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.
•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 Q2 2021 and YTD 2021 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 endedJuly 4, 2021 . This MD&A discussion contains forward-looking statements that involve risks and uncertainties. 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
MANAGEMENT'S OVERVIEW AND OUTLOOK
This overview and outlook provide 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
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 leading genomic research centers, academic institutions, government laboratories, and hospitals, as well as pharmaceutical, biotechnology, commercial molecular diagnostic laboratories, and consumer genomics companies.
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.
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OnAugust 18, 2021 , we acquired GRAIL, a healthcare company focused on early detection of multiple cancers. GRAIL's Galleri blood test detects various types of cancers before they are symptomatic. We believe our acquisition of GRAIL will accelerate the adoption of next-generation sequencing based early multi-cancer detection tests, enhance our position in Clinical Genomics, and increase our directly accessible total addressable market. The acquisition is subject to ongoing legal proceedings and GRAIL is currently being held and operated as a separate company, with oversight provided by an appointed, independent monitoring trustee during theEuropean Commission's ongoing merger review. See note " 7. Legal Proceedings " for further details. We have included the financial results of GRAIL in our condensed consolidated financial statements from the date of acquisition. GRAIL is a separate reportable segment. 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
Beginning in 2020, 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. In addition, beginning in 2022, the armed conflict betweenRussia andUkraine and the imposed sanctions by theU.S. and other countries may impact our ability to ship products into the regions. Both the COVID-19 pandemic and the armed conflict betweenRussia andUkraine could potentially impact our sales and results of operations in 2022, the size and duration of which are significantly uncertain.
Financial highlights for YTD 2022 included the following:
•Revenue increased 8% in YTD 2022 to$2,386 million compared to$2,219 million in YTD 2021 primarily due to growth in sequencing consumables and instruments, as well as in service and other revenue. We expect our revenue to continue to increase in 2022. •Gross profit as a percentage of revenue (gross margin) was 66.3% in YTD 2022 compared to 70.6% in YTD 2021. The decrease in gross margin was driven primarily by the gross loss incurred by GRAIL in YTD 2022. Our gross margin depends on many factors, including: market conditions that may impact our pricing; sales mix changes among consumables, instruments, services, and development and licensing revenue; product mix changes between established products and new products; excess and obsolete inventories; royalties; our cost structure for manufacturing operations relative to volume; freight costs; and product support obligations. •(Loss) income from operations as a percentage of revenue was (16.6)% in YTD 2022 compared to 17.2% in YTD 2021. The decrease was primarily due to legal contingencies recorded as they relate to the potentialEuropean Commission fine and our settlement with BGI, and a decrease in gross margin. We expect our operating expenses to continue to grow on an absolute basis in 2022. •Our effective tax rate was 9.7% in YTD 2022 compared to 11.8% in YTD 2021. The tax benefit in YTD 2022 had an effective tax rate that was lower than theU.S. federal statutory tax rate of 21% primarily because of the impact of the potentialEuropean Commission fine related to the GRAIL acquisition which is nondeductible for tax purposes, the impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization ofU.S. foreign tax credits, and the impact of research and development expense capitalization for tax purposes. 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 .
•We ended Q2 2022 with cash, cash equivalents, and short-term investments
totaling
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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(1).
Q2 2022 Q2 2021 YTD 2022 YTD 2021
Revenue:
Product revenue 86.6 % 86.3 % 87.0 % 86.8 %
Service and other revenue 13.4 13.7 13.0 13.2
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of product revenue 24.7 22.6 24.6 23.4
Cost of service and other revenue 5.9 5.6 5.8 5.4
Amortization of acquired intangible assets 3.4 0.6 3.3 0.6
Total cost of revenue 34.0 28.8 33.7 29.4
Gross profit 66.0 71.2 66.3 70.6
Operating expense:
Research and development 28.1 18.0 27.3 18.0
Selling, general and administrative 35.4 36.6 30.1 35.4
Legal contingencies 52.3 - 25.5 -
Total operating expense 115.8 54.6 82.9 53.4
(Loss) income from operations (49.8) 16.6 (16.6) 17.2
Other income (expense):
Interest income 0.1 - - -
Interest expense (0.5) (1.4) (0.5) (1.6)
Other (expense) income, net (4.6) 3.2 (3.8) 1.4
Total other (expense) income, net (5.0) 1.8 (4.3) (0.2)
(Loss) income before income taxes (54.8) 18.4 (20.9) 17.0
(Benefit) provision for income taxes (8.8) 2.0 (2.1) 2.0
Net (loss) income (46.0) % 16.4 % (18.8) % 15.0 %
_____________(1)Percentages may not recalculate due to rounding.
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Table of Contents Revenue Dollars in millions Q2 2022 Q2 2021 Change % Change YTD 2022 YTD 2021 Change % Change Core Illumina: Consumables$ 818 $ 778 $ 40 5 %$ 1,676 $ 1,552 $ 124 8 % Instruments 193 194 (1) (1) 412 373 39 10 Total product revenue 1,011 972 39 4 2,088 1,925 163 8 Service and other revenue 145 154 (9) (6) 289 294 (5) (2) Total Core Illumina revenue 1,156 1,126 30 3 2,377 2,219 158 7 GRAIL: Service and other revenue 12 - 12 100 22 - 22 100 Eliminations (6) - (6) 100 (13) - (13) 100 Total consolidated revenue$ 1,162 $ 1,126 $ 36 3 %$ 2,386 $ 2,219 $ 167 8 % The increases in Core Illumina consumables revenue in Q2 2022 and YTD 2022 were primarily due to increases in sequencing consumables revenue of$40 million and$128 million , respectively, driven primarily by growth in the instrument installed base. Core Illumina instruments revenue slightly decreased in Q2 2022 due to fewer shipments. Core Illumina instruments revenue increased in YTD 2022, primarily due to an increase in sequencing instruments revenue of$37 million , driven primarily by increased shipments of our NovaSeq instrument, partially offset by fewer shipments of our NextSeq instrument. Core Illumina service and other revenue decreased in Q2 2022 and YTD 2022, primarily due to revenue from a patent litigation settlement in Q2 2021, partially offset by increased revenue from extended maintenance service contracts in Q2 2022 and YTD 2022. Additionally, Core Illumina revenue was impacted by$19 million in Q2 2022 and$33 million in YTD 2022 due to unfavorable foreign exchange rate fluctuations, which is net of amounts reclassified to revenue of$10 million and$16 million in Q2 2022 and YTD 2022, respectively, related to our cash flow hedges. GRAIL service and other revenue for Q2 2022 and YTD 2022 related primarily to sales of Galleri. Gross Margin Dollars in millions Q2 2022 Q2 2021 Change % Change YTD 2022 YTD 2021 Change % Change Gross profit (loss): Core Illumina$ 801 $ 802 $ (1) - %$ 1,651 $ 1,566 $ 85 5 % GRAIL (29) - (29) 100 (58) - (58) 100 Eliminations (5) - (5) 100 (10) - (10) 100 Consolidated gross profit$ 767 $ 802 $ (35) (4) %$ 1,583 $ 1,566 $ 17 1 % Gross margin: Core Illumina 69.3 % 71.2 % 69.5 % 70.6 % GRAIL * - * - Consolidated gross margin 66.0 % 71.2 % 66.3 % 70.6 % _____________ *Not meaningful. 31
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The decreases in Core Illumina gross margin in Q2 2022 and YTD 2022 were driven primarily by less fixed cost leverage and higher freight costs, increased revenue from a patent litigation settlement in Q2 2021, partially offset by favorable product mix.
GRAIL gross loss for Q2 2022 and YTD 2022 was primarily due to amortization of
intangible assets of
Operating Expense
Dollars in millions Q2 2022 Q2 2021 Change % Change YTD 2022 YTD 2021 Change % Change Research and development: Core Illumina$ 249 $ 202 $ 47 23 %$ 486 $ 398 $ 88 22 % GRAIL 86 - 86 100 171 - 171 100 Eliminations (8) - (8) 100 (7) - (7) 100 Consolidated research and development 327 202 125 62 650 398 252
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Selling, general and administrative: Core Illumina 339 413 (74) (18) 590 787 (197) (25) GRAIL 72 - 72 100 130 - 130 100 Eliminations (1) - (1) 100 (1) - (1) 100 Consolidated selling, general and administrative 410 413 (3) (1) 719 787 (68) (9) Legal contingencies: Core Illumina 609 - 609 100 609 - 609 100 Total consolidated operating expense$ 1,346 $ 615 $ 731 119 %$ 1,978 $ 1,185 $ 793 67 % Core Illumina research and development expense increased by$47 million , or 23%, in Q2 2022 and by$88 million , or 22%, in YTD 2022 primarily due to increases in headcount, as we continue to invest in the research and development of new products and enhancements to existing products and professional services, partially offset by a decrease in performance-based compensation.
GRAIL research and development expense for Q2 2022 and YTD 2022 consisted primarily of expenses related to headcount, including performance-based compensation, and clinical trials.
Core Illumina selling, general and administrative expense decreased by$74 million , or 18%, in Q2 2022 and by$197 million , or 25%, in YTD 2022 primarily due to a decrease in acquisition-related expenses as a result of$105 million and$210 million in Continuation Payments made to GRAIL in Q2 2021 and YTD 2021, respectively, and a decrease in performance-based compensation, partially offset in Q2 2022 by the fair value change of$38 million related to our contingent consideration liability. The decreases in Q2 2022 and YTD 2022 were partially offset by increases in headcount and travel expenses.
GRAIL selling, general and administrative expense for Q2 2022 and YTD 2022 consisted primarily of expenses related to headcount, including performance-based compensation, and professional services.
Core Illumina legal contingencies for Q2 2022 and YTD 2022 consisted of an accrual of$453 million , recorded in Q2 2022, for the potential fine that theEuropean Commission may impose of up to 10% of our consolidated annual revenues and an estimated accrual of$156 million , also recorded in Q2 2022, related to the settlement of our litigation with BGI inJuly 2022 . See note " 7. Legal Proceedings " for additional details. 32
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Table of Contents Other Income (Expense) Dollars in millions Q2 2022 Q2 2021 Change % Change YTD 2022 YTD 2021 Change % Change Interest income$ 1 $ -$ 1 100 %$ 1 $ -$ 1 100 % Interest expense (6) (16) 10 (63) (12) (34) 22 (65) Other (expense) income, net (53) 36 (89) (247) (91) 31 (122) (394) Total other (expense) income, net$ (58) $ 20 $ (78) (390) %$ (102) $ (3) $ (99) 3,300 %
Total other (expense) income, net relates primarily to the Core Illumina segment.
Interest expense in Q2 2022 and YTD 2022 consisted primarily of accrued interest on our Term Notes. The decreases in Q2 2022 and YTD 2022 were primarily due to the accretion of the original debt discount on our convertible senior notes, prior to the adoption of ASU 2020-06. The decrease in YTD 2022 was also due to the recognition of interest expense in Q2 2021 and YTD 2021 associated with the amortization of debt issuance costs related to the termination of our Bridge Facility in Q1 2021. The fluctuations in other (expense) income, net were primarily due to unrealized losses on our marketable equity securities in Q2 2022 and YTD 2022, and unrealized gains on our non-marketable equity securities and Helix contingent value right in Q2 2021 and YTD 2021. For YTD 2022 the fluctuation was also due to a$26 million gain recorded on our derivative assets related to the terminated PacBio acquisition in Q1 2021.
(Benefit) Provision for Income Taxes
Dollars in millions Q2 2022 Q2 2021 Change % Change YTD 2022 YTD 2021 Change %
Change
(Loss) income before income taxes$ (637) $ 207 $ (844) (408) %$ (497) $ 378 $ (875) (231) % (Benefit) provision for income taxes (102) 22 (124) (564) (48) 45 (93)
(207)
Net (loss) income$ (535) $ 185 $ (720) (389) %$ (449) $ 333 $ (782) (235) % Effective tax rate 16.0 % 10.8 % 9.7 % 11.8 % Our effective tax rate was 16.0% in Q2 2022 compared to 10.8% in Q2 2021. The tax benefit in Q2 2022 had an effective tax rate that was lower than the U.S. federal statutory tax rate of 21% primarily because of the$95 million impact from the potentialEuropean Commission fine related to the GRAIL acquisition which is nondeductible for tax purposes, the$6 million impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization ofU.S. foreign tax credits, and the$23 million impact of capitalizing research and development expenses for tax purposes beginning in 2022, in accordance with the 2017 Tax Cuts and Jobs Act. If the capitalization requirement is not repealed, modified, or deferred, potentially retroactively to the beginning of 2022, our provision for income taxes will continue to be negatively impacted and our cash tax payments will increase by approximately$142 million in 2022. The tax benefit in Q2 2022 was also favorably impacted 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 . In Q2 2021, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to discrete tax benefits related to GRAIL Continuation Payments and the mix of earnings in jurisdictions with lower statutory tax rates than theU.S. federal statutory tax rate, such as inSingapore and theUnited Kingdom . Our effective tax rate was 9.7% in YTD 2022 compared to 11.8% in YTD 2021. The tax benefit in YTD 2022 had an effective tax rate that was lower than theU.S. federal statutory tax rate of 21% primarily because of the$95 million impact from the potentialEuropean Commission fine related to the GRAIL acquisition which is nondeductible for tax purposes, the$31 million impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization of theU.S. foreign tax credits, and the$27 million impact of capitalizing research and development expenses for tax purposes beginning in 2022, in accordance with the 2017 Tax Cuts and Jobs Act. The tax benefit in YTD 2022 was also favorably impacted 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 . 33
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In YTD 2021, the variance from theU.S. federal statutory tax rate of 21% was primarily attributable to discrete tax benefits related to GRAIL Continuation Payments and the mix of earnings in jurisdictions with lower statutory tax rates than theU.S. federal statutory tax rate, such as inSingapore and theUnited Kingdom . This was partially offset by tax expense on certain foreign subsidiary earnings that are no longer indefinitely reinvested. Our future effective tax rate may vary from theU.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" described in "Risk Factors" within the Business & Market Information section of our Annual Report on Form
10-K for the fiscal year ended
LIQUIDITY AND CAPITAL RESOURCES
AtJuly 3, 2022 , we had approximately$1.3 billion in cash and cash equivalents, of which approximately$611 million was held by our foreign subsidiaries. Cash and cash equivalents increased by$57 million fromJanuary 2, 2022 , 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 and, from time to time, issuances of debt. Our ability to generate cash from operations provides us with the financial flexibility we need to meet operating, investing, and financing needs.
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
As ofJuly 3, 2022 , the fair value of our contingent consideration liability related to our acquisition of GRAIL was$605 million . The contingent value rights issued as part of the acquisition entitle the holders to receive future cash payments on a quarterly basis (Covered Revenue Payments) representing a pro rata portion of certain GRAIL-related revenues (Covered Revenues) each year for a 12-year period. This will reflect a 2.5% payment right to the first$1 billion of revenue each year for 12 years. Revenue above$1 billion each year will be subject to a 9% contingent payment right during this same period. Covered Revenues for Q4 2021 and Q1 2022 were$20 million in aggregate, driven primarily by sales of GRAIL's Galleri test. Covered Revenue Payments in YTD 2022 were approximately$187,000 ; however, pursuant to the Contingent Value Rights Agreement, a portion of the Covered Revenue Payments were applied to reimburse us for certain expenses. We expect Covered Revenue Payments to total approximately$110,000 in Q3 2022 due to Covered Revenues for Q2 2022 of approximately$12 million . We continued to grant GRAIL employees cash incentive equity awards in YTD 2022. As ofJuly 3, 2022 , the aggregate cash value of awards outstanding and unvested was$267 million , and we accrued an estimated liability of$40 million , included in accrued liabilities. In addition, we have an outstanding performance-based award for which vesting is based on GRAIL's future revenues. The award has an aggregate potential value of up to$78 million , which is expected to be settled in cash, and expires, to the extent unvested, inAugust 2030 . As ofJuly 3, 2022 , it was not probable that the performance conditions associated with the award will be achieved. As a result of our decision to proceed with the completion of acquisition of GRAIL during the pendency of theEuropean Commission's review, theEuropean Commission will likely seek to impose a fine on us. In Q2 2022, we accrued$453 million , included in accrued liabilities, representing 10% of our consolidated annual revenues for fiscal year 2021, as further disclosed in note " 7. Legal Proceedings ."
On
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OnMarch 23, 2021 , we issued term notes due 2023 with an aggregate principal amount of$500 million and term notes due 2031 with an aggregate principal amount of$500 million . The 2023 Term Notes and the 2031 Term Notes accrue interest at a rate of 0.550% and 2.550% per annum, respectively, payable semi-annually onMarch 23 andSeptember 23 of each year. The 2023 Term Notes, which are classified as short-term, mature onMarch 23, 2023 and the 2031 Term Notes mature onMarch 23, 2031 . We may redeem for cash all or any portion of the Term Notes, at our option, at any time prior to maturity. Our convertible senior notes, with an aggregate principal amount of$750 million , due onAugust 15, 2023 , were not convertible as ofJuly 3, 2022 . As ofJuly 3, 2022 , our convertible notes were reclassified to short-term given the holders may convert their notes on or afterMay 15, 2023 untilAugust 11, 2023 . OnMarch 8, 2021 , we obtained a Credit Facility, which provides us with a$750 million senior unsecured five-year revolving credit facility, including a$40 million sublimit for swingline borrowings and a$50 million sublimit for letters of credit. The Credit Facility matures, and all amounts outstanding thereunder become due and payable in full, onMarch 8, 2026 , subject to two one-year extensions at our option and the consent of the extending lenders and certain other conditions. As ofJuly 3, 2022 , there were no borrowings outstanding under the Credit Facility.
We had
Authorizations to repurchase$15 million of our common stock remained available as ofJuly 3, 2022 under the$750 million share repurchase program authorized by our Board of Directors onFebruary 5, 2020 . The repurchases may be completed under a 10b5-1 plan or at management's discretion. We do not intend to make any share repurchases during fiscal year 2022. We anticipate that our current cash, cash equivalents, and short-term investments, together with cash provided by operating activities and available borrowing capacity under the Credit Facility, 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:
•support of commercialization efforts related to our current and future products;
•acquisitions of equipment and other fixed assets for use in our current and future manufacturing and research and development facilities;
•the continued advancement of research and development efforts;
•potential strategic acquisitions and investments;
•repayment of debt obligations; and
•the expansion needs of our facilities, including costs of leasing and building out additional facilities.
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
•the need to enter into collaborations with other companies or acquire other companies or technologies to enhance or complement our product and service offerings.
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