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 Q1 2022 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 endedApril 3, 2022 . 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
necessarily indicative of results that may occur in future periods.
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 a 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. 27
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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, currently, GRAIL must be held and operated separately and independently from Illumina pursuant to interim measures ordered by theEuropean Commission , which prohibited our acquisition of GRAIL onSeptember 6, 2022 . See note " 7. Legal Proceedings " for further details.
We have two reportable segments, Core Illumina and GRAIL. Core Illumina relates
to our core operations, excluding the results of GRAIL. See note ” 9 .
Seg ment Information ” for additional 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
Since 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 where we sell our products and services and conduct our business operations. In addition, armed conflict betweenRussia andUkraine , which began in 2022, and the sanctions imposed by theU.S. and other countries, has impacted our ability to ship products into affected regions and to designated customers. Furthermore, macroeconomic factors such as inflation, exchange rates and concerns about an economic downturn have impacted both Illumina directly and our customers' behavior. For example, some customers experienced supply chain pressures that delayed their lab expansions and others are managing inventory and capital more conservatively. We expect these factors to continue to impact our sales and results of operations in 2023, the size and duration of which is significantly uncertain.
Financial highlights for Q1 2023 included the following:
•Revenue decreased 11% in Q1 2023 to$1,087 million compared to$1,223 million in Q1 2022 primarily due to decreases in sequencing consumables revenue and sequencing instruments revenue, partially offset by an increase in service and other revenue. We made our first shipments of our NovaSeq X instrument in Q1 2023. We continue to expect revenue to grow 7% to 10% in 2023 compared to 2022. •Gross profit as a percentage of revenue (gross margin) was 60.3% in Q1 2023 compared to 66.6% in Q1 2022. The decrease in gross margin was driven primarily by less fixed cost leverage on lower manufacturing volumes and lower instrument margins due to the NovaSeq X launch in Q1 2023. Our gross margin depends on many factors, including: market conditions that may impact our pricing; sales mix changes among consumables, instruments, services, and development and licensing revenue; product mix changes between established products and new products; excess and obsolete inventories; royalties; our cost structure for manufacturing operations relative to volume; freight costs; and product support obligations. •Loss from operations was$(64) million in Q1 2023 compared to income from operations of$184 million in Q1 2022. The decrease was primarily due to a decrease of$160 million in gross profit and an increase in operating expense of$88 million . We plan to reduce our annualized run rate expenses by more than$100 million beginning later in 2023 to accelerate progress toward higher margins and create flexibility for further investment in high-growth areas. •Our effective tax rate was 103.9% in Q1 2023 compared to 38.3% in Q1 2022. The variance from theU.S. federal statutory tax rate of 21% was primarily because of the tax impact of research and development expense capitalization for tax purposes, and the tax impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization ofU.S. foreign tax credits. 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 . 28
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•We ended Q1 2023 with cash, cash equivalents, and short-term investments
totaling
foreign subsidiaries.
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) Q1 2023 Q1 2022 Revenue: Product revenue 84.8 % 87.5 % Service and other revenue 15.2 12.5 Total revenue 100.0 100.0 Cost of revenue: Cost of product revenue 26.2 24.5 Cost of service and other revenue 9.1 5.6
Amortization of acquired intangible assets 4.4 3.3
Total cost of revenue
39.7 33.4 Gross profit 60.3 66.6 Operating expense: Research and development 31.4 26.4 Selling, general and administrative 34.8 25.2 Total operating expense 66.1 51.6 (Loss) income from operations (5.7) 15.0 Other income (expense): Interest income 1.6 - Interest expense (1.8) (0.5) Other expense, net (1.0) (3.1) Total other expense, net (1.3) (3.6) (Loss) income before income taxes (7.1) 11.4 (Benefit) provision for income taxes (7.5) 4.4 Net income 0.4 % 7.0 %
_____________
(1)Percentages may not recalculate due to rounding.
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Table of Contents Revenue Dollars in millions Q1 2023 Q1 2022 Change % Change Core Illumina: Consumables$ 770 $ 859 $ (89) (10) % Instruments 160 218 (58) (27) Total product revenue 930 1,077 (147) (14) Service and other revenue 146 144 2 1 Total Core Illumina revenue 1,076 1,221 (145) (12) GRAIL: Service and other revenue 20 10 10 100 Eliminations (9) (8) (1) 13 Total consolidated revenue$ 1,087 $ 1,223 $ (136) (11) % The decrease in Core Illumina consumables revenue in Q1 2023 was primarily due to a decrease in sequencing consumables revenue of$92 million driven primarily by lower NovaSeq 6000 consumables pull-through as some of our high throughput customers transition to NovaSeq X, as well as customers managing tighter inventory given the continued impact of challenging macroeconomic factors. Core Illumina instruments revenue decreased in Q1 2023 primarily due to a decrease in sequencing instruments revenue of$58 million driven primarily by fewer shipments of our NovaSeq 6000 high-throughput instrument, given availability of the NovaSeq X, and fewer shipments of our NextSeq 550 mid-throughput instrument, partially offset by shipments of our NovaSeq X instrument that launched in Q1 2023. Core Illumina service and other revenue slightly increased in Q1 2023 primarily due to increased revenue from extended maintenance service contracts on a growing installed base, partially offset by decreases in genotyping services and development and licensing agreements in Q1 2023. Additionally, Core Illumina revenue was adversely impacted by$24 million in Q1 2023 due to unfavorable foreign exchange rate fluctuations, which is net of the amount reclassified to revenue of$2 million in Q1 2023 related to our cash flow hedges.
GRAIL service and other revenue increased
primarily due to sales of Galleri.
Gross Margin Dollars in millions Q1 2023 Q1 2022 Change % Change Gross profit (loss): Core Illumina$ 687 $ 851 $ (164) (19) % GRAIL (25) (29) 4 (14) Eliminations (7) (7) - - Consolidated gross profit$ 655 $ 815 $ (160) (20) % Gross margin: Core Illumina 63.8 % 69.7 % GRAIL * * Consolidated gross margin 60.3 % 66.6 % ________________ *Not meaningful. The decrease in Core Illumina gross margin in Q1 2023 was driven primarily by less fixed cost leverage on lower manufacturing volumes and lower instrument margins due to the NovaSeq X launch, which is typical with a new platform introduction until we scale manufacturing and gain operating efficiencies.
GRAIL gross loss in Q1 2023 and Q1 2022 was primarily due to amortization of
intangible assets of
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Table of Contents Operating Expense Dollars in millions Q1 2023 Q1 2022 Change % Change Research and development: Core Illumina$ 259 $ 238 $ 21 9 % GRAIL 86 85 1 1 Eliminations (4) - (4) 100 Consolidated research and development 341 323 18 6 Selling, general and administrative: Core Illumina 286 251 35 14 GRAIL 93 58 35 60 Eliminations (1) (1) - - Consolidated selling, general and administrative 378 308 70 23 Total consolidated operating expense$ 719 $ 631 $ 88 14 %
Core Illumina R&D expense increased by
due to increases in headcount, as we continue to invest in the research and
development of new products and enhancements to existing products.
GRAIL R&D expense in Q1 2023 and Q1 2022 consisted primarily of expenses related
to headcount, including performance-based compensation, and clinical trials.
Core Illumina SG&A expense increased by$35 million , or 14%, in Q1 2023 primarily due to recognizing a lower gain on our contingent consideration liability related to our acquisition of GRAIL. We recognized gains of$1 million and$49 million in Q1 2023 and Q1 2022, respectively. This was partially offset by a decrease in professional services. GRAIL SG&A expense increased by$35 million , or 60%, in Q1 2023 primarily due to increases in headcount, including an increase in performance-based compensation, and professional services. 31
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Table of Contents Other Income (Expense) Dollars in millions Q1 2023 Q1 2022 Change % Change Interest income$ 17 $ -$ 17 100 % Interest expense (20) (6) (14) 233 Other expense, net (11) (38) 27 (71) Total other expense, net$ (14) $ (44) $ 30 (68) %
Total other expense, net primarily relates to the Core Illumina segment.
Interest income consisted primarily of interest on our money market funds, which benefited from higher yields in Q1 2023 due to rising interest rates. Interest expense consisted primarily of interest on our Term Notes and increased in Q1 2023 due to the issuance of our 2025 and 2027 Term Notes inDecember 2022 . The decrease in other expense, net in Q1 2023 was primarily due to lower net losses recognized on our strategic investments. We recognized net losses on our strategic investments of$16 million and$44 million in Q1 2023 and Q1 2022, respectively.
(Benefit) Provision for Income Taxes
Dollars in millions Q1 2023 Q1 2022 Change % Change (Loss) income before income taxes$ (78) $ 140 $ (218) (156) % (Benefit) provision for income taxes (81) 54 (135) (250) Net income$ 3 $ 86 $ (83) (97) % Effective tax rate 103.9 % 38.3 % Our effective tax rate was 103.9% in Q1 2023 compared to 38.3% in Q1 2022. The variance from theU.S. federal statutory tax rate of 21% was primarily because of the$49 million tax impact of capitalizing research and development expenses for tax purposes, and the$44 million tax impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization ofU.S. foreign tax credits. The tax benefit in Q1 2023 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 Q1 2022, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to the$24 million impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization ofU.S. foreign tax credits, and the$4 million impact of capitalizing research and development expenses for tax purposes beginning in 2022, in accordance with the 2017 Tax Cuts and Jobs Act. Our effective tax rate in Q1 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 . 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
As ofApril 2, 2023 , we had approximately$1.5 billion in cash and cash equivalents, of which approximately$506 million was held by our foreign subsidiaries. Cash and cash equivalents decreased by$517 million fromJanuary 1, 2023 due primarily to the repayment of our 2023 Term Notes of$500 million and other 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 to finance our business needs as a supplement to cash provided by operating activities. As ofApril 2, 2023 , we had$24 million in short-term investments comprised of marketable equity securities. 32
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As a result of our decision to proceed with the completion of our acquisition of GRAIL during the pendency of theEuropean Commission's review, theEuropean Commission will likely seek to impose a fine on us. As ofApril 2, 2023 , we accrued$458 million , included in accrued liabilities, representing 10% of our consolidated annual revenues for fiscal year 2022, as further disclosed in note " 7. Legal Proceedings ." InMarch 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 matured and were repaid in cash onMarch 23, 2023 . The 2031 Term Notes, which mature onMarch 23, 2031 , accrue interest at a rate of 2.550% per annum, payable semi-annually in March and September of each year. We may redeem for cash all or any portion of the 2031 Term Notes, at our option, at any time prior to maturity. Our convertible senior notes, with an aggregate principal amount of$750 million , which are due onAugust 15, 2023 and are classified as short-term, were not convertible as ofApril 2, 2023 . The holders may convert their notes on or afterMay 15, 2023 untilAugust 11, 2023 . InDecember 2022 , we issued term notes due 2025 with an aggregate principal amount of$500 million and term notes due 2027 with an aggregate principal amount of$500 million . The 2025 Term Notes, which mature onDecember 12, 2025 , and the 2027 Term Notes, which mature onDecember 13, 2027 , accrue interest at a rate of 5.800% and 5.750% per annum, respectively, payable semi-annually in June and December of each year. We may redeem for cash all or any portion of the 2025 or 2027 Term Notes, at our option, at any time prior to maturity. OnJanuary 4, 2023 , we obtained a new 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, onJanuary 4, 2028 , subject to two one-year extensions at our option and the consent of the extending lenders and certain other conditions. As ofApril 2, 2023 , there were no borrowings outstanding under the Credit Facility; however, we may draw upon the facility in the future to manage cash flow or for other corporate purposes, including in connection with the payment of any potentialEuropean Commission fines, the timing of which is uncertain. As ofApril 2, 2023 , the fair value of our contingent consideration liability related to our acquisition of GRAIL was$411 million , of which$410 million was included in other long-term liabilities. 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. We expect Covered Revenues for Q1 2023 to be approximately$19 million and for related Covered Revenue Payments to total approximately$183,000 in Q2 2023. In Q1 2023, we paid$217,000 in Covered Revenue Payments related to Covered Revenues for Q4 2022 of$23 million . We grant cash incentive equity awards to GRAIL employees that generally have terms of four years and vest in equal annual installments. As ofApril 2, 2023 , the aggregate cash value of awards outstanding and unvested was$378 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 ofApril 2, 2023 , it was not probable that the performance conditions associated with the award will be achieved. We had$7 million and up to$88 million , respectively, remaining in our capital commitments to two venture capital investment funds as ofApril 2, 2023 that are callable throughApril 2026 andJuly 2029 , respectively. Authorizations to repurchase$15 million of our common stock remained available as ofApril 2, 2023 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 2023. 33
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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;
•the potential payment of
of GRAIL;
•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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