to Verinata's verifiฎ prenatal test, the broadest non-invasive prenatal test (NIPT) available today for high-risk pregnancies, and what we believe to be the most comprehensive intellectual propert

y portfolio in the NIPT industry. To further enhance our genetic analysis workflows, in 2011 we acquired Epicentre Technologies Corporation (Epicentre), a leading provider of nucleic acid sample preparation reagents and specialty enzymes for sequencing and microarray applications. In 2010, through our acquisition of Helixis, Inc., we expanded our portfolio to include real-time polymerase chain reaction (PCR), one of the most widely used technologies in life sciences. Our Eco Real-Time PCR System provides researchers with an affordable, full-featured system to perform targeted validation studies.

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 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 I of this report.

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 in 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. In fiscal 2012, approximately 30% of our total revenue came from commercial customers who are not reliant on government agencies for funding, and it is our strategy to diversify our customer base to increase further the portion of our revenue from commercial customers over time. 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 first quarter of 2013 will be subject to the continuing resolution that was signed into law by President Obama and funds the NIH at 90% of budget. The significance and timing of any reductions to the NIH budget from March 2013 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. We further believe that allocations within the NIH budget will continue to favor genetic analysis tools generally and, in particular, research programs that utilize next-generation sequencing.

Next-Generation Sequencing

Next-generation sequencing has become a core technology for modern life science research and is increasingly being used in the applied, molecular diagnostics, and translational markets. 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 2012. As a result, we believe that our sequencing consumable revenue will continue to grow in future periods.

Our sequencing instrument portfolio primarily includes the HiSeq product family and MiSeq. We began full commercial shipments in the fourth quarter of 2012 of our previously announced HiSeq 2500 sequencing system, which allows customers to sequence an entire human genome in approximately a day. Our MiSeq sequencing system is a low-cost personal sequencing system that we believe will provide individual researchers a platform with rapid turnaround time, high accuracy, and streamlined workflow. We believe our MiSeq systems will continue to be a competitive offering in the lower throughput sequencing market and help us expand our presence in this emerging market segment.

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. As the cost of sequencing continues to decrease, we believe that life science researchers will migrate certain whole genome array studies to sequencing over the next few years; however, we expect this decline to be offset by demand from customers in applied and translational markets.

Financial Overview

Financial highlights for 2012 include the following:
•         Net revenue increased by 9% during 2012 compared to 2011. The increase
          in revenue was primarily driven by an increase in consumable sales and
          instrument service contract revenue as our installed base continued to
          expand in 2012. We believe our revenue will continue to grow in 2013.


•         Gross profit as a percentage of revenue (gross margin) was 67.4% in
          2012, an increase from 67.2% in 2011. Gross margin improved in 2012 due
          in large part to the shift in sales mix from instruments to
          consumables, which have a higher gross margin than instruments. We
          believe our gross margin in future periods will depend on several
          factors, including market conditions that may impact our pricing power,
          product mix changes between consumable, instrument, and service sales,
          product mix changes between established products and new products in
          new markets, our cost structure for manufacturing operations, and our
          ability to create innovative and high premium products that meet or
          stimulate customer demand.


•         Income from operations increased slightly by $1.3 million in 2012
          compared to 2011. This was a result of higher gross profit, which was
          driven by increased revenue, being mostly offset by higher operating
          expenses. In 2012, our research and development expenses increased by
          $34.1 million and our selling, general and administrative expenses
          increased by $24.1 million as we continue to grow our business. We
          anticipate that the dollar amount of these expenses will increase as we
          continue to invest in our technology, people, and infrastructure to
          support our growth.

In 2012, we completed the relocation of our headquarters that started in 2011 and incurred $26.3 million in headquarter relocation expense, which primarily included a cease-use loss upon vacating our prior headquarters, double rent expense during the transition to the new facility, and the accretion of interest expense on the related lease exit liability. We do not expect to incur significant additional headquarter relocation expense other than the accretion of interest expense on lease exit liability.
In 2012, we also incurred $23.1 million in expenses associated with the unsolicited tender offer for shares of our common stock commenced by CKH Acquisition Corp. and Roche Holding Ltd. (together, "Roche") in early 2012. We anticipate incurring additional advisory expenses through mid-2013.
• Our effective tax rate was 32.1% in 2012, as compared to 34.9% in 2011. 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" in Item 1A of this report. For 2013 and beyond, we anticipate the provision for income taxes to increase in absolute dollars but the effective tax rate to trend lower than the U.S. federal statutory rate as the portion of our earnings subject to lower statutory tax rates increases.

The American Taxpayer Relief Act of 2012, which was signed into law on January 2, 2013, included the retroactive reinstatement of the federal research and development credit from January 1, 2012, through December 31, 2013. Our provision for income taxes for the year ended December 30, 2012, did not include the impact of the federal research credit generated in 2012 since the law was enacted subsequent to our reporting period. Had the legislation been enacted in 2012, the provision for income taxes for the year ended December 30, 2012, would have been reduced by approximately $2.0 million. Our provision for income taxes in the first quarter of 2013 will include the tax benefit as a result of the retroactive reinstatement of the federal research credit for 2012.
• We ended 2012 with cash, cash equivalents, and short-term investments totaling $1.35 billion.

Results of Operations

To enhance comparability, the following table sets forth audited consolidated statement of operations data for the years ended December 30, 2012, January 1, 2012, and January 2, 2011 stated as a percentage of total revenue.

                                                  2012       2011       2010
Revenue:
Product revenue                                  91.9  %    93.5  %    93.3  %
Service and other revenue                         8.1        6.5        6.7
Total revenue                                   100.0      100.0      100.0
Cost of revenue:
Cost of product revenue                          27.6       29.2       30.1
Cost of service and other revenue                 3.8        2.5        2.4
Amortization of acquired intangible assets        1.2        1.1        0.9
Total cost of revenue                            32.6       32.8       33.4
Gross profit                                     67.4       67.2       66.6
Operating expense:
Research and development                         20.1       18.7       19.7
Selling, general and administrative              24.9       24.8       24.4
Headquarter relocation expense                    2.3        4.0          -
Unsolicited tender offer related expense          2.0          -          -
Restructuring charges                             0.4        0.8          -
Acquisition related expense (gain), net           0.2        0.1       (0.9 )
Total operating expense                          49.9       48.4       43.2
Income from operations                           17.5       18.8       23.4
Other income (expense):
Cost-method investment related gain (loss), net   4.0          -       (1.1 )
Interest income                                   1.4        0.7        0.9
Interest expense                                 (3.3 )     (3.3 )     (2.7 )
Other (expense) income, net                      (0.2 )     (3.7 )        -
Total other income (expense), net                 1.9       (6.3 )     (2.9 )
Income before income taxes                       19.4       12.5       20.5
Provision for income taxes                        6.2        4.4        6.7
Net income                                       13.2  %     8.1  %    13.8  %

Our fiscal year is the 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 years ended December 30, 2012, January 1, 2012, and January 2, 2011 were 52 weeks, respectively.

Revenue

                                        2012 - 2011                                       2011 - 2010
 (Dollars in
thousands)            2012            2011          Change       % Change       2010         Change       % Change
Product revenue   $ 1,055,826     $   987,280     $  68,546          7 %     $ 842,510     $ 144,770         17 %
Service and other
revenue                92,690          68,255        24,435         36          60,231         8,024         13
Total revenue     $ 1,148,516     $ 1,055,535     $  92,981          9 %     $ 902,741     $ 152,794         17 %

Product revenue consists primarily of revenue from the sale of consumables and instruments. Services and other revenue consists primarily of instrument service contract revenue as well as sequencing and genotyping service revenue.

2012 Compared to 2011

Consumables revenue increased $133.5 million, or 22%, to $729.3 million in 2012 compared to $595.8 million in 2011. The increase was primarily attributable to increased sales of sequencing consumables, driven by higher consumable sales per HiSeq instrument and the growth in both the HiSeq and MiSeq installed base.

Instrument revenue decreased $58.8 million, or 16%, to $314.3 million in 2012 compared to $373.1 million in 2011, driven by a decrease in HiSeq shipments, partially offset by a full year of MiSeq shipments in 2012 as compared to less than two quarters of shipments in 2011.

Revenue in 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, 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 II, Item 8, of this Form 10-K for additional information on the Genome Analyzer trade-in program.

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

2011 Compared to 2010

Consumables revenue increased $90.8 million, or 18%, to $595.8 million in 2011 compared to $505.0 million in 2010. The increase was primarily attributable to increased sales of sequencing consumables, which accounted for more than half of our consumables revenue in 2011, driven by growth in the installed base of our sequencing systems, partially offset by a decrease in the consumable revenue per sequencing instrument.

Instrument revenue increased $48.5 million, or 15%, to $373.1 million in 2011 compared to $324.6 million in 2010. The increase was primarily attributable to the launch of MiSeq in the third quarter of 2011 and higher HiSeq revenue primarily driven by increased average selling price following completion of the Genome Analyzer trade-in program during the first half of 2011. These increases in instrument revenue were partially offset by a decrease in sales of our Genome Analyzer from 2010 to 2011, as our Genome Analyzer customers upgraded to HiSeq 2000.

Revenue from HiSeq 2000 sales in 2011 and 2010 was impacted by 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 and $47.8 million in 2011 and 2010, respectively. See "Revenue Recognition" in note "1. Organization and Summary of Significant Accounting Policies" in Part II, Item 8, of this Form 10-K for additional information on the Genome Analyzer trade-in program.

The increase in service and other revenue in 2011 compared to 2010 was primarily driven by an increase in our instrument service contract revenue resulting from our expanded installed base and an increase in sequencing services.

Gross Margin

                                             2012 - 2011                                      2011 - 2010
 (Dollars in thousands)    2012          2011         Change       % Change        2010         Change       % Change

2012 Compared to 2011

Gross profit in 2012 increased in comparison to 2011 primarily due to higher sales. Gross margin improved in 2012 due in large part to the shift in sales mix from instruments to consumables, which have a higher margin than instruments. This improvement was partially offset by a legal settlement charge recorded to cost of sales in 2012. In addition, instrument sales in 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 1.1% in 2011. This trade-in program was completed in Q4 2011.

2011 Compared to 2010

Gross margin increased in 2011 compared to 2010. During the period, the gross margin of our instrument sales improved, primarily driven by an increase in average selling price per instrument as our Genome Analyzer trade-in program was substantially completed in the first half of 2011. The Genome Analyzer trade-in program negatively impacted our gross margin by approximately 1.1% and 5.3% in 2011 and 2010, respectively, based on the estimated amount of incremental sales incentive provided. The gross margin of our consumable sales also increased as we experienced a shift in sales mix from lower gross margin microarray consumables to higher gross margin sequencing consumables, primarily due to the expansion of our sequencing instrument installed base. The improvements in gross margins were partially offset by the negative impact from higher stock compensation expense and higher amortization expense of acquired intangible assets included in cost of revenue.

Operating Expense

                                             2012 - 2011                                     2011 - 2010
 (Dollars in thousands)     2012          2011         Change      % Change        2010         Change      % Change
Research and development $ 231,025     $ 196,913     $ 34,112         17  %     $ 177,947     $  18,966         11  %
Selling, general and
administrative             285,991       261,843       24,148          9          220,454        41,389         19
Headquarter relocation
expense                     26,328        41,826      (15,498 )      (37 )              -        41,826        100
Unsolicited tender offer
related expense             23,136             -       23,136        100                -             -          -
Restructuring charges        3,522         8,136       (4,614 )      (57 )              -         8,136        100
Acquisition related
expense (gain), net          2,774           919        1,855        202           (8,515 )       9,434       (111 )
Total operating expense  $ 572,776     $ 509,637     $ 63,139         12  %     $ 389,886     $ 119,751         31  %

2012 Compared to 2011

Research and development expense increased by $34.1 million, or 17%, in 2012 from 2011, primarily due to a $21.4 million impairment loss recognized for IPR&D recorded as a result of a prior acquisition and increased personnel expenses as we continue to increase our investment in projects to develop and commercialize new products. In addition, we incurred increased facilities expenses in 2012 as the rental fees for our current headquarters are higher than our prior facility.

Selling, general and administrative expense increased by $24.1 million in 2012 from 2011. The increase is primarily driven by a $15.8 million increase in personnel expenses associated with increased headcount, and a $9.5 million increase in legal and other consulting fees. Personnel expenses included salaries, share-based compensation, and benefits. These increases in expense were partially offset by a $2.3 million decrease in bad debt expense, as certain customer bankruptcies impacted us in 2011. In addition, we had the benefit of a $2.3 million legal settlement gain recorded in selling, general and administrative expenses in 2011.

In Q3 2012, we completed the relocation of our headquarters that started in 2011. During 2012, we incurred $26.3 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 2011 consisted of accelerated depreciation and rent expense on the new facility during the transition period of occupying both the current and new facility.

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 up to $51.00 per share. During 2012, we recorded $23.1 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 $3.5 million during 2012, comprised primarily of separation and other employee costs.

Acquisition related expense (gain), net in 2012 consisted of acquisition transaction costs of $0.8 million and changes in fair value of contingent consideration of $2.0 million. Acquisition related expense (gain), net in 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.

2011 Compared to 2010

The increase in research and development expense in 2011 from 2010 was primarily attributable to an increase in personnel expenses of $17.5 million associated with increased average headcount during 2011 and an increase of $2.9 million in research and development supplies. Personnel expenses included salaries, share-based compensation, and benefits.

The increase in selling, general and administrative expense in 2011 from 2010 was primarily attributable to an increase in personnel expenses of $33.5 million associated with the growth of our business during the period. The remaining increase was primarily driven by a $4.0 million increase in bad debt expenses as . . .