ILLUMINA, INC. Our Management's Discussion and Analysis (MD&A) will help readers understand our results of operations, financial condition, and cash flow. It is provided in addition to the accompanying condensed consolidated financial statements and notes. This MD&A is organized as follows:
•Management's 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 condensed consolidated statements of cash flows, changes in our financial position, and our financial commitments.
•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 condensed consolidated financial statements.
•Recent Accounting Pronouncements. Summary of recent accounting pronouncements applicable to our condensed consolidated financial statements.
•Off-Balance Sheet Arrangements. We have no off-balance sheet arrangements.
•Quantitative and Qualitative Disclosure About Market Risk. Discussion of our financial instruments' exposure to market risk.
Our discussion of our results of operations, financial condition, and cash flow for Q3 2019 and YTD 2019 can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" within our filing of Form 10-Q for the fiscal quarter ended September 29, 2019. This MD&A discussion contains forward-looking statements that involve risks and uncertainties. Please see " Consideration Regarding Forward-Looking Statements " preceding the Condensed Consolidated Financial Statements section of this report 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, 2019. Operating results are not necessarily indicative of results that may occur in future periods.
MANAGEMENT'S 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 report. About Illumina We have one reportable segment, Core Illumina, which relates to Illumina's core operations. Prior to the Helix deconsolidation onApril 25, 2019 , our reportable segments included both Core Illumina and Helix. Our focus on innovation has established us as the global leader in DNA sequencing and array-based technologies, serving customers in the research, clinical and applied markets. Our products are used for applications in the life sciences, oncology, reproductive health, agriculture and other emerging segments.
Our customers include a broad range of academic, government, pharmaceutical, biotechnology, and other leading institutions around the globe.
Our comprehensive line of products addresses the scale of experimentation and breadth of functional analysis to advance disease research, drug development, and the development of molecular tests. This portfolio of leading- edge sequencing and array-based solutions addresses a range of genomic complexity and throughput, enabling researchers and clinical practitioners to select the best solution for their scientific challenge. OnSeptember 20, 2020 , we entered into an Agreement and Plan of Merger to acquire GRAIL for total consideration of$8 billion , consisting of$3.5 billion in cash and$4.5 billion in shares of Illumina common stock, subject to a collar. We believe our acquisition of GRAIL will accelerate the adoption of NGS-based early multi-cancer detection tests, enhance our position in Clinical Genomics, and increase our directly accessible total addressable market. The transaction is subject to customary closing conditions, including applicable regulatory approvals, and is expected to close in the second half of 2021. See note " 3. Investments and Fair Value Measurements " for further details. 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 within the Condensed Consolidated Financial Statements section of this report, and the other transactions, events, and trends discussed in " Risk Factors " within the Other Key Information section of this report.
Financial Overview
The COVID-19 pandemic and international efforts to control its spread have significantly curtailed the movement of people, goods, and services worldwide, including in the regions in which we sell our products and services and conduct our business operations. As a result, we experienced a decline in our sales and results of operations during Q3 2020 compared to Q3 2019 and YTD 2020 compared to YTD 2019. We expect the COVID-19 pandemic to continue to have a negative impact on our sales and our results of operations, the size and duration of which we are currently unable to predict. As such, we will provide an update on our Q3 2020 and YTD 2020 results only, without discussion about our expectations for the rest of the year.
Consolidated financial highlights for YTD 2020 included the following:
•Revenue decreased 12% in YTD 2020 to$2,286 million compared to$2,591 million in YTD 2019 primarily due to decreased shipments of sequencing consumables and instruments to our customers impacted by the effects of the COVID-19 pandemic. •Gross profit as a percentage of revenue (gross margin) was 68.8% in YTD 2020 compared to 69.7% in YTD 2019. The gross margin decrease was driven primarily by lower revenue, which generated less fixed cost leverage, increased freight costs attributable to the COVID-19 pandemic, and decreased revenue from development and licensing agreements. Our gross margin depends on many factors, including: market conditions that may impact our pricing; sales mix changes among consumables, instruments, and services; product mix changes between established products and new products; excess and obsolete inventories; royalties; our cost structure for manufacturing operations relative to volume; and product support obligations. •Income from operations as a percentage of revenue was 19.6% in YTD 2020 compared to 27.7% in YTD 2019. The decrease was due to an increase in operating expenses as a percentage of revenue, primarily due to the decrease in revenue in YTD 2020 compared to YTD 2019, and a decrease in gross margin. •Our effective tax rate was 28.4% in YTD 2020 compared to 11.5% in YTD 2019. In YTD 2020, the variance from theU.S. federal statutory tax rate of 21% was primarily attributable to discrete tax expense related to the valuation allowance recorded against the deferred tax asset forCalifornia research and development credits and the finalization of the Altera court case which determined stock-based compensation must be included in intercompany cost sharing payments. This was partially offset by the mix of earnings in jurisdictions with lower statutory tax rates than theU.S. federal statutory tax rate, such as inSingapore and theUnited Kingdom , discrete tax benefits related to the derivative assets recorded as a result of the terminated PacBio acquisition, and tax benefits related to share-based compensation.
•We ended Q3 2020 with cash, cash equivalents, and short-term investments
totaling
RESULTS OF OPERATIONS
To enhance comparability, the following table sets forth unaudited condensed
consolidated statement of operations data for the specified reporting periods,
stated as a percentage of total revenue.
Q3 2020 Q3 2019 YTD 2020 YTD 2019
Revenue:
Product revenue 85.1 % 82.2 % 83.3 % 81.7 %
Service and other revenue 14.9 17.8 16.7 18.3
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of product revenue 26.4 21.5 23.4 22.1
Cost of service and other revenue 6.5 6.0 6.9 7.1
Amortization of acquired intangible assets 0.9 1.0 0.9 1.1
Total cost of revenue 33.8 28.5 31.2 30.3
Gross profit 66.2 71.5 68.8 69.7
Operating expense:
Research and development 21.6 16.7 21.1 18.8
Selling, general and administrative 24.2 20.9 28.1 23.2
Total operating expense 45.8 37.6 49.2 42.0
Income from operations 20.4 33.9 19.6 27.7
Other income (expense):
Interest income 0.6 1.8 1.1 2.3
Interest expense (1.5) (1.2) (1.4) (1.6)
Other income (expense), net 7.5 (4.8) 5.1 4.4
Total other income (expense), net 6.6 (4.2) 4.8 5.1
Income before income taxes 27.0 29.7 24.4 32.8
Provision for income taxes 4.5 3.9 6.9 3.8
Consolidated net income 22.5 25.8 17.5 29.0
Add: Net loss attributable to
noncontrolling interests - - - 0.5
Net income attributable to Illumina
stockholders 22.5 % 25.8 % 17.5 % 29.5 %
Percentages may not recalculate due to rounding
Our fiscal year is the 52 or 53 weeks ending the Sunday closest toDecember 31 , with quarters of 13 or 14 weeks ending the Sunday closest to March 31, June 30, September 30, and December 31. References to Q3 2020 and Q3 2019 refer to the three months endedSeptember 27, 2020 andSeptember 29, 2019 , respectively, which were both 13 weeks, and references to year-to-date (YTD) of 2020 and 2019 refer to the nine months endedSeptember 27, 2020 andSeptember 29, 2019 , respectively, which were both 39 weeks. Revenue Dollars in millions Q3 2020 Q3 2019 Change % Change YTD 2020 YTD 2019 Change % Change Consumables$ 562 $ 600 $ (38) (6) %$ 1,618 $ 1,727 $ (109) (6) % Instruments 114 146 (32) (22) 286 390 (104) (27) Total product revenue 676 746 (70) (9) 1,904 2,117 (213) (10) Service and other revenue 118 161 (43) (27) 382 474 (92) (19) Total revenue$ 794 $ 907 $ (113) (12) %$ 2,286 $ 2,591 $ (305) (12) % 25
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Service and other revenue primarily consists of revenue generated from genotyping and sequencing services, instrument service contracts, and development and licensing agreements. Total revenue relates primarily to Core Illumina for all periods presented.
The decreases in consumables revenue in Q3 2020 and YTD 2020 were primarily due to decreases in sequencing consumables revenue of$25 million and$63 million , respectively, driven primarily by decreased shipments to our customers impacted by the effects of the COVID-19 pandemic, which more than offset the positive impacts from the growth in instrument installed base. Microarray consumables revenue also decreased in Q3 2020 and YTD 2020 due to the COVID-19 pandemic and ongoing weakness in the direct-to-consumer (DTC) market. Instruments revenue decreased in Q3 2020 and YTD 2020 primarily due to decreases in sequencing instruments revenue of$33 million and$100 million , respectively, which were driven by decreased shipments to our customers impacted by the effects of the COVID-19 pandemic. We experienced fewer shipments across our portfolio in Q3 2020 and YTD 2020, with the exception of our NextSeq 2000 platform, which launched in Q1 2020. Service and other revenue decreased in Q3 2020 primarily due to decreased revenue from development and licensing agreements. The decrease in service and other revenue in YTD 2020 was primarily due to decreased revenue from genotyping and sequencing services, as well as decreased revenue from development and licensing agreements. Gross Margin Dollars in millions Q3 2020 Q3 2019 Change % Change YTD 2020 YTD 2019 Change % Change Gross profit$ 526 $ 648 $ (122) (19)%$ 1,573 $ 1,805 $ (232) (13)% Gross margin 66.2 % 71.5 % 68.8 % 69.7 % The gross margin decrease in Q3 2020 and YTD 2020 was driven primarily by lower revenue, which generated less fixed cost leverage, increased freight costs attributable to the COVID-19 pandemic, and decreased revenue from development and licensing agreements. Operating Expense Dollars in millions Q3 2020 Q3 2019 Change % Change YTD 2020 YTD 2019 Change % Change Research and development$ 172 $ 151 $ 21 14 %$ 483 $ 486 $ (3) (1) % Selling, general and administrative 192 189 3 2 643 602 41 7
Total operating expense
7 %$ 1,126 $ 1,088 $ 38 3 % Core Illumina R&D expense increased by$21 million , or 14%, in Q3 2020 and by$6 million , or 1%, in YTD 2020 primarily due to increases in compensation related expenses, including performance-based compensation, partially offset by decreases in travel expenses and, for YTD 2020, a decrease in outside services. Helix R&D expense decreased by$9 million in YTD 2020 due to its deconsolidation onApril 25, 2019 . Core Illumina SG&A expense increased by$3 million , or 2%, in Q3 2020, primarily due to increases in compensation related expenses, including performance-based compensation, outside services, and expenses related to the pending acquisition of GRAIL, partially offset by a$25 million gain on litigation and decreased travel expenses. Core Illumina SG&A expense increased by$51 million , or 9%, in YTD 2020, primarily due to expenses related to the Reverse Termination Fee and Continuation Advances paid to PacBio in Q1 2020, partially offset by a$25 million gain on litigation, and decreased travel expenses and performance-based compensation. Helix SG&A expense decreased by$10 million in YTD 2020 due to its deconsolidation onApril 25, 2019 . 26
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Table of Contents Other Income (Expense), Net
Dollars in millions Q3 2020 Q3 2019 Change % Change YTD 2020 YTD 2019 Change % Change Interest income$ 5 $ 16 $ (11) (69) %$ 26 $ 59 $ (33) (56) % Interest expense (11) (11) - - (33) (41) 8 (20) Other income (expense), net 59 (43) 102 (237) 117 114 3 3 Total other income (expense), net$ 53 $ (38) $ 91 (239) %$ 110 $ 132 $ (22) (17) %
Other income, net, relates primarily to Core Illumina for all periods presented.
Interest income decreased in Q3 2020 and YTD 2020 as a result of lower yields on our short-term debt securities and money market funds. Interest expense consisted primarily of accretion of discount on our convertible senior notes. The increases in other income (expense), net, in Q3 2020 and YTD 2020 were primarily due to increased unrealized gains on our marketable equity securities, partially offset by decreases in the fair value of our derivative assets related to the terminated PacBio acquisition and, for YTD 2020, the$39 million gain recorded on the deconsolidation of Helix in Q2 2019 and the$15 million gain recorded in Q1 2019 from the settlement of a contingency related to the deconsolidation of GRAIL in 2017.
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