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ILMN > SEC Filings for ILMN > Form 10-Q on 7-May-2014All Recent SEC Filings

Show all filings for ILLUMINA INC

Form 10-Q for ILLUMINA INC


7-May-2014

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 December 29, 2013. 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 innovative sequencing- and array-based solutions for genotyping, copy-number variation (CNV) analysis, methylation studies, and gene expression profiling of DNA and RNA. Our customers include leading genomic research centers, academic institutions, government laboratories, hospitals, and reference laboratories, as well as pharmaceutical, biotechnology, agrigenomics, commercial molecular diagnostic, and consumer genomics companies.

Our broad portfolio of instruments, consumables, and analysis tools are designed to simplify and accelerate genetic analysis. This portfolio addresses a broad range of genomic complexity, throughput, and price points, enabling customers 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 (CNV) analyses, as well as gene expression profiling and other DNA and RNA studies.

To provide our customers with more comprehensive sample-to-answer workflow solutions, we acquired: NextBio, a leader in clinical and genomic informatics, in November 2013; Advanced Liquid Logic Inc., a leader in digital microfluidics and liquid handling solutions, in July 2013; and Epicentre Technologies Corporation, a leading provider of nucleic acid sample preparation reagents and specialty enzymes for sequencing and microarray applications, in 2011.

During the last two years, we have taken significant steps to support our goal of becoming a leader in the reproductive health market by acquiring Verinata Health, Inc. (Verinata) in February 2013 and BlueGnome Ltd. (BlueGnome) in 2012. Our acquisition of Verinata further strengthened our focus on reproductive health by adding to our product portfolio Verinata's verifiฎ prenatal test, a comprehensive non-invasive prenatal test (NIPT) for high-risk pregnancies. Our acquisition of BlueGnome, a leading provider of genetic solutions for the screening of chromosomal abnormalities associated with developmental delay, cancer, and infertility, expanded our ability to establish integrated solutions in reproductive health and cancer.

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 December 29, 2013.

Funding Environment

While many of our customers receive funding from government agencies to purchase our products or services, we are diversifying our customer base to include customers that do not depend on government funding. In 2013, approximately 45% of our total revenue came from customers who are not directly reliant on government agencies for funding. We estimate that less than 30% of our total revenue in 2013 came from academic or government customers in the United States that, directly or indirectly, derive funding from the U.S. National Institute of Health (NIH). NIH funding for the U.S. fiscal year 2014 increased more than 3% compared to the 2013 sequestration budget, and we 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. Our sequencing instrument installed base continued to expand in Q1 2014, and we believe that 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. As a result, we believe that our sequencing consumable revenue will continue to grow in future periods.

Our portfolio of sequencing platforms represents a family of systems that are designed to meet the workflow, output, and accuracy demands of a full range of sequencing applications. Our MiSeq sequencing system is a low-cost desktop platform that provides individual researchers with rapid turnaround time, high accuracy, and streamlined workflow. NextSeq 500, launched in January 2014, provides flexibility from whole genome sequencing to targeted panels in a desktop platform. Our HiSeq 2500 sequencing system allows customers to sequence an entire human genome in approximately a day. HiSeq X Ten, announced in January 2014, is a set of ten ultra-high-throughput sequencers built for large-scale human whole-genome sequencing with the ability to generate 1.8 terabases of DNA sequence per sequencer in less than three days.

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 life science researchers will migrate certain array studies to sequencing; however, we expect this decline to be offset by demand from customers in consumer, reproductive health, and applied markets. Additionally, demand in the array market has trended toward microarrays that have large-sample numbers at a lower complexity, thus having a lower selling price per sample, and we believe our innovation in microarray products supports the lower selling price.

Financial Overview

Financial highlights for Q1 2014 include the following:

•         Net revenue increased by 27.1% during Q1 2014 to $420.8 million
          compared to Q1 2013. Our sales increased across our portfolio of
          sequencing products, including consumables, instruments, and services.



•         Gross profit as a percentage of revenue (gross margin) for Q1 2014 was
          66.1% compared to 66.3% in Q1 2013. Gross margin in Q1 2014 decreased
          due to the negative impact of higher legal contingency charges
          associated with the Syntrix litigation matter and a lower sales mix of
          consumables, which have higher gross margins. Such impact was partially
          offset by higher margins on instrument and service sales. We believe
          our gross margin in future periods will depend on several factors,
          including: market conditions that may impact our pricing power; sales
          mix changes among consumable, instrument, and services; product mix
          changes between established products and new products in new markets;
          our cost structure for manufacturing operations; royalties; and our
          ability to create innovative and high premium products that meet or
          stimulate customer demand.



•         Income from operations increased by $137.2 million in Q1 2014 compared
          to Q1 2013. Operating expenses in Q1 2013 included a $105.9
          million legal contingency charge associated primarily with the Syntrix
          patent litigation matter. The lack of such expense in Q1 2014 and the
          increase in gross profit during the current quarter led to the increase
          in income from operations, despite the increases in research and
          development and selling, general and administrative expenses, which we
          expect to continue to grow.



•         Our effective tax rate was 28.4% in Q1 2014, as compared to 52.5% in Q1
          2013. The variance from the U.S. federal statutory tax rate of 35% was
          primarily attributable to a higher mix of foreign earnings, such as
          earnings in Singapore and the United Kingdom, taxed at rates lower than
          the U.S. federal statutory tax rate, and tax deductions related to
          stock award activities which were recorded as discrete items in the
          quarter. Our future effective tax rate may vary from the U.S. federal
          statutory tax rate due to 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 Part I Item 1A of our Annual Report on Form 10-K for
          the fiscal year ended December 29, 2013. We anticipate that our
          effective tax rate will trend lower than the U.S. federal statutory tax
          rate in the future due to the portion of our earnings that will be
          subject to lower statutory tax rates.

• We ended Q1 2014 with cash, cash equivalents, and short-term investments totaling $1.1 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.

                                           Q1 2014    Q1 2013
Revenue:
Product revenue                             86.1  %    89.5  %
Service and other revenue                   13.9       10.5
Total revenue                              100.0      100.0
Cost of revenue:
Cost of product revenue                     26.5       27.2
Cost of service and other revenue            5.1        4.5
Amortization of acquired intangible assets   2.3        2.0
Total cost of revenue                       33.9       33.7
Gross profit                                66.1       66.3
Operating expense:
Research and development                    18.3       18.6
Selling, general and administrative         26.0       25.7
Acquisition related (gain) expense, net     (0.2 )      1.2
Headquarter relocation                       0.1        0.2
Legal contingencies                            -       32.0
Unsolicited tender offer related expense       -        2.2
Total operating expense                     44.2       79.9
Income (loss) from operations               21.9      (13.6 )
Other income (expense):
Interest income                              0.2        0.6
Interest expense                            (2.3 )     (2.9 )
Cost-method investment related gain            -        1.8
Other income (expense), net                  0.1       (0.2 )
Total other expense, net                    (2.0 )     (0.7 )
Income (loss) before income taxes           19.9      (14.3 )
Provision for (benefit from) income taxes    5.6       (7.5 )
Net income (loss)                           14.3  %    (6.8 )%

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 month periods ended March 30, 2014 and March 31, 2013 were both 13 weeks.

Revenue

(Dollars in thousands)     Q1 2014      Q1 2013      Change      % Change
Product revenue           $ 362,211    $ 296,170    $ 66,041        22 %
Service and other revenue    58,570       34,788      23,782        68
Total revenue             $ 420,781    $ 330,958    $ 89,823        27 %

Product revenue consists primarily of revenue from the sale of consumables and instruments. Service and other revenue consists primarily of instrument service contract revenue as well as sequencing and genotyping service revenue. Revenues from businesses acquired in 2013 are predominantly service revenue.


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Consumables revenue increased $37.6 million, or 18%, to $242.5 million in Q1 2014 compared to $204.9 million in Q1 2013. The increase was primarily attributable to sales of sequencing consumables, driven by higher utilization of our instruments and growth in the instrument installed base.

Instrument revenue increased $27.7 million, or 31%, to $115.8 million in Q1 2014 compared to $88.1 million in Q1 2013, driven primarily by shipments of sequencing instruments, including new platforms introduced during the current quarter.

Service and other revenue increased $23.8 million, or 68%, to $58.6 million in Q1 2014 compared to $34.8 million in Q1 2013. Revenues from businesses acquired in 2013 are predominantly service revenue. Excluding the impact of acquisitions completed in 2013, the increase in service and other revenue was 38%, which was driven by microarray service revenue as well as sequencing instrument service contract revenue as a result of our growing installed base.

Gross Margin

(Dollars in thousands)   Q1 2014       Q1 2013      Change      % Change
Gross profit           $ 278,292     $ 219,292     $ 59,000        27 %
Gross margin                66.1 %        66.3 %

Gross profit increased $59 million, or 27%, to $278.3 million in Q1 2014 in comparison to $219.3 million in Q1 2013, primarily due to the increase in revenue. Excluding the gross profit from acquisitions completed in 2013, which was predominantly included in gross profit from service sales, the increase in gross profit was 26%. Gross margin decreased in Q1 2014 in comparison to Q1 2013 due to the negative impact from higher legal contingency charges and a lower sales mix of consumables, which have higher gross margins. Such impact was partially offset by higher margins on instruments and services sales during Q1 2014.

Operating Expense

(Dollars in thousands)                     Q1 2014      Q1 2013       Change      % Change
Research and development                 $  77,041     $  61,450    $  15,591         25  %
Selling, general and administrative        109,573        85,074       24,499         29
Acquisition related (gain) expense, net     (1,013 )       3,821       (4,834 )     (127 )
Headquarter relocation                         595           757         (162 )      (21 )
Legal contingencies                              -       105,853     (105,853 )     (100 )
Unsolicited tender offer related expense         -         7,484       (7,484 )     (100 )
Total operating expense                  $ 186,196     $ 264,439    $ (78,243 )      (30 )%

Research and development expense increased by $15.6 million, or 25%, in Q1 2014 from Q1 2013, primarily due to increased headcount as we continue to increase our investment in the development of new products as well as enhancements to existing products.

Selling, general and administrative expense increased $24.5 million, or 29%, in Q1 2014 from Q1 2013. The increase is primarily driven by increased headcount and consulting services to support the growth of our Company, as well as increased amortization of intangible assets.

Acquisitions completed in 2013 also contributed to the increases in research and development expense and selling, general and administrative expense from Q1 2013 to Q1 2014.

Acquisition related (gain) expense, net, in Q1 2014 primarily consisted of gains from changes in fair value of contingent consideration of $1.8 million. Such gains were partially offset by other acquisition related costs. Acquisition related (gain) expense, net in Q1 2013 consisted of acquisition transaction costs of $3.4 million and net changes in the value of contingent consideration.


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We completed the relocation of our headquarters in 2012. During Q1 2014 and Q1 2013, we incurred $0.6 million and $0.8 million, respectively, in additional headquarter relocation expense, primarily consisting of accretion expense related to the facility exit obligation recorded upon vacating our former headquarters.

During Q1 2013, we recorded a $105.9 million charge within operating expenses primarily related to the Syntrix litigation matter. The amount recorded in operating expense included the damages and prejudgment interest awarded to Syntrix through March 14, 2013, the day we received the related jury verdict. See additional discussion on this matter in the note "9 Legal Proceedings" in

Part I, Item 1 of this Form 10-Q.

During Q1 2013, we recorded $7.5 million of expenses incurred in relation to an unsolicited tender offer in Q1 2012. The expenses consisted primarily of advisory and legal fees. The advisory service arrangements were completed in 2013.

Other Expense, Net

(Dollars in thousands)                    Q1 2014      Q1 2013       Change     % Change
Interest income                          $    956     $  1,933     $   (977 )      (51 )%
Interest expense                           (9,743 )     (9,747 )          4          -
Cost-method investment related gain, net        -        6,113       (6,113 )     (100 )
Other income (expense), net                   479         (714 )      1,193       (167 )
Total other expense, net                 $ (8,308 )   $ (2,415 )   $ (5,893 )      244  %

Interest income primarily consists of returns from our investment portfolio. Interest income decreased in Q1 2014 from Q1 2013 as a result of a decrease in our investment portfolio balance as well as the decline in market interest rates. Interest expense in Q1 2013 remained relatively consistent as compared to the same period in Q1 2013 and consisted primarily of accretion of discount on our convertible senior notes.

During Q1 2013, we recognized a $6.1 million gain as a result of the sale of a cost-method investment.

Other income (expense), net, in Q1 2014 and Q1 2013 primarily consisted of net foreign exchange gains and losses.

Provision for (Benefit from) Income Taxes

(Dollars in thousands)                     Q1 2014       Q1 2013       Change     % Change
Income (loss) before income taxes         $ 83,788     $ (47,562 )   $ 131,350      (276 )%
Provision for (benefit from) income taxes $ 23,811     $ (24,975 )   $  48,786      (195 )%
Effective tax rate                            28.4 %        52.5 %

Our effective tax rate was 28.4% for Q1 2014 compared to 52.5% in Q1 2013. The variance from the U.S. federal statutory tax rate of 35% in Q1 2014 was primarily attributable to a higher mix of foreign earnings, such as earnings in Singapore and the United Kingdom, taxed at rates lower than the U.S. federal statutory tax rate, and tax deductions related to stock award activities which were recorded as discrete items in the quarter. In Q1 2013 the variance from the U.S. statutory rate of 35% was primarily attributable to the tax treatment of the Syntrix legal contingency, which was recorded as a discrete item during Q1 2013 and is nondeductible for tax purposes until paid.

Liquidity and Capital Resources

At March 30, 2014, we had approximately $518.5 million in cash and cash equivalents, a $193.1 million decrease from last year, due to the factors described in the "Cash Flow Summary" below. Our primary source of liquidity, other than our holdings of cash, cash equivalents and investments, has been cash flows from operations. Our ability to generate cash from operations provides us with the financial flexibility we need to meet operating, investing, and financing needs. Cash and cash equivalents held by our foreign subsidiaries at March 30, 2014 were approximately $413.2 million. It is our intention to indefinitely reinvest all current and future foreign earnings in foreign subsidiaries.


Table of Contents

Historically, we have liquidated our short-term investments and/or issued debt and equity securities to finance our business needs as a supplement to cash provided by operating activities. As of March 30, 2014, we had $573.3 million in short-term investments. Our short-term investments include marketable securities consisting of debt securities in government-sponsored entities, corporate debt securities, and U.S. Treasury notes.

As of March 30, 2014, $920.0 million in principal amount of our convertible senior notes due 2016 (2016 Notes) remained outstanding, with a maturity date of March 15, 2016. The 2016 Notes became convertible on April 1, 2014 and continue to be convertible through June 30, 2014. It is our intent and policy to settle conversions of the 2016 Notes through combination settlement, which essentially involves repayment of an amount of cash equal to the principal amount and delivery of the excess of conversion value over the principal amount in shares of common stock.

We anticipate that our current cash, cash equivalents and short-term investments, together with cash provided by operating activities are sufficient to fund our near term capital and operating needs for at least the next 12 months. Operating needs include the planned costs to operate our business, including amounts required to fund working capital and capital expenditures. Our primary short-term needs for capital, which are subject to change, include:
• potential early repayments of debt obligations as a result of conversions;

•         support of commercialization efforts related to our current and future
          products, including expansion of our direct sales force and field
          support resources both in the United States and abroad;


•         acquisitions of equipment and other fixed assets for use in our current
          and future manufacturing and research and development facilities;

• repurchases of our outstanding common stock;

• the continued advancement of research and development efforts;

• potential strategic acquisitions and investments;

•         the expansion needs of our facilities, including costs of leasing
          additional facilities; and


•         investment in our global business processes, and the associated
          Enterprise Resource Planning platform.

As of March 30, 2014, we had $47.7 million in fair value of contingent consideration liabilities associated with prior acquisitions to be settled in future periods.

During Q1 2014, we used $130.0 million to repurchase our outstanding shares under the stock repurchase programs authorized by our Board of Directors. As of March 30, 2014, we had authorization to repurchase $237.5 million of our common stock.

We expect that our revenue and the resulting operating income, as well as the status of each of our new product development programs, will significantly impact our cash management decisions.

Our future capital requirements and the adequacy of our available funds will depend on many factors, including:

•         our ability to successfully commercialize and further develop our
          technologies and create innovative products in our markets;


•         scientific progress in our research and development programs and the
          magnitude of those programs;

• competing technological and market developments; and

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