FY15 Q1 10-Q
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 March 29, 2015
 
¨
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
¨
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 April 10, 2015, there were 144.1 million shares of the registrant’s common stock outstanding.


Table of Contents

ILLUMINA, INC.
INDEX
 
 
Page
 
 


2
Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.

ILLUMINA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
 
March 29,
2015
 
December 28,
2014
 
(Unaudited)
 
 
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
533,537

 
$
636,154

Short-term investments
832,952

 
702,217

Accounts receivable, net
350,044

 
289,458

Inventory
205,184

 
191,144

Deferred tax assets, current portion
49,105

 
40,786

Prepaid expenses and other current assets
89,459

 
29,844

Total current assets
2,060,281

 
1,889,603

Property and equipment, net
280,628

 
265,264

Goodwill
724,904

 
724,904

Intangible assets, net
301,302

 
314,500

Deferred tax assets, long-term portion
63,122

 
49,848

Other assets
68,856

 
95,521

Total assets
$
3,499,093

 
$
3,339,640

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Accounts payable
$
106,674

 
$
82,626

Accrued liabilities
296,150

 
335,276

Long-term debt, current portion
307,427

 
304,256

Total current liabilities
710,251

 
722,158

Long-term debt
993,777

 
986,780

Other long-term liabilities
171,739

 
167,904

Stockholders’ equity:
 
 
 
Preferred stock
—

 
—

Common stock
1,823

 
1,805

Additional paid-in capital
2,311,970

 
2,172,940

Accumulated other comprehensive income (loss)
2,334

 
(1,080
)
Retained earnings
697,864

 
561,206

Treasury stock, at cost
(1,390,665
)
 
(1,272,073
)
Total stockholders’ equity
1,623,326

 
1,462,798

Total liabilities and stockholders’ equity
$
3,499,093

 
$
3,339,640

See accompanying notes to the condensed consolidated financial statements.


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Table of Contents

ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
March 29,
2015
 
March 30,
2014
Revenue:
 
 
 
Product revenue
$
459,127

 
$
362,211

Service and other revenue
79,438

 
58,570

Total revenue
538,565

 
420,781

Cost of revenue:
 
 
 
Cost of product revenue
119,624

 
111,441

Cost of service and other revenue
32,529

 
21,513

Amortization of acquired intangible assets
11,385

 
9,535

Total cost of revenue
163,538

 
142,489

Gross profit
375,027

 
278,292

Operating expense:
 
 
 
Research and development
91,772

 
77,041

Selling, general and administrative
116,317

 
109,573

Acquisition related gain, net
(9,887
)
 
(1,013
)
Headquarter relocation
699

 
595

Total operating expense
198,901

 
186,196

Income from operations
176,126

 
92,096

Other income (expense):
 
 
 
Interest income
1,693

 
956

Interest expense
(11,164
)
 
(9,743
)
Cost-method investment gain, net
12,582

 
—

Other (expense) income, net
(1,191
)
 
479

Total other income (expense), net
1,920

 
(8,308
)
Income before income taxes
178,046

 
83,788

Provision for income taxes
41,388

 
23,811

Net income
$
136,658

 
$
59,977

Net income per basic share
$
0.95

 
$
0.47

Net income per diluted share
$
0.92

 
$
0.40

Shares used in calculating basic net income per share
143,771

 
128,146

Shares used in calculating diluted net income per share
148,683

 
150,619

See accompanying notes to the condensed consolidated financial statements.


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Table of Contents

ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
 
 
Three Months Ended
 
March 29,
2015
 
March 30,
2014
Net income
$
136,658

 
$
59,977

Unrealized gain (loss) on available-for-sale securities, net of deferred tax
3,414

 
(26
)
Total comprehensive income
$
140,072

 
$
59,951

See accompanying notes to the condensed consolidated financial statements.


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Table of Contents

ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Three Months Ended
 
March 29,
2015
 
March 30,
2014
Cash flows from operating activities:
 
 
 
Net income
$
136,658

 
$
59,977

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation expense
16,754

 
14,593

Amortization of intangible assets
13,348

 
13,814

Share-based compensation expense
31,918

 
33,424

Accretion of debt discount
10,169

 
8,992

Contingent compensation expense
—

 
2,417

Incremental tax benefit related to share-based compensation
(76,445
)
 
(50,528
)
Deferred income taxes
53,452

 
33,943

Change in fair value of contingent consideration
(9,887
)
 
(1,760
)
Change in estimated cease-use loss
699

 
—

Cost-method investment gain, net
(12,582
)
 
—

Other
556

 
(636
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(59,474
)
 
(52,156
)
Inventory
(14,044
)
 
(9,991
)
Prepaid expenses and other current assets
(1,157
)
 
125

Other assets
(2,530
)
 
(8,972
)
Accounts payable
28,867

 
10,060

Accrued liabilities
(51,044
)
 
(23,147
)
Accrued legal contingencies
—

 
5,847

Other long-term liabilities
1,521

 
1,085

Net cash provided by operating activities
66,779

 
37,087

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(325,383
)
 
(253,255
)
Sales of available-for-sale securities
152,156

 
89,030

Maturities of available-for-sale securities
42,564

 
44,075

Net sales proceeds from (purchases of) strategic investments
13,067

 
(4,600
)
Purchases of property and equipment
(36,551
)
 
(19,012
)
Cash paid for intangible assets
—

 
(625
)
Net cash used in investing activities
(154,147
)
 
(144,387
)
Cash flows from financing activities:
 
 
 
Payments on financing obligations
(114
)
 
(29,654
)
Incremental tax benefit related to share-based compensation
76,445

 
50,528

Common stock repurchases
(34,753
)
 
(130,017
)
Taxes paid related to net share settlement of equity awards
(83,839
)
 
(8,826
)
Proceeds from issuance of common stock
29,727

 
32,045

Net cash used in financing activities
(12,534
)
 
(85,924
)
Effect of exchange rate changes on cash and cash equivalents
(2,715
)
 
100

Net decrease in cash and cash equivalents
(102,617
)
 
(193,124
)
Cash and cash equivalents at beginning of period
636,154

 
711,637

Cash and cash equivalents at end of period
$
533,537

 
$
518,513


See accompanying notes to the condensed consolidated financial statements.

6
Table of Contents

Illumina, Inc.
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.

1. 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. The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. 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.

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 Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2014, from which the 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.

Fiscal Year

The Company’s fiscal year consists of 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 months ended March 29, 2015 and March 30, 2014 were both 13 weeks.

Recent Accounting Pronouncements

In February 2015, the Financial Accounting Standards Board issued Accounting Standard Update (ASU) 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The new standard modifies current guidance on consolidation under the variable interest model and the voting model. ASU 2015-02 will be effective for the Company beginning in the first quarter of 2016. The Company is currently evaluating the impact of the ASU 2015-02 on its consolidated financial statements.

In May 2014, the Financial Accounting Standards Board issued ASU 2014-09, Revenue from Contracts with Customers. The new standard is based on the principle that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 will be effective for the Company beginning in the first quarter of 2017 and allows for a full retrospective or a modified retrospective adoption approach. The Company is currently evaluating the impact of ASU 2014-09 on its consolidated financial statements.

Derivatives

The Company is exposed to foreign exchange rate risks in the normal course of business. The Company enters 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 assets or other liabilities and are not designated as hedging instruments. Changes in the value of the derivative are recognized in other expense, net, along with the remeasurement gain or loss on the foreign currency denominated assets or liabilities.


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Table of Contents

As of March 29, 2015, the Company had foreign exchange forward contracts in place to hedge exposures in the euro, Japanese yen, and Australian dollar. As of March 29, 2015 and December 28, 2014, the total notional amounts of outstanding forward contracts in place for foreign currency purchases were $69.9 million and $61.0 million, respectively.

Reserve for Product Warranties

The Company generally provides a one-year warranty on instruments. Additionally, the Company provides 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, the Company establishes an accrual for estimated warranty expenses based on historical experience as well as anticipated product performance. The Company periodically reviews its warranty reserve for adequacy and adjusts 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.

Revenue Recognition

The Company’s 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.
 
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product or system is required, revenue is deferred until all the acceptance criteria have been met. The Company occasionally offers discounts on newly introduced products to recent customers of existing products. These promotions sometimes involve the trade-in of existing products in exchange for a discount on new products. Where applicable, the Company defers a portion of revenue on the sales of existing products in recognition of the promotional discounts until the delivery of new products. All revenue is recorded net of discounts and sales taxes collected on behalf of governmental authorities.

 Revenue from product sales is recognized generally upon transfer of title to the customer, provided that no significant obligations remain and collection of the receivable is reasonably assured. 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.
 
In order to assess whether the price is fixed or determinable, the Company evaluates whether an arrangement is cancellable or subject to future changes in price, deliverables, or other terms. If it is determined that the price is not fixed or determinable, the Company defers revenue recognition until the price becomes fixed or determinable. The Company assesses collectibility based on a number of factors, including past transaction history with, and the creditworthiness of, the customer. If the Company determines that collection of a payment is not reasonably assured, revenue recognition is deferred until receipt of payment.
 
The Company regularly enters into contracts where revenue is derived from multiple deliverables including products or services. These products or services are generally delivered 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 individual units of accounting determined to exist in the contract. A delivered item is considered a separate unit of accounting when the delivered item has value to the customer on a stand-alone basis. Items are considered to have stand-alone value when they are sold separately by any vendor or when the customer could resell the item on a stand-alone basis.

For transactions with multiple deliverables, consideration is allocated at the inception of the contract to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence (VSOE) of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence exists, the Company uses its best estimate of the selling price for the deliverable.
 
In order to establish VSOE of selling price, the Company must regularly sell the product or service on a standalone basis with a substantial majority priced within a relatively narrow range. VSOE of selling price is usually the midpoint of that range. If there are not a sufficient number of standalone sales and VSOE of selling price cannot be determined, then the Company considers whether third party evidence can be used to establish selling price. Due to the lack of similar products and services sold by other companies within the industry, the Company has rarely established selling price using third-party evidence. If neither VSOE nor third party evidence of selling price exists, the Company determines its best estimate of selling price using

8
Table of Contents

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, the Company relies upon prices set by the Company’s pricing committee adjusted for applicable discounts. The Company recognizes revenue for delivered elements only when it determines there are no uncertainties regarding customer acceptance.
 
In certain markets, the Company sells products and provides services to customers through distributors that specialize in life science products. In most sales through distributors, the product is delivered directly to customers. In cases where the product is delivered to a distributor, revenue recognition is deferred until acceptance is received from the distributor, and/or the end-user, if required by the applicable sales contract. The terms of sales transactions through distributors are consistent with the terms of direct sales to customers. These transactions are accounted for in accordance with the Company’s revenue recognition policy described herein.

Net Income per Share

Basic net income per share is computed based on the weighted average number of common shares outstanding during the period. Diluted net income 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, equity awards, and warrants. Convertible senior notes have a dilutive impact when the average market price of the Company’s common stock exceeds the applicable conversion price of the respective notes. Potentially dilutive common shares from equity awards and warrants are determined using the average share price for each period under the treasury stock method. In addition, the following amounts are assumed to be used to repurchase shares: proceeds from exercise of equity awards and warrants; the average amount of unrecognized compensation expense for equity awards; and estimated tax benefits that will be recorded in additional paid-in capital when expenses related to equity awards become deductible. In loss periods, basic net loss per share and diluted net loss per share are identical because the otherwise dilutive potential common shares become anti-dilutive and are therefore excluded.

The following table presents the calculation of weighted average shares used to calculate basic and diluted net income per share (in thousands):
 
Three Months Ended
 
March 29,
2015
 
March 30,
2014
Weighted average shares outstanding
143,771

 
128,146

Effect of potentially dilutive common shares from:
 
 
 
Convertible senior notes
2,177

 
5,518

Equity awards
2,735

 
4,816

Warrants
—

 
12,139

Weighted average shares used in calculation of diluted net income per share
148,683

 
150,619

Potentially dilutive shares excluded from calculation due to anti-dilutive effect
3

 
124



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Table of Contents

2. Balance Sheet Account Details

Short-Term Investments

The following is a summary of short-term investments (in thousands):
 
 
March 29, 2015
 
December 28, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Available-for-sale securities:
 
 
 
 
 
 
 
 
Debt securities in government sponsored entities
$
53,975

 
$
16

 
$
(13
)
 
$
53,978

 
$
51,308

 
$
10

 
$
(55
)
 
$
51,263

Corporate debt securities
587,346

 
340

 
(416
)
 
587,270

 
502,924

 
46

 
(2,882
)
 
500,088

U.S. Treasury securities
191,487

 
263

 
(46
)
 
191,704

 
151,255

 
5

 
(394
)
 
150,866

Total available-for-sale securities
$
832,808

 
$
619

 
$
(475
)
 
$
832,952

 
$
705,487

 
$
61

 
$
(3,331
)
 
$
702,217


As of March 29, 2015, the Company had 291 available-for-sale securities in a gross unrealized loss position, all of which had been in such position for less than twelve months. There were no material impairments considered other-than-temporary as it is more likely than not the Company will hold the securities until maturity or the recovery of the cost basis.

The following table shows the fair values and the gross unrealized losses of such available-for-sale securities that were in an unrealized loss position for less than twelve months as of March 29, 2015 and December 28, 2014, aggregated by investment category (in thousands):
 
 
March 29, 2015
 
December 28, 2014
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
Debt securities in government sponsored entities
$
31,068

 
$
(13
)
 
$
36,084

 
$
(55
)
Corporate debt securities
298,212

 
(416
)
 
428,078

 
(2,882
)
U.S. Treasury securities
84,323

 
(46
)
 
143,755

 
(394
)
Total
$
413,603

 
$
(475
)
 
$
607,917

 
$
(3,331
)

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 March 29, 2015 were as follows (in thousands):
 
 
Estimated
Fair Value
Due within one year
$
375,825

After one but within five years
457,127

Total
$
832,952



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Cost-Method Investments

As of March 29, 2015 and December 28, 2014, the aggregate carrying amounts of the Company’s cost-method investments in non-publicly traded companies were $38.8 million and $37.2 million, respectively, included in other assets. During the three months ended March 29, 2015, the Company sold a cost-method investment and recognized a $15.1 million gain. The Company’s cost-method investments are assessed for impairment quarterly. The Company determines that it is not practicable to estimate the fair value of its cost-method investments on a regular basis and does not reassess the fair value of cost-method investments if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investments. No material impairment loss was recorded during the three months ended March 29, 2015 or March 30, 2014.

Inventory

Inventory consists of the following (in thousands):
 
March 29,
2015
 
December 28,
2014
Raw materials
$
72,083

 
$
70,316

Work in process
104,329

 
94,102

Finished goods
28,772

 
26,726

Total inventory
$
205,184

 
$
191,144


Accrued Liabilities

Accrued liabilities consist of the following (in thousands):
 
March 29,
2015
 
December 28,
2014
Deferred revenue, current portion
$
83,758

 
$
75,294

Accrued compensation expenses
78,776

 
112,606

Accrued taxes payable
46,622

 
38,942

Acquisition related contingent liability, current portion
34,237

 
44,124

Reserve for product warranties
15,991

 
15,616

Customer deposits
11,945

 
20,274

Facility exit obligation, current portion
3,769

 
3,837

Other
21,052

 
24,583

Total accrued liabilities
$
296,150

 
$
335,276


Warranties

Changes in the Company’s reserve for product warranties during the three months ended March 29, 2015 and March 30, 2014 are as follows (in thousands):
 
Three Months Ended
 
March 29,
2015
 
March 30,
2014
Balance at beginning of period
$
15,616

 
$
10,407

Additions charged to cost of revenue
6,897

 
4,192

Repairs and replacements
(6,522
)
 
(3,107
)
Balance at end of period
$
15,991

 
$
11,492



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Leases

Changes in the Company’s facility exit obligation related to its former headquarters lease during the three months ended March 29, 2015 and March 30, 2014 are as follows (in thousands):
 
Three Months Ended
 
March 29,
2015
 
March 30,
2014
Balance at beginning of period
$
37,700

 
$
38,218

Accretion of interest expense
607

 
595

Cash payments
(1,488
)
 
(1,633
)
Balance at end of period
$
36,819

 
$
37,180

 
On December 30, 2014, the Company entered into a lease agreement with BMR-Lincoln Centre LP (“BMR”) for certain office buildings in Foster City, California. Minimum lease payments during the initial term of 16 years are estimated to be $204.0 million. One of our Board members also serves on the Board of BMR. In addition, the Company entered into an amendment of its headquarter lease for additional rental square footage, which is expected to increase its minimum lease payments by $44.1 million over 15 years.

3. Fair Value Measurements

The following table presents the Company’s hierarchy for assets and liabilities measured at fair value on a recurring basis as of March 29, 2015 and December 28, 2014 (in thousands):
 
 
March 29, 2015
 
December 28, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds (cash equivalents)
$
317,288

 
$
—

 
$
—

 
$
317,288

 
$
431,172

 
$
—

 
$
—

 
$
431,172

Debt securities in government-sponsored entities
—

 
53,978

 
—

 
53,978

 
—

 
51,263

 
—

 
51,263

Corporate debt securities
—

 
587,270

 
—

 
587,270

 
—

 
500,088

 
—

 
500,088

U.S. Treasury securities
191,704

 
—

 
—

 
191,704

 
150,866

 
—

 
—

 
150,866

Deferred compensation plan assets
—

 
26,052

 
—

 
26,052

 
—

 
23,486

 
—

 
23,486

Total assets measured at fair value
$
508,992

 
$
667,300

 
$
—

 
$
1,176,292

 
$
582,038

 
$
574,837

 
$
—

 
$
1,156,875

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquisition related contingent consideration liabilities
$
—

 
$
—

 
$
34,237

 
$
34,237

 
$
—

 
$
—

 
$
44,124

 
$
44,124

Deferred compensation liability
—

 
24,760

 
—

 
24,760

 
—

 
20,310

 
—

 
20,310

Total liabilities measured at fair value
$
—

 
$
24,760

 
$
34,237

 
$
58,997

 
$
—

 
$
20,310

 
$
44,124

 
$
64,434


The Company holds available-for-sale securities that consist of highly liquid, investment grade debt securities. The Company considers information provided by the Company’s investment accounting and reporting service provider in the measurement of fair value of its 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. The Company’s 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. The Company performs control procedures to corroborate the fair value of its holdings, including comparing valuations obtained from its investment service provider to valuations reported by the Company’s asset custodians, validation of pricing sources and models, and review of key model inputs if necessary.


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At March 29, 2015, the fair value of the contingent consideration liabilities consists primarily of amounts related to the 2013 Verinata Health, Inc. acquisition. The Company reassesses the fair value of contingent consideration to be settled in cash related to its acquisitions on a quarterly basis using the income approach. Assumptions used to estimate the acquisition date fair value of the contingent consideration include discount rates ranging from 6% to 20%, volatility of 50%, risk-free rate of 0.26%, revenue projections, and the probability of achieving regulatory milestones. This fair value measurement of the contingent consideration is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The changes in the fair value of the contingent considerations during the three months ended March 29, 2015 were due to changes in the estimated payments and a shorter discounting period.
Changes in estimated fair value of contingent consideration liabilities during the three months ended March 29, 2015 are as follows (in thousands):
 
Contingent
Consideration
Liability
(Level 3 
Measurement)
Balance as of December 28, 2014
$
44,124

Change in estimated fair value, recorded in acquisition related gain, net
(9,887
)
Balance as of March 29, 2015
$
34,237


4. Convertible Senior Notes

As of March 29, 2015, the Company had outstanding $320.0 million in principal amount of 0.25% convertible senior notes due March 15, 2016, $632.5 million in principal amount of 0% convertible senior notes due June 15, 2019, and $517.5 million in principal amount of 0.5% convertible senior notes due June 15, 2021.

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

In June 2014, the Company issued $632.5 million aggregate principal amount of 0% convertible senior notes due 2019 (2019 Notes) and $517.5 million aggregate principal amount of 0.5% convertible senior notes due 2021 (2021 Notes). The Company used the net proceeds plus cash on hand to repurchase a portion of the outstanding 2016 Notes in privately negotiated transactions concurrently with the issuance of the 2019 and 2021 Notes. The 2019 Notes carry no coupon interest. The Company pays 0.5% interest per annum on the principal amount of the 2021 Notes, payable semiannually in arrears in cash on June 15 and December 15 of each year. 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. 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 rates were applied to the 2019 and 2021 Notes, which resulted in a fair value of the liability component in aggregate of $971.5 million upon issuance, calculated as the present value of implied future payments based on the $1,150.0 million aggregate principal amount. The $161.2 million difference between the cash proceeds of $1,132.7 million and the estimated fair value of the liability component was recorded in additional paid-in capital as the 2019 and 2021 Notes are not considered redeemable.

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 the Company's 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 Note for each day of such measurement period was less than 98% of the product of the last reported sale price of the Company’s 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 the Company’s 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.


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As noted in the indentures for the 2019 and 2021 Notes, it is the Company’s intent and policy to settle conversions through combination settlement, which essentially involves repayment of an amount of cash equal to the “principal portion” and delivery of the “share amount” in excess of the conversion value over the principal portion in shares of common stock. As a policy election under applicable guidance related to the calculation of diluted net income per share, the Company elected the combination settlement method as its stated settlement policy and applied the treasury stock method in the calculation of the potential dilutive impact of the 2019 and 2021 Notes. Neither the 2019 nor the 2021 Notes were convertible as of March 29, 2015 and had no dilutive impact during the three months ended March 29, 2015. If the 2019 and 2021 Notes were converted as of March 29, 2015, the if-converted value would not exceed the principal amount.

0.25% Convertible Senior Notes due 2016

In 2011, the Company issued $920.0 million aggregate principal amount of 0.25% convertible senior notes due 2016 (2016 Notes). The Company pays 0.25% interest per annum on the principal amount of the 2016 Notes semiannually in arrears in cash on March 15 and September 15 of each year. The 2016 Notes mature on March 15, 2016. The effective rate of the liability component was estimated to be 4.5%.

The 2016 Notes are convertible into cash, shares of common stock, or a combination of cash and shares of common stock, at the Company’s election, based on an initial conversion rate, subject to adjustment, of 11.9687 shares per $1,000 principal amount of the 2016 Notes (which represents an initial conversion price of approximately $83.55 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 2016 Note for each day of such measurement period was less than 98% of the product of the last reported sale price of the Company’s 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 March 31, 2011, if the last reported sale price of the Company’s 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 2016 Notes; and (4) at any time on or after December 15, 2015 through the second scheduled trading day immediately preceding the maturity date. Based upon meeting the stock trading price conversion requirement during the three months ended March 30, 2015, the 2016 Notes will continue to be convertible through June 30, 2015.

In conjunction with the issuance of the 2019 and 2021 Notes, the Company used the net proceeds from the issuance plus cash on hand to repurchase $600.0 million in principal amount of the outstanding 2016 Notes in privately negotiated transactions. The aggregate cash used for the repurchase was $1,244.7 million. The repurchase is accounted for as an extinguishment of debt and resulted in a $31.4 million loss for the difference between the $588.8 million fair value of debt component and the carrying value of the repurchased 2016 Notes. The $655.9 million of the repurchase price allocated to the equity component was recorded as a reduction of additional paid-in capital.

As noted in the indenture for the 2016 Notes, it is the Company’s intent and policy to settle conversions through combination settlement, which essentially involves repayment of an amount of cash equal to the “principal portion” and delivery of the “share amount” in excess of the conversion value over the principal portion in shares of common stock. As a policy election under applicable guidance related to the calculation of diluted net income per share, the Company elected the combination settlement method as its stated settlement policy and applied the treasury stock method in the calculation of the dilutive impact of the 2016 Notes. The calculation of dilutive potential common shares outstanding for the three months ended March 29, 2015 reflects the dilutive impact from the 2016 Notes. If the 2016 Notes were converted as of March 29, 2015, the if-converted value would exceed the principal amount by $417.5 million.

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Summary of Convertible Senior Notes

The following table summarizes information about the equity and liability components of all convertible senior notes outstanding as of the period reported (dollars in thousands). The fair values of the respective notes outstanding were measured based on quoted market prices.
 
 
March 29,
2015
 
December 28,
2014
Principal amount of convertible notes outstanding
$
1,470,027

 
$
1,470,027

Unamortized discount of liability component
(168,823
)
 
(178,991
)
Net carrying amount of liability component
1,301,204

 
1,291,036

Less: current portion
(307,427
)
 
(304,256
)
Long-term debt
$
993,777

 
$
986,780

Carrying value of equity component, net of debt issuance cost
$
215,283

 
$
215,283

Fair value of outstanding notes
$
2,023,059

 
$
2,021,750

Weighted-average remaining amortization period of discount on the liability component
5.0 years

 
5.2 years


5. Share-based Compensation Expense

Share-based compensation expense for all stock awards consists of the following (in thousands):

 
Three Months Ended
 
March 29,
2015
 
March 30,
2014
Cost of product revenue
$
2,332

 
$
2,095

Cost of service and other revenue
279

 
285

Research and development
11,307

 
11,669

Selling, general and administrative
18,000

 
19,375

Share-based compensation expense before taxes
31,918

 
33,424

Related income tax benefits
(9,113
)
 
(10,577
)
Share-based compensation expense, net of taxes
$
22,805

 
$
22,847


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 three months ended March 29, 2015 are as follows:
 
 
Employee Stock Purchase Rights
Risk-free interest rate
0.07% - 0.17%

Expected volatility
35% - 38%

Expected term
0.5 - 1.0 year

Expected dividends
—

Weighted-average fair value per share
$
53.35


As of March 29, 2015, approximately $243.5 million of unrecognized compensation cost related to stock options, restricted stock, and ESPP shares granted to date is expected to be recognized over a weighted-average period of approximately 2.0 years.

6. Stockholders’ Equity

As of March 29, 2015, approximately 5.5 million shares remained available for future grants under the 2005 Stock and Incentive Plan, the 2005 Solexa Equity Plan, and the 2008 Verinata Health Stock Plan.

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Restricted Stock

A summary of the Company’s restricted stock activity and related information for the three months ended March 29, 2015 is as follows:
 
Restricted
Stock Awards
(RSA)
 
Restricted
Stock Units
(RSU)
 
Performance
Stock Units
(PSU)
 
Weighted-Average
Grant-Date Fair Value per Share
 
 
 
 
RSA
 
RSU
 
PSU
Outstanding at December 28, 2014
108

 
2,841

 
1,257

 
$
56.62

 
$
92.35

 
$
96.21

Awarded
—

 
22

 
3

 
—

 
$
194.61

 
$
194.34

Vested
—

 
(308
)
 
—

 
—

 
$
70.22

 
—

Cancelled
—

 
(132
)
 
(103
)
 
—

 
$
91.13

 
$
81.12

Outstanding at March 29, 2015
108

 
2,423

 
1,157

 
$
56.62

 
$
96.18

 
$
97.77


Stock Options

The Company’s stock option activity under all stock option plans during the three months ended March 29, 2015 is as follows:
 
Options
(in thousands)
 
Weighted-Average
Exercise Price
Outstanding at December 28, 2014
3,211

 
$
34.74

Exercised
(593
)
 
$
28.10

Cancelled
(25
)
 
$
17.94

Outstanding at March 29, 2015
2,593

 
$
36.42


At March 29, 2015, outstanding options to purchase 2.4 million shares were exercisable with a weighted-average exercise price per share of $37.57.

Employee Stock Purchase Plan

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 or last day of the offering period, whichever is lower. During the three months ended March 29, 2015, approximately 0.1 million shares were issued under the ESPP. As of March 29, 2015, there were approximately 14.6 million shares available for issuance under the ESPP.
 
Share Repurchases

In April 2012 the Company’s Board of Directors authorized share repurchases for up to $250.0 million via a combination of Rule 10b5-1 and discretionary share repurchase programs. In addition, on January 30, 2014, the Company’s Board of Directors authorized up to $250.0 million to repurchase shares of the Company’s common stock on a discretionary basis. During the three months ended March 29, 2015 and March 30, 2014, the Company repurchased approximately 0.2 million and 0.8 million shares for $34.8 million and $130.0 million, respectively. Authorizations to repurchase up to an additional $95.6 million of the Company’s common stock remained available as of March 29, 2015.

7. Income Taxes

The Company’s 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 rate for the three months ended March 29, 2015 was 23.2%. The variance from the U.S. federal statutory tax rate of 35% 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. The decrease from the U.S. federal statutory rate also resulted from the reversal of a valuation allowance related to research and development tax credits as well as tax deductions related to stock award activities, which were recorded as discrete items in the quarter.


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The Company is currently under examination by the IRS for tax year 2011. The IRS has not yet proposed any adjustments to the filed return.

8. Legal Proceedings

The Company is 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, the Company assesses, 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. The Company regularly reviews 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, the Company is 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 that 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 the Company’s 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.

On November 14, 2014, the Company entered into a Settlement and License Agreement with Syntrix Biosystems, Inc. and its sole shareholders, John A. Zebala and Amy Zebala, that settled all claims in the litigation brought against the Company. On December 2, 2014, the Company and its subsidiary Verinata Health, Inc. entered into a series of agreements with Sequenom, Inc. and several other parties that, among other items, settled a patent litigation among the parties involved. For more detailed discussions on these matters, refer to note “10. Legal Proceedings” in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 28, 2014.

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 flows. 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 significant 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.

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 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 28, 2014. Operating results are not necessarily indicative of results that may occur in future periods.


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Table of Contents

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 Quarterly Report on Form 10-Q.

About Illumina

We are the global leader in sequencing-and array-based solutions for genetic analysis. Our solutions serve customers in a wide range of markets, enabling the broad adoption of genomics solutions in research and clinical settings. Our customers include leading genomic research centers, academic institutions, government laboratories, hospitals, and reference laboratories as well as pharmaceutical, biotechnology, agrigenomics, commercial molecular diagnostic, and consumer genomics companies.

Our portfolio of integrated systems, consumables, and analysis tools is designed to accelerate and simplify genetic analysis. This portfolio addresses a range of genomic complexity, price points, and throughput, enabling customers to select the best solution for their research or clinical challenge. Our leading-edge sequencing instruments can efficiently perform a broad range of nucleic-acid (DNA, RNA) analyses across a wide range of sample sizes.

To provide our customers with more comprehensive sample-to-answer solutions, we acquired several companies: NextBio, a leader in clinical and genomic informatics, in November 2013, Advanced Liquid Logic Inc., a leader in digital microfluidics and liquid handling solutions, in July 2013, and Epicentre Technologies Corporation, a leading provider of nucleic-acid sample preparation reagents and specialty enzymes for sequencing and array applications, in January 2011.

Over the last few years, we have made key acquisitions to enable our goal of becoming a leader in the clinical market. These include Myraqa, Inc. in July 2014, Verinata Health, Inc. in February 2013, and BlueGnome Ltd. in September 2012. Our acquisition of Myraqa bolstered our regulatory and quality capabilities and enhanced our leadership team in molecular and companion diagnostics. The acquisition of Verinata strengthened our reproductive health portfolio by adding the Verinata verifi prenatal test, a comprehensive noninvasive prenatal test (NIPT) for high-risk pregnancies. Our acquisition of BlueGnome, a leading provider of genetic solutions for screening chromosomal abnormalities and genetic variations associated with developmental delay and infertility, expanded our ability to offer integrated solutions in reproductive health and cancer.
 
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 28, 2014.

Next-Generation Sequencing

Next-generation sequencing has become a core technology for modern life-science research, and our portfolio of sequencing platforms represents a family of systems that are designed to meet the workflow, output, and accuracy demands of a full range of sequencing applications. We believe that the expanding sequencing market, along with an increase in the number of samples available and enhancements in our sequencing portfolio, will continue to drive demand for our next-generation sequencing technologies. As a result, we believe that our sequencing consumables revenue will continue to grow in future periods.

Arrays

As a complement to next-generation sequencing, we believe arrays offer a less expensive, faster, and highly accurate technology for use when genetic content is already known. The information content of microarrays is fixed and reproducible. As such, arrays provide repeatable, standardized assays for certain subsets of nucleotide bases within the overall genome. We believe that life science researchers will migrate certain array studies to sequencing. However, we expect that demand from customers in consumer, reproductive health, and applied markets will offset this decline. Demand in the array market has trended toward lower complexity array that can be used on larger numbers of samples, entailing a lower selling price per sample. We believe that our innovation in array products supports the lower selling price.

Financial Overview

Financial highlights for Q1 2015 include the following:

•
Net revenue increased by 28.0% during Q1 2015 to $538.6 million compared to Q1 2014. Our sales increased across our portfolio of sequencing products, including consumables, instruments, and services.

•
Gross profit as a percentage of revenue (gross margin) was 69.6% in Q1 2015 compared to 66.1% in Q1 2014. In Q1 2014, gross profit and gross margin were negatively affected by legal contingency charges associated with Syntrix patent litigation subsequently settled in November 2014. See details on this matter in note “8. Legal Proceedings” in Part I, Item 1 of this Form 10-Q. Higher margins on sequencing instrument sales during the period also contributed to the increase in gross margin in Q1 2015. We believe 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 in new markets; our cost structure for manufacturing operations; royalties; and our ability to create innovative and high premium products that meet or stimulate customer demand.

•
Income from operations increased by $84.0 million in Q1 2015 compared to Q1 2014, as a result of higher gross profit, despite the increase in research and development and selling, general and administrative expenses, which we expect to continue to grow.

•
Our effective tax rate was 23.2% in Q1 2015, compared to 28.4% in Q1 2014. The variance from the U.S. federal statutory tax rate of 35% 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. The decrease from the U.S federal statutory rate also resulted from the reversal of a valuation allowance related to research and development tax credits as well as tax deductions related to stock award activities, which were recorded as discrete items in the quarter. 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” in Part I Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 28, 2014. We anticipate that our effective tax rate will trend lower than the U.S. federal statutory tax rate in the future due to the portion of our earnings that will be subject to lower statutory tax rates.
 
•
We ended Q1 2015 with cash, cash equivalents, and short-term investments totaling $1.4 billion.


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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.
 
 
Q1 2015
 
Q1 2014
Revenue:
 
 
 
Product revenue
85.3
 %
 
86.1
 %
Service and other revenue
14.7

 
13.9

Total revenue
100.0

 
100.0

Cost of revenue:
 
 
 
Cost of product revenue
22.2

 
26.5

Cost of service and other revenue
6.0

 
5.1

Amortization of acquired intangible assets
2.2

 
2.3

Total cost of revenue
30.4

 
33.9

Gross profit
69.6

 
66.1

Operating expense:
 
 
 
Research and development
17.0

 
18.3

Selling, general and administrative
21.6

 
26.0

Acquisition related gain, net
(1.8
)
 
(0.2
)
Headquarter relocation
0.1

 
0.1

Total operating expense
36.9

 
44.2

Income from operations
32.7

 
21.9

Other income (expense):
 
 
 
Interest income
0.3

 
0.2

Interest expense
(2.0
)
 
(2.3
)
Cost-method investment gain, net
2.3

 
—

Other (expense) income, net
(0.2
)
 
0.1

Total other income (expense), net
0.4

 
(2.0
)
Income before income taxes
33.1

 
19.9

Provision for income taxes
7.7

 
5.6

Net income
25.4
 %
 
14.3
 %

Our fiscal year consists of 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 month periods ended March 29, 2015 and March 30, 2014 were both 13 weeks.
Revenue 
(Dollars in thousands)
Q1 2015
 
Q1 2014
 
Change
 
% Change
Product revenue
$
459,127

 
$
362,211

 
$
96,916

 
27
%
Service and other revenue
79,438

 
58,570

 
20,868

 
36

Total revenue
$
538,565

 
$
420,781

 
$
117,784

 
28
%

Product revenue consists primarily of revenue from the sale of consumables and instruments. Service and other revenue consists primarily of sequencing and genotyping service revenue as well as instrument service contract revenue.

Consumables revenue increased $65.9 million, or 27%, to $308.4 million in Q1 2015 compared to $242.5 million in Q1 2014, primarily attributable to increases in sequencing consumable sales, driven by growth in the instrument installed base.


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Instrument revenue increased $30.6 million, or 26%, to $146.4 million in Q1 2015 compared to $115.8 million in Q1 2014, driven primarily by shipments of sequencing instruments, in particular, shipments of our high-throughput platforms, partially offset by a decline in microarray instrument revenue.

Service and other revenue increased $20.9 million, or 36%, to $79.4 million in Q1 2015 compared to $58.6 million in Q1 2014, driven primarily by increases in sequencing service revenue, including growth in NIPT services from higher test volumes. Revenue from extended instrument service contracts also contributed to the increase as our installed base continues to grow.

Overall, these increases were negatively impacted by the foreign exchange fluctuations in the comparative periods. Absent these fluctuations, revenues would have grown 33% on a constant currency basis from Q1 2014 to Q1 2015.

Gross Margin
(Dollars in thousands)
Q1 2015
 
Q1 2014
 
Change
 
% Change
Gross profit
$
375,027

 
$
278,292

 
$
96,735

 
35
%
Gross margin
69.6
%
 
66.1
%
 
 
 
 

Gross profit increased $96.7 million, or 35%, to $375.0 million in Q1 2015 compared to $278.3 million in Q1 2014, primarily due to the increase in revenue. In Q1 2014, gross profit and gross margin were negatively affected by legal contingency charges associated with Syntrix patent litigation subsequently settled in November 2014. See details on this matter in note “8. Legal Proceedings” in Part I, Item 1 of this Form 10-Q. Higher margins on sequencing instruments sales also contributed to the increase in the gross margin.

Operating Expense

(Dollars in thousands)
Q1 2015
 
Q1 2014
 
Change
 
% Change
Research and development
$
91,772

 
$
77,041

 
$
14,731

 
19
%
Selling, general and administrative
116,317

 
109,573

 
6,744

 
6

Acquisition related gain, net
(9,887
)
 
(1,013
)
 
(8,874
)
 
876

Headquarter relocation
699

 
595

 
104

 
17

Total operating expense
$
198,901

 
$
186,196

 
$
12,705

 
7
%

Research and development expense increased by $14.7 million, or 19%, in Q1 2015 from Q1 2014, primarily due to increased headcount as we continue to expand our investment in the development of our products as well as enhancements to existing products.

Selling, general and administrative expense increased by $6.7 million, or 6%, in Q1 2015 from Q1 2014, primarily driven by increased headcount and outside services to support our continued growth, as well as investments in scaling our operations.

Acquisition related gain, net, in both periods consisted of changes in fair value of contingent consideration. The changes in the fair value of the contingent consideration during the periods were primarily due to changes in the estimated payments and a shorter discounting period.

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Other Income (Expense), Net 
(Dollars in thousands)
Q1 2015
 
Q1 2014
 
Change
 
% Change
Interest income
$
1,693

 
$
956

 
$
737

 
77
 %
Interest expense
(11,164
)
 
(9,743
)
 
(1,421
)
 
15

Cost-method investment gain, net
12,582

 
—

 
12,582

 
100

Other (expense) income, net
(1,191
)
 
479

 
(1,670
)
 
(349
)
Total other income (expense), net
$
1,920

 
$
(8,308
)
 
$
10,228

 
(123
)%

Interest income increased in Q1 2015 as a result of an increase in our investment portfolio balance. Interest expense consisted primarily of accretion of discount on our convertible senior notes. The increase in interest expense in Q1 2015 compared to Q1 2014 was due to the issuance in June 2014 of our 0% Convertible Senior Notes due 2019 and 0.5% Convertible Senior Notes due 2021, partially offset by the impact from the concurrent repurchase of $600.0M in principal amount of our 0.25% Convertible Senior Notes due 2016.

Cost-method investment gain, net during Q1 2015 consisted primarily of a gain on the sale of a cost-method investment.

Other (expense) income, net, in Q1 2015 and Q1 2014 primarily consisted of net foreign exchange gains and losses.

Provision for Income Taxes
 
(Dollars in thousands)
Q1 2015
 
Q1 2014
 
Change
 
% Change
Income before income taxes
$
178,046

 
$
83,788

 
$
94,258

 
112
%
Provision for income taxes
41,388

 
23,811

 
17,577

 
74

Net income
$
136,658

 
$
59,977

 
$
76,681

 
128
%
Effective tax rate
23.2
%
 
28.4
%
 
 
 
 

Our effective tax rate was 23.2% for Q1 2015 compared to 28.4% in Q1 2014. The variance from the U.S. federal statutory tax rate of 35% in Q1 2015 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. The decrease from the U.S. federal statutory rate also resulted from the reversal of a valuation allowance related to research and development tax credits as well as tax deductions related to stock award activities, which were recorded as discrete items in the quarter. In Q1 2014, the variance from the U.S. statutory rate of 35% 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 tax deductions related to stock award activities which were recorded as discrete items in the quarter.

Liquidity and Capital Resources

At March 29, 2015, we had approximately $533.5 million in cash and cash equivalents, of which approximately $348 million were held by our foreign subsidiaries. Cash and cash equivalents decreased by $102.6 million from last year, 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. Our ability to generate cash from operations provides us with the financial flexibility we need to meet operating, investing, and financing needs. It is our intention to indefinitely reinvest all current and future foreign earnings in foreign subsidiaries.

Historically, we have liquidated our short-term investments and/or issued debt and equity securities to finance our business needs as a supplement to cash provided by operating activities. As of March 29, 2015, we had $833.0 million in short-term investments. Short-term investments held by our foreign subsidiaries as of March 29, 2015 were approximately $352 million. Our short-term investments include marketable securities consisting of U.S. government-sponsored entities, corporate debt securities, and U.S. Treasury securities.


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In June 2014, we issued convertible senior notes due 2019 and 2021 (2019 and 2021 Notes) with an aggregate principal amount of $1,150.0 million. The proceeds from such issuance and cash on hand totaling $1,244.7 million were used to repurchase $600.0 million in principal amount of our convertible senior notes due 2016 (2016 Notes). As of March 29, 2015, $320.0 million in principal amount of the 2016 Notes remained outstanding, with a maturity date of March 15, 2016. Based upon meeting the stock trading price conversion requirement during the three months ended March 30, 2015, the 2016 Notes will continue to be convertible through June 30, 2015. It is our intent and policy to settle conversions of the 2016 Notes through combination settlement, which essentially involves repayment of an amount of cash equal to the principal amount and delivery of the excess of conversion value over principal amount in shares of common stock. The 2019 and 2021 Notes were not convertible as of March 29, 2015.

We anticipate that our current cash, cash equivalents and short-term investments, together with cash provided by operating activities 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:
•
potential early repayment of debt obligations as a result of conversions;
•
support of commercialization efforts related to our current and future products, including expansion of our direct sales force and field support resources both in the United States and abroad;
•
acquisitions of equipment and other fixed assets for use in our current and future manufacturing and research and development facilities;
•
repurchases of our outstanding common stock;
•
the continued advancement of research and development efforts;
•
potential strategic acquisitions and investments;
•
the expansion needs of our facilities, including costs of leasing additional facilities; and
•
investment in our global business processes, and the associated Enterprise Resource Planning platform.

As of March 29, 2015, we had $34.2 million in fair value of contingent consideration liabilities associated with prior acquisitions to be settled in future periods.

During Q1 2015, we used $34.8 million to repurchase our outstanding shares under the stock repurchase programs authorized by our Board of Directors. As of March 29, 2015, there remains $95.6 million under the authorized programs.

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.

Cash Flow Summary
(In thousands)
Q1 2015
 
Q1 2014
Net cash provided by operating activities
$
66,779

 
$
37,087

Net cash used in investing activities
(154,147
)
 
(144,387
)
Net cash used in financing activities
(12,534
)
 
(85,924
)
Effect of exchange rate changes on cash and cash equivalents
(2,715
)
 
100

Net decrease in cash and cash equivalents
$
(102,617
)
 
$
(193,124
)


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Operating Activities

Net cash provided by operating activities in Q1 2015 consisted of net income of $136.7 million plus net adjustments of $28.0 million partially offset by net changes in operating assets and liabilities of $97.9 million. The primary non-cash expenses added back to net income included deferred income taxes of $53.5 million, share-based compensation of $31.9 million, depreciation and amortization expenses of $30.1 million, and accretion of debt discount of $10.2 million. These non-cash add-backs were partially offset by $76.4 million in incremental tax benefit related to share-based compensation, $12.6 million in cost-method investment gain, net and $9.9 million in change in fair value of contingent consideration. Cash flow impact from changes in net operating assets included increases in accounts receivable and inventory, and a decrease in accrued liabilities, partially offset by an increase in accounts payable.

Net cash provided by operating activities in Q1 2014 consisted of net income of $60.0 million plus net adjustments of $54.3 million in addition to net changes in operating assets and liabilities of $77.1 million. The primary non-cash expenses added back to net income included deferred income taxes of $33.9 million, share-based compensation of $33.4 million, and depreciation and amortization expenses of $28.4 million. These non-cash add-backs were partially offset by $50.5 million in incremental tax benefit related to share-based compensation. Cash flow impact from changes in net operating assets included increases in accounts receivable and accrued liabilities.

Investing Activities

Net cash used in investing activities totaled $154.1 million for Q1 2015. We purchased $325.4 million of available-for-sale securities and $194.7 million of our available-for-sale securities matured or were sold during the period. We invested $36.6 million in capital expenditures primarily associated with facilities, information technology equipment and systems, and the purchase of manufacturing, research and development equipment. We also received $13.1 million in net proceeds from the sale of a cost-method investment.

Net cash used in investing activities totaled $144.4 million for Q1 2014. We purchased $253.3 million of available-for-sale securities and $133.1 million of our available-for-sale securities matured or were sold during the period. We also invested $19.0 million in capital expenditures primarily associated with the purchase of manufacturing, research, and development equipment, leasehold improvements, and information technology equipment and systems.

Financing Activities

Net cash used in financing activities totaled $12.5 million for Q1 2015. We used $83.8 million to pay taxes related to net share settlement of equity awards and $34.8 million to repurchase our common stock. We received $76.4 million in incremental tax benefit related to share-based compensation and $29.7 million in proceeds from issuance of common stock through the exercise of stock options and under our employee stock purchase plan.

Net cash used in financing activities totaled $85.9 million for Q1 2014. We used $130.0 million to repurchase our common stock, repaid $29.7 million of our convertible senior notes due 2014 and paid $8.8 million in taxes for net share settlement of equity awards. We received $50.5 million in incremental tax benefit related to share-based compensation and $32.0 million in proceeds from issuance of common stock through the exercise of stock options and under our employee stock purchase plan.

Off-Balance Sheet Arrangements

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 Q1 2015, we were not involved in any “off-balance sheet arrangements” within the meaning of the rules of the Securities and Exchange Commission.

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 Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 28, 2014 have the greatest potential impact on our financial

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statements, so we consider them to be our critical accounting policies and estimates. There were no material changes to our critical accounting policies and estimates during Q1 2015.

In February 2015, the Financial Accounting Standards Board issued Accounting Standard Update (ASU) 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The new standard modifies current guidance on consolidation under the variable interest model and the voting model. ASU 2015-02 will be effective for us beginning in the first quarter of 2016. We are currently evaluating the impact of the ASU 2015-02 on our consolidated financial statements.

In May 2014, the Financial Accounting Standards Board issued ASU 2014-09, Revenue from Contracts with Customers. The new standard is based on the principle that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 will be effective for us in the first quarter of 2017 and allows for a full retrospective or a modified retrospective adoption approach. We are currently evaluating the impact of ASU 2014-09 on our consolidated financial statements.
 
Consideration Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, strategies, objectives, expectations, intentions, and adequacy of resources. Words such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” 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 regarding the integration of our acquired technologies with our existing technology, the commercial launch of new products, the entry into new business segments or markets, and the duration which our existing cash and other resources is expected to fund our operating activities.

Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Among the important factors that could cause actual results to differ materially from those in any forward-looking statements include the following:

•
our ability to develop and commercialize our instruments and consumables, to deploy new products, services, and applications, and expand the markets for our technology platforms;
•
our ability to manufacture robust instrumentation and consumables;
•
our ability to identify and integrate acquired technologies, products, or businesses successfully;
•
our expectations and beliefs regarding prospects and growth for the business and its markets;
•
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; and
•
other factors detailed in our filings with the SEC, including the risks, uncertainties, and assumptions described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 28, 2014, 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 update these forward-looking statements, to review or confirm analysts’ expectations, or to provide interim reports or updates on the progress of the current financial quarter. Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q.


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Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There were no substantial changes to our market risks in the three months ended March 29, 2015, when compared to the disclosures in Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 28, 2014.

Item 4. 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 Q1 2015, 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.

An evaluation was also performed under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of any change in our internal control over financial reporting that occurred during Q1 2015 and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. The evaluation did not identify any such change.


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Table of Contents

PART II — OTHER INFORMATION

Item 1. 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 assesses, 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 that 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.

Item 1A. Risk Factors.

Our business is subject to various risks, including those described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 28, 2014, which we strongly encourage you to review. There have been no material changes from the risk factors disclosed in Item 1A of our Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Unregistered Sales of Equity Securities

None during the quarterly period ended March 29, 2015.

Purchases of Equity Securities by the Issuer

In April 2012, the Company’s Board of Directors authorized share repurchases for up to $250.0 million via a combination of Rule 10b5-1 and discretionary share repurchase programs. In addition, on January 30, 2014, the Company’s Board of Directors authorized up to $250.0 million to repurchase shares of the Company’s common stock on a discretionary basis. The following table summarizes shares repurchased pursuant to these programs during the three months ended March 29, 2015.
Period
 

Total Number
of Shares
Purchased (1)
 
 

Average Price
Paid per Share
 
Total Number of
Shares Purchased as
Part of Publicly
Announced Programs
 
Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Programs
December 29, 2014 - January 25, 2015
32,244

 
$
186.08

 
32,244

 
$
124,369,470

January 26, 2015 - February 22, 2015
46,397

 
$
193.97

 
46,397

 
$
115,369,715

February 23, 2015 - March 29, 2015
101,572

 
$
194.44

 
101,572

 
$
95,620,362

Total
180,213

 
$
192.82

 
180,213

 
$
95,620,362

___________
(1) All shares purchased during the three months ended March 29, 2015, were made in open-market transactions.


Item 3. Defaults Upon Senior Securities.

None.


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Table of Contents

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.
 
Exhibit Number
  
Description of Document
 
 
31.1
  
Certification of Jay T. Flatley pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2
  
Certification of Marc A. Stapley pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1
  
Certification of Jay T. Flatley pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
32.2
  
Certification of Marc A. Stapley pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101.INS
  
XBRL Instance Document
 
 
101.SCH
  
XBRL Taxonomy Extension Schema
 
 
101.CAL
  
XBRL Taxonomy Extension Calculation Linkbase
 
 
101.LAB
  
XBRL Taxonomy Extension Label Linkbase
 
 
101.PRE
  
XBRL Taxonomy Extension Presentation Linkbase
 
 
101.DEF
  
XBRL Taxonomy Extension Definition Linkbase


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SIGNATURES
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.
 
 
ILLUMINA, INC.
(registrant)
 
 
 
Date: 
May 1, 2015
 
/s/ MARC A. STAPLEY
 
 
 
Marc A. Stapley
Senior Vice President and Chief Financial Officer


28