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(Address of principal executive offices) (Zip code)
(i858)
i202-4500
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol(s)
Name of each exchange on which registered
iCommon Stock, $0.01 par value
iILMN
iThe
NASDAQ Stock Market LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☑ No
☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☑ No ☐
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
þ
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging growth company
i☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13a of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No
þ
See “Form 10-Q Cross-Reference Index” within Other Key Information for a cross-reference to the parts and items requirements of the Securities and Exchange Commission Quarterly Report on Form 10-Q.
This Quarterly Report on Form 10-Q contains, and our officers and representatives may from time to time make, “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as: “anticipate,”“intend,”“plan,”“goal,”“seek,”“believe,”“continue,”“project,”“estimate,”“expect,”“strategy,”“future,”“likely,”“may,”“potential,”“predict,”“should,”“will,” or similar words or phrases, or the negatives of these words, may identify forward-looking statements, but the absence of these words does
not necessarily mean that a statement is not forward looking. Examples of forward-looking statements include, among others, statements we make regarding:
•our expectations as to our future financial performance, results of operations, or other operational results or metrics;
•our expectations regarding the launch of new products or services;
•the benefits that we expect will result from our business activities and certain transactions we have completed, such as product introductions, increased revenue, decreased expenses, and avoided expenses and expenditures;
•our expectations of the effect on our financial condition of claims, litigation, contingent liabilities, and governmental investigations,
proceedings, and regulations;
•our strategies or expectations for product development, market position, financial results, and reserves;
•our expectations regarding the outcome of the legal and regulatory proceedings related to our recently completed acquisition of GRAIL, Inc. (GRAIL) and other actions that may be taken or pursued by the European Commission, the Federal Trade Commission and/or other governmental or regulatory authorities in connection with such acquisition;
•the hold separate arrangements we voluntarily offered to enter into or that the European Commission may seek to impose, and the duration and impacts on Illumina and GRAIL of such arrangements;
•our expectations regarding the
integration of any acquired technologies with our existing technology; and
•other expectations, beliefs, plans, strategies, anticipated developments, and other matters that are not historical facts.
Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations, and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy, and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the
forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
•the impact to our business and operating results caused by the COVID-19 pandemic;
•our expectations and beliefs regarding prospects and growth for our business and the markets in which we operate;
•the timing and mix of customer orders among our products and services;
•challenges inherent in developing, manufacturing, and launching new products and services, including expanding manufacturing operations and
reliance on third-party suppliers for critical components;
•the impact of recently launched or pre-announced products and services on existing products and services;
•our ability to develop and commercialize our instruments and consumables, to deploy new products, services, and applications, and to expand the markets for our technology platforms;
•our ability to manufacture robust instrumentation and consumables;
•our ability to identify and acquire technologies and integrate them into our products or businesses successfully;
•risks and uncertainties regarding the legal and regulatory proceedings relating to our recently completed acquisition of GRAIL and our ability to achieve the expected benefits of such acquisition and other actions that may be taken or pursued by the European Commission, the Federal Trade Commission and/or other governmental or regulatory authorities in connection with such acquisition;
•the hold separate arrangements we voluntarily offered to enter into or that the European Commission may seek to impose, and the duration and impacts on Illumina and GRAIL of such arrangements, which impacts may include material and adverse effects on synergies and other benefits we expect to achieve as a result of the acquisition of GRAIL, additional costs or liabilities, loss of revenue
and other adverse effects on our business, financial condition and results of operations;
•our compliance with the terms of the hold separate arrangements, which may be burdensome to implement and administer, and the risk that the European Commission could impose or seek to impose fines and other penalties for alleged noncompliance with such terms;
•the assumptions underlying our critical accounting policies and estimates;
•our assessments and estimates that determine our effective tax rate;
•our assessments and beliefs regarding the outcome of pending legal proceedings and any liability that we may incur as a result of those proceedings;
•uncertainty,
or adverse economic and business conditions, including as a result of slowing or uncertain economic growth in the United States or worldwide; and
•other factors detailed in our filings with the SEC, including the risks, uncertainties, and assumptions described in “Risk Factors” within the Business and Market Information section of our Annual Report on Form 10-K for the fiscal year ended January 3, 2021, or in information disclosed in public conference calls, the date and time of which are released beforehand.
The foregoing factors should be considered together with other factors detailed in
our filings with the Securities and Exchange Commission, including our most recent filings on Forms 10-K and 10-Q, or in information disclosed in public conference calls, the date and time of which are released beforehand. We undertake no obligation, and do not intend, to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, or to review or confirm analysts’ expectations, or to provide interim reports or updates on the progress of any current financial quarter, in each case whether as a result of new information, future developments, or otherwise.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Unless the context requires otherwise, references in this report to“Illumina,” “we,”“us,” the “Company,” and “our” refer to Illumina, Inc.
and its consolidated subsidiaries.
i
1.
ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Business Overview
We are a provider of sequencing- and array-based solutions, 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.
On August 18, 2021, we acquired GRAIL, a healthcare company focused on early detection of multiple cancers. GRAIL’s Galleri blood test detects more than
50 different cancers before they are symptomatic. We will hold GRAIL as a separate company during the European Commission’s ongoing merger review. Refer to note “4.Business Combinations” for additional details.
Basis of Presentation
iThe
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Interim financial results are not necessarily indicative of results anticipated for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Annual Report on Form 10-K for the fiscal year ended January 3, 2021, from which the prior
year balance sheet information herein was derived. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expense, and related disclosure of contingent assets and liabilities. Though the impact of the COVID-19 pandemic to our business and operating results presents additional uncertainty, we continue to use the best information available to form our critical accounting estimates. Actual results could differ from those estimates.
iThe unaudited condensed consolidated
financial statements include our accounts, our wholly-owned subsidiaries, and majority-owned or controlled companies. All intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation. In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the results for the interim periods presented.
We have included the results of operations for GRAIL in our condensed consolidated statements of operations from the date of acquisition. GRAIL operates as a separate reportable segment. See note “10.
Segment Information” for additional details.
Fiscal Year
iOur fiscal year is the 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. References to Q3 2021 and Q3 2020 refer to the three months ended October 3, 2021 and September 27,
2020, respectively, which were both 13 weeks, and references to year-to-date (YTD) 2021 and 2020 refer to the nine months ended October 3, 2021 and September 27, 2020, respectively, which were both 39 weeks.
During
YTD 2021, there were no changes to our significant accounting policies as described in our Annual Report on Form 10-K for the fiscal year ended January 3, 2021. See below for our policy related to business combinations.
Business Combinations
i
Under the acquisition method of accounting, we allocate the fair
value of the total consideration transferred to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition. The fair values assigned, defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants, are based on estimates and assumptions determined by management. These valuations require us to make significant estimates and assumptions, especially with respect to intangible assets. We record the excess consideration over the aggregate fair value of tangible and intangible assets, net of liabilities assumed, as goodwill.
In connection with certain of our acquisitions, additional contingent consideration can be earned by the sellers upon completion of certain future performance milestones. In these cases, a liability is recorded on
the acquisition date, as a component of accrued liabilities or other long-term liabilities for an estimate of the acquisition date fair value of the contingent consideration by applying the income approach utilizing variable inputs such as anticipated future cash flows, risk-free adjusted discount rates, and nonperformance risk. This method requires significant management judgment, including the probability of achieving certain future milestones and discount rates. Future changes in our estimates could result in expenses or gains. Any change in the fair value of the contingent consideration subsequent to the acquisition date is recognized in selling, general and administrative expenses in our consolidated statements of income.
We typically use the discounted cash flow method to value our acquired intangible assets. This method requires significant management judgment to forecast future operating results
and establish residual growth rates and discount factors. The estimates we use to value and amortize intangible assets are consistent with the plans and estimates that we use to manage our business and are based on available historical information and industry estimates and averages. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, we could experience impairment charges. In addition, we have estimated the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If our estimates of the economic lives change, depreciation or amortization expenses could be accelerated or extended. We capitalize in-process research and development (IPR&D) and either amortize it over the life of the product upon commercialization or impair it if the project is abandoned.
If
the initial accounting for a business combination is incomplete by the end of a reporting period that falls within the measurement period, we report provisional amounts in our financial statements. During the measurement period, we adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date and we record those adjustments to our financial statements.
For our policy on goodwill and intangible assets, see the significant policies as described in our Annual Report on Form 10-K for the fiscal year ended January 3,
2021.
i
Accounting Pronouncements Pending Adoption
In August 2020, the FASB issued ASU 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). The new standard reduces the number of accounting models for convertible debt instruments, amends
the accounting for certain contracts in an entity’s own equity, and modifies how certain convertible instruments and contracts that may be settled in cash or shares impact the calculation of diluted EPS. We expect to adopt the standard on its effective date beginning in the first quarter of 2022. We are currently evaluating the impact of ASU 2020-06 on our consolidated financial statements, particularly as it relates to our outstanding Convertible Senior Notes.
Basic earnings per share is computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed based on the sum of the weighted average number of common shares and potentially dilutive common shares outstanding during the period.
Potentially dilutive common shares consist of shares issuable under convertible senior notes and equity awards. Convertible senior notes have a dilutive impact when the average market price of
our common stock exceeds the applicable conversion price of the respective notes. Potentially dilutive common shares from equity awards are determined using the average share price for each period under the treasury stock method. In addition, proceeds from exercise of equity awards and the average amount of unrecognized compensation expense for equity awards are assumed to be used to repurchase shares.
i
The following table presents the calculation of weighted average shares used to calculate basic and diluted
earnings per share:
In millions
Q3 2021
Q3 2020
YTD 2021
YTD
2020
Weighted average shares outstanding
i152
i146
i148
i147
Effect
of potentially dilutive common shares from:
Equity awards
i1
i1
i1
i1
Convertible
senior notes
i—
i1
i—
i—
Weighted
average shares used in calculating diluted earnings per share
i153
i148
i149
i148
/
i
2.
REVENUE
Our revenue is generated primarily from the sale of products and services. Product revenue primarily consists of sales of instruments and consumables used in genetic analysis. Service and other revenue primarily consists of revenue generated from genotyping and sequencing services, instrument service contracts, development and licensing agreements, and cancer detection testing services related to the GRAIL business.
(1)Region
includes revenue from China, Taiwan, and Hong Kong.
Performance Obligations
We regularly enter into contracts with multiple performance obligations. Most performance obligations are generally satisfied within a short time frame, approximately three to isix months, after the contract
execution date. As of October 3, 2021, the aggregate amount of the transaction price allocated to remaining performance obligations was $i1,131 million, of which approximately i90%
is expected to be converted to revenue in the next itwelve months, approximately i8% in the following itwelve
months, and the remainder thereafter.
Contract liabilities, which consist of deferred revenue and customer deposits, as of October 3, 2021 and January 3, 2021 were $i256
million and $i230 million, respectively, of which the short-term portions of $i198 million and $i186
million, respectively, were recorded in accrued liabilities and the remaining long-term portions were recorded in other long-term liabilities. Revenue recorded in Q3 2021 and YTD 2021 included $i32 million and $i159
million, respectively, of previously deferred revenue that was included in contract liabilities as of January 3, 2021.
i
3. INVESTMENTS AND FAIR VALUE
MEASUREMENTS
Debt Securities
i
Our short-term investments include available-for-sale debt securities that consisted of the following:
During
Q1 2021, we sold all of our available-for-sale debt securities in anticipation of funding the GRAIL acquisition. See note “4. Business Combinations” for further details. Realized gains and losses are determined based on the specific-identification method and are reported in interest income.
As of October 3, 2021 and January 3, 2021, the fair value of our marketable equity securities, included in short-term investments, totaled $i185 million and $i376
million, respectively. Total net unrealized gains on our marketable equity securities, included in other income, net, were $i45 million in Q3 2021 and total net unrealized losses were $i16 million
in YTD 2021. Total unrealized gains on our marketable equity securities were $i59 million and $i128 million in
Q3 2020 and YTD 2020, respectively. Total net losses on marketable equity securities sold, included in other income, net, were $i7 million in YTD 2021. There were iino/
sales of our marketable equity securities in Q3 2021 or YTD 2020.
Non-Marketable Equity Securities
As of October 3, 2021 and January 3, 2021, the aggregate carrying amounts of our non-marketable equity securities without readily determinable fair values, included in other assets, were $i61
million and $i314 million, respectively. The decrease was due to our acquisition of GRAIL and the reclassification of several of our equity investments, that became marketable in Q3 2021, to short-term investments.
On August 18, 2021, we completed our acquisition of GRAIL. Prior to the acquisition, we held an investment in GRAIL for which we had concluded that GRAIL was a
VIE for which we were not the primary beneficiary and, therefore, we did not consolidate GRAIL in our consolidated financial statements. The carrying value of our investment was $i250 million as of January 3, 2021. See note “4. Business Combinations” for further details.
Revenue recognized from transactions with our strategic investees
was $i14 million and $i47 million for Q3 2021 and YTD 2021, respectively, and $i16
million and $i39 million for Q3 2020 and YTD 2020, respectively.
Venture Funds
We invest in itwo
venture capital investment funds (the Funds) with capital commitments of $i100 million, callable through April 2026, and up to $i150 million, callable through July 2029, respectively, of which $i23
million and up to $i122 million, respectively, remained callable as of October 3, 2021. Our investments in the Funds are accounted for as equity-method investments. The aggregate carrying amounts of the Funds, included in other assets, were $i172
million and $i104 million as of October 3, 2021 and January 3, 2021, respectively.
Helix Contingent Value Right
In conjunction with the deconsolidation of Helix Holdings I, LLC (Helix) in April 2019, we received a contingent value right with a i7-year
term that entitles us to consideration dependent upon the outcome of Helix’s future financing and/or liquidity events. Changes in the fair value of the contingent value right resulted in unrealized gains of $i12 million and $i30
million in Q3 2021 and YTD 2021, respectively, and an unrealized gain of $i5 million in YTD 2020, included in other income, net. There was no change in fair value in Q3 2020.
Derivative Assets Related to Terminated Acquisition
On November 1, 2018, we entered into an Agreement and Plan
of Merger (the PacBio Merger Agreement) to acquire Pacific Biosciences of California, Inc. (PacBio) for an all-cash price of approximately $i1.2 billion (or $i8.00
per share). On January 2, 2020, we entered into an agreement to terminate the PacBio Merger Agreement (the Termination Agreement). Pursuant to the Termination Agreement, we made a cash payment to PacBio of $i98 million on January 2, 2020, which represented the Reverse Termination Fee (as
defined in the PacBio Merger Agreement). The Reverse Termination Fee was repayable, without interest, if PacBio entered into a definitive agreement providing for, or consummating, a Change of Control Transaction by September 30, 2020 (as defined in the Termination Agreement), and such transaction was consummated by the two-year anniversary of the execution of the definitive agreement for such Change of Control Transaction. PacBio did not enter into a definitive agreement that provided for, or consummated, a Change of Control Transaction by September 30, 2020 (as defined in the Termination Agreement); therefore, the Reverse Termination Fee is no longer repayable.
In addition, we made cash payments to PacBio of $i18 million in Q4 2019, pursuant to Amendment No. 1 to the PacBio Merger Agreement, and $i34
million in Q1 2020, pursuant to the Termination Agreement, collectively referred to as the Continuation Advances. Up to the $i52 million of Continuation Advances was repayable, without interest, if, within two years of March 31, 2020, PacBio entered into a Change of Control Transaction or raised at least $i100
million in equity or debt financing in a single transaction (with the amount repayable dependent on the amount raised by PacBio). In February 2021, PacBio entered into an investment agreement with SB Northstar LP for the issuance and sale of $i900 million in aggregate principal amount of PacBio’s convertible notes. Pursuant to the PacBio Merger Agreement, PacBio repaid to us the $i52 million
of Continuation Advances and we recorded a gain of $i26 million in Q1 2021, which was included in other income, net.
The potential repayments of the Continuation Advances and Reverse Termination Fee met the definition of derivative assets and were recorded at fair value. The $i92
million difference between the $i132 million in cash paid during Q1 2020 for the Continuation Advances and Reverse Termination Fee and the $i40 million fair value of these derivative
assets on the payment dates was recorded as selling, general and administrative expense in Q1 2020. Changes in the fair value of the derivative assets were included in other income, net. Unrealized losses of $i10 million and $i25
million were recorded in Q3 2020 and YTD 2020, respectively.
Fair Value Measurements
i
The following table presents the hierarchy for assets and liabilities measured at fair value on a recurring basis:
We consider information provided by our investment accounting and reporting service provider in the measurement of fair value of our debt securities. The investment service provider provides valuation information from an industry-recognized valuation service. Such valuations may be based on trade prices in active markets for identical assets or liabilities (Level 1 inputs) or valuation models using inputs that are observable either directly or indirectly (Level 2 inputs), such as quoted prices for similar assets or liabilities, yield curve, volatility factors, credit spreads, default rates, loss severity, current market and contractual prices for the underlying instruments or debt, broker and dealer quotes, as well as other relevant economic measures. Our marketable equity securities are measured at fair value based on quoted trade prices in active markets. Our deferred
compensation plan assets consist primarily of investments in life insurance contracts carried at cash surrender value, which reflects the net asset value of the underlying publicly traded mutual funds. We perform control procedures to corroborate the fair value of our holdings, including comparing valuations obtained from our investment service provider to valuations reported by our asset custodians, validating pricing sources and models, and reviewing key model inputs, if necessary. We elected the fair value option to measure the contingent value right received from Helix. The fair value of our contingent value right, included in other assets, is derived using a Monte Carlo simulation. The derivative assets related to the terminated acquisition of PacBio were financial instruments measured at fair value, included in other assets. Significant estimates and assumptions required
for these valuations include, but are not limited to, probabilities related to the timing and outcome of future financing and/or liquidity events and an assumption regarding collectibility. These unobservable inputs represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value.
We reassess the fair value of contingent consideration to be settled in cash related to acquisitions on a quarterly basis. We use a Monte Carlo simulation to estimate the fair value of contingent consideration related to the GRAIL acquisition and an income approach to estimate the fair value of contingent consideration related to our other acquisition. See note “4. Business Combinations” for details regarding
the contingent consideration arrangement related to the GRAIL acquisition. Significant assumptions used in the Monte Carlo simulation include forecasted revenues for GRAIL, a revenue risk premium, a revenue volatility, an operational leverage ratio and a counterparty credit spread. Significant assumptions used in the income approach include the probability of achieving certain milestones and a discount rate. These unobservable inputs represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value. Changes in the fair value of the contingent consideration liabilities are recognized in selling, general and administrative expense.
i
Changes
in the estimated fair value of contingent consideration liabilities during YTD 2021 were as follows:
We
recorded a contingent consideration liability of $i14 million as a result of an acquisition completed in Q2 2021. The acquisition-date fair value of the contingent consideration liability was derived using the income approach. Assumptions used to estimate the liability included the probability of achieving certain milestones and a discount rate. As of October 3, 2021, the estimated fair value of the contingent consideration liability was $i15 million,
which is included in accrued liabilities. We recorded an expense of $ii1/ million
in selling, general and administrative expense in Q3 2021 and YTD 2021 due to the change in estimated fair value of the contingent consideration liability.
On August 18, 2021, we completed our acquisition of GRAIL, a healthcare company focused on early detection of multiple cancers. The acquisition is expected to accelerate access and adoption of GRAIL’s blood test, Galleri, that detects more than 50 different cancers before they are symptomatic. The acquisition is subject to ongoing legal proceedings and pending the European Commission’s ongoing merger review. Refer to note “8. Legal Proceedings” for further details. As a result of the acquisition, GRAIL stockholders received as consideration (i) cash, (ii) shares of Illumina common stock and (iii) at their election, either a contingent
value right or additional shares of Illumina common stock. We issued i9.8 million common shares as part of the consideration.
GRAIL is a separate reportable segment.See note “10. Segment Information” for more
information.We have included the financial results of GRAIL in the condensed consolidated financial statements from the date of acquisition.
i
The total purchase price consisted of the following:
in millions
Cash
$
i2,862
Fair
value of common stock issued
i4,975
Fair value of contingent consideration
i762
Fair
value of previously held investment
i1,150
Settlement of preexisting relationships
i2
Total
purchase price
$
i9,751
/
The contingent consideration relates to the GRAIL stockholders who elected to receive contingent value rights as part of the acquisition
(the Contingent Value Rights Agreement). The contingent value rights entitle the holders to receive future cash payments representing a pro rata portion of certain GRAIL-related revenues each year for a i12-year period starting at the acquisition date. This will reflect a i2.5%
payment right to the first $i1 billion of revenue each year for i12 years. Revenue above $i1 billion
each year will be subject to a i9% contingent payment right during this same period. The acquisition-date fair value of the contingent consideration liability was measured using a Monte Carlo simulation. Key assumptions used in the fair value assessment included forecasted revenues for GRAIL, a revenue risk premium, a revenue volatility, an operational leverage ratio and a counterparty credit spread. As of October 3, 2021, the estimated fair value of the contingent consideration liability
was $i754 million, of which $i753 million was included
in other long-term liabilities, with the remaining balance included in accrued liabilities. Accordingly, we recorded a gain of $i8 million in selling, general and administrative expense in Q3 2021.
Prior to the acquisition, we owned a i12%
interest in GRAIL. Authoritative guidance on accounting for business combinations requires that an acquirer remeasure its previously held equity investment in the acquiree at its acquisition-date fair value and recognize the resulting gain or loss in earnings. We remeasured our previously held equity investment to its fair value, as of the date of acquisition, based on the fair value of total consideration transferred and a discount for lack of control. Significant assumptions used in the remeasurement represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring the fair value. As a result of the remeasurement, we valued our previously held equity investment in GRAIL at $i1.2 billion
and recognized a gain of $i900 million, included in other income, net, in Q3 2021.
In connection with the acquisition of GRAIL, we accelerated the vesting of certain outstanding and unvested equity awards of GRAIL employees. Approximately $i69 million was included in the purchase price related to the fair value of accelerated equity awards attributable to the pre-combination period,
with the fair value attributable to the post-combination period of $i615 million included in share-based compensation expense in Q3 2021. In addition, we issued Illumina equity awards to GRAIL employees in exchange for any of their remaining outstanding and unvested GRAIL equity awards (the “replacement awards”) at acquisition. The replacement awards consist of restricted stock units and performance stock options. The terms of
the replacement awards are substantially similar to the former GRAIL equity awards for which they were exchanged. The fair value of the replacement awards was $i48 million, all of which is attributable to post-combination service, and will be recognized as share-based compensation expense over the remaining vesting period subsequent to the acquisition. The weighted-average
acquisition-date fair value of the replacement performance stock options was determined using the Black-Scholes option pricing model with the following assumptions: (i) market price of $i510.61 per share, which was the closing price of Illumina’s common stock on the acquisition date; (ii) weighted average expected term ranging from i1.6
years to i2.2 years; (iii) weighted-average risk-free interest rate ranging from i0.17%
to i0.28%; (iv) weighted average annualized volatility ranging from i40%
to i43%; and (v) ino
dividend yield. The weighted average acquisition-date fair value per share of the replaced performance stock options was $i424.39. Refer to note “6. Stockholders’ Equity” for more information.
We
are still finalizing the allocation of the purchase price, therefore, the fair value estimates assigned to intangible assets, goodwill and the related tax impacts of the acquisition, among other items, are subject to change as additional information is received to complete our analysis and certain tax returns are finalized. We expect to finalize the valuation as soon as practicable, but no later than one year after the acquisition date.
i
The preliminary fair values of assets acquired
and liabilities assumed as of the acquisition date were:
in millions
Cash and cash equivalents
$
i571
Property
and equipment
i89
Operating lease right-of-use assets
i121
Goodwill
i6,082
Intangible
assets
i3,180
Other current and noncurrent assets
i35
Deferred
tax liability
(i82)
Long-term lease liabilities
(i97)
Other
current and noncurrent liabilities
(i148)
Total net assets acquired
$
i9,751
/
Goodwill
is primarily attributable to assembled workforce, expanded market opportunities, and expected synergies to be achieved. The goodwill recognized was assigned to the GRAIL segment and is not deductible for tax purposes.
i
The preliminary fair values assigned to identifiable intangible assets acquired were as follows:
The fair values of the developed technology, trade name and IPR&D were estimated using an income approach. Under the income approach, an intangible asset’s fair value is equal to the present value of future economic benefits to be derived from ownership of the asset. The estimated fair values were developed by discounting future net cash flows to their present value at market-based rates of return. The useful lives of the intangible assets for amortization purposes were determined by considering the period of expected cash flows used to measure the fair values of the intangible assets adjusted as appropriate for entity-specific factors including legal, regulatory, contractual, competitive, economic and other factors that may limit the useful life. The developed technology and trade name assets are amortized on a straight-line basis over their estimated useful lives. As
of October 3, 2021, the IPR&D project had not been completed or abandoned and was therefore not subject to amortization.
The transaction costs associated with the acquisition of GRAIL, excluding any Continuation Payments paid to GRAIL prior to the close of the acquisition, consisted primarily of legal, regulatory and financial advisory fees of approximately $i66 million and $i156 million
for Q3 2021 and YTD 2021, respectively. These transaction costs were expensed as incurred as selling, general and administrative expense in the respective periods.
Unaudited Pro Forma Financial Information
i
The following unaudited pro forma financial information summarizes the combined results of operations of Illumina and GRAIL as if the companies had been combined as of the beginning of our fiscal year 2020.
in
millions
Q3 2021
Q3 2020
YTD 2021
YTD 2020
Revenue
$
i1,109
$
i794
$
i3,330
$
i2,286
Net
income
$
i194
$
i95
$
i548
$
i148
/
The
unaudited pro forma financial information is presented for information purposes only and is not indicative of the results of operations that would have been achieved had the acquisition been completed at the beginning of our fiscal year 2020. In addition, the unaudited pro forma financial information is not a projection of future results of operations of the combined company nor does it reflect the expected realization of any synergies or cost savings associated with the acquisition. The unaudited pro forma financial information includes adjustments to reflect the elimination of intercompany transactions, incremental amortization and depreciation expense of the identifiable intangible assets and property and equipment acquired, respectively, the additional interest expense associated with the issuance of debt to finance the acquisition, and share-based compensation expense.
Prior to
the acquisition, we were required to make monthly cash payments to GRAIL of $i35 million (the Continuation Payments) through the earlier of the consummation of the acquisition or termination of the GRAIL Merger Agreement, subject to certain exceptions. We made Continuation Payments to GRAIL totaling $i35 million
and $i245 million in Q3 2021 and YTD 2021, respectively, which were recorded as selling, general and administrative expenses. Subsequent to the acquisition, we did not make any additional monthly payments.
As
a result of an acquisition completed in Q2 2021, we recorded an IPR&D intangible asset of $i35 million, with an indefinite useful life. As of October 3, 2021, the IPR&D project had not been completed or abandoned and was therefore not subject to amortization. Additionally, as a result of another acquisition completed in Q3 2021, we recorded a developed technology intangible asset of $i28 million,
with a useful life of i10 years.
Total amortization expense recognized was $i19 million and $i34 million
during Q3 2021 and YTD 2021, respectively.
i
The estimated annual amortization of finite-lived intangible assets for the next five years is shown in the following table. Actual amortization expense to be reported in future periods could differ from these estimates as a result of acquisitions, divestitures, and asset impairments, among other factors.
In
millions
Estimated Annual Amortization
2021 (balance of year)
$
i42
2022
i166
2023
i165
2024
i163
2025
i163
Thereafter
i1,947
Total
$
i2,646
/
Goodwill
i
Changes
to goodwill during YTD 2021 were as follows:
Goodwill is reviewed for impairment at least annually during the second quarter, or more frequently if an event occurs indicating the potential for impairment. We performed our annual assessment for goodwill impairment in Q2 2021, noting no impairment.
i0.550%
Term Notes due 2023 (2023 Term Notes) and i2.550% Term Notes due 2031 (2031 Term Notes)
On March 23, 2021, we issued $i500 million
aggregate principal amount of term notes due 2023 (2023 Term Notes) and $i500 million aggregate principal amount of term notes due 2031 (2031 Term Notes, together the Term Notes). We received net proceeds from the issuance of $i992 million,
after deducting discounts and debt issuance costs.
The 2023 and 2031 Term Notes accrue interest at a rate of i0.550% and i2.550%
per annum, respectively, payable semi-annually. Interest is payable on March 23 and September 23 of each year, beginning on September 23, 2021. The 2023 Term Notes mature on March 23, 2023 and the 2031 Term Notes mature on March 23, 2031.
We may redeem for cash all or any portion of the Term Notes, at our option, at any time prior to maturity. The 2023 Term Notes and, prior to December 23, 2030, the 2031 Term Notes are redeemable at make-whole premium redemption prices as defined in the applicable forms of note. After December 23, 2030, the 2031 Term Notes are redeemable at a redemption price equal to i100%
of the principal amount of the notes to be redeemed, plus any accrued and unpaid interest up to, but excluding, the redemption date.
Interest expense recognized on the Term Notes was $i4 million and $i9 million
during Q3 2021 and YTD 2021, respectively, which included amortization of debt discounts and issuance costs.
Principal amount of 2023 Convertible Senior Notes outstanding
$
i750
$
i750
Principal
amount of 2021 Convertible Senior Notes outstanding
i—
i517
Unamortized
discount of liability component of convertible senior notes
(i56)
(i83)
Net
carrying amount of liability component of convertible senior notes
i694
i1,184
Less:
current portion
i—
(i511)
Convertible
senior notes, non-current
$
i694
$
i673
Carrying
value of equity component of convertible senior notes, net of debt issuance costs
$
i126
$
i213
Fair
value of convertible senior notes outstanding (Level 2)
$
i869
$
i1,595
Weighted-average
remaining amortization period of discount on the liability component of convertible senior notes
i1.9 years
i2.4
years
Interest expense recognized on the Convertible Senior Notes, which included amortization of debt discounts and issuance costs, was $i7 million and $i28 million
during Q3 2021 and YTD 2021, respectively, and $i11 million and $i33 million during Q3 2020 and YTD 2020, respectively.
i0%
Convertible Senior Notes due 2023 (2023 Convertible Notes)
In August 2018, we issued $i750 million aggregate principal amount of convertible senior notes due 2023 (2023 Convertible Notes). The 2023 Convertible Notes mature on August 15, 2023, and the implied estimated effective rate of the liability component of the notes was i3.7%,
assuming no conversion option.
The 2023 Convertible Notes will be convertible into cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, based on an initial conversion rate, subject to adjustment, of 2.1845 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $i457.77 per share of common stock), only in the following circumstances: (1) during any calendar quarter commencing after
the calendar quarter ending on September 30, 2018 (and only during such calendar quarter), if the last reported sale price of our common stock for at least i20 trading days (whether or not consecutive) during a period of i30
consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to i130% of the conversion price in effect on each applicable trading day; (2) during the ifive
business day period after any i10 consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of 2023 Convertible Notes for each trading day of the measurement period was less than i98%
of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; (3) if we call any or all of the notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events described in the indenture. Regardless of the foregoing circumstances, the holders may convert their notes on or after May 15, 2023 until August 11, 2023.
We may redeem for cash all or any portion of the 2023 Convertible Notes, at our option, on or after August 20, 2021 if the last reported sale price of our common stock
has been at least i130% of the conversion price then in effect (currently $i595.10) for at least i20
trading days (whether or not consecutive) during any i30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption at a redemption price equal to i100%
of the principal amount of the notes to be redeemed, plus any accrued and unpaid special interest to, but excluding, the redemption date.
The 2023 Convertible Notes were not convertible as of October 3, 2021 and had no dilutive impact during YTD 2021. If the notes were converted as of October 3, 2021, the if-converted value would not exceed the principal amount.
i0.5%
Convertible Senior Notes due 2021 (2021 Convertible Notes)
In June 2014, we issued $i517 million aggregate principal amount of convertible senior notes due 2021 (2021 Convertible Notes). The implied estimated effective rate of the liability component of the notes was i3.5%,
assuming no conversion option. The 2021 Convertible Notes were convertible into cash, shares of common stock, or a combination of cash and shares of common stock, at our election, based on conversion rates as defined in the indenture. The 2021 Convertible Notes matured on June 15, 2021, by which time the principal had been converted and was repaid in cash. The excess of the conversion value over the principal amount was paid in shares of common stock.
i
The
following table summarizes information about the conversions during YTD 2021:
In millions
2021 Notes
Cash paid for principal of notes converted
$
i517
Conversion
value over principal amount, paid in shares of common stock
$
i313
Number of shares of common stock issued upon conversion
i0.7
Loss
on extinguishment of debt
$
i1
/
Credit Agreement
On March 8, 2021, we entered into a credit agreement (the Credit
Agreement), which provides us with a $i750 million senior unsecured ifive-year revolving credit facility, including a $i40 million
sublimit for swingline borrowings and a $i50 million sublimit for letters of credit (the Credit Facility). The proceeds of the loans under the Credit Facility may be used to finance working capital needs and for general corporate purposes.
Any loans under the Credit Facility will have a variable interest rate based on either the eurocurrency rate or the alternate base rate, plus an applicable spread that varies with the
Company’s debt rating. The Credit Agreement includes an option for us to elect to increase the commitments under the Credit Facility or to enter into one or more tranches of term loans in the aggregate principal amount of up to $i250 million, subject to the consent of the lenders providing the additional commitments or term loans, as applicable, and certain other conditions.
The Credit Agreement contains financial and operating covenants. Pursuant
to the Credit Agreement, we are required to maintain a ratio of total debt to annual earnings before interest, taxes, depreciation and amortization (EBITDA), calculated based on the four consecutive fiscal quarters ending with the most recent fiscal quarter, of not greater than i3.50 to 1.00 as of the end of each fiscal quarter. Upon the consummation of any Qualified Acquisition (as defined in the Credit Agreement) and us providing notice to the Administrative Agent, the ratio increases to i4.00
to 1.00 for the fiscal quarter in which the acquisition is consummated and the three consecutive fiscal quarters thereafter. The operating covenants include, among other things, limitations on (i) the incurrence of indebtedness by our subsidiaries, (ii) liens on our and our subsidiaries assets, and (iii) certain fundamental changes and the disposition of assets by us and our subsidiaries. The Credit Agreement contains other customary covenants, representations and warranties, and events of default.
The Credit Facility matures, and all amounts outstanding thereunder become due and payable in full, on March
8, 2026, subject to itwoione-year extensions at our option, the consent of the extending lenders and certain other conditions. We may prepay amounts borrowed and terminate commitments under the Credit Facility at any time without premium
or penalty.
As of October 3, 2021, there were ino borrowings outstanding under the Credit Facility, and we were in compliance with all financial and operating covenants.
Bridge Facility
In advance of the acquisition of GRAIL, we obtained a bridge facility commitment letter from Goldman Sachs
Bank USA for a i364-day senior unsecured bridge loan facility, in an aggregate principal amount of $i1 billion. The bridge facility commitment letter was subject to certain conditions, including consummation of the acquisition pursuant to the GRAIL Merger Agreement. On
March 23, 2021, we terminated the bridge facility commitment letter in conjunction with the issuance of the 2023 and 2031 Term Notes.
(1)In
connection with the GRAIL acquisition, replacement awards of i59,000 RSUs were awarded to GRAIL employees.
//
(2)The
number of units reflect the estimated number of shares to be issued at the end of the performance period. Awarded units are presented net of performance adjustments.
(1)In
connection with the GRAIL acquisition, we issued performance stock options. The number of units reflect awards that have been granted and for which it is assumed to be probable that the underlying performance goals will be achieved.
/
As of October 3, 2021, all outstanding options were exercisable and ino
outstanding performance stock options were exercisable.
Employee Stock Purchase Plan
The price at which common stock is purchased under the Employee Stock Purchase Plan (ESPP) is equal to i85% of the fair market value of the common stock on the first day of the offering period or purchase date, whichever is lower. During
YTD 2021, approximately i0.2 million shares were issued under the ESPP. As of October 3, 2021, there were approximately i13.1
million shares available for issuance under the ESPP.
Share Repurchases
On February 5, 2020, our Board of Directors authorized a new share repurchase program, which supersedes all prior and available repurchase authorizations, to repurchase $i750 million of outstanding common stock. The repurchases may be completed under a 10b5-1 plan or at management’s discretion. We
did inot repurchase any shares during YTD 2021. Authorizations to repurchase approximately $i15
million of our common stock remained available as of October 3, 2021.
Share-based
compensation expense reported in our condensed consolidated statements of income was as follows:
In millions
Q3 2021
Q3 2020
YTD
2021
YTD 2020
Cost of product revenue
$
i7
$
i6
$
i22
$
i13
Cost
of service and other revenue
i1
i1
i3
i3
Research
and development
i193
i21
i243
i48
Selling,
general and administrative
i496
i33
i576
i52
Share-based
compensation expense before taxes
i697
i61
i844
i116
Related
income tax benefits
(i29)
(i12)
(i57)
(i27)
Share-based
compensation expense, net of taxes
$
i668
$
i49
$
i787
$
i89
/
In
connection with the acquisition of GRAIL, we recognized share-based compensation expense of $i615 million in Q3 2021 related to the fair value of accelerated equity awards attributable to the post-combination period, of which $i167 million
was recorded in research and development expense and $i448 million in selling, general and administrative expense. We also recognized $i6 million
of expense in Q3 2021 related to the replacement awards.
In February 2021, we modified the metrics and reduced the maximum potential payouts for our performance stock units granted in 2019 and 2020, which vest at the end of the ithree-year periods ended January 2, 2022 and January 1, 2023, respectively. The modifications affected i52
employees with units granted in 2019, which resulted in total incremental share-based compensation cost of approximately $i41 million, and i72
employees with units granted in 2020, which resulted in total incremental share-based compensation cost of approximately $i65 million.
i
The
assumptions used for the specified reporting periods and the resulting estimates of weighted-average fair value per share for stock purchased under the ESPP during YTD 2021 were as follows:
Employee Stock Purchase Rights
Risk-free interest rate
i0.06%
- i0.12%
Expected volatility
i37%
- i47%
Expected term
i0.5
- i1.0 year
Expected dividends
i0
%
Weighted-average
grant-date fair value per share
$
i134.47
/
As
of October 3, 2021, approximately $i511 million of total unrecognized compensation cost related to restricted stock, performance stock options and ESPP shares issued to date was expected to be recognized over a weighted-average period of approximately i2.0
years.
(a)
iChanges in the reserve for product warranties were as follows:
In
millions
Q3 2021
Q3 2020
YTD 2021
YTD 2020
Balance at beginning of period
$
i16
$
i10
$
i13
$
i14
Additions
charged to cost of product revenue
i5
i6
i20
i11
Repairs
and replacements
(i6)
(i6)
(i18)
(i15)
Balance
at end of period
$
i15
$
i10
$
i15
$
i10
iWe
generally provide a ione-year warranty on instruments. Additionally, we provide a warranty on consumables through the expiration date, which generally ranges from six to itwelve months after the manufacture date. At the time revenue
is recognized, an accrual is established for estimated warranty expenses based on historical experience as well as anticipated product performance. We periodically review the warranty reserve for adequacy and adjust the warranty accrual, if necessary, based on actual experience and estimated costs to be incurred. Warranty expense is recorded as a component of cost of product revenue./
Derivative Financial Instruments
iWe
are exposed to foreign exchange rate risks in the normal course of business and use derivative financial instruments to partially offset this exposure. We do not use derivative financial instruments for speculative or trading purposes. All foreign exchange contracts are carried at fair value in other current assets or accrued liabilities on the condensed consolidated balance sheets.
We use foreign exchange forward contracts to manage foreign currency risks related to monetary assets and liabilities denominated in currencies other than the U.S. dollar. These derivative financial instruments have terms of one month or less and are not designated as hedging instruments. Changes in fair value of these derivatives are
recognized in other income, net, along with the re-measurement gain or loss on the foreign currency denominated assets or liabilities. As of October 3, 2021, we had foreign exchange forward contracts in place to hedge exposures in the euro, Japanese yen, Australian dollar, Canadian dollar, Singapore dollar, Chinese Yuan Renminbi, and British pound. As of October 3, 2021 and January 3, 2021, the total notional amounts of outstanding forward contracts in place for these foreign currency purchases were $i429
million and $i405 million, respectively.
We also use foreign currency forward contracts to hedge portions of our foreign
currency exposure associated with forecasted revenue transactions. These derivative financial instruments have terms up to 24 months and are designated as cash flow hedges. Changes in fair value of our cash flow hedges are recorded as a component of accumulated other comprehensive income and are reclassified to revenue in the same period the underlying hedged transactions are recorded. We regularly review the effectiveness of our cash flow hedges and consider them to be ineffective if it becomes probable that the forecasted transactions will not occur in the identified period. Changes in fair value of the ineffective portions of our cash flow hedges, if any, will be recognized in other income, net. As of October 3, 2021, we had foreign currency forward contracts in place to hedge exposures associated with forecasted revenue
transactions denominated in the euro, Japanese yen, Australian dollar, and Canadian dollar. As of October 3, 2021 and January 3, 2021, the total notional amounts of outstanding cash flow hedge contracts in place for these foreign currency purchases were $i421 million and $i305
million, respectively.
i
8. LEGAL PROCEEDINGS
We are involved in various lawsuits and claims arising in the ordinary course of business, including actions with respect to intellectual property, employment, and contractual matters. In
connection with these matters, we assess, on a regular basis, the probability and range of possible loss based on the developments in these matters. A liability is recorded in the consolidated financial statements if it is believed to be probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly subjective and requires judgments about future events. We regularly review outstanding legal matters to determine the adequacy of the liabilities accrued and related disclosures in consideration of many factors, which include, but are not limited to, past history, scientific and other evidence, and the specifics and status of each matter. We may change our estimates if our assessment of the various factors changes and the amount of ultimate loss may differ from our estimates, resulting in a material effect on our business,
financial condition, results of operations, and/or cash flows.
Acquisition of GRAIL
On March 30, 2021, the Federal Trade Commission (the FTC) filed an administrative complaint and a motion for a preliminary injunction in the United States District Court for the District of Columbia. In both actions, the FTC alleged that our acquisition of GRAIL would violate Section 7 of the Clayton Act, as amended, 15 U.S.C. § 18. We filed an answer to the FTC’s complaint in federal district court on April 6, 2021, and in the administrative court on April 13, 2021. On April 20, 2021, the United States District Court for the District of Columbia granted our motion
to transfer venue to the United States District Court for the Southern District of California. On May 28, 2021, the district court granted the FTC’s motion to dismiss the complaint without prejudice. The administrative trial commenced on August 24, 2021, and live testimony concluded on September 24, 2021. Post-trial briefing deadlines have not yet been scheduled. We intend to vigorously defend the FTC action.
On April 19, 2021, the European Commission accepted a request for a referral of the GRAIL acquisition for European Union merger review, submitted by a Member State of the European Union (France), and joined by several other Member States (Belgium, Greece, Iceland, the Netherlands and Norway), under Article
22(1) of Council Regulation (EC) No 139/2004 (the EU Merger Regulation). On April 29, 2021, we filed an action in the General Court of the European Union (the EU General Court) asking for annulment of the European Commission’s assertion of jurisdiction to review the acquisition under Article 22 of the EU Merger Regulation, as the acquisition does not meet the jurisdictional criteria under the EU Merger Regulation or under the national merger control laws of any Member State of the European Union. The date of our hearing before the General Court has not yet been set. We intend to vigorously challenge the European Commission’s assertion of jurisdiction. See the risk factor “Our acquisition of GRAIL remains subject to ongoing legal and regulatory proceedings in the United States and in the European Union” described in “Risk Factors” for discussion of the risks associated with these proceedings.
We are involved in lawsuits against BGI Genomics Co. Ltd (BGI) and its affiliates, including Complete Genomics, Inc. (CGI), in the United States and elsewhere.
On June 27, 2019, we filed suit against BGI in the United States District Court for the Northern District of California, alleging that certain BGI sequencing products infringe our U.S. Patent No. 7,566,537 (‘537 patent) and U.S. Patent No. 9,410,200 (‘200 patent). BGI has denied our claims and has counterclaimed that our technology infringes U.S. Patent No. 9,944,984 (‘984 patent). We deny their allegations. On February 27, 2020, we filed a second patent
infringement suit against BGI in the United States District Court for the Northern District of California alleging that BGI sequencing products infringed U.S. Patent 7,771,973 (‘973 patent), U.S. Patent 7,541,444 (‘444 patent), and U.S. Patent 10,480,025 (‘025 patent). On June 15, 2020, the Court granted our motions requesting preliminary injunctions against BGI, finding that our patents were likely valid and infringed by BGI’s chemistries. The injunction prohibits the sale of BGI’s sequencers and sequencing reagents in the US. On December 9, 2020, BGI filed a motion to amend its answer to our second suit to include allegations that the ‘444 and ‘937 patents are unenforceable under the doctrine of unequitable conduct; we deny BGI’s allegations. As of April 12, 2021, BGI is seeking approximately $i54 million
in alleged damages and an ongoing royalty of i3.6% on sales of the accused products by us in the United States until the ‘984 patent expires on June 13, 2026. We deny that we owe any damages or ongoing royalty. On August 27, 2021, and September 9, 2021, the Court issued its decisions on the summary judgment motions: (i) the Court granted our motion for summary judgment that we do not infringe BGI’s ‘984
patent; (ii) the Court granted our motion for summary judgment that our ‘444 and ‘973 patents are not unenforceable; (iii) the Court granted our motion for summary judgment that BGI’s standard MPS products infringe all of our patents-in-suit: (iv) the Court granted our motion for summary judgment that BGI’s “Cool MPS” sequencing products infringe the ‘973 and ‘444 patents, and granted BGI’s motion for summary judgment that BGI’s “Cool MPS” sequencing products do not infringe the ‘025 patent; and (v) the Court denied BGI’s motion for summary judgment that our ‘973 patent is invalid for lack of written description and enablement. Trial is scheduled to begin November 15, 2021, on the remaining issues, including BGI’s allegation that our patents are invalid for obviousness, and our claims against BGI for damages and willful infringement.
On January
11, 2021, Complete Genomics, Inc., BGI Americas Corp., and MGI Americas, Inc. also filed a complaint in the United States District Court for the Northern District of California alleging the Company and its subsidiary Illumina Cambridge Ltd. violated federal antitrust and state unfair competition laws. CGI and these affiliates allege that the Company fraudulently withheld a prior art reference that was material to patentability for the ‘444 and ‘973 patents. They also allege that our infringement claims of the ‘025 against BGI’s “CoolMPS” chemistry were objectively baseless. The Company denies the allegations in the complaint. On March 30, 2021, the
Court stayed the antitrust case pending resolution of the underlying patent infringement suit taking place in the same court.
On May 28, 2019, CGI filed suit against us in the United States District Court for the District of Delaware alleging that our two-channel sequencing systems, including the NovaSeq, NextSeq, and MiniSeq systems, infringe certain claims of U.S. Patent No. 9,222,132. We have denied CGI’s allegations and have counterclaimed for infringement by CGI, BGI Americas Corp., and MGI Americas, Inc. of U.S. Patent No. 9,303,290, U.S. Patent No. 9,217,178, and U.S. Patent No. 9,970,055. On August 15, 2019, CGI filed a motion to dismiss our counterclaims. On August 29, 2019, we filed our Opposition to the Motion to Dismiss. The Court denied and
granted the motion in part, denying the motion as to our claims for inducing infringement and granting it for contributory infringement. The Court gave us leave to file an amended complaint to attempt to cure the alleged deficiencies as to contributory infringement. On July 1, 2020, CGI amended its complaint to add claims of infringement of U.S. Patent No. 10,662,473 by our two-channel sequencing systems. We deny these allegations. As of May 12, 2021, CGI is seeking $i225 million
in alleged past damages and an average ongoing royalty of i5.5% on sales of the accused two-channel sequencing instruments and chemistry in the U.S. until the patents-in-suit expire on January 28, 2029. We deny that we owe any damages or ongoing royalty. On October 22, 2021, pursuant to the Court’s local rules, the Company sought leave to file a motion for summary judgment
of non-infringement of the CGI patents-in-suit. CGI sought leave to file a motion for summary judgment against the Company’s invalidity defense based on prior invention. We are awaiting decisions by the Court. Trial is scheduled to begin April 18, 2022.
We will continue to pursue our claims against BGI and CGI, and vigorously defend against BGI’s and CGI’s claims. We currently cannot estimate any possible loss or range of loss that may result from BGI’s and CGI’s claims against us.
Our effective tax rate may vary from the U.S. federal statutory tax rate due to the change in the mix of earnings in tax jurisdictions with different statutory rates, benefits related to tax credits, and the tax impact of non-deductible expenses and other permanent differences between income before income taxes and taxable income.
The
effective tax rates for Q3 2021 and YTD 2021 were i24.7% and i18.6%, respectively. The variance from the U.S. federal statutory tax rate of 21% in Q3 2021 was
primarily attributable to discrete tax expense related to GRAIL Continuation Payments and prior year tax adjustments. Due to the acquisition of GRAIL, the tax treatment of the GRAIL Continuation Payments changed from what was recorded in prior quarters, which resulted in a discrete tax expense being recorded for Q3 2021. The variance from the U.S. federal statutory tax rate of 21% in Q3 2021 was also attributable to the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom.
In YTD 2021, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom. This was partially offset by the discrete tax expense on certain foreign subsidiary
earnings that are no longer indefinitely reinvested, and discrete tax expense due to prior year tax adjustments.
/
i
10. SEGMENT INFORMATION
We
have itwo reportable segments, Core Illumina and GRAIL, as described below. We report segment information based on the management approach, which designates the internal reporting used by the Chief Operating Decision Maker (“CODM”) for making decisions and assessing performance as the source of our reportable segments. The CODM allocates resources and assesses the performance of each operating segment using information about its revenue and income (loss) from operations. We do not allocate expenses between segments.
On
August 18, 2021, we acquired GRAIL in a business combination and it operates as a separate reportable segment. We have included the results of operations of GRAIL in our condensed consolidated statements of operations from the date of acquisition. See note “4. Business Combinations” for further details. Core Illumina sells products and provides services to GRAIL, and vice versa, in accordance with contractual agreements between the entities.
Core Illumina:
Core Illumina’s products and services serve customers in the research, clinical and applied markets, and enable the adoption of a variety of genomic
solutions. Core Illumina includes all of our operations, excluding the results of GRAIL.
GRAIL:
GRAIL is a healthcare company focused on early detection of multiple cancers.
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 2020 and YTD 2020 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 27, 2020.
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 January 3, 2021. 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
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.
On August 18, 2021, we completed our acquisition of GRAIL, a healthcare company focused on life-saving early detection of multiple cancers. GRAIL’s Galleri blood test detects more than 50 different 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 results of operations of GRAIL have been included in our condensed consolidated financial statements from the date of acquisition. The acquisition is subject to ongoing legal proceedings and pending the European Commission’s ongoing merger review. We will hold GRAIL as a separate company during the European Commission’s ongoing merger review. See note “4. Business Combinations” and note “8. Legal Proceedings” 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
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. We expect the COVID-19 pandemic to continue to impact our sales and results of operations in 2021, the size and duration of which is significantly uncertain.
Financial highlights for YTD 2021 included the following:
•Revenue increased 46% in YTD 2021 to $3,327 million compared to $2,286 million in YTD 2020 primarily due to growth in sequencing consumables and instruments, as our customers experience a broader recovery from the COVID-19 pandemic, as well as increases in service and other revenue. We expect our revenue to grow in 2021 compared to 2020.
•Gross
profit as a percentage of revenue (gross margin) was 70.2% in YTD 2021 compared to 68.8% in YTD 2020. The increase in gross margin was driven primarily by higher revenue, which generated increased fixed cost leverage, partially offset by less favorable product mix. 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 (5.0)% in YTD 2021 compared to 19.6% in YTD 2020. The decrease was primarily due to share-based compensation expense
recorded in Q3 2021 related to the acceleration of outstanding equity awards as part of the GRAIL acquisition and an increase in performance-based compensation. We expect our operating expenses to continue to grow on an absolute basis in 2021.
•Our effective tax rate was 18.6% in YTD 2021 compared to 28.4% in YTD 2020. In YTD 2021, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable by the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom. This was partially offset by the discrete tax expense on certain foreign subsidiary earnings that are no longer indefinitely reinvested, and discrete tax expense due to prior year tax adjustments.
•We
ended Q3 2021 with cash, cash equivalents, and short-term investments totaling $1.3 billion as of October 3, 2021, of which approximately $532 million was held by our foreign subsidiaries.
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).
Q3 2021
Q3 2020
YTD 2021
YTD
2020
Revenue:
Product revenue
88.3
%
85.1
%
87.3
%
83.3
%
Service
and other revenue
11.7
14.9
12.7
16.7
Total revenue
100.0
100.0
100.0
100.0
Cost
of revenue:
Cost of product revenue
23.8
26.4
23.5
23.4
Cost of service and other revenue
5.1
6.5
5.4
6.9
Amortization
of acquired intangible assets
1.6
0.9
0.9
0.9
Total cost of revenue
30.5
33.8
29.8
31.2
Gross
profit
69.5
66.2
70.2
68.8
Operating expense:
Research and development
39.4
21.6
25.1
21.1
Selling,
general and administrative
79.3
24.2
50.1
28.1
Total
operating expense
118.7
45.8
75.2
49.2
(Loss) income from operations
(49.2)
20.4
(5.0)
19.6
Other
income (expense):
Interest income
—
0.6
—
1.1
Interest expense
(1.3)
(1.5)
(1.5)
(1.4)
Other
income, net
88.4
7.5
30.4
5.1
Total other income, net
87.1
6.6
28.9
4.8
Income
before income taxes
37.9
27.0
23.9
24.4
Provision for income taxes
9.3
4.5
4.4
6.9
Net
income
28.6
%
22.5
%
19.5
%
17.5
%
_____________
(1)Percentages
may not recalculate due to rounding.
Revenue
Dollars
in millions
Q3 2021
Q3 2020
Change
% Change
YTD 2021
YTD 2020
Change
% Change
Consumables
$
794
$
562
$
232
41
%
$
2,347
$
1,618
$
729
45
%
Instruments
184
114
70
61
556
286
270
94
Total product revenue
978
676
302
45
2,903
1,904
999
52
Service
and other revenue
130
118
12
10
424
382
42
11
Total revenue
$
1,108
$
794
$
314
40
%
$
3,327
$
2,286
$
1,041
46
%
Service
and other revenue primarily consists of revenue generated from genotyping and sequencing services, instrument service contracts, and development and licensing agreements, as well as cancer detection services related to the GRAIL business, which totaled approximately $2 million in Q3 2021 and YTD 2021.
The increases in consumables revenue in Q3 2021 and YTD 2021 were primarily due to increases in sequencing consumables revenue of $223 million and $683 million, respectively, driven
primarily by growth in the instrument installed base, as our customers experience a broader recovery from the COVID-19 pandemic. Instruments revenue increased in Q3 2021 and YTD 2021 primarily due to increases in sequencing instruments revenue of $71 million and $268 million, respectively, which were driven primarily by increased shipments of our NovaSeq and NextSeq instruments. Service and other revenue increased in Q3 2021, primarily due to increased revenue from extended maintenance service contracts and sequencing services. Service and other revenue increased in YTD 2021, primarily due to increased revenue from extended maintenance service contracts, a patent litigation settlement in Q2 2021, and sequencing services, partially offset
by a decrease in development and licensing agreements.
Gross Margin
Dollars
in millions
Q3 2021
Q3 2020
Change
% Change
YTD 2021
YTD 2020
Change
% Change
Gross profit:
Core
Illumina
$
781
$
526
$
255
48
%
$
2,348
$
1,573
$
775
49
%
GRAIL
(11)
—
(11)
100
(11)
—
(11)
100
Total
gross profit
$
770
$
526
$
244
46
%
$
2,337
$
1,573
$
764
49
%
Gross
margin:
Core Illumina
70.7
%
66.2
%
70.6
%
68.8
%
GRAIL
*
—
*
—
Consolidated
gross margin
69.5
%
66.2
%
70.2
%
68.8
%
_____________
*Not meaningful.
Core
Illumina gross margin increases in Q3 2021 and YTD 2021 were driven primarily by higher revenue, which generated increased fixed cost leverage, partially offset by less favorable product mix. The increase in YTD 2021 was also driven by increased revenue from a patent litigation settlement in Q2 2021.
GRAIL gross margin, for the period subsequent to the acquisition, primarily included amortization of intangible assets of $12 million.
Core Illumina R&D expense increased by $40 million, or 23%, in Q3 2021 and by $128 million, or 27%, in YTD 2021 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 an increase in performance-based compensation.
GRAIL R&D expense, for the period subsequent to the acquisition, consisted primarily of $167 million of share-based compensation expense related to the acceleration of outstanding equity awards as part of the acquisition, as well as other compensation costs related to the acquisition, and expenses related to headcount and clinical trials.
Core Illumina SG&A expense increased by $173 million, or 90%, in Q3 2021 primarily due to
expenses related to our acquisition of GRAIL, including a $35 million Continuation Payment paid to GRAIL prior to the close of the acquisition, and increases in headcount, performance-based compensation, and outside services. Core Illumina SG&A expense increased by $509 million, or 79%, in YTD 2021, primarily due to expenses related to our acquisition of GRAIL, including $245 million in Continuation Payments paid to GRAIL prior to the close of the acquisition, and increases in headcount, performance-based compensation, and outside services, partially offset by expenses for fees and other payments to PacBio of $92 million in Q1 2020.
GRAIL SG&A expense, for the period subsequent to the acquisition, consisted primarily of $448 million of share-based compensation expense related to the acceleration of outstanding equity awards as part of the acquisition, as well as other compensation and transaction
costs related to the acquisition, and expenses related to headcount.
Other Income, Net
Dollars
in millions
Q3 2021
Q3 2020
Change
% Change
YTD 2021
YTD 2020
Change
% Change
Interest
income
$
—
$
5
$
(5)
(100)
%
$
—
$
26
$
(26)
(100)
%
Interest
expense
(14)
(11)
(3)
27
(48)
(33)
(15)
45
Other
income, net
979
59
920
1,559
1,010
117
893
763
Total
other income, net
$
965
$
53
$
912
1,721
%
$
962
$
110
$
852
775
%
Total
other income, net relates to the Core Illumina segment. Interest income decreased in Q3 2021 and YTD 2021 as a result of selling all of our available-for-sale debt securities in Q1 2021. Interest expense consists primarily of accretion of discount on our convertible senior notes. The increases in Q3 2021 and YTD 2021 relate to accrued interest on our Term Notes. The increase in YTD 2021 interest expense also relates to amortization of debt issuance costs on our Bridge Facility, which we terminated in Q1 2021. The increases in other income, net, in Q3 2021 and YTD 2021 were primarily due to the gain of $900 million from our previously held investment in GRAIL as part of the acquisition, fair value adjustments to our Helix contingent value right, and a $26 million gain recorded on our derivative assets related to the terminated PacBio acquisition in Q1 2021. The increase in YTD 2021 was partially offset by lower unrealized gains on marketable equity securities compared
to YTD 2020.
Our effective tax rate was 24.7% in Q3 2021 compared to 16.8% in Q3 2020. The variance from the U.S. federal statutory tax rate of 21% in Q3 2021 was primarily attributable to discrete tax expense related to GRAIL Continuation Payments and prior year tax adjustments. Due to the acquisition of GRAIL, the tax treatment of the GRAIL Continuation Payments changed from what was recorded in prior quarters, which resulted in a discrete tax expense being recorded for Q3 2021. The variance from the U.S. federal statutory tax rate of 21% in Q3 2021 was also attributable to the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom. In Q3 2020, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to the mix of earnings in jurisdictions with lower statutory
tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom, and discrete tax benefits due to prior year tax adjustments and uncertain tax positions.
Our effective tax rate was 18.6% in YTD 2021 compared to 28.4% in YTD 2020. In YTD 2021, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom. This was partially offset by the discrete tax expense on certain foreign subsidiary earnings that are no longer indefinitely reinvested, and discrete tax expense due to prior year tax adjustments. In YTD 2020, the variance from the U.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
for California 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 the U.S. federal statutory tax rate, such as in Singapore and the United 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.
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” described in “Risk Factors” within the Business and Market Information section
of our Annual Report on Form 10-K for the fiscal year ended January 3, 2021.
LIQUIDITY AND CAPITAL RESOURCES
At October 3, 2021, we had approximately $1.1 billion in cash and cash equivalents, of which approximately $532 million was held by our foreign subsidiaries. Cash and cash equivalents decreased by $0.7 billion from January 3,
2021, 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. During YTD 2021, we sold all of our available-for-sale debt securities and a portion of our marketable equity securities to fund the GRAIL acquisition. As of October 3, 2021, we had $185 million remaining in short-term investments.
On
August 18, 2021, we acquired GRAIL for total cash and other consideration of $9.8 billion, which included cash of $2.9 billion and $762 million in fair value of contingent consideration in the form of a contingent value right. As of October 3, 2021, the fair value of the contingent consideration was $754 million. The cash consideration was funded using existing cash of both Illumina and GRAIL, including the $1 billion in capital raised in Q1 2021 through the issuance of term debt. The contingent value rights entitle the holders to receive future payments representing a pro rata portion of certain 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. Prior to the acquisition,
we were required to make monthly Continuation Payments to GRAIL of $35 million through the earlier of the consummation of the acquisition or termination of the GRAIL Merger Agreement, subject to certain exceptions. We made a Continuation Payment to GRAIL totaling $35 million in Q3 2021. Subsequent to the acquisition, we did not make any additional monthly payments.
On March 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 net proceeds from the issuance were $992 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 on March 23 and September 23 of each year. The 2023 Term Notes mature on March 23, 2023 and the 2031 Term Notes mature on March 23, 2031. We may redeem for cash all or any portion of the Term Notes, at our option, at any time prior to maturity.
On March 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, on March 8, 2026, subject to two one-year extensions at our option and the consent of the extending lenders and certain other conditions. As of October 3, 2021, there were no borrowings outstanding under the Credit Facility.
Our 2021 Convertible Notes matured on June 15, 2021, by which time the $517 million in principal had been converted and was repaid in cash. The excess of the conversion value over the principal amount was paid in shares of common stock. Our convertible senior notes due in 2023 were not convertible as of October 3, 2021.
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.
On February 5, 2020, our Board of Directors authorized a new share repurchase program, which supersedes all prior and available repurchase authorizations, to repurchase $750 million of outstanding common stock. The repurchases may be completed under a 10b5-1 plan or at management’s discretion. Authorizations to repurchase $15 million of our common stock remained available as of October 3, 2021. We do not intend to make any share repurchases during fiscal year 2021.
We
had $23 million and up to $122 million, respectively, remaining in our capital commitments to two venture capital investment funds as of October 3, 2021 that are callable through April 2026 and July 2029, respectively.
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.
Net cash provided by (used in) financing activities
78
(435)
Effect
of exchange rate changes on cash and cash equivalents
(2)
—
Net decrease in cash and cash equivalents
$
(730)
$
(281)
Operating Activities
Net cash provided by operating activities in YTD 2021 primarily consisted of net income of $650 million less net adjustments of $220 million and net changes in operating assets and liabilities of $167 million. The
primary adjustments to net income included a gain on our previously held investment in GRAIL of $900 million, deferred income taxes of $81 million, a gain on our Helix contingent value right of $30 million, and a gain on derivative assets related to a terminated acquisition of $26 million, partially offset by share-based compensation of $656 million, depreciation and amortization expenses of $162 million, and accretion of debt discount on convertible senior notes of $26 million. Cash flow impact from changes in net operating assets and liabilities were primarily driven by increases in accounts receivable, other assets, prepaid expenses, and inventory and a decrease in accounts payable, partially offset by an increase in accrued liabilities.
Investing Activities
Net cash used in investing activities totaled $1,069 million in YTD 2021. We
paid net $2,444 million for acquisitions, invested $138 million in capital expenditures, primarily associated with our investment in facilities, purchased $77 million of available-for-sale debt securities, and purchased $44 million of strategic investments during the period. We received $1,362 million related to maturities and sales of our available-for-sale debt securities during the period, $220 million for sales of strategic investments and $52 million from PacBio for repayment of Continuation Advances.
Financing Activities
Net cash provided by financing activities totaled $78 million in YTD 2021. We received $988 million in net proceeds from the issuance of debt and $59 million in proceeds from the sale of shares under our employee stock purchase plan and the issuance of common stock through the exercise of stock options. We made payments
on our convertible senior notes due in 2021 of $517 million and used $452 million to pay taxes related to net share settlement of equity awards, of which $419 million was for taxes paid for the common stock issued related to the GRAIL acquisition.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our condensed consolidated financial statements, we make estimates, assumptions and judgments that can have a significant impact on our net revenue, operating income and net income, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described in “Critical Accounting Policies and Estimates” within the
Management’s Discussion & Analysis section of our Annual Report on Form 10-K for the fiscal year ended January 3, 2021 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates. Though the impact of the COVID-19 pandemic to our business and operating results presents additional uncertainty, we continue to use the best information available to inform our critical accounting estimates. For our policy on business combinations, see the significant accounting policies under note “1. Organization and Significant Accounting Policies”. There
were no other material changes to our critical accounting policies and estimates during YTD 2021.
We do not participate in any transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. During YTD 2021, we were not involved in any “off-balance sheet arrangements” within the meaning of the rules of the Securities
and Exchange Commission.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There were no substantial changes to our market risks in YTD 2021, when compared to the disclosures in ”Quantitative and Qualitative Disclosures about Market Risk” within the Management’s Discussion & Analysis section of our Annual Report on Form 10-K for the fiscal year ended January 3, 2021.
OTHER
KEY INFORMATION
CONTROLS AND PROCEDURES
We design our internal controls to provide reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported in conformity with U.S. generally accepted accounting principles. We also maintain internal controls and procedures to ensure that we comply with applicable laws and our established financial policies.
Based on management’s evaluation (under the supervision and with the participation of our chief executive officer (CEO) and chief financial officer (CFO)), as of the end of the period covered by this report, our CEO and CFO concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
During Q3 2021, we continued to monitor and evaluate the design and operating effectiveness of key controls, including the impact of the COVID-19 pandemic on our internal control environment. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that materially affected
or are reasonably likely to materially affect internal control over financial reporting.
Our
business is subject to various risks, including those described in “Risk Factors” within the Business and Market Information Section of our Annual Report on Form 10-K for the fiscal year ended January 3, 2021, which we strongly encourage you to review. In addition to the risk factors disclosed in our Form 10-K, the issues raised in the following risk factors could adversely affect our operating results and stock price:
Our acquisition of GRAIL remains subject to ongoing legal and regulatory proceedings in the United States and in the European Union. Adverse decisions by the EU General Court, the European Commission, the FTC and/or other governmental or regulatory authorities and/or other adverse consequences resulting from our decision to proceed with the completion of the acquisition, could result in significant financial penalties, operational restrictions, increased costs or loss of revenues or require us to divest all or a portion of the assets or equity interests of GRAIL on terms that are materially worse than the terms on which we acquired GRAIL, any or all of which, individually or in the aggregate, could have a material adverse effect on our business, financial condition and results of operation.
As previously disclosed,
on March 30, 2021, the U.S. Federal Trade Commission (the FTC) filed an administrative complaint alleging that our acquisition of GRAIL (the Acquisition) would violate Section 7 of the Clayton Act, as amended, 15 U.S.C. § 18. We filed an answer to the FTC’s complaint in the administrative court on April 13, 2021, and the administrative trial commenced on August 24, 2021. At the effective time of the mergers, no legal prohibition on the consummation of the Acquisition was in effect in the United States. We intend to vigorously defend against the FTC’s action.
As previously disclosed, on April 19, 2021, the European Commission accepted a request for referral of the Acquisition (the Referral) for European Union
merger review under Article 22(1) of Council Regulation (EC) No 139/2004 (the EU Merger Regulation), which had been submitted by a Member State of the European Union. The European Commission had previously notified us asserting that as a result of the Referral, pursuant to Article 22(4) of the EU Merger Regulation, we were prohibited from implementing the Acquisition (i) until the European Commission clears the Acquisition under the EU Merger Regulation or (ii) until the European Commission refuses the Referral, and therefore the European Commission’s acceptance of the Referral continued the purported standstill on the completion of the Acquisition until such time as the European Commission completes its review and approves the Acquisition. On April 29, 2021, we filed an action in the General Court of the European Union (the EU General Court) asking for annulment of the European Commission’s decision asserting jurisdiction
to review the Acquisition under Article 22 of the EU Merger Regulation, as the Acquisition does not meet the jurisdictional criteria under the EU Merger Regulation or under the national merger control laws of any Member State of the European Union. The date of the hearing before the EU General Court has not yet been set. We intend to vigorously challenge the European Commission’s assertion of jurisdiction to review the Acquisition.
As previously disclosed, on July 22, 2021, the European Commission announced it had initiated a Phase II review of the Acquisition. The duration of the Phase II review cannot be foreseen with certainty. As of the completion of the Acquisition, the European Commission’s purported standstill on such completion, the validity and appropriateness of which we are challenging, had not been suspended or overturned. We continue to work
with the European Commission on its review and had voluntarily offered to enter into a hold separate arrangement with the European Commission with respect to GRAIL and its operations pending the resolution of the action in the EU General Court and/or completion of the European Commission’s review. On October 29, 2021, the European Commission adopted an order imposing interim measures r (the Interim Measures Order), which provided that (i) we ensure that Illumina and GRAIL will continue to operate as independent legal entities that transact at arms’ length, no integration activity will take place, the day-to-day operation of GRAIL will remain the sole responsibility of GRAIL’s management and our management will have no involvement in or influence over GRAIL, (ii) we take certain supportive measures to preserve GRAIL’s viability, marketability and competitiveness, including with respect to the provision of resources to
GRAIL and the retention and/or replacement of key personnel of GRAIL, (iii) subject to limited exceptions, we implement all necessary measures to ensure that Illumina does not obtain any confidential information relating to GRAIL during the hold separate period and vice versa and (iv) we *appoint an independent firm as monitoring trustee to monitor our compliance with the Interim Measures Order. Such hold separate arrangement, and our obligations pursuant thereto, may be burdensome to implement and administer, and will likely require us to incur additional costs and/or liabilities, any or all of which could result in loss of revenue and other adverse effects on our business, financial condition and results of operations. Further, our failure to comply with the terms of the Interim Measures Order may result in the European Commission seeking to impose fines or other penalties on us.
As a result of our decision to proceed with the completion of the Acquisition during the pendency of the European Commission’s review, the European Commission will likely seek to impose a fine on us pursuant to Article 14(2)(b) of the EU Merger Regulation of up to 10% of our consolidated annual revenues. In addition, the European Commission, the FTC and/or other governmental or regulatory authorities may seek to impose other fines, penalties, remedies or restrictions. We intend to vigorously defend against any such fines, penalties, remedies or restrictions, but we cannot predict the scope or severity thereof or the outcome of any related proceedings. We also cannot predict what other adverse consequences to, among other things, our reputation, our relationships with governmental or regulatory authorities or our ability to successfully complete future acquisitions and/or
divestitures may result from our decision to proceed with the completion of the Acquisition. We will hold the assets or equity interests of GRAIL separate for some period of time, and such delay in integration may materially and adversely affect the synergies and other benefits we expect to achieve as a result of the Acquisition and could result in additional costs or liabilities, loss of revenue and other adverse effects on our business, financial condition and results of operations.
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* Certain schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K.A copy of any omitted schedule or exhibit will be furnished supplementally to the SEC upon request.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
