SEC Filing Form Details

 

ILLUMINA INC filed this Form 10-Q on 11/02/2015

Form 10-Q

 
 
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 September 27, 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 October 8, 2015, there were 146.4 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 thousands)
 
 
September 27,
2015
 
December 28,
2014
 
(Unaudited)
 
 
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
551,529

 
$
636,154

Short-term investments
887,877

 
702,217

Accounts receivable, net
413,474

 
289,458

Inventory
233,781

 
191,144

Deferred tax assets, current portion
43,737

 
40,786

Prepaid expenses and other current assets
80,030

 
29,844

Total current assets
2,210,428

 
1,889,603

Property and equipment, net
308,722

 
265,264

Goodwill
756,687

 
724,904

Intangible assets, net
286,346

 
314,500

Deferred tax assets, long-term portion
86,827

 
49,848

Other assets
84,538

 
95,521

Total assets
$
3,733,548

 
$
3,339,640

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Accounts payable
$
123,432

 
$
82,626

Accrued liabilities
358,259

 
335,276

Long-term debt, current portion
102,166

 
304,256

Total current liabilities
583,857

 
722,158

Long-term debt
1,007,935

 
986,780

Other long-term liabilities
173,061

 
167,904

Redeemable noncontrolling interests
32,128

 

Stockholders’ equity:
 
 
 
Common stock
1,849

 
1,805

Additional paid-in capital
2,454,876

 
2,172,940

Accumulated other comprehensive income (loss)
1,040

 
(1,080
)
Retained earnings
918,288

 
561,206

Treasury stock, at cost
(1,439,486
)
 
(1,272,073
)
Total stockholders’ equity
1,936,567

 
1,462,798

Total liabilities and stockholders’ equity
$
3,733,548

 
$
3,339,640

See accompanying notes to the condensed consolidated financial statements.


3


ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
 
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Revenue:
 
 
 
 
 
 
 
Product revenue
$
470,824

 
$
416,163

 
$
1,392,711

 
$
1,169,182

Service and other revenue
79,447

 
64,467

 
235,503

 
179,797

Total revenue
550,271

 
480,630

 
1,628,214

 
1,348,979

Cost of revenue:
 
 
 
 
 
 
 
Cost of product revenue
120,954

 
113,103

 
360,037

 
338,851

Cost of service and other revenue
29,590

 
23,909

 
94,289

 
68,598

Amortization of acquired intangible assets
12,188

 
9,677

 
34,957

 
28,757

Total cost of revenue
162,732

 
146,689

 
489,283

 
436,206

Gross profit
387,539

 
333,941

 
1,138,931

 
912,773

Operating expense:
 
 
 
 
 
 
 
Research and development
99,226

 
85,082

 
287,180

 
245,108

Selling, general and administrative
136,648

 
119,888

 
377,406

 
344,110

Legal contingencies
15,000

 
7,705

 
15,000

 
7,705

Headquarter relocation
(5,226
)
 
870

 
(3,047
)
 
4,357

Acquisition related expense (gain), net
1,109

 
903

 
(6,449
)
 
(335
)
Total operating expense
246,757

 
214,448

 
670,090

 
600,945

Income from operations
140,782

 
119,493

 
468,841

 
311,828

Other income (expense):
 
 
 
 
 
 
 
Interest income
2,767

 
534

 
5,804

 
2,954

Interest expense
(12,821
)
 
(10,987
)
 
(35,190
)
 
(30,652
)
Cost-method investment gain, net
2,900

 
4,427

 
15,482

 
4,427

Other expense, net
(4,711
)
 
(1,024
)
 
(6,802
)
 
(31,860
)
Total other expense, net
(11,865
)
 
(7,050
)
 
(20,706
)
 
(55,131
)
Income before income taxes
128,917

 
112,443

 
448,135

 
256,697

Provision for income taxes
13,296

 
18,954

 
93,609

 
56,626

Consolidated net income
115,621

 
93,489

 
354,526

 
200,071

Add: Net loss attributable to noncontrolling interests
2,556

 

 
2,556

 

Net income attributable to Illumina stockholders
$
118,177

 
$
93,489

 
$
357,082

 
$
200,071

Earnings per share attributable to Illumina stockholders:
 
 
 
 
 
 
 
Basic
$
0.81

 
$
0.66

 
$
2.47

 
$
1.50

Diluted
$
0.79

 
$
0.63

 
$
2.39

 
$
1.34

Shares used in computing earnings per common share:
 
 
 
 
 
 
 
Basic
145,349

 
141,142

 
144,447

 
133,290

Diluted
149,672

 
147,512

 
149,108

 
149,084

See accompanying notes to the condensed consolidated financial statements.


4


ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
 
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Consolidated net income
$
115,621

 
$
93,489

 
$
354,526

 
$
200,071

Unrealized gain (loss) on available-for-sale securities, net of deferred tax
441

 
(972
)
 
2,120

 
(873
)
Total consolidated comprehensive income
116,062

 
92,517

 
356,646

 
199,198

Add: Comprehensive loss attributable to noncontrolling interests
2,556

 

 
2,556

 

Comprehensive income attributable to Illumina stockholders
$
118,618

 
$
92,517

 
$
359,202

 
$
199,198

See accompanying notes to the condensed consolidated financial statements.


5


ILLUMINA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
Cash flows from operating activities:
 
 
 
Consolidated net income
$
354,526

 
$
200,071

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation expense
52,774

 
44,783

Amortization of intangible assets
40,884

 
37,839

Share-based compensation expense
97,104

 
114,089

Accretion of debt discount
29,828

 
27,989

Loss on extinguishment of debt
3,737

 
31,360

Incremental tax benefit related to share-based compensation
(121,703
)
 
(102,639
)
Deferred income taxes
83,679

 
30,428

Change in fair value of contingent consideration
(6,449
)
 
(2,958
)
Change in estimated cease-use loss
(3,047
)
 
4,357

Cost-method investment gain, net
(15,482
)
 
(4,427
)
Other
5,488

 
6,369

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(121,309
)
 
(37,733
)
Inventory
(43,598
)
 
(44,693
)
Prepaid expenses and other current assets
(4,982
)
 
(20,152
)
Other assets
(428
)
 
(5,262
)
Accounts payable
49,532

 
14,748

Accrued liabilities
8,884

 
40,598

Accrued legal contingencies
15,000

 
22,147

Other long-term liabilities
(5,220
)
 
3,808

Net cash provided by operating activities
419,218

 
360,722

Cash flows from investing activities:
 
 
 
Purchases of available-for-sale securities
(713,862
)
 
(428,700
)
Sales of available-for-sale securities
335,351

 
324,554

Maturities of available-for-sale securities
189,929

 
118,229

Net cash paid for acquisitions
(35,226
)
 
(3,285
)
Net sales proceeds from (purchases of) strategic investments
(4,100
)
 
(6,755
)
Purchases of property and equipment
(107,361
)
 
(71,164
)
Cash paid for intangible assets
(275
)
 
(6,720
)
Net cash used in investing activities
(335,544
)
 
(73,841
)
Cash flows from financing activities:
 
 
 
Payments on financing obligations
(216,207
)
 
(29,880
)
Payments on acquisition related contingent consideration liability
(1,500
)
 

Proceeds from issuance of convertible notes

 
1,132,378

Repurchases of convertible notes

 
(1,244,721
)
Incremental tax benefit related to share-based compensation
121,703

 
102,639

Common stock repurchases
(72,256
)
 
(202,431
)
Taxes paid related to net share settlement of equity awards
(95,157
)
 
(9,668
)
Proceeds from issuance of common stock
65,668

 
84,733

Contributions from noncontrolling interest owners
32,128

 

Net cash used in financing activities
(165,621
)
 
(166,950
)
Effect of exchange rate changes on cash and cash equivalents
(2,678
)
 
(1,673
)
Net (decrease) increase in cash and cash equivalents
(84,625
)
 
118,258

Cash and cash equivalents at beginning of period
636,154

 
711,637

Cash and cash equivalents at end of period
$
551,529

 
$
829,895


See accompanying notes to the condensed consolidated financial statements.

6


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 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.

The unaudited condensed consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, majority-owned or controlled companies, and variable interest entities (VIEs) for which the Company is 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.

The Company evaluates its ownership, contractual and other interests in entities that are not wholly-owned by the Company to determine if these entities are VIEs, and, if so, whether the Company is the primary beneficiary of the VIE. In determining whether the Company is the primary beneficiary of a VIE and is therefore required to consolidate the VIE, the Company applies a qualitative approach that determines whether it has 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. The Company continuously assesses whether it is the primary beneficiary of a VIE as changes to existing relationships or future transactions may result in the consolidation or deconsolidation, as the case may be.

Redeemable Noncontrolling Interests

Noncontrolling interests represent the portion of equity (net assets) in an entity that is not wholly-owned by the Company that is not attributable, directly or indirectly, to the Company. Noncontrolling interests with embedded redemption features, such as put rights, that are not solely within the Company’s control are considered redeemable noncontrolling interests. Redeemable noncontrolling interests are presented outside of stockholders’ equity on the condensed consolidated balance sheets.

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 and nine months ended September 27, 2015 and September 28, 2014 were both 13 and 39 weeks, respectively.

Significant Accounting Policies

During the three and nine months ended September 27, 2015, there have been no changes in to the Company’s significant accounting policies as described in the Annual Report on Form 10-K for the fiscal year ended December 28, 2014.


7


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 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 2018 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.

Earnings per Share

Basic earnings per share is computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed based on the sum of the weighted average number of common shares and potentially dilutive common shares outstanding during the period.

Potentially dilutive common shares consist of shares issuable under convertible senior notes, 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 earnings per share (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Weighted average shares outstanding
145,349

 
141,142

 
144,447

 
133,290

Effect of potentially dilutive common shares from:
 
 
 
 
 
 
 
Convertible senior notes
1,670

 
1,972

 
2,013

 
3,967

Equity awards
2,653

 
4,124

 
2,648

 
4,367

Warrants

 
274

 

 
7,460

Weighted average shares used in calculation of diluted earnings per share
149,672

 
147,512

 
149,108

 
149,084

Potentially dilutive shares excluded from calculation due to anti-dilutive effect
13

 
54

 
7

 
112



8


2. Balance Sheet Account Details

Short-Term Investments

The following is a summary of short-term investments (in thousands):
 
 
September 27, 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
$
32,962

 
$
12

 
$
(1
)
 
$
32,973

 
$
51,308

 
$
10

 
$
(55
)
 
$
51,263

Corporate debt securities
608,622

 
193

 
(952
)
 
607,863

 
502,924

 
46

 
(2,882
)
 
500,088

U.S. Treasury securities
246,671

 
374

 
(4
)
 
247,041

 
151,255

 
5

 
(394
)
 
150,866

Total available-for-sale securities
$
888,255

 
$
579

 
$
(957
)
 
$
887,877

 
$
705,487

 
$
61

 
$
(3,331
)
 
$
702,217


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 27, 2015 were as follows (in thousands):
 
 
Estimated
Fair Value
Due within one year
$
390,385

After one but within five years
497,492

Total
$
887,877


Cost-Method Investments

As of September 27, 2015 and December 28, 2014, the aggregate carrying amounts of the Company’s cost-method investments in non-publicly traded companies were $54.7 million and $37.2 million, respectively, included in other assets. Revenue recognized from transactions with such companies were $16.1 million and $47.3 million, respectively, for the three and nine months ended September 27, 2015 and $14.7 million and $31.4 million, respectively, for the three and nine months ended September 28, 2014.

During the nine months ended September 27, 2015, the Company recognized gains on dispositions of cost-method investments of $18.0 million. During the nine months ended September 28, 2014, the Company recognized a gain of $4.4 million associated with additional proceeds received for a cost-method investment sold in a prior period. 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 and nine months ended September 27, 2015 or September 28, 2014.

Inventory

Inventory consists of the following (in thousands):
 
September 27,
2015
 
December 28,
2014
Raw materials
$
84,136

 
$
73,179

Work in process
114,848

 
94,102

Finished goods
34,797

 
23,863

Total inventory
$
233,781

 
$
191,144



9


Goodwill

The Company tests the carrying value of goodwill in accordance with accounting rules on impairment of goodwill, which require the Company to estimate the fair value of the reporting unit annually, or when impairment indicators exist, and compare such amounts to their respective carrying values to determine if an impairment is required. The Company performed its annual assessment for goodwill impairment in the second quarter of 2015, noting no impairment.

Changes in the Company’s goodwill balance during the nine months ended September 27, 2015 are as follows (in thousands):
 
Goodwill
Balance as of December 28, 2014
$
724,904

Current period acquisitions
31,783

Balance as of September 27, 2015
$
756,687


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.

As of September 27, 2015, the Company had foreign exchange forward contracts in place to hedge exposures in the euro, Japanese yen, and Australian dollar. As of September 27, 2015 and December 28, 2014, the total notional amounts of outstanding forward contracts in place for foreign currency purchases were $61.3 million and $61.0 million, respectively.

Accrued Liabilities

Accrued liabilities consist of the following (in thousands):
 
September 27,
2015
 
December 28,
2014
Accrued compensation expenses
$
107,209

 
$
112,606

Deferred revenue, current portion
84,432

 
75,294

Acquisition related contingent liability, current portion
36,175

 
44,124

Accrued taxes payable
29,457

 
38,942

Customer deposits
28,783

 
20,274

Reserve for product warranties
17,933

 
15,616

Accrued legal contingencies
15,000

 

Other
39,270

 
28,420

Total accrued liabilities
$
358,259

 
$
335,276


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.


10


Changes in the Company’s reserve for product warranties during the three and nine months ended September 27, 2015 and September 28, 2014 are as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Balance at beginning of period
$
16,365

 
$
13,000

 
$
15,616

 
$
10,407

Additions charged to cost of product revenue
6,916

 
6,803

 
20,737

 
16,616

Repairs and replacements
(5,348
)
 
(5,370
)
 
(18,420
)
 
(12,590
)
Balance at end of period
$
17,933

 
$
14,433

 
$
17,933

 
$
14,433


Leases

Changes in the Company’s facility exit obligation related to its former headquarters lease during the three and nine months ended September 27, 2015 and September 28, 2014 are as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Balance at beginning of period
$
36,677

 
$
38,480

 
$
37,700

 
$
38,218

Adjustment to facility exit obligation
(5,935
)
 
57

 
(5,278
)
 
2,065

Accretion of interest expense
590

 
666

 
1,926

 
1,948

Cash payments
(1,539
)
 
(1,153
)
 
(4,555
)
 
(4,181
)
Balance at end of period
$
29,793

 
$
38,050

 
$
29,793

 
$
38,050

 
On December 30, 2014, the Company entered into a lease agreement with an affiliate of Biomed Realty Trust, Inc. (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. On June 25, 2015, the Company entered into a lease agreement with another affiliate of BMR for an office building near Cambridge, England. Minimum lease payments during the initial term of 20 years are estimated to be approximately $147.9 million. One of our Board members also serves on the Board of BMR.

On March 12, 2015, 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.

Investment in Helix

In July 2015, the Company 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. The Company determined that Helix is a variable interest entity as the group of holders of at risk equity investments lacks the power to direct the activities of Helix that most significantly impact Helix’s economic performance. Additionally, the Company determined that it has (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, the Company is deemed to be the primary beneficiary of Helix and is required to consolidate Helix.

The assets and liabilities of Helix are not significant to the Company’s financial position. Helix has an immaterial impact on the Company’s consolidated statements of operations and cash flows.

The Company has not provided financing to Helix outside its contractual arrangements, which include the contributions of certain perpetual licenses, instruments, intangibles, initial laboratory setup, and discounted supply terms in exchange for voting equity interests in Helix. Such contributions are recorded at their historical basis as they remain within the control of the Company. Helix is financed through cash contributions made by the third party investors in exchange for voting equity interests in Helix.


11


Redeemable Noncontrolling Interests

The noncontrolling interests in Helix contain a contingent put right exercisable by certain noncontrolling Helix investors that may require the Company to redeem all noncontrolling interests in cash at the then approximate fair market value. The fair value of the redeemable noncontrolling interests is considered a Level 3 instrument. Such redemption right is exercisable at the option of certain noncontrolling interest holders provided that a bona fide pursuit of the sale of Helix has occurred, and after the fifth anniversary of either January 1, 2016, or the date that Helix begins processing samples for commercial operations, whichever is earlier.

As such, the redeemable noncontrolling interests in Helix are classified outside of stockholders’ equity on the consolidated balance sheet. 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 value at each reporting date. As of September 27, 2015, the noncontrolling shareholders and Illumina each held 50% of Helix’s outstanding equity interests.

The activity of the redeemable noncontrolling interests during the three months ended September 27, 2015 is as follows (in thousands):
 
Redeemable Noncontrolling Interests
Balance as of June 28, 2015
$

Cash contributions
54,167

Amount held in escrow by third party
(22,039
)
Net loss attributable to noncontrolling interests
(2,556
)
Adjustment up to the redemption value
2,556

Balance as of September 27, 2015
$
32,128


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 September 27, 2015 and December 28, 2014 (in thousands):
 
 
September 27, 2015
 
December 28, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds (cash equivalents)
$
185,885

 
$

 
$

 
$
185,885

 
$
431,172

 
$

 
$

 
$
431,172

Debt securities in government-sponsored entities

 
32,973

 

 
32,973

 

 
51,263

 

 
51,263

Corporate debt securities

 
607,862

 

 
607,862

 

 
500,088

 

 
500,088

U.S. Treasury securities
247,041

 

 

 
247,041

 
150,866

 

 

 
150,866

Deferred compensation plan assets

 
25,382

 

 
25,382

 

 
23,486

 

 
23,486

Total assets measured at fair value
$
432,926

 
$
666,217

 
$

 
$
1,099,143

 
$
582,038

 
$
574,837

 
$

 
$
1,156,875

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquisition related contingent consideration liabilities
$

 
$

 
$
36,175

 
$
36,175

 
$

 
$

 
$
44,124

 
$
44,124

Deferred compensation liability

 
24,086

 

 
24,086

 

 
20,310

 

 
20,310

Total liabilities measured at fair value
$

 
$
24,086

 
$
36,175

 
$
60,261

 
$

 
$
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),

12


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.

At September 27, 2015, the fair value of the contingent consideration liabilities consisted 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 and nine months ended September 27, 2015 were due to changes in the estimated payments.
Changes in estimated fair value of contingent consideration liabilities during the nine months ended September 27, 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 expense (gain), net
(6,449
)
Cash payments
(1,500
)
Balance as of September 27, 2015
$
36,175


4. Convertible Senior Notes

As of September 27, 2015, the Company had outstanding $104.2 million in principal amount of 0.25% convertible senior notes due March 15, 2016 (2016 Notes), $632.5 million in principal amount of 0% convertible senior notes due June 15, 2019 (2019 Notes), and $517.5 million in principal amount of 0.5% convertible senior notes due June 15, 2021 (2021 Notes).

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 2019 Notes and $517.5 million aggregate principal amount of 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

13


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.

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 September 27, 2015 and had no dilutive impact during the three and nine months ended September 27, 2015. If the 2019 and 2021 Notes were converted as of September 27, 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 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, 2014, the 2016 Notes became convertible on April 1, 2014 and will continue to be convertible through March 11, 2016.

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 and nine months ended September 27, 2015 reflects the dilutive impact from the 2016 Notes. If the remaining 2016 Notes were converted as of September 27, 2015, the if-converted value would exceed the principal amount by $141.2 million.

During the nine months ended September 27, 2015, the Company recorded a loss on extinguishment of debt calculated as the difference between the estimated fair value of the debt and the carrying value of the notes as of the settlement date. To measure the fair value of the converted notes as of the settlement date, the applicable interest rate was estimated using Level 2 observable inputs and applied to the converted notes using the same methodology as in the issuance date valuation.


14


The following table summarizes information about the conversion of the 2016 Notes during the nine months ended September 27, 2015 (in thousands, except percentage):
 
2016 Notes
Cash paid for principal of notes converted
$
215,859

Conversion value over principal amount paid in shares of common stock
$
320,868

Number of shares of common stock issued upon conversion
1,564

Loss on extinguishment of debt
$
3,737

Effective interest rate used to measure fair value of converted notes upon conversion
1.2% - 1.4%


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.
 
 
September 27,
2015
 
December 28,
2014
Principal amount of convertible notes outstanding
$
1,254,168

 
$
1,470,027

Unamortized discount of liability component
(144,067
)
 
(178,991
)
Net carrying amount of liability component
1,110,101

 
1,291,036

Less: current portion
(102,166
)
 
(304,256
)
Long-term debt
$
1,007,935

 
$
986,780

Carrying value of equity component, net of debt issuance cost
$
213,897

 
$
215,283

Fair value of outstanding notes
$
1,506,257

 
$
2,021,750

Weighted-average remaining amortization period of discount on the liability component
4.8 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
 
Nine Months Ended
 
September 27,
2015
 
September 28,
2014
 
September 27,
2015
 
September 28,
2014
Cost of product revenue
$
2,567

 
$
2,572

 
$
7,012

 
$
6,816

Cost of service and other revenue
498

 
311

 
1,243

 
880

Research and development
9,098

 
14,589

 
31,152

 
39,043

Selling, general and administrative
20,066

 
27,197

 
57,697

 
67,350

Share-based compensation expense before taxes
32,229

 
44,669

 
97,104

 
114,089

Related income tax benefits
(9,876
)
 
(14,852
)
 
(28,304
)
 
(37,103
)
Share-based compensation expense, net of taxes
$
22,353

 
$
29,817

 
$
68,800

 
$
76,986



15


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 27, 2015 are as follows:
 
 
Employee Stock Purchase Rights
Risk-free interest rate
0.07% - 0.33%

Expected volatility
29% - 38%

Expected term
0.5 - 1.0 year

Expected dividends

Weighted-average fair value per share
$
53.92


As of September 27, 2015, approximately $198.8 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 2.3 years.

6. Stockholders’ Equity

During the nine months ended September 27, 2015, the Company’s stockholders approved the 2015 Stock and Incentive Compensation Plan (the 2015 Stock Plan), which replaced both the 2005 Stock and Incentive Plan and the 2008 Verinata Health Stock Plan, and increased the maximum number of shares of common stock authorized for issuance by 2.7 million shares. As of September 27, 2015, approximately 8.3 million shares remained available for future grants under the 2015 Stock Plan and the 2005 Solexa Equity Plan.

Restricted Stock

The Company’s restricted stock activity and related information for the nine months ended September 27, 2015 is as follows (units in thousands):
 
Restricted
Stock Awards
(RSA)
 
Restricted
Stock Units
(RSU)
 
Performance
Stock Units
(PSU)(1)
 
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

 
119

 
12

 

 
$
202.45

 
$
204.44

Vested
(76
)
 
(488
)
 

 
$
60.21

 
$
72.71

 

Cancelled

 
(222
)
 
(123
)
 

 
$
96.97

 
$
97.24

Outstanding at September 27, 2015
32

 
2,250

 
1,146

 
$
47.93

 
$
101.98

 
$
97.24

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

Stock Options

The Company’s stock option activity under all stock option plans during the nine months ended September 27, 2015 is as follows:
 
Options
(in thousands)
 
Weighted-Average
Exercise Price
Outstanding at December 28, 2014
3,211

 
$
34.74

Exercised
(1,338
)
 
$
28.32

Cancelled
(77
)
 
$
10.65

Outstanding at September 27, 2015
1,796

 
$
40.55


At September 27, 2015, outstanding options to purchase 1.8 million shares were exercisable with a weighted-average exercise price per share of $40.92.


16


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 nine months ended September 27, 2015, approximately 0.2 million shares were issued under the ESPP. As of September 27, 2015, there were approximately 14.5 million shares available for issuance under the ESPP.
 
Share Repurchases

In January 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. In addition, on May 1, 2015, the Company’s Board of Directors authorized $150.0 million of repurchases under a Rule 10b5-1 plan. During the three months ended September 27, 2015, 0.2 million shares for $37.5 million were repurchased. During the nine months ended September 27, 2015, the Company repurchased approximately 0.4 million shares for $72.2 million. Authorizations to repurchase up to an additional $208.1 million of the Company’s common stock remained available as of September 27, 2015. On October 29, 2015, the Company’s Board of Directors authorized a new discretionary share repurchase program of $250.0 million.

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 rates for the three and nine months ended September 27, 2015 were 10.3% and 20.9%, respectively. For the three and nine months ended September 27, 2015, the variance from the U.S. federal statutory tax rate of 35% was primarily attributable to a discrete tax benefit of $24.8 million related to the exclusion of stock compensation from prior period cost-sharing charges as a result of a recent tax court opinion in which an unrelated third party was successful in challenging such charges. The variance from the U.S. federal statutory tax rate of 35% was also attributable to the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom.

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. As of September 27, 2015, the Company had $15.0 million in accrued legal contingencies. 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 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.


17


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.

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 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.

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

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 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.

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 an essential technology in our markets, 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 arrays is fixed and reproducible. As such, arrays provide repeatable, standardized assays for certain subsets of nucleotide bases within the overall genome. We believe that our customers will migrate certain array studies to sequencing. However, we expect that demand from customers in reproductive health, agriculture, and applied markets will partially mitigate this decline. Demand in the array market has trended toward lower complexity arrays that can be used on larger numbers of samples, resulting in a lower selling price per sample. We believe that our innovation in array products supports the lower selling price.

Financial Overview

Financial highlights for the first three quarters of 2015 include the following:

Net revenue increased by 20.7% during the first three quarters of 2015 to $1,628.2 million compared to the first three quarters of 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 69.9% in the first three quarters of 2015 compared to 67.7% in the first three quarters of 2014. In the first three quarters of 2015, gross margins increased due to efficiencies and leverage in manufacturing operations, as well as a positive shift in product mix to sequencing consumables, offset in part by unfavorable foreign exchange fluctuations. In addition, gross profit and gross margin in the first three quarters of 2014 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. 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; 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 $157.0 million in the first three quarters of 2015 compared to the first three quarters of 2014, as a result of higher revenue, despite the increase in research and development and selling, general and administrative expenses, which we expect will continue to grow.

Our effective tax rate was 20.9% in the first three quarters of 2015, compared to 22.1% in the first three quarters of 2014. The variance from the U.S. federal statutory tax rate of 35% was primarily attributable to a discrete tax benefit of $24.8 million, related to the exclusion of stock compensation from prior period cost-sharing charges as a result of a recent tax court opinion in which an unrelated third party was successful in challenging such charges. If this tax court opinion is overturned, our tax rate will be adversely impacted by the reversal of the discrete tax benefit recorded this quarter and any stock compensation that should have been included in the cost-sharing charges from this year going forward. The decrease from the U.S. federal statutory tax rate also resulted from the mix of earnings in jurisdictions with lower statutory tax rates from the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom. 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.
 
Cash, cash equivalents, and short-term investments were $1.4 billion as of September 27, 2015.


18


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 2015
 
Q3 2014
 
YTD 2015
 
YTD 2014
Revenue:
 
 
 
 
 
 
 
Product revenue
85.6
 %
 
86.6
 %
 
85.5
 %
 
86.7
 %
Service and other revenue
14.4

 
13.4

 
14.5

 
13.3

Total revenue
100.0

 
100.0

 
100.0

 
100.0

Cost of revenue:
 
 
 
 
 
 
 
Cost of product revenue
22.0

 
23.5

 
22.1

 
25.1

Cost of service and other revenue
5.4

 
5.0

 
5.8

 
5.1

Amortization of acquired intangible assets
2.2

 
2.0

 
2.2

 
2.1

Total cost of revenue
29.6

 
30.5

 
30.1

 
32.3

Gross profit
70.4

 
69.5

 
69.9

 
67.7

Operating expense:
 
 
 
 
 
 
 
Research and development
18.0

 
17.7

 
17.6

 
18.2

Selling, general and administrative
24.8

 
24.9

 
23.2

 
25.5

Legal contingencies
2.7

 
1.6

 
0.9

 
0.6

Headquarter relocation
(0.9
)
 
0.2

 
(0.2
)
 
0.3

Acquisition related expense (gain), net
0.2

 
0.2

 
(0.4
)
 

Total operating expense
44.8

 
44.6

 
41.1

 
44.6

Income from operations
25.6

 
24.9

 
28.8

 
23.1

Other income (expense):
 
 
 
 
 
 
 
Interest income
0.5

 
0.1

 
0.4

 
0.3

Interest expense
(2.3
)
 
(2.3
)
 
(2.2
)
 
(2.3
)
Cost-method investment gain, net
0.5

 
0.9

 
1.0

 
0.3

Other expense, net
(0.9
)
 
(0.2
)
 
(0.5
)
 
(2.4
)
Total other expense, net
(2.2
)
 
(1.5
)
 
(1.3
)
 
(4.1
)
Income before income taxes
23.4

 
23.4

 
27.5

 
19.0

Provision for income taxes
2.4

 
3.9

 
5.7

 
4.2

Consolidated net income
21.0

 
19.5

 
21.8

 
14.8

Add: Net loss attributable to noncontrolling interests
0.5

 

 
0.1

 

Net income attributable to Illumina stockholders
21.5
 %
 
19.5
 %
 
21.9
 %
 
14.8
 %

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 and nine month periods ended September 27, 2015 and September 28, 2014 were both 13 and 39 weeks, respectively.
Revenue 
(Dollars in thousands)
Q3 2015
 
Q3 2014
 
Change
 
% Change
 
YTD 2015
 
YTD 2014
 
Change
 
% Change
Product revenue
$
470,824

 
$
416,163

 
$
54,661

 
13
%
 
$
1,392,711

 
$
1,169,182

 
$
223,529

 
19
%
Service and other revenue
79,447

 
64,467

 
14,980

 
23

 
235,503

 
179,797

 
55,706

 
31

Total revenue
$
550,271

 
$
480,630

 
$
69,641

 
14
%
 
$
1,628,214

 
$
1,348,979

 
$
279,235

 
21
%

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.

19



QTD 2015 vs. QTD 2014

Revenue increased $69.6 million, or 14%, to $550.3 million in Q3 2015 compared to $480.6 million in Q3 2014.

Consumables revenue increased $59.8 million, or 23%, to $321.1 million in Q3 2015 compared to $261.3 million in Q3 2014, driven by growth in the sequencing instrument installed base.

Instrument revenue decreased $4.9 million, or 3%, to $145.4 million in Q3 2015 compared to $150.3 million in Q3 2014, due to decreases in HiSeq X and MiSeq shipments.

Service and other revenue increased $15.0 million, or 23%, to $79.4 million in Q3 2015 compared to $64.5 million in Q3 2014, driven primarily by the growth in NIPT services resulting from higher test volumes. Also contributing to the increase was revenue from genotyping services and extended instrument service contracts as our sequencing instrument 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 18% on a constant currency basis from Q3 2014 to Q3 2015.

YTD 2015 vs. YTD 2014

Revenue increased $279.2 million, or 21%, to $1,628.2 million in the first three quarters of 2015 compared to $1,349.0 million in the first three quarters of 2014.

Consumables revenue increased $182.2 million, or 24%, to $932.8 million in the first three quarters of 2015 compared to $750.6 million in the first three quarters of 2014, driven by growth in the sequencing instrument installed base.

Instrument revenue increased $40.8 million, or 10%, to $447.1 million in the first three quarters of 2015 compared to $406.3 million in the first three quarters of 2014, driven by shipments of our high-throughput platforms.

Service and other revenue increased $55.7 million, or 31%, to $235.5 million in the first three quarters of 2015 compared to $179.8 million in the first three quarters of 2014, driven by the growth in NIPT services resulting from higher test volumes. Revenue from extended instrument service contracts also contributed to the increase as our sequencing instrument 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 25% on a constant currency basis from the first three quarters of 2014 to the first three quarters of 2015.

Gross Margin
(Dollars in thousands)
Q3 2015
 
Q3 2014
 
Change
 
% Change
 
YTD 2015
 
YTD 2014
 
Change
 
% Change
Gross profit
$
387,539

 
$
333,941

 
$
53,598

 
16%
 
$
1,138,931

 
$
912,773

 
$
226,158

 
25%
Gross margin
70.4
%
 
69.5
%
 
 
 
 
 
69.9
%
 
67.7
%
 
 
 
 

QTD 2015 vs. QTD 2014

Gross margin increased to 70.4% in Q3 2015 from 69.5% in Q3 2014. In Q3 2014, gross margin was 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. Gross margin was further affected by a positive shift in product mix to sequencing consumables, which carry a higher margin, partially offset by an unfavorable shift in foreign exchange rates.

YTD 2015 vs. YTD 2014

Gross margin increased to 69.9% in the first three quarters of 2015 compared to 67.7% in the first three quarters of 2014, primarily due to efficiencies and leverage in manufacturing operations and a positive shift in product mix to sequencing consumables, partially offset by unfavorable foreign exchange fluctuations. In addition, gross margin in the first three quarters

20


of 2014 was 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.


Operating Expense
(Dollars in thousands)
Q3 2015
 
Q3 2014
 
Change
 
% Change
 
YTD 2015
 
YTD 2014
 
Change
 
% Change
Research and development
$
99,226

 
$
85,082

 
$
14,144

 
17
 %
 
$
287,180

 
$
245,108

 
$
42,072

 
17
 %
Selling, general and administrative
136,648

 
119,888

 
16,760

 
14

 
377,406

 
344,110

 
33,296

 
10

Legal contingencies
15,000

 
7,705

 
7,295

 
95

 
15,000

 
7,705

 
7,295

 
95

Headquarter relocation
(5,226
)
 
870

 
(6,096
)
 
(701
)
 
(3,047
)
 
4,357

 
(7,404
)
 
(170
)
Acquisition related expense (gain), net
1,109

 
903

 
206

 
23

 
(6,449
)
 
(335
)
 
(6,114
)
 
1,825

Total operating expense
$
246,757

 
$
214,448

 
$
32,309

 
15
 %
 
$
670,090

 
$
600,945

 
$
69,145

 
12
 %

QTD 2015 vs. QTD 2014

Research and development expense increased by $14.1 million, or 17%, in Q3 2015 from Q3 2014, primarily due to increased headcount as we continue to invest in the development of our products as well as enhancements to existing products.

Selling, general and administrative expense increased by $16.8 million, or 14%, in Q3 2015 from Q3 2014, primarily driven by increased headcount to support our continued growth, investments in scaling our operations, and start-up costs related to our Helix joint venture.

Legal contingencies in Q3 2015 and Q3 2014 represent charges related to litigation matters.

Headquarter relocation costs for Q3 2015 include a net gain related to a change in a lease exit liability, partially offset by accretion of interest on such liability.

YTD 2015 vs. YTD 2014

Research and development expense increased by $42.1 million, or 17%, in the first three quarters of 2015 compared to the first three quarters of 2014, primarily due to increased headcount and outside services as we continue to invest in the development of new products as well as enhancements to existing products.

Selling, general and administrative expense increased by $33.3 million, or 10%, in the first three quarters of 2015 compared to the first three quarters of 2014, primarily driven by increased headcount to support our continued growth, investments in scaling our operations, and start-up costs related to our Helix joint venture.

Legal contingencies for the first three quarters of 2015 and 2014 represent charges related to litigation matters.

Headquarter relocation costs for the first three quarters of 2015 include a net gain related to a change in a lease exit liability recorded in Q3, partially offset by accretion of interest on such liability.

Other Expense, Net 
(Dollars in thousands)
Q3 2015
 
Q3 2014
 
Change
 
% Change
 
YTD 2015
 
YTD 2014
 
Change
 
% Change
Interest income
$
2,767

 
$
534

 
$
2,233

 
418
 %
 
$
5,804

 
$
2,954

 
$
2,850

 
96
 %
Interest expense
(12,821
)
 
(10,987
)
 
(1,834
)
 
17

 
(35,190
)
 
(30,652
)
 
(4,538
)
 
15

Cost-method investment gain, net
2,900

 
4,427

 
(1,527
)
 
(34
)
 
15,482

 
4,427

 
11,055

 
250

Other expense, net
(4,711
)
 
(1,024
)
 
(3,687
)
 
360

 
(6,802
)
 
(31,860
)
 
25,058

 
(79
)
Total other expense, net
$
(11,865
)
 
$
(7,050
)
 
$
(4,815
)
 
68
 %
 
$
(20,706