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SEC Filing Form Details

ILLUMINA INC filed this form on 10/24/2018

Form 10-Q
Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2018
 
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from             to            
Commission File Number 001-35406 
Illumina, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
33-0804655
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
5200 Illumina Way,
San Diego, CA
 
92122
(Address of principal executive offices)
 
(Zip Code)
(858) 202-4500
(Registrant’s telephone number, including area code)
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.    Yes   þ    No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes   þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
þ
 
Accelerated filer
¨
 
 
 
 
 
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
 
 
 
 
 
Emerging growth company
¨
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. o    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No   þ

As of October 19, 2018, there were 147 million shares of the registrant’s common stock outstanding.




ILLUMINA, INC.
INDEX
 
 
Page
 
 


2


PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.

ILLUMINA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)
 
 
September 30,
2018
 
December 31,
2017
 
(Unaudited)
 
 
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
1,346

 
$
1,225

Short-term investments
2,043

 
920

Accounts receivable, net
433

 
411

Inventory
374

 
333

Prepaid expenses and other current assets
66

 
91

Total current assets
4,262

 
2,980

Property and equipment, net
1,060

 
931

Goodwill
831

 
771

Intangible assets, net
195

 
175

Deferred tax assets
86

 
88

Other assets
325

 
312

Total assets
$
6,759

 
$
5,257

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Accounts payable
$
156

 
$
160

Accrued liabilities
450

 
432

Build-to-suit lease liability
22

 
144

Long-term debt, current portion
1,107

 
10

Total current liabilities
1,735

 
746

Long-term debt
860

 
1,182

Other long-term liabilities
352

 
360

Redeemable noncontrolling interests
218

 
220

Stockholders’ equity:
 
 
 
Preferred stock

 

Common stock
2

 
2

Additional paid-in capital
3,093

 
2,833

Accumulated other comprehensive loss
(2
)
 
(1
)
Retained earnings
2,872

 
2,256

Treasury stock, at cost
(2,462
)
 
(2,341
)
Total Illumina stockholders’ equity
3,503

 
2,749

Noncontrolling interests
91

 

Total stockholders’ equity
3,594

 
2,749

Total liabilities and stockholders’ equity
$
6,759

 
$
5,257

See accompanying notes to condensed consolidated financial statements.


3


ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In millions, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
Revenue:
 
 
 
 
 
 
 
Product revenue
$
710

 
$
596

 
$
2,011

 
$
1,631

Service and other revenue
143

 
118

 
455

 
344

Total revenue
853

 
714

 
2,466

 
1,975

Cost of revenue:
 
 
 
 
 
 
 
Cost of product revenue
184

 
173

 
540

 
508

Cost of service and other revenue
62

 
50

 
190

 
153

Amortization of acquired intangible assets
10

 
9

 
26

 
30

Total cost of revenue
256

 
232

 
756

 
691

Gross profit
597

 
482

 
1,710

 
1,284

Operating expense:
 
 
 
 
 
 
 
Research and development
159

 
134

 
447

 
409

Selling, general and administrative
197

 
167

 
577

 
499

Total operating expense
356

 
301

 
1,024

 
908

Income from operations
241

 
181

 
686

 
376

Other income (expense):
 
 
 
 
 
 
 
Interest income
14

 
4

 
31

 
13

Interest expense
(15
)
 
(10
)
 
(37
)
 
(26
)
Other (expense) income, net
(8
)
 

 
5

 
457

Total other (expense) income, net
(9
)
 
(6
)
 
(1
)
 
444

Income before income taxes
232

 
175

 
685

 
820

Provision for income taxes
44

 
23

 
100

 
199

Consolidated net income
188

 
152

 
585

 
621

Add: Net loss attributable to noncontrolling interests
11

 
11

 
31

 
37

Net income attributable to Illumina stockholders
$
199

 
$
163

 
$
616

 
$
658

Net income attributable to Illumina stockholders for earnings per share
$
199

 
$
163

 
$
616

 
$
657

Earnings per share attributable to Illumina stockholders:
 
 
 
 
 
 
 
Basic
$
1.35

 
$
1.12

 
$
4.20

 
$
4.49

Diluted
$
1.33

 
$
1.11

 
$
4.15

 
$
4.45

Shares used in computing earnings per share:
 
 
 
 
 
 
 
Basic
147

 
146

 
147

 
146

Diluted
149

 
148

 
148

 
148

See accompanying notes to condensed consolidated financial statements.


4


ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In millions)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
Consolidated net income
$
188

 
$
152

 
$
585

 
$
621

Unrealized (loss) gain on available-for-sale debt securities, net of deferred tax
(1
)
 
1

 
(1
)
 
1

Total consolidated comprehensive income
187

 
153

 
584

 
622

Add: Comprehensive loss attributable to noncontrolling interests
11

 
11

 
31

 
37

Comprehensive income attributable to Illumina stockholders
$
198

 
$
164

 
$
615

 
$
659

See accompanying notes to condensed consolidated financial statements.


5


ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
(In millions)
 
Illumina Stockholders
 
 
 
 
 
 
 
Additional
 
Accumulated Other
 
 
 
 
 
 
 
Total
 
Common
 
Paid-In
 
Comprehensive
 
Retained
 
Treasury
 
Noncontrolling
 
Stockholders’
 
Stock
 
Capital
 
Loss
 
Earnings
 
Stock
 
Interests
 
Equity
Balance as of December 31, 2017
$
2

 
$
2,833

 
$
(1
)
 
$
2,256

 
$
(2,341
)
 
$

 
$
2,749

Net income (loss)

 

 

 
616

 

 
(6
)
 
610

Unrealized loss on available-for-sale debt securities, net of deferred tax

 

 
(1
)
 

 

 

 
(1
)
Issuance of common stock, net of repurchases

 
45

 

 

 
(121
)
 

 
(76
)
Share-based compensation

 
145

 

 

 

 

 
145

Adjustment to the carrying value of redeemable noncontrolling interests

 
(21
)
 

 

 

 

 
(21
)
Issuance of convertible senior notes, net of tax impact

 
93

 

 

 

 

 
93

Contributions from noncontrolling interest owners

 

 

 

 

 
92

 
92

Issuance of subsidiary shares

 

 

 

 

 
5

 
5

Vesting of redeemable equity awards

 
(2
)
 

 

 

 

 
(2
)
Balance as of September 30, 2018
$
2

 
$
3,093

 
$
(2
)
 
$
2,872

 
$
(2,462
)
 
$
91

 
$
3,594


See accompanying notes to condensed consolidated financial statements.


6


ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
Cash flows from operating activities:
 
 
 
Consolidated net income
$
585

 
$
621

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Gain on deconsolidation of GRAIL

 
(453
)
Depreciation expense
100

 
81

Amortization of intangible assets
29

 
36

Share-based compensation expense
146

 
123

Accretion of debt discount
26

 
23

Deferred income taxes
(32
)
 
53

Impairment of intangible assets

 
23

Other

 
(2
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(24
)
 
1

Inventory
(40
)
 
(27
)
Prepaid expenses and other current assets
7

 
14

Other assets
(9
)
 
(3
)
Accounts payable
13

 
12

Accrued liabilities
45

 
56

Other long-term liabilities
(4
)
 
23

Net cash provided by operating activities
842

 
581

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(2,352
)
 
(359
)
Sales of available-for-sale securities
520

 
314

Maturities of available-for-sale securities
710

 
181

Net cash paid for acquisitions
(100
)
 

Proceeds from sale of GRAIL securities

 
278

Deconsolidation of GRAIL cash

 
(52
)
Net purchases of strategic investments
(12
)
 
(25
)
Purchases of property and equipment
(231
)
 
(234
)
Cash paid for intangible assets

 
(2
)
Net cash (used in) provided by investing activities
(1,465
)
 
101

Cash flows from financing activities:
 
 
 
Payments on financing obligations
(3
)
 
(7
)
Payments on acquisition related contingent consideration liability

 
(3
)
Proceeds from issuance of debt, net
735

 
5

Common stock repurchases
(103
)
 
(176
)
Taxes paid related to net share settlement of equity awards
(18
)
 
(28
)
Proceeds from issuance of common stock
45

 
63

Contributions from noncontrolling interest owners
92

 
79

Net cash provided by (used in) financing activities
748

 
(67
)
Effect of exchange rate changes on cash and cash equivalents
(4
)
 
4

Net increase in cash and cash equivalents
121

 
619

Cash and cash equivalents at beginning of period
1,225

 
735

Cash and cash equivalents at end of period
$
1,346

 
$
1,354


See accompanying notes to condensed consolidated financial statements.

7


Illumina, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Unless the context requires otherwise, references in this report toIllumina,” “we,” “us,” the “Company,” and “our” refer to Illumina, Inc. and its consolidated subsidiaries.

1. Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation

The 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 December 31, 2017, 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. Actual results could differ from those estimates.

The unaudited condensed consolidated financial statements include our accounts, our wholly-owned subsidiaries, majority-owned or controlled companies, and variable interest entities (VIEs) for which we are the primary beneficiary. All intercompany transactions and balances have been eliminated in consolidation. In management’s opinion, the accompanying 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 evaluate our ownership, contractual, and other interests in entities that are not wholly-owned to determine if these entities are VIEs, and, if so, whether we are the primary beneficiary of the VIE. In determining whether we are the primary beneficiary of a VIE and therefore required to consolidate the VIE, a qualitative approach is applied that determines whether we have both (1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (2) the obligation to absorb losses of, or the rights to receive benefits from, the VIE that could potentially be significant to that VIE. We continuously assess whether we are the primary beneficiary of a VIE, as changes to existing relationships or future transactions may result in the consolidation or deconsolidation of such VIE. During the nine months ended September 30, 2018, our consolidated VIE, Helix, received additional cash contributions from us and third-party investors in exchange for voting equity interests in Helix. Therefore, we reassessed and concluded that Helix continued to be a variable interest entity and that we remained the primary beneficiary. During the periods presented, we have not provided any other financial or other support to our VIEs that we were not contractually required to provide.

The equity method is used to account for investments in which we have the ability to exercise significant influence, but not control, over the investee. Such investments are recorded within other assets, and the share of net income or losses of equity investments is recognized on a one quarter lag in other (expense) income, net.

Redeemable Noncontrolling Interests

Noncontrolling interests represent the portion of equity (net assets) in Helix, our consolidated but not wholly-owned entity, that is neither directly nor indirectly attributable to us. Noncontrolling interests with embedded contingent redemption features, such as put rights, that are not solely within our control are considered redeemable noncontrolling interests. Redeemable noncontrolling interests are presented outside of stockholders’ equity on the condensed consolidated balance sheets.

Fiscal Year

Our 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. The three and nine months ended September 30, 2018 and October 1, 2017 were both 13 and 39 weeks, respectively.

8



Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.

Significant Accounting Policies

During the three and nine months ended September 30, 2018, there have been no changes to our significant accounting policies as described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, except as described below.

Recently Adopted Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The new standard is based on the principle that revenue should be recognized in an amount that reflects the consideration to which we expect to be entitled in exchange for the transfer of promised goods or services. We adopted Topic 606 using the modified retrospective transition method. The cumulative effect of applying the new revenue standard to all incomplete contracts as of January 1, 2018 was not material and, therefore, did not result in an adjustment to retained earnings. There was no material difference to the condensed consolidated financial statements for the three and nine months ended September 30, 2018 due to the adoption of Topic 606.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10), which requires equity investments (other than those accounted for under the equity method or those that result in consolidation) to be measured at fair value, with changes in fair value recognized in net income. This standard was effective for us beginning in the first quarter of 2018. Based on our elections, our strategic equity investments that do not have readily determinable fair values and do not qualify for the net asset value practical expedient for estimating fair value are measured at cost, less any impairments, plus or minus changes resulting from observable price changes in orderly transactions for identifiable or similar investments of the same issuer. The measurement alternative was applied prospectively and did not result in an adjustment to retained earnings.

Recently Issued Accounting Pronouncements

In February 2016, the FASB issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). The new standard requires lessees to recognize most leases on their balance sheet as lease liabilities with corresponding right-of-use assets. ASU 2016-02 is effective for us beginning in the first quarter of 2019 and will be adopted on a modified retrospective basis by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption; we will continue to report comparative periods under the current lease accounting standard. We are currently designing and implementing changes to our systems, processes, policies, and controls for lease accounting, including implementation of a third-party software application, to help us comply with the standard. We expect to elect the standard’s package of practical expedients on adoption, which allows us to carry forward our historical assessment of whether existing agreements contain a lease and the classification of our existing lease agreements. We do not expect to elect the standard’s available hindsight practical expedient on adoption. While we continue to review our existing lease agreements and assess the effects of adoption, we believe the new standard will have a material effect on our consolidated financial statements and disclosures. We expect substantially all of our real-estate operating lease commitments will be recognized as lease liabilities with corresponding right-of-use assets, resulting in a significant increase in the assets and liabilities on the consolidated balance sheet upon adoption. We are currently evaluating the impact of Topic 842 on the consolidated financial statements as it relates to other aspects of our business.

In June 2016, the FASB issued Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which amends the impairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables and available-for-sale debt securities. The standard is effective for us beginning in the first quarter of 2020, with early adoption permitted.  We are currently evaluating the expected impact of ASU 2016-13 on our consolidated financial statements.


9


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 and instrument service contracts.

We recognize revenue when control of our products and services is transferred to our customers in an amount that reflects the consideration we expect to receive from our customers in exchange for those products and services. This process involves identifying the contract with a customer, determining the performance obligations in the contract, determining the contract price, allocating the contract price to the distinct performance obligations in the contract, and recognizing revenue when the performance obligations have been satisfied. A performance obligation is considered distinct from other obligations in a contract when it provides a benefit to the customer either on its own or together with other resources that are readily available to the customer and is separately identified in the contract. We consider a performance obligation satisfied once we have transferred control of a good or service to the customer, meaning the customer has the ability to use and obtain the benefit of the good or service. We recognize revenue for satisfied performance obligations only when we determine there are no uncertainties regarding payment terms or transfer of control.

Revenue from product sales is recognized generally upon delivery to the end customer, which is when control of the product is deemed to be transferred. Invoicing typically occurs upon shipment; the term between invoicing and when payment is due is not significant. In instances where right of payment or transfer of title is contingent upon the customer’s acceptance of the product, revenue is deferred until all acceptance criteria have been met. Revenue from instrument service contracts is recognized as the services are rendered, typically evenly over the contract term. Revenue from genotyping and sequencing services is recognized when earned, which is generally at the time the genotyping or sequencing analysis data is made available to the customer or agreed-upon milestones are reached.

Revenue is recorded net of discounts, distributor commissions, and sales taxes collected on behalf of governmental authorities. Employee sales commissions are recorded as selling, general and administrative expenses when incurred as the amortization period for such costs, if capitalized, would have been one year or less.

We regularly enter into contracts with multiple performance obligations. Such obligations are generally satisfied within a short time frame, approximately three to six months, after the contract execution date. Revenue recognition for contracts with multiple deliverables is based on the separate, distinct performance obligations within the contract. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less, and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

The contract price is allocated to each performance obligation in proportion to its standalone selling price. We determine our best estimate of standalone selling price using average selling prices over a rolling 12-month period coupled with an assessment of current market conditions. If the product or service has no history of sales or if the sales volume is not sufficient, we rely upon prices set by our pricing committee, adjusted for applicable discounts.

Contract liabilities, which consist of deferred revenue and customer deposits, as of September 30, 2018 and December 31, 2017 were $181 million, of which the short-term portions of $154 million and $150 million, respectively, were recorded in accrued liabilities and the remaining long-term portions were recorded in other long-term liabilities. Revenue recorded in the three and nine months ended September 30, 2018 included $26 million and $128 million of previously deferred revenue that was included in contract liabilities as of December 31, 2017. Contract assets as of September 30, 2018 and December 31, 2017 were not material.

In certain markets, products and services are sold to customers through distributors. In most sales through distributors, the product is delivered directly to customers. The terms of sales transactions through distributors are consistent with the terms of direct sales to customers.

10



The following tables represent revenue by source (in millions):
 
Three Months Ended
 
September 30,
2018
 
October 1,
2017
 
Sequencing
 
Microarray
 
Total
 
Sequencing
 
Microarray
 
Total
Consumables
$
467

 
$
83

 
$
550

 
$
380

 
$
71

 
$
451

Instruments
138

 
16

 
154

 
128

 
12

 
140

Other product
5

 
1

 
6

 
5

 

 
5

Total product revenue
610

 
100

 
710

 
513

 
83

 
596

Service and other revenue
109

 
34

 
143

 
80

 
38

 
118

Total revenue
$
719

 
$
134

 
$
853

 
$
593

 
$
121

 
$
714

 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
Sequencing
 
Microarray
 
Total
 
Sequencing
 
Microarray
 
Total
Consumables
$
1,340

 
$
255

 
$
1,595

 
$
1,036

 
$
204

 
$
1,240

Instruments
372

 
26

 
398

 
353

 
23

 
376

Other product
16

 
2

 
18

 
14

 
1

 
15

Total product revenue
1,728

 
283

 
2,011

 
1,403

 
228

 
1,631

Service and other revenue
312

 
143

 
455

 
235

 
109

 
344

Total revenue
$
2,040

 
$
426

 
$
2,466

 
$
1,638

 
$
337

 
$
1,975


Revenue related to our Consolidated VIEs is included in sequencing services and other revenue.

The following table represents revenue by geographic area, based on region of destination (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
Americas (1)
$
474

 
$
417

 
$
1,380

 
$
1,153

Europe, Middle East, and Africa
219

 
165

 
615

 
443

Greater China (2)
102

 
87

 
288

 
221

Asia-Pacific
58

 
45

 
183

 
158

Total revenue
$
853

 
$
714

 
$
2,466

 
$
1,975

____________________________________
(1) Revenue for the Americas region included United States revenue of $455 million and $1,316 million, respectively, for the three and nine months ended September 30, 2018 and $397 million and $1,096 million, respectively, for the three and nine months ended October 1, 2017.
(2) Revenue for the Greater China region, which consists of China, Taiwan, and Hong Kong, is reported separately from the Asia-Pacific region.

Earnings per Share

Basic earnings per share attributable to Illumina stockholders is computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share attributable to Illumina stockholders is computed based on the sum of the weighted average number of common shares and potentially dilutive common shares outstanding during the period. Per-share earnings of our VIEs are included in the consolidated basic and diluted earnings per share computations based on our share of the VIE’s securities.

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

11


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.

The following is the calculation of weighted average shares used to calculate basic and diluted earnings per share (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
Weighted average shares outstanding
147

 
146

 
147

 
146

Effect of potentially dilutive common shares from:
 
 
 
 
 
 
 
Convertible senior notes
1

 

 

 

Equity awards
1

 
2

 
1

 
2

Weighted average shares used in calculating diluted earnings per share
149

 
148

 
148

 
148


2. Balance Sheet Account Details

Short-Term Investments

The following is a summary of short-term investments (in millions):
 
September 30, 2018
 
December 31, 2017
 
Amortized
Cost
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Amortized
Cost
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Available-for-sale debt securities:
 
 
 
 
 
 
 
 
 
 
 
Debt securities in government sponsored entities
$
21

 
$

 
$
21

 
$
67

 
$

 
$
67

Corporate debt securities
1,063

 
(3
)
 
1,060

 
423

 
(2
)
 
421

U.S. Treasury securities
964

 
(2
)
 
962

 
433

 
(1
)
 
432

Total available-for-sale debt securities
$
2,048

 
$
(5
)
 
$
2,043

 
$
923

 
$
(3
)
 
$
920


Realized gains and losses are determined based on the specific identification method and are reported in interest income.

Contractual maturities of available-for-sale debt securities as of September 30, 2018 were as follows (in millions):
 
Estimated
Fair Value
Due within one year
$
1,253

After one but within five years
790

Total
$
2,043


We have the ability, if necessary, to liquidate any of our cash equivalents and short-term investments to meet our liquidity needs in the next 12 months. Accordingly, those investments with contractual maturities greater than one year from the date of purchase are classified as short-term on the accompanying condensed consolidated balance sheets.


12


Strategic Investments

The carrying amounts of our strategic equity investments without readily determinable fair values are initially measured at cost and are remeasured for impairment and observable price changes in orderly transactions for identifiable or similar investments of the same issuer.

As of September 30, 2018 and December 31, 2017, the aggregate carrying amounts of our strategic equity investments without readily determinable fair values were $249 million and $250 million, respectively, included in other assets. Revenue recognized from transactions with such companies was $32 million and $104 million, respectively, for the three and nine months ended September 30, 2018 and $38 million and $96 million, respectively, for the three and nine months ended October 1, 2017.

We invest in a venture capital investment fund (the Fund) with a capital commitment of $100 million that is callable over ten years, of which $73 million remained as of September 30, 2018. Our investment in the Fund is accounted for as an equity-method investment. The carrying amounts of the Fund included in other assets were $25 million and $16 million as of September 30, 2018 and December 31, 2017, respectively.

Inventory

Inventory consisted of the following (in millions):
 
September 30,
2018
 
December 31,
2017
Raw materials
$
98

 
$
93

Work in process
224

 
188

Finished goods
52

 
52

Total inventory
$
374

 
$
333


Property and Equipment

Property and equipment, net consisted of the following (in millions):
 
September 30,
2018
 
December 31,
2017
Leasehold improvements
$
505

 
$
331

Machinery and equipment
352

 
316

Computer hardware and software
207

 
185

Furniture and fixtures
43

 
34

Buildings
279

 
155

Construction in progress
156

 
326

Total property and equipment, gross
1,542

 
1,347

Accumulated depreciation
(482
)
 
(416
)
Total property and equipment, net
$
1,060

 
$
931


Property and equipment, net included non-cash expenditures of $38 million and $94 million for the nine months ended September 30, 2018 and October 1, 2017, respectively, which were excluded from the condensed consolidated statements of cash flows. Such non-cash expenditures included $18 million and $60 million recorded under build-to-suit lease accounting for the nine months ended September 30, 2018 and October 1, 2017, respectively.

Intangible Assets and Goodwill
    
On May 14, 2018, we acquired Edico Genome, a provider of data analysis acceleration solutions for next-generation sequencing (NGS) for total cash consideration of $100 million, net of cash acquired. As a result of this transaction, we recorded $56 million as goodwill. In addition, we recorded developed technology of $45 million and a trade name of $1 million, with useful lives of 10 and 3 years, respectively.


13


We test the carrying value of goodwill in accordance with accounting rules on impairment of goodwill, which require us to estimate the fair value of each reporting unit annually, or when impairment indicators exist, and compare such amounts to their respective carrying values to determine if an impairment is required. We performed the annual assessment for goodwill impairment in the second quarter of 2018, noting no impairment. 

Changes to goodwill during the nine months ended September 30, 2018 were as follows (in millions):
 
Goodwill
Balance as of December 31, 2017
$
771

Current period acquisitions
60

Balance as of September 30, 2018
$
831


We perform regular reviews to determine if any event has occurred that may indicate our identifiable intangible assets are potentially impaired.  During the nine months ended October 1, 2017, we performed a recoverability test when the planned use of a finite-lived acquired intangible asset changed, resulting in an impairment charge of $18 million recorded in cost of product revenue. Also during the nine months ended October 1, 2017, we recorded a $5 million impairment charge in research and development related to an in-process research and development project that was determined to have no future alternative use.

Derivatives

We are exposed to foreign exchange rate risks in the normal course of business. We enter into foreign exchange contracts to manage foreign currency risks related to monetary assets and liabilities that are denominated in currencies other than the U.S. dollar. These foreign exchange contracts are carried at fair value in other current assets or accrued liabilities and are not designated as hedging instruments. Changes in the value of derivatives are recognized in other (expense) income, net, along with the remeasurement gain or loss on the foreign currency denominated assets or liabilities.

As of September 30, 2018, we had foreign exchange forward contracts in place to hedge exposures in the euro, Japanese yen, Australian dollar, and Canadian dollar. As of September 30, 2018 and December 31, 2017, the total notional amounts of outstanding forward contracts in place for foreign currency purchases were $99 million and $88 million, respectively.

Accrued Liabilities

Accrued liabilities consisted of the following (in millions):
 
September 30,
2018
 
December 31,
2017
Contract liabilities, current portion
$
154

 
$
150

Accrued compensation expenses
154

 
177

Accrued taxes payable
94

 
50

Other
48

 
55

Total accrued liabilities
$
450

 
$
432



14


Warranties

We generally provide a one-year warranty on instruments. Additionally, we provide a warranty on consumables through the expiration date, which generally ranges from six to twelve 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.

Changes in the reserve for product warranties during the three and nine months ended September 30, 2018 and October 1, 2017 were as follows (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
Balance at beginning of period
$
15

 
$
14

 
$
17

 
$
13

Additions charged to cost of product revenue
8

 
7

 
20

 
18

Repairs and replacements
(6
)
 
(5
)
 
(20
)
 
(15
)
Balance at end of period
$
17

 
$
16

 
$
17

 
$
16


Investments in Consolidated VIEs

Helix Holdings I, LLC

In July 2015, we obtained a 50% voting equity ownership interest in Helix Holdings I, LLC (Helix), a limited liability company formed with unrelated third-party investors to pursue the development and commercialization of a marketplace for consumer genomics. We determined that Helix is a VIE as the holders of the at-risk equity investments as a group lack the power to direct the activities of Helix that most significantly impact Helix’s economic performance. Additionally, we determined that we have (a) unilateral power over one of the activities that most significantly impacts the economic performance of Helix through its contractual arrangements and no one individual party has unilateral power over the remaining significant activities of Helix and (b) the obligation to absorb losses of and the right to receive benefits from Helix that are potentially significant to Helix. As a result, we are deemed to be the primary beneficiary of Helix and are required to consolidate Helix.

As contractually committed, in July 2015, we contributed certain perpetual licenses, instruments, intangibles, initial laboratory setup, and discounted supply terms in exchange for voting equity interests in Helix. Such contributions were recorded at their historical basis as they remained within our control. Helix is financed through cash contributions made by us and the third-party investors in exchange for voting equity interests in Helix. During the nine months ended September 30, 2018, we made additional investments of $100 million in exchange for voting equity interests in Helix. As of September 30, 2018, the noncontrolling shareholders and Illumina each held 50% of Helix’s outstanding voting equity interests.

Certain noncontrolling Helix investors may require us to redeem certain noncontrolling interests in cash at the then approximate fair market value. Such redemption right is exercisable at the option of certain noncontrolling interest holders after January 1, 2021, provided that a bona fide pursuit of the sale of Helix has occurred and an initial public offering of Helix has not been completed. As the contingent redemption is outside of our control, the redeemable noncontrolling interests in Helix are classified outside of stockholders’ equity on the accompanying condensed consolidated balance sheets. The balance of the redeemable noncontrolling interests is reported at the greater of its carrying value after receiving its allocation of Helix’s profits and losses or its estimated redemption fair value at each reporting date. The fair value of the redeemable noncontrolling interests is considered a Level 3 instrument.

As of September 30, 2018, the accompanying condensed consolidated balance sheet included $149 million of cash, cash equivalents, and short-term investments attributable to Helix that will be used to settle its respective obligations and will not be available to settle obligations of Illumina. The remaining assets and liabilities of Helix were not significant to our financial position as of September 30, 2018. Helix had an immaterial impact on our condensed consolidated statements of income and cash flows for the three and nine months ended September 30, 2018.


15


GRAIL, Inc.

In 2016, we obtained a majority equity ownership interest in GRAIL, a company formed with unrelated third-party investors to develop a blood test for early-stage cancer detection. At that time, we determined that GRAIL was a VIE as the entity lacked sufficient equity to finance its activities without additional support. Additionally, we determined that we were the primary beneficiary of GRAIL and were required to consolidate GRAIL. On February 28, 2017, GRAIL completed the initial close of its Series B preferred stock financing, we ceased to have a controlling financial interest in GRAIL, and our equity ownership was reduced from 52% to 19%. Additionally, our voting interest was reduced to 13% and we no longer had representation on GRAIL’s board of directors. As a result, we deconsolidated GRAIL’s financial statements effective February 28, 2017 and recorded a pretax gain on deconsolidation of $453 million in other (expense) income, net. The operations of GRAIL from January 2, 2017 up to February 28, 2017, the date of deconsolidation, were included in the accompanying condensed consolidated statements of income for the nine months ended October 1, 2017. During this period, we absorbed approximately 50% of GRAIL’s losses based upon our proportional ownership of GRAIL’s common stock.

The carrying value of the investment recorded in other assets was $189 million and $185 million as of September 30, 2018 and December 31, 2017, respectively.

Redeemable Noncontrolling Interests

The activity of the redeemable noncontrolling interests during the nine months ended September 30, 2018 was as follows (in millions):
 
Redeemable Noncontrolling Interests
Balance as of December 31, 2017
$
220

Vesting of redeemable equity awards
2

Net loss attributable to noncontrolling interests
(25
)
Adjustment up to the redemption value
21

Balance as of September 30, 2018
$
218


3. Fair Value Measurements

The following table presents the hierarchy for assets and liabilities measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 (in millions):
 
September 30, 2018
 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds (cash equivalents)
$
1,053

 
$

 
$

 
$
1,053

 
$
957

 
$

 
$

 
$
957

Debt securities in government-sponsored entities

 
21

 

 
21

 

 
67

 

 
67

Corporate debt securities

 
1,060

 

 
1,060

 

 
421

 

 
421

U.S. Treasury securities
962

 

 

 
962

 
432

 

 

 
432

Deferred compensation plan assets

 
39

 

 
39

 

 
35

 

 
35

Total assets measured at fair value
$
2,015

 
$
1,120

 
$

 
$
3,135

 
$
1,389

 
$
523

 
$

 
$
1,912

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation liability
$

 
$
37

 
$

 
$
37

 
$

 
$
33

 
$

 
$
33


We hold available-for-sale securities that consist of highly-liquid, investment-grade debt securities. 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.

16


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 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, validation of pricing sources and models, and review of key model inputs, if necessary.

4. Debt and Other Commitments

Summary of debt obligations

Debt obligations consisted of the following (dollars in millions):
 
September 30,
2018
 
December 31,
2017
Principal amount of 2023 Notes outstanding
$
750

 
$

Principal amount of 2021 Notes outstanding
517

 
517

Principal amount of 2019 Notes outstanding
633

 
633

Unamortized discount of liability component of convertible senior notes
(190
)
 
(75
)
Net carrying amount of liability component of convertible senior notes
1,710

 
1,075

Obligations under financing leases
254

 
113

Other
3

 
4

Less: current portion
(1,107
)
 
(10
)
Long-term debt
$
860

 
$
1,182

Carrying value of equity component of convertible senior notes, net of debt issuance cost
$
287

 
$
161

Fair value of convertible senior notes outstanding (Level 2)
$
2,533

 
$
1,305

Weighted-average remaining amortization period of discount on the liability component of convertible senior notes
4.1 years

 
2.8 years


Convertible Senior Notes

0% Convertible Senior Notes due 2023 (2023 Notes)

On August 21, 2018, we issued $750 million aggregate principal amount of convertible senior notes due 2023 (2023 Notes). The net proceeds from the issuance, after deducting the offering expenses payable by us, were $735 million. The 2023 Notes carry no coupon interest and mature on August 15, 2023.

The 2023 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 $457.77 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 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price in effect on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of 2023 Notes for each trading day of the measurement period was less than 98% 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 13, 2023.

It is our intent and policy to settle conversions, if any, through combination settlement; this involves repayment of an amount of cash equal to the principal amount and delivery of the excess of conversion value over the principal amount in shares

17


of common stock. In general, the “principal amount” paid in cash upon settlement is the lesser of $1,000 and the sum of the daily conversion values during a 20-day observation period. The daily conversion value is the product of the effective conversion rate (2.1845) and the daily volume weighted average price (VWAP) of our common stock divided by 20. The “share amount” is the cumulative “daily share amount” during the observation period, which is calculated by dividing the daily VWAP into the difference between the daily conversion value (i.e., conversion rate x daily VWAP) and $1,000.

We may redeem for cash all or any portion of the 2023 Notes, at our option, on or after August 20, 2021 if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect (currently $595.10) for at least 20 trading days (whether or not consecutive) during any 30 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 100% 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 Notes are accounted for in accordance with authoritative guidance for convertible debt instruments that may be settled in cash upon conversion. The guidance requires the carrying amount of the liability component to be estimated by estimating the fair value of a similar liability that does not have an associated conversion feature. Because we have no outstanding non-convertible public debt, we determined that market-traded senior, unsecured corporate bonds represent a similar liability without a conversion option. Based on market data available for publicly traded, senior, unsecured corporate bonds issued by companies in our industry, and with similar maturities to the 2023 Notes, we estimated an implied interest rate of 3.7%, assuming no conversion option. Assumptions used in the estimate represent what market participants would use in pricing the liability component, including market interest rates, credit standing, and yield curves, all of which are defined as Level 2 observable inputs. The estimated implied interest rate was applied to the 2023 Notes, which resulted in a fair value of the liability component in aggregate of $624 million upon issuance, calculated as the present value of implied future payments based on the $750 million aggregate principal amount. The $126 million difference ($93 million, net of tax) between the aggregate principal amount of $750 million and the estimated fair value of the liability component was recorded in additional paid-in capital as the 2023 Notes are not considered redeemable.

As a policy election under applicable guidance related to the calculation of diluted net income per share, we have elected the combination settlement method as our stated settlement policy and apply the treasury stock method in the calculation of the potential dilutive impact of the 2023 Notes on net income per share each period. The 2023 Notes were not convertible as of September 30, 2018 and had no dilutive impact during the three and nine months ended September 30, 2018. If the 2023 Notes were converted as of September 30, 2018, the if-converted value would not exceed the principal amount.

18



0% Convertible Senior Notes due 2019 (2019 Notes) and 0.5% Convertible Senior Notes due 2021 (2021 Notes)

In June 2014, we issued $633 million aggregate principal amount of 2019 Notes and $517 million aggregate principal amount of 2021 Notes. We used the net proceeds plus cash on hand to repurchase outstanding debt. The 2019 and 2021 Notes mature on June 15, 2019 and June 15, 2021, respectively, and the implied estimated effective rates of the liability components of the Notes were 2.9% and 3.5%, respectively, assuming no conversion.

Both the 2019 and 2021 Notes will be convertible into cash, shares of common stock, or a combination of cash and shares of common stock, at our election, based on an initial conversion rate, subject to adjustment, of 3.9318 shares per $1,000 principal amount of the notes (which represents an initial conversion price of approximately $254.34 per share), only in the following circumstances and to the following extent: (1) during the five business-day period after any 10 consecutive trading day period (the measurement period) in which the trading price per 2019 and 2021 Notes for each day of such measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such day; (2) during any calendar quarter (and only during that quarter) after the calendar quarter ending September 30, 2014, if the last reported sale price of our common stock for 20 or more trading days in the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the applicable conversion price in effect on the last trading day of the immediately preceding calendar quarter; (3) upon the occurrence of specified events described in the indenture for the 2019 and 2021 Notes; and (4) at any time on or after March 15, 2019 for the 2019 Notes, or March 15, 2021 for the 2021 Notes, through the second scheduled trading day immediately preceding the maturity date.

During the three months ended September 30, 2018, the market price of our common stock met the stock trading price conversion requirement of $330.64 and the 2019 and 2021 Notes became convertible on October 1, 2018 and continue to be convertible through December 31, 2018. The potential dilutive impact of the 2019 and 2021 notes has been included in our calculation of diluted earnings per share for the three and nine months ended September 30, 2018. If the 2019 and 2021 Notes were converted as of September 30, 2018, the if-converted value would exceed the principal amount by $452 million. During the nine months ended September 30, 2018, the carrying values of the 2019 and 2021 Notes were reclassified to short-term as they are convertible within twelve months of the balance sheet date.

Build-to-suit leases

We evaluate whether we are the accounting owner of leased assets during the construction period when we are involved in the construction of leased assets. As of September 30, 2018, we were considered the owner of a construction project for accounting purposes only under build-to-suit lease accounting due to certain indemnification obligations related to the construction. As of September 30, 2018, and December 31, 2017, we recorded $22 million and $144 million, respectively, in project construction costs paid or reimbursed by the landlord as construction in progress and a corresponding build-to-suit lease liability.

During the nine months ended September 30, 2018, construction of a build-to-suit property was completed. We concluded we did not qualify for sale-leaseback treatment and the lease is accounted for as a financing obligation. Accordingly, $142 million of construction in progress and build-to-suit lease liability were reclassified to building asset and obligations under financing leases, respectively.


19


5. Share-based Compensation Expense

Share-based compensation expense reported in our statements of income was as follows (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
Cost of product revenue
$
4

 
$
3

 
$
12

 
$
9

Cost of service and other revenue
1

 
1

 
3

 
2

Research and development
15

 
12

 
45

 
38

Selling, general and administrative
28

 
18

 
86

 
74

Share-based compensation expense before taxes
48

 
34

 
146

 
123

Related income tax benefits
(8
)
 
(11
)
 
(29
)
 
(34
)
Share-based compensation expense, net of taxes
$
40

 
$
23

 
$
117

 
$
89


The assumptions used for the specified reporting periods and the resulting estimates of weighted-average fair value per share for stock purchased under the Employee Stock Purchase Plan (ESPP) during the nine months ended September 30, 2018 were as follows:
 
Employee Stock Purchase Rights
Risk-free interest rate
1.22% - 2.45%

Expected volatility
29% - 39%

Expected term
0.5 - 1.0 year

Expected dividends
0
%
Weighted-average fair value per share
$
61.59


As of September 30, 2018, approximately $293 million of unrecognized compensation cost related to restricted stock and ESPP shares granted to date was expected to be recognized over a weighted-average period of approximately 2.1 years.

6. Stockholders’ Equity

As of September 30, 2018, approximately 5.5 million shares remained available for future grants under the 2015 Stock Plan.

20



Restricted Stock

Restricted stock activity and related information for the nine months ended September 30, 2018 was as follows (units in thousands):
 
Restricted
Stock Units
(RSU)
 
Performance
Stock Units
(PSU)(1)
 
Weighted-Average
Grant-Date Fair Value per Share
 
 
 
RSU
 
PSU
Outstanding at December 31, 2017
2,085

 
542

 
$
172.92

 
$
166.15

Awarded
80

 
211

 
$
272.83

 
$
177.93

Vested
(139
)
 

 
$
162.89

 

Cancelled
(155
)
 
(30
)
 
$
171.35

 
$
162.54

Outstanding at September 30, 2018
1,871

 
723

 
$
178.07

 
$
169.73

______________________________________
(1)
The number of units reflect the estimated number of shares to be issued at the end of the performance period.

Stock Options

Stock option activity during the nine months ended September 30, 2018 was as follows:
 
Options
(in thousands)
 
Weighted-Average
Exercise Price
Outstanding at December 31, 2017
322

 
$
46.93

Exercised
(101
)
 
$
35.32

Outstanding and exercisable at September 30, 2018
221

 
$
52.22


ESPP

The price at which common stock is purchased under the ESPP is equal to 85% of the fair market value of the common stock on the first day of the offering period or purchase date, whichever is lower. During the nine months ended September 30, 2018, approximately 0.3 million shares were issued under the ESPP. As of September 30, 2018, there were approximately 13.7 million shares available for issuance under the ESPP.
 
Share Repurchases

On July 28, 2016, our Board of Directors authorized a share repurchase program, which superseded all prior and available repurchase authorizations, to repurchase $250 million of outstanding common stock. During the year ended December 31, 2017, we repurchased 0.6 million shares for $101 million, completing the share repurchase program.

On May 4, 2017, our Board of Directors authorized a share repurchase program to repurchase $250 million of outstanding common stock. During the year ended December 31, 2017, we repurchased 0.8 million shares for $150 million from this program.

On May 1, 2018, our Board of Directors authorized an additional share repurchase program to repurchase $150 million of outstanding common stock. The repurchases may be completed under a 10b5-1 plan or at management’s discretion. During the three months ended September 30, 2018, we repurchased 0.3 million shares for $103 million concurrently with the offering of our 2023 Notes. Authorizations to repurchase $147 million of our common stock remained available as of September 30, 2018.

7. Income Taxes

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 the three and nine months ended September 30, 2018 were 19.0% and 14.6%, respectively. For the three and nine months ended September 30, 2018, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to the mix of

21


earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom, offset partially by the discrete tax expense associated with updating prior year estimates of the impact of U.S. Tax Reform. For the nine months ended September 30, 2018, the decrease from the federal statutory rate was also attributable to the discrete tax benefit associated with the recognition of prior year losses from our investment in Helix.

We continue to evaluate the impacts of U.S. Tax Reform as we interpret the legislation, including the newly-enacted global intangible low-taxed income (GILTI) provisions which subject our foreign earnings to a minimum level of tax. Because of the complexities of the new legislation, we have not yet elected an accounting policy for GILTI and, therefore, have only included GILTI related to current year operations in our estimated provision for income taxes. Recent FASB guidance indicates that accounting for GILTI either as part of deferred taxes or as a period cost is acceptable. Once further information is gathered and interpretation and analysis of the tax legislation evolves, we will make an appropriate accounting method election.

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 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 results 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. The amount of ultimate loss may differ from these estimates. Each matter presents its own unique circumstances, and prior litigation does not necessarily provide a reliable basis on which to predict the outcome, or range of outcomes, in any individual proceeding. Because of the uncertainties related to the occurrence, amount, and range of loss on any pending litigation or claim, we are currently unable to predict their ultimate outcome, and, with respect to any pending litigation or claim where no liability has been accrued, to make a meaningful estimate of the reasonably possible loss or range of loss that could result from an unfavorable outcome. In the event opposing litigants in outstanding litigations or claims ultimately succeed at trial and any subsequent appeals on their claims, any potential loss or charges in excess of any established accruals, individually or in the aggregate, could have a material adverse effect on our business, financial condition, results of operations, and/or cash flows in the period in which the unfavorable outcome occurs or becomes probable, and potentially in future periods.

9. Segment Information

We have two reportable segments: Core Illumina and one segment related to the combined activities of our Consolidated VIEs. Our Consolidated VIEs currently include only the operations of Helix, whereas prior to the deconsolidation of GRAIL on February 28, 2017, our Consolidated VIEs included the combined operations of GRAIL and Helix.

We report segment information based on the management approach. This approach 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. Based on the information used by the CODM, we have determined our reportable segments as follows:

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 operations, excluding the results of the consolidated VIEs.

Consolidated VIEs:

Helix: Helix was established to enable individuals to explore their genetic information by providing affordable sequencing and database services for consumers through third-party partners, driving the creation of an ecosystem of consumer applications.

GRAIL: GRAIL was created to develop a blood test for early-stage cancer detection. GRAIL was in the early stages of developing this test and as such, had no revenues through the date of deconsolidation.


22


Management evaluates the performance of our operating segments based upon income (loss) from operations. We do not allocate expenses between segments. Core Illumina sells products and provides services to GRAIL and Helix in accordance with contractual agreements between the entities.

The following table presents the operating performance of each reportable segment (in millions):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2018
 
October 1,
2017
 
September 30,
2018
 
October 1,
2017
Revenue:
 
 
 
 
 
 
 
Core Illumina
$
855

 
$
715

 
$
2,467

 
$
1,978

Consolidated VIEs
2

 
1

 
8

 
4

Elimination of intersegment revenue
(4
)
 
(2
)
 
(9
)
 
(7
)
Consolidated revenue
$
853

 
$
714

 
$
2,466

 
$
1,975

 
 
 
 
 
 
 
 
Income (loss) from operations:
 
 
 
 
 
 
 
Core Illumina
$
264

 
$
203

 
$
748

 
$
447

Consolidated VIEs
(23
)
 
(22
)
 
(64
)
 
(72
)
Elimination of intersegment earnings

 

 
2

 
1

Consolidated income from operations
$
241

 
$
181

 
$
686

 
$
376


The following table presents the total assets of each reportable segment (in millions):
 
September 30,
2018
 
December 31,
2017
Core Illumina
$
6,691

 
$
5,223

Consolidated VIEs
177

 
45

Elimination of intersegment assets
(109
)
 
(11
)
Consolidated total assets
$
6,759

 
$
5,257



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) 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:

Business Overview and Outlook. High level discussion of our operating results and significant known trends that affect our business.

Results of Operations. Detailed discussion of our revenues and expenses.

Liquidity and Capital Resources. Discussion of key aspects of our statements of cash flows, changes in our financial position, and our financial commitments.

Off-Balance Sheet Arrangements. We have no off-balance sheet arrangements.

Critical Accounting Policies and Estimates. Discussion of significant changes since our most recent Annual Report on Form 10-K we believe are important to understanding the assumptions and judgments underlying our financial statements.

Recent Accounting Pronouncements. Summary of recent accounting pronouncements applicable to our condensed consolidated financial statements.

This MD&A discussion contains forward-looking statements that involve risks and uncertainties. Please see “Consideration Regarding Forward-Looking Statements” at the end of this MD&A section for additional factors relating to

23


such statements. This MD&A should be read in conjunction with our condensed consolidated financial statements and accompanying notes included in this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Operating results are not necessarily indicative of results that may occur in future periods.

Business Overview and Outlook

This overview and outlook provides a high-level discussion of our operating results and significant known trends that affect our business. We believe that an understanding of these trends is important to understanding our financial results for the periods being reported herein as well as our future financial performance. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this report.

About Illumina

We have two reportable segments: Illumina’s core operations (Core Illumina) and one segment related to the activities of our Consolidated VIEs. Our Consolidated VIEs currently include only the operations of Helix, whereas prior to the GRAIL deconsolidation on February 28, 2017, our Consolidated VIEs included the combined operations of GRAIL and Helix. For information on GRAIL and Helix, refer to notes 2 and 9 of the Notes to the Condensed Consolidated Financial Statements provided in this report.
 
Our focus on innovation has established us as the global leader in DNA sequencing and array-based technologies, serving customers in the research, clinical and applied markets. Our products are used for applications in the life sciences, oncology, reproductive health, agriculture and other emerging segments.

Our customers include a broad range of academic, government, pharmaceutical, biotechnology, and other leading institutions around the globe.

Our comprehensive line of products addresses the scale of experimentation and breadth of functional analysis to advance disease research, drug development, and the development of molecular tests. This portfolio of leading-edge sequencing and array-based solutions address a range of genomic complexity and throughput, enabling researchers and clinical practitioners to select the best solution for their scientific challenge.

Our financial results have been, and will continue to be, impacted by several significant trends, which are described below. While these trends are important to understanding and evaluating our financial results, this discussion should be read in conjunction with our condensed consolidated financial statements and the notes thereto in Item 1, Part I of this report, and the other transactions, events, and trends discussed in “Risk Factors” in Item 1A, Part II of this report and Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Financial Overview

Consolidated financial highlights for the first three quarters of 2018 included the following:

Net revenue increased 25% during the first three quarters of 2018 to $2.5 billion compared to $2.0 billion in the first three quarters of 2017 due to the growth in sales of our consumables, services and instruments, primarily driven by increases in sequencing. We expect our revenue, as compared to the prior year, to continue to increase in 2018.

Gross profit as a percentage of revenue (gross margin) was 69.4% in the first three quarters of 2018 compared to 65.0% in the first three quarters of 2017. The gross margin increase was primarily driven by an increase in consumables as a percentage of revenue, which generate higher gross margins, and the impairment of an acquired intangible asset and inventory reserves related to product transitions that were recorded in the first three quarters of 2017. Our gross margin in future periods will depend on several factors, including: market conditions that may impact our pricing power; sales mix changes among consumables, instruments, and services; product mix changes between established products and new products; excess and obsolete inventories; royalties; our cost structure for manufacturing operations relative to volume; and product support obligations.

Income from operations as a percentage of revenue increased to 27.8% in the first three quarters of 2018 compared to 19.0% in the first three quarters of 2017 primarily due to increased revenue, improved gross margins, and a decrease in operating expenses as a percentage of revenue. We expect our operating expenses to continue to grow on an absolute basis.

Our effective tax rate was 14.6% in the first three quarters of 2018 compared to 24.3% in the first three quarters of 2017. The variance from the U.S. federal statutory tax rate of 21% in the first three quarters of 2018 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 the discrete tax benefit associated with the recognition of prior year losses from our investment in Helix, offset partially by the discrete tax expense associated with updating prior year estimates of the impact of U.S. Tax Reform.

Cash, cash equivalents, and short-term investments were $3.4 billion as of September 30, 2018, of which approximately $817 million was held by our foreign subsidiaries.
 
Results of Operations

To enhance comparability, the following table sets forth our unaudited condensed consolidated statements of income for the specified reporting periods stated as a percentage of total revenue.
 
Q3 2018
 
Q3 2017
 
YTD 2018
 
YTD 2017
Revenue:
 
 
 
 
 
 
 
Product revenue
83.2
 %
 
83.5
 %
 
81.5
 %
 
82.6
 %
Service and other revenue
16.8

 
16.5

 
18.5

 
17.4

Total revenue
100.0

 
100.0

 
100.0

 
100.0

Cost of revenue:
 
 
 
 
 
 
 
Cost of product revenue
21.6

 
24.2

 
21.9

 
25.7

Cost of service and other revenue
7.2

 
7.0

 
7.7

 
7.7

Amortization of acquired intangible assets
1.2

 
1.3

 
1.0

 
1.6

Total cost of revenue
30.0

 
32.5

 
30.6

 
35.0

Gross profit
70.0

 
67.5

 
69.4

 
65.0

Operating expense:
 
 
 
 
 
 
 
Research and development
18.6

 
18.7

 
18.1

 
20.7

Selling, general and administrative
23.2

 
23.5

 
23.5

 
25.3

Total operating expense
41.8

 
42.2

 
41.6

 
46.0

Income from operations
28.2

 
25.3

 
27.8

 
19.0

Other income (expense):
 
 
 
 
 
 
 
Interest income
1.6

 
0.6

 
1.3

 
0.7

Interest expense
(1.8
)
 
(1.4
)
 
(1.5
)
 
(1.3
)
Other (expense) income, net
(0.9
)
 

 
0.2

 
23.1

Total other (expense) income, net
(1.1
)
 
(0.8
)
 

 
22.5

Income before income taxes
27.1

 
24.5

 
27.8

 
41.5

Provision for income taxes
5.1

 
3.2

 
4.1

 
10.1

Consolidated net income
22.0

 
21.3

 
23.7

 
31.4

Add: Net loss attributable to noncontrolling interests
1.3

 
1.5

 
1.3

 
1.9

Net income attributable to Illumina stockholders
23.3
 %
 
22.8
 %
 
25.0
 %
 
33.3
 %
Percentages may not recalculate due to rounding

Our 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. The three and nine month periods ended September 30, 2018 and October 1, 2017 were both 13 and 39 weeks, respectively.

24


Revenue 
(Dollars in millions)
Q3 2018
 
Q3 2017
 
Change
 
% Change
 
YTD 2018
 
YTD 2017
 
Change
 
% Change
Consumables
$
550

 
$
451

 
$
99

 
22
%
 
$
1,595

 
$
1,240

 
$
355

 
29
%
Instruments
154

 
140

 
14

 
10

 
398

 
376

 
22

 
6

Other product
6

 
5

 
1

 
20

 
18

 
15

 
3

 
20

Total product revenue
710

 
596

 
114

 
19

 
2,011

 
1,631

 
380

 
23

Service and other revenue
143

 
118

 
25

 
21

 
455

 
344

 
111

 
32

Total revenue
$
853

 
$
714

 
$
139

 
20
%
 
$
2,466

 
$
1,975

 
$
491

 
25
%

Other product revenue consists primarily of freight. Service and other revenue consists primarily of sequencing and genotyping service revenue as well as instrument service contract revenue. Total revenue primarily relates to Core Illumina for all periods presented.

The increases in consumables revenue in Q3 2018 and the first three quarters of 2018 were primarily due to an $87 million and $304 million increase in sequencing consumables revenue, respectively, driven primarily by growth in the instrument installed base. Instruments revenue increased in Q3 2018 primarily due to a $10 million increase in sequencing instruments revenue. The increase in instruments revenue in the first three quarters of 2018 was primarily due to a $19 million increase in sequencing instruments revenue driven by increased shipments of our NovaSeq instruments, partially offset by fewer shipments of our HiSeq instruments. Service and other revenue increased in Q3 2018 and the first three quarters of 2018 as a result of increased revenue from sequencing services and co-development agreements. Service and other revenue also increased in the first three quarters of 2018 due to increased revenue from genotyping services.

Gross Margin
(Dollars in millions)
Q3 2018
 
Q3 2017
 
Change
 
% Change
 
YTD 2018
 
YTD 2017
 
Change
 
% Change
Gross profit
$
597

 
$
482

 
$
115

 
24%
 
$
1,710

 
$
1,284

 
$
426

 
33%
Gross margin
70.0
%
 
67.5
%
 
 
 
 
 
69.4
%
 
65.0
%
 
 
 
 

The gross margin increase in Q3 2018 and the first three quarters of 2018 was primarily driven by increases in consumables as a percentage of revenue, which generate higher gross margins. Gross margin also increased in the first three quarters of 2018 due to an $18 million impairment of an acquired intangible asset and inventory reserves related to product transitions that were recorded in Q1 2017.
 
Operating Expense
(Dollars in millions)
Q3 2018
 
Q3 2017
 
Change
 
% Change
 
YTD 2018
 
YTD 2017
 
Change
 
% Change
Research and development
$
159

 
$
134

 
$
25

 
19
%
 
$
447

 
$
409

 
$
38

 
9
%
Selling, general and administrative
197

 
167

 
30

 
18

 
577

 
499

 
78

 
16

Total operating expense
$
356

 
$
301

 
$
55

 
18
%
 
$
1,024

 
$
908

 
$
116

 
13
%

Core Illumina R&D expense increased by $23 million, or 18%, in Q3 2018 and by $40 million, or 10%, in the first three quarters of 2018, primarily due to increased 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. R&D expense of our Consolidated VIEs increased by $2 million in Q3 2018 due to growth in Helix’s operations. R&D expense of our Consolidated VIEs decreased by $2 million in the first three quarters of 2018