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ILMN > SEC Filings for ILMN > Form 10-Q on 1-Aug-2014All Recent SEC Filings

Show all filings for ILLUMINA INC

Form 10-Q for ILLUMINA INC


1-Aug-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.


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• 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 the first half of 2014 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 Q2 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. Demand in the array market has trended toward large-sample, lower-complexity studies, thus having a lower selling price per sample. In addition, we believe that researchers in the life science market 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.

Financial Overview

Financial highlights for the first half of 2014 include the following:

•         Net revenue increased by 28.3% during the first half of 2014 to $868.3
          million compared to the first half of 2013. Our sales increased across
          our portfolio of sequencing products, including consumables,
          instruments, and services.



•         Gross profit as a percentage of revenue (gross margin) was 66.7% for
          the first half of 2014 compared to 65.4% in the first half of 2013.
          Gross margin in the first half of 2014 increased primarily due to
          higher margins on instrument 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
          consumables, instruments, 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 $177.5 million in the first half of
          2014 compared to the first half of 2013. Operating expenses in the
          first half of 2013 included a $115.4 million legal contingency charge
          associated primarily with the Syntrix patent litigation matter. The
          lack of such expense in the first half of 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 26.1% in the first half of 2014 while the
          tax rate was negative in the first half of 2013. The variance from the
          U.S. federal statutory tax rate of 35% was primarily attributable to
          the tax treatment of the loss on extinguishment of debt and tax
          deductions related to stock award activities, which were recorded as
          discrete items. In addition, we generated a higher mix of foreign
          earnings, such as earnings in Singapore and the United Kingdom, which
          were taxed at rates lower than the U.S. federal statutory tax rate. 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 Q2 2014 with cash, cash equivalents, and short-term investments totaling $1.1 billion.

Results of Operations

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

                                           Q2 2014    Q2 2013    YTD 2014    YTD 2013
Revenue:
Product revenue                             87.3  %    90.6  %     86.7  %     90.0  %
Service and other revenue                   12.7        9.4        13.3        10.0
Total revenue                              100.0      100.0       100.0       100.0
Cost of revenue:
Cost of product revenue                     25.5       28.4        26.0        27.8
Cost of service and other revenue            5.3        4.6         5.1         4.6
Amortization of acquired intangible assets   2.1        2.4         2.2         2.2
Total cost of revenue                       32.9       35.4        33.3        34.6
Gross profit                                67.1       64.6        66.7        65.4
Operating expense:
Research and development                    18.5       19.5        18.4        19.1
Selling, general and administrative         25.7       25.7        25.8        25.7
Headquarter relocation                       0.7       (0.4 )       0.4        (0.1 )
Acquisition related gain, net               (0.1 )     (1.7 )      (0.1 )      (0.3 )
Legal contingencies                            -        2.7           -        17.0
Unsolicited tender offer related expense       -        1.4           -         1.8
Total operating expense                     44.8       47.2        44.5        63.2
Income from operations                      22.3       17.4        22.2         2.2
Other income (expense):
Interest income                              0.3        0.2         0.3         0.4
Interest expense                            (2.2 )     (2.9 )      (2.2 )      (2.9 )
Cost-method investment related gain            -          -           -         0.9
Other expense, net                          (7.0 )     (0.4 )      (3.6 )      (0.3 )
Total other expense, net                    (8.9 )     (3.1 )      (5.5 )      (1.9 )
Income before income taxes                  13.4       14.3        16.7         0.3
Provision for (benefit from) income taxes    3.0        3.9         4.4        (1.7 )
Net income                                  10.4  %    10.4  %     12.3  %      2.0  %


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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 six month periods ended June 29, 2014 and June 30, 2013 were both 13 and 26 weeks, respectively.

Revenue
(Dollars in
thousands)      Q2 2014       Q2 2013       Change       % Change     YTD 2014      YTD 2013       Change       % Change
Product
revenue       $ 390,808     $ 313,497     $  77,311         25 %     $ 753,019     $ 609,667     $ 143,352          24 %
Service and
other revenue    56,760        32,597        24,163         74         115,330        67,385        47,945          71
Total revenue $ 447,568     $ 346,094     $ 101,474         29 %     $ 868,349     $ 677,052     $ 191,297          28 %

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.

QTD 2014 vs. QTD 2013

Consumables revenue increased $31.3 million, or 15%, to $246.7 million in Q2 2014 compared to $215.4 million in Q2 2013. The increase was primarily attributable to sales of sequencing consumables, driven by growth in the instrument installed base, including HiSeq X Ten and NextSeq platforms introduced in the current year. Such increase was partially offset by a decrease in microarray consumables.

Instrument revenue increased $45.4 million, or 48%, to $140.2 million in Q2 2014 compared to $94.8 million in Q2 2013, driven primarily by shipments of sequencing instruments.

Service and other revenue increased $24.2 million, or 74%, to $56.8 million in Q2 2014 compared to $32.6 million in Q2 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 50%, which was driven by microarray service revenue as well as sequencing instrument service contract revenue as a result of our growing installed base.

YTD 2014 vs. YTD 2013

Consumables revenue increased $68.9 million, or 16%, to $489.2 million in the first half of 2014 compared to $420.3 million in the first half of 2013. The increase was primarily attributable to sales of sequencing consumables, driven by growth in the instrument installed base, including HiSeq X Ten and NextSeq platforms introduced in the current year. Such increase was partially offset by a decrease in microarray consumables.

Instrument revenue increased $73.1 million, or 40%, to $256.0 million in the first half of 2014 compared to $182.9 million in the first half of 2013, driven primarily by shipments of sequencing instruments.

Service and other revenue increased $47.9 million, or 71%, to $115.3 million in the first half of 2014 compared to $67.4 million in the first half of 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 45%, 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)     Q2 2014       Q2 2013       Change      % Change     YTD 2014      YTD 2013       Change       % Change
Gross profit $ 300,540     $ 223,409     $ 77,131         35 %     $ 578,832     $ 442,701     $ 136,131         31 %
Gross margin      67.1 %        64.6 %                                  66.7 %        65.4 %

QTD 2014 vs. QTD 2013

Gross profit increased $77.1 million, or 35%, to $300.5 million in Q2 2014 compared to $223.4 million in Q2 2013, primarily due to the increase in revenue. Excluding the gross profit from acquisitions completed in 2013, which was


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predominantly included in gross profit from service sales, the increase in gross profit was 32%. Gross margin increased in Q2 2014 in comparison to Q2 2013 primarily due to higher margins on sequencing instrument sales during the period and lower legal contingency charges.

YTD 2014 vs. YTD 2013

Gross profit increased $136.1 million, or 31%, to $578.8 million in the first half of 2014 compared to $442.7 million the first half of 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 29%. Gross margin increased in the first half of 2014 compared to the first half of 2013 primarily due to higher margins on sequencing instrument sales during the period.

Operating Expense

(Dollars in
thousands)           Q2 2014       Q2 2013       Change     % Change     YTD 2014      YTD 2013       Change      % Change
Research and
development        $  82,985     $  67,608     $ 15,377         23  %   $ 160,026     $ 129,058     $  30,968         24  %
Selling, general
and administrative   114,649        88,700       25,949         29        224,222       173,774        50,448         29
Headquarter
relocation             2,892        (1,507 )      4,399       (292 )        3,487          (750 )       4,237       (565 )
Acquisition
related gain, net       (225 )      (5,725 )      5,500        (96 )       (1,238 )      (1,904 )         666        (35 )
Legal
contingencies              -         9,516       (9,516 )     (100 )            -       115,369      (115,369 )     (100 )
Unsolicited tender
offer related
expense                    -         4,811       (4,811 )     (100 )            -        12,295       (12,295 )     (100 )
Total operating
expense            $ 200,301     $ 163,403     $ 36,898         23  %   $ 386,497     $ 427,842     $ (41,345 )      (10 )%

QTD 2014 vs. QTD 2013

Research and development expense increased by $15.4 million, or 23%, in Q2 2014 from Q2 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 by $25.9 million, or 29%, in Q2 2014 from Q2 2013. The increase is primarily driven by increased headcount and consulting services to support the growth of our Company.

Acquisitions completed in 2013 also contributed to the increases in research and development expense and selling, general and administrative expense from Q2 2013 to Q2 2014.

We completed the relocation of our headquarters in 2012. During Q2 2014 and Q2 2013, we incurred $2.9 million and $1.5 million, respectively, in additional headquarter relocation expense. Such expense in Q2 2014 consisted primarily of changes in estimated lease exit liability recorded upon vacating our former headquarters and accretion expense related to such facility exit obligation. During Q2 2013, we recorded a gain from the reduction of accrued facility exit obligation, which was partially offset by accretion expense related to such facility exit obligation.

Acquisition related gain, net, in Q2 2014 primarily consisted of gains from changes in fair value of contingent consideration of $1.5 million, partially offset by other acquisition related costs. Acquisition related gain expense, net in Q2 2013 consisted of changes in the value of contingent consideration.

During Q2 2013, we recorded a $9.5 million charge within operating expense 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 Q2 2013, we recorded $4.8 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.


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YTD 2014 vs. YTD 2013

Research and development expense increased by $31.0 million, or 24%, in the first half of 2014 compared to the first half of 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 by $50.4 million, or 29%, in the first half of 2014 compared to the first half of 2013. The increase is primarily driven by increased headcount and consulting services to support the growth of our Company.

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

We completed the relocation of our headquarters in 2012. During the first half of 2014 and 2013, we incurred $3.5 million and $0.8 million, respectively, in additional headquarter relocation expense. Such expense in the first half of 2014 consisted primarily of changes in estimated lease exit liability recorded upon vacating our former headquarters and accretion expense related to such facility exit obligation. Headquarter relocation in the first half of 2013 consisted primarily of a gain from the reduction of accrued facility exit obligation, which was partially offset by accretion expense related to such facility exit obligation.

Acquisition related gain, net, in the first half of 2014 primarily consisted of gains from changes in fair value of contingent consideration of $3.3 million, partially offset by other acquisition related costs. Acquisition related gain, net in the first half of 2013 consisted of acquisition transaction costs of $3.4 million and net changes in the value of contingent consideration.

During the first half of 2014, we recorded a $115.4 million charge within operating expense 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 the first half of 2013, we recorded $12.3 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)         Q2 2014       Q2 2013       Change      % Change     YTD 2014      YTD 2013       Change      % Change
Interest income  $   1,464     $     722     $     742        103  %   $   2,420     $   2,655     $    (235 )       (9 )%
Interest expense    (9,922 )     (10,045 )         123         (1 )      (19,665 )     (19,792 )         127         (1 )
Cost-method
investment
related gain,
net                      -             -             -          -              -         6,113        (6,113 )     (100 )
Other expense,
net                (31,315 )      (1,323 )     (29,992 )    2,267        (30,836 )      (2,037 )     (28,799 )    1,414
Total other
expense, net     $ (39,773 )   $ (10,646 )   $ (29,127 )      274  %   $ (48,081 )   $ (13,061 )   $ (35,020 )      268  %

QTD 2014 vs. QTD 2013

Interest income increased in Q2 2014 from Q2 2013 as a result of higher returns from our investment portfolio. Interest expense in Q2 2014 remained relatively consistent compared to Q2 2013 and consisted primarily of accretion of discount on our convertible senior notes.

Other expense, net, in Q2 2014 and Q2 2013 primarily consisted of loss on extinguishment of debt and net foreign exchange gains and losses. In conjunction with the issuance of the 2019 and 2021 Notes, the Company used $1,244.7 million in cash to repurchase $600.0 million in principal amount of the outstanding 2016 Notes in privately negotiated transactions. As a result, we recorded $31.4 million in loss on extinguishment of debt, calculated as the difference between the fair value and the carrying value of the liability component of the debt.


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YTD 2014 vs. YTD 2013

Interest income decreased slightly in the first half of 2014 compared to the first half of 2013 as a result of a decrease in our investment portfolio balance. Interest expense in the first half of 2014 remained relatively consistent compared to the first half of 2013 and consisted primarily of accretion of discount on our convertible senior notes.

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

Other expense, net, in the first half of 2014 and 2013 primarily consisted of loss on extinguishment of debt and net foreign exchange gains and losses. In conjunction with the issuance of the 2019 and 2021 Notes, the Company used $1,244.7 million in cash to repurchase $600.0 million in principal amount of the outstanding 2016 Notes in privately negotiated transactions. As a result, we recorded $31.4 million in loss on extinguishment of debt calculated as the difference between the fair value and the carrying value of the liability component of the debt.

. . .

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