Illumina, Inc.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For Quarterly Period Ended July 3, 2005
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o |
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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 000-30361
Illumina, Inc.
(Exact name of registrant as specified in its charter)
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Delaware
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33-0804655 |
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.) |
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9885 Towne Centre Drive, San Diego, CA 92121 |
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(Address of principal executive offices)
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(Zip Code) |
(858) 202-4500
(Registrants 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 o
Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of
the Exchange Act).
Yes þ No o
Indicate the number of shares outstanding of each of issuers classes of common stock, as of the
latest practicable date.
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Common Stock, $0.01 par value
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40,554,585 Shares |
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Class
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Outstanding at July 3, 2005 |
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ILLUMINA, INC.
Condensed Consolidated Balance Sheets
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July 3, 2005 |
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January 2, 2005 |
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(unaudited) |
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(Note) |
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(in thousands) |
ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
54,566 |
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$ |
54,789 |
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Restricted cash and investments |
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12,205 |
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Accounts receivable, net |
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12,192 |
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11,891 |
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Inventory, net |
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5,157 |
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3,807 |
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Prepaid expenses and other current assets |
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1,023 |
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999 |
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Total current assets |
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72,938 |
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83,691 |
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Property and equipment, net |
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13,573 |
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8,574 |
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Goodwill |
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2,315 |
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Intangible and other assets, net |
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2,433 |
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2,642 |
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Total assets |
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$ |
91,259 |
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$ |
94,907 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable and accrued liabilities |
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$ |
15,067 |
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$ |
13,091 |
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Litigation judgment |
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5,957 |
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Total current liabilities |
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15,067 |
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19,048 |
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Deferred gain on sale of land and building |
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3,030 |
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3,218 |
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Other long-term liabilities |
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2,873 |
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379 |
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Commitments and contingencies |
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Stockholders equity |
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70,289 |
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72,262 |
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Total liabilities and stockholders equity |
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$ |
91,259 |
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$ |
94,907 |
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Note: The Balance Sheet at January 2, 2005 has been derived from the audited financial
statements as of that date.
See accompanying notes.
3
ILLUMINA, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
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Three months ended |
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Six months ended |
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July 3, |
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June 27, |
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July 3, |
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June 27, |
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2005 |
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2004 |
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2005 |
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2004 |
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(in thousands, except per share |
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(in thousands, except per share |
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amounts) |
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amounts) |
Revenue |
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Product |
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$ |
12,636 |
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$ |
9,045 |
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$ |
24,801 |
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$ |
17,984 |
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Service |
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2,783 |
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1,815 |
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5,474 |
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2,965 |
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Research |
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405 |
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626 |
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697 |
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1,340 |
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Total revenue |
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15,824 |
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11,486 |
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30,972 |
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22,289 |
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Costs and expenses: |
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Cost of product revenue |
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4,033 |
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2,701 |
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7,970 |
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5,263 |
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Cost of service revenue |
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701 |
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366 |
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1,363 |
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606 |
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Research and development |
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7,301 |
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5,320 |
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13,179 |
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10,496 |
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Selling, general and administrative |
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6,494 |
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5,993 |
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12,487 |
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11,731 |
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Acquired in-process research and
development |
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15,800 |
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15,800 |
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Amortization of deferred compensation
and other stock-based compensation
charges |
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41 |
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250 |
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98 |
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568 |
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Litigation judgment |
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189 |
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378 |
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Total costs and expenses |
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34,370 |
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14,819 |
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50,897 |
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29,042 |
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Loss from operations |
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(18,546 |
) |
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(3,333 |
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(19,925 |
) |
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(6,753 |
) |
Interest and other income (expense), net |
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7 |
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(183 |
) |
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151 |
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(694 |
) |
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Net loss |
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$ |
(18,539 |
) |
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$ |
(3,516 |
) |
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$ |
(19,774 |
) |
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$ |
(7,447 |
) |
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Net loss per share, basic and diluted |
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$ |
(0.46 |
) |
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$ |
(0.10 |
) |
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$ |
(0.50 |
) |
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$ |
(0.22 |
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Shares used in calculating net loss per
share, basic and diluted |
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40,187 |
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34,960 |
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39,267 |
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33,754 |
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The composition of stock-based
compensation is as follows: |
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Research and development |
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$ |
17 |
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$ |
108 |
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$ |
32 |
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$ |
247 |
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Selling, general and administrative |
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24 |
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142 |
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66 |
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321 |
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$ |
41 |
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$ |
250 |
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$ |
98 |
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$ |
568 |
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See accompanying notes.
4
ILLUMINA, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
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Six months ended |
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July 3, |
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June 27, |
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2005 |
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2004 |
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(in thousands) |
Operating activities: |
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Net loss |
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$ |
(19,774 |
) |
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$ |
(7,447 |
) |
Adjustments to reconcile net loss to net cash used in operating
activities: |
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Acquired in-process research and development |
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15,800 |
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Depreciation and amortization |
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1,669 |
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2,168 |
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Loss on disposal of property and equipment |
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71 |
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Amortization of premium on investments |
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(14 |
) |
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369 |
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Amortization of deferred compensation and other stock-based
compensation charges |
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98 |
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568 |
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Amortization of gain on sale of land and building |
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(187 |
) |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(742 |
) |
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(5,397 |
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Interest receivable |
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|
249 |
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Inventory |
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(1,349 |
) |
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(748 |
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Prepaid expenses and other current assets |
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231 |
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331 |
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Other assets |
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(129 |
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Accounts payable and accrued liabilities |
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524 |
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3,800 |
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Accrued litigation judgment |
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(5,957 |
) |
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|
378 |
|
Other long term liabilities |
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2,436 |
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Net cash used in operating activities |
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(7,194 |
) |
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(5,858 |
) |
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Investing activities: |
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Cash paid for acquisition, net of cash acquired |
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(2,388 |
) |
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Purchases of available-for-sale securities |
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(6,603 |
) |
Sales and maturities of available for sale securities |
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12,248 |
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26,348 |
|
Purchase of property and equipment |
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(6,232 |
) |
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(1,446 |
) |
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Net cash provided by investing activities |
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3,628 |
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18,299 |
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Financing activities: |
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Payments on long-term debt |
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(27 |
) |
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(207 |
) |
Payments on equipment financing |
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(231 |
) |
Proceeds from issuance of common stock |
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2,935 |
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29,478 |
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Net cash provided by financing activities |
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2,908 |
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29,040 |
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Effect of foreign currency translation on cash and cash equivalents |
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|
435 |
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64 |
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Net (decrease) increase in cash and cash equivalents |
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(223 |
) |
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|
41,545 |
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Cash and cash equivalents at beginning of period |
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54,789 |
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12,465 |
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Cash and cash equivalents at end of period |
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$ |
54,566 |
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$ |
54,010 |
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See accompanying notes.
5
1. Summary of Significant Accounting Principles
The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States 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 generally accepted accounting
principles for complete financial statements. The 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 managements opinion, the
accompanying financial statements reflect all adjustments, consisting only 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 Companys 2004 audited consolidated financial statements and footnotes included in the
Companys Annual Report on Form 10-K.
The preparation of financial statements requires that management make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and
related disclosure of contingent assets and liabilities. Actual results could differ from those
estimates.
Fiscal Year
The Companys fiscal year is 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, and September 30. The
quarters and six month periods ended July 3, 2005 and June 27, 2004 are both 13 and 26 weeks,
respectively.
Revenue Recognition
The Company records revenue in accordance with the guidelines established by SEC Staff
Accounting Bulletin No. 104 (SAB 104). Under SAB 104, revenue cannot be recorded until all of the
following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or
services have been rendered; the sellers price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Product revenue consists of sales of oligonucleotides,
arrays, assay reagents, genotyping systems and gene expression systems. Service revenue consists of
revenue received for performing SNP genotyping services and for extended warranty sales.
Revenue for product sales is recognized generally upon shipment and transfer of title to the
customer, provided no significant obligations remain and collection of the receivables is
reasonably assured. BeadLab and BeadStation revenue is recognized when earned, which is generally
upon shipment except for BeadLab revenue which is recognized upon installation, training and
acceptance. Reserves are provided for anticipated product warranty expenses at the time the
associated revenue is recognized. Revenue for extended warranty sales is recognized ratably over
the term of the extended warranty. Revenue for genotyping services is recognized generally at the
time the genotyping analysis data is delivered to the customer. The Company was awarded a $9.1
million grant from the National Institutes of Health in September 2002 to perform
genotyping services in connection with the first phase of the International HapMap Project. A
portion of the revenue from this project was earned at the time the related costs were incurred
while the remainder of the revenue was earned upon the delivery of genotyping data. The Company
recorded no revenue under this grant in the three months ended July 3, 2005. Research revenue
consists of amounts earned under research agreements with government grants, which is recognized in
the period during which the related costs are incurred. Some contracts entered into by the Company
qualify as multiple element arrangements as defined by Emerging Issues Task Force Issue No. 00-21
(EITF 00-21), Revenue Arrangements with Multiple Deliverables. The Company recognizes revenue
for delivered
6
elements only when the delivered element has stand-alone value, the fair values of undelivered
elements are known, and there are no uncertainties regarding customer acceptance. All revenues
are recognized net of applicable allowances for returns or discounts.
Cash, Cash Equivalents & Investments
Cash and cash equivalents are comprised of highly liquid investments with a remaining maturity
of less than three months from the date of purchase.
The Company applies Statement of Financial Accounting Standards (SFAS) No. 115, Accounting
for Certain Investments in Debt and Equity Securities, to its investments. Under SFAS No. 115, the
Company classifies its investments as Available-for-Sale and records such assets at estimated
fair value in the balance sheet, with unrealized gains and losses, if any, reported in
stockholders equity. The Company invests its excess cash balances in marketable debt securities,
primarily government securities and corporate bonds and notes, with strong credit ratings or short
maturity mutual funds providing similar financial returns. The Company limits the amount of
investment exposure as to institutions, maturity and investment type.
As of January 2, 2005, restricted cash and investments primarily consist of corporate debt
securities that are used as collateral against a letter of credit (see Note 10). This letter of
credit was released in January of 2005.
Stock-Based Compensation
As of July 3, 2005, the Company has three stock-based employee and non-employee director
compensation plans, which are described more fully in the Companys 2004 Annual Report on Form
10-K. As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the Company accounts
for common stock options granted, and restricted stock sold, to employees, founders and directors
using the intrinsic value method and, thus, recognizes no compensation expense for options granted,
or restricted stock sold, with exercise prices equal to or greater than the fair value of the
Companys common stock on the date of the grant. The Company has recorded deferred stock
compensation related to certain stock options, and restricted stock, which were granted prior to
the Companys initial public offering and as part of a business acquisition with exercise prices
below estimated fair value, which is being amortized on an accelerated amortization methodology in
accordance with Financial Accounting Standards Board Interpretation Number (FIN) 28.
In June 2005, the board of directors and stockholders adopted the 2005 Stock and Incentive
Plan (the 2005 Stock Plan). Upon adoption of the 2005 Stock Plan, issuance of options under the
2000 Stock Plan ceased. The 2005 Stock Plan provides that an aggregate of up to 11,542,358 shares
of the Companys common stock be reserved and available to be issued. In addition, the 2005 Stock
Plan provides for an automatic annual increase in the shares reserved for issuance by the lesser of
5% of outstanding shares of the Companys common stock on the last day of the immediately preceding
fiscal year, 1,200,000 shares or such lesser amount as determined by the Companys board of
directors.
Pro forma information regarding net loss is required by SFAS No. 123 and has been determined
as if the Company had accounted for its employee stock options and employee stock purchases under
the fair value method of that statement. The fair value for these options was estimated at the
dates of grant using the fair value option pricing model (Black Scholes) with the following
weighted-average assumptions:
7
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Three Months Ended |
|
|
Six Months Ended |
|
|
|
July 3, |
|
|
June 27, |
|
|
July 3, |
|
|
June 27, |
|
|
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
Weighted average risk-free interest rate |
|
|
3.87 |
% |
|
|
3.67 |
% |
|
|
3.88 |
% |
|
|
3.11 |
% |
Expected dividend yield |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
Weighted average volatility |
|
|
90 |
% |
|
|
96 |
% |
|
|
90 |
% |
|
|
98 |
% |
Estimated life (in years) |
|
|
5 |
|
|
|
5 |
|
|
|
5 |
|
|
|
5 |
|
Weighted average fair value of options
granted per share |
|
$ |
6.81 |
|
|
$ |
5.10 |
|
|
$ |
6.60 |
|
|
$ |
5.81 |
|
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to
expense over the vesting period. The Companys pro forma information is as follows (in thousands
except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
July 3, |
|
June 27, |
|
July 3, |
|
June 27, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
Net loss as reported |
|
$ |
(18,539 |
) |
|
$ |
(3,516 |
) |
|
$ |
(19,774 |
) |
|
$ |
(7,447 |
) |
Add: Stock-based compensation expense
recorded |
|
|
41 |
|
|
|
250 |
|
|
|
98 |
|
|
|
568 |
|
Less: Assumed stock compensation expense |
|
|
(1,535 |
) |
|
|
(2,313 |
) |
|
|
(3,796 |
) |
|
|
(4,653 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma net loss |
|
$ |
(20,033 |
) |
|
$ |
(5,579 |
) |
|
$ |
(23,472 |
) |
|
$ |
(11,532 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and Diluted net loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported |
|
$ |
(0.46 |
) |
|
$ |
(0.10 |
) |
|
$ |
(0.50 |
) |
|
$ |
(0.22 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma |
|
$ |
(0.50 |
) |
|
$ |
(0.16 |
) |
|
$ |
(0.60 |
) |
|
$ |
(0.34 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The pro forma effect on net loss presented is not likely to be representative of the pro forma
effects on reported net income or loss in future years.
In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No.
123 (revised 2004), Share Based Payment (SFAS 123R), which is a revision of FASB Statement No. 123,
Accounting for Stock-Based Compensation (SFAS 123). This statement supercedes FASB Accounting
Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees (APB 25), and amends
FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS 123R is similar to
the approach described in SFAS 123; however, SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the income statement
based on their fair values. Pro forma disclosure is no longer an alternative.
SFAS 123R permits companies to adopt its requirements using either a modified prospective
method or a modified retrospective method. Under the modified prospective method, compensation
cost is recognized in the financial statements beginning with the effective date, based on the
requirements of SFAS 123R for all share-based payments granted after that date, and based on the
requirements for SFAS 123 for all unvested awards granted prior to the effective date of SFAS 123R.
Under the modified retrospective method, the requirements are the same as under the modified
prospective method, but companies may also restate financial statements of previous periods based
on pro forma disclosures made in accordance with SFAS 123. The Company currently utilizes the
Black-Scholes model to measure the fair value of stock options granted to employees under the pro
forma disclosure requirements of SFAS 123. While SFAS 123R permits companies to continue to use
such a model, it also permits the use of a lattice model. The Company has not yet determined
which method or model it will use to measure the fair value of employee stock options under SFAS
123R. The new standard is effective for accelerated filers for fiscal years beginning on or after
June 15, 2005, and the Company expects to adopt SFAS 123R on January 2, 2006.
The Company currently accounts for share-based payments to employees using APB 25s intrinsic
value method and, as such, recognizes no compensation cost for employee stock options granted with
exercise prices equal to or greater than the fair value of the Companys common stock on the date
of the grant. Accordingly, the adoption of SFAS 123Rs fair value method is expected to result in
significant non-cash charges that will increase the Companys reported operating expenses; however,
it will have no impact on the Companys cash flows. The precise
8
impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on the
level of share-based payments granted in the future and the model the Company chooses to use.
However, had the Company adopted SFAS 123R in prior periods, the Company believes the impact of
that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro
forma net loss above.
Deferred compensation for options granted, and restricted stock sold, to consultants has been
determined in accordance with SFAS 123 and Emerging Issues Task Force Issue No. 96-18 as the fair
value of the consideration received or the fair value of the equity instruments issued, whichever
is more reliably measured. Deferred charges for options granted, and restricted stock sold, to
consultants are periodically re-measured as the underlying options vest.
Net Loss per Share
Basic and diluted net loss per common share is presented in conformity with SFAS No. 128,
Earnings per Share for all periods presented. In accordance with SFAS No. 128, basic and diluted
net loss per share is computed using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. Diluted net loss per share is
typically computed using the weighted average number of common and dilutive common equivalent
shares from stock options using the treasury stock method. However, for all periods presented,
diluted net loss per share is the same as basic net loss per share because the Company reported a
net loss and therefore the inclusion of weighted average shares of common stock issuable upon the
exercise of stock options would be antidilutive.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
Six months ended |
|
|
July 3, |
|
June 27, |
|
July 3, |
|
June 27, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
|
|
(in thousands) |
|
(in thousands) |
Weighted-average shares outstanding |
|
|
40,232 |
|
|
|
35,366 |
|
|
|
39,325 |
|
|
|
34,212 |
|
Less: Weighted-average shares of
common stock subject to repurchase |
|
|
(45 |
) |
|
|
(406 |
) |
|
|
(58 |
) |
|
|
(458 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares used in
calculating net loss per share,
basic and diluted |
|
|
40,187 |
|
|
|
34,960 |
|
|
|
39,267 |
|
|
|
33,754 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total number of shares excluded from the calculation of diluted net loss per share, prior
to application of the treasury stock method for options and shares of restricted stock, was
7,313,986 and 5,809,649 as of July 3, 2005 and June 27, 2004, respectively.
Comprehensive Income (Loss)
Comprehensive loss is comprised of net loss and other comprehensive loss. Other comprehensive
loss includes unrealized gains and losses on the Companys available-for-sale securities, changes
in the fair value of derivatives designated as effective as cash flow hedges, and foreign currency
translation adjustments.
The components of other comprehensive income (loss) are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
Six months ended |
|
|
July 3, |
|
June 27, |
|
July 3, |
|
June 27, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
|
|
(in thousands) |
|
(in thousands) |
Net loss |
|
$ |
(18,539 |
) |
|
$ |
(3,516 |
) |
|
$ |
(19,774 |
) |
|
$ |
(7,447 |
) |
Foreign currency translation adjustments |
|
|
77 |
|
|
|
(4 |
) |
|
|
108 |
|
|
|
40 |
|
Unrealized gain (loss) on available-for-sale securities |
|
|
7 |
|
|
|
(550 |
) |
|
|
29 |
|
|
|
(325 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss |
|
$ |
(18,455 |
) |
|
$ |
(4,070 |
) |
|
$ |
(19,637 |
) |
|
$ |
(7,732 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
2. Acquisition of CyVera Corporation
On April 8, 2005, the Company completed its acquisition of 100% of the voting equity interests
of CyVera Corporation (CyVera). Pursuant to an Agreement and Plan of Merger, dated as of
February 22, 2005 (the Merger Agreement), by and among Illumina, Semaphore Acquisition Sub, Inc.,
a Delaware corporation and wholly owned subsidiary of Illumina (Merger Sub), and CyVera, Merger
Sub merged with and into CyVera, with CyVera surviving as a wholly owned subsidiary of Illumina.
The results of CyVeras operations have been included in the Companys consolidated financial
statements since the acquisition date of April 8, 2005.
CyVera was created in October 2003 to commercialize its digital microbead technology platform
and optical instrumentation/reader concepts. The Company believes that the CyVera technology is
highly complementary to the Companys own portfolio of products and services; will enhance the
Companys capabilities to service its existing customers; and will accelerate the development of
additional technologies, products and services. In summary, the Company believes that integrating
CyVeras capabilities with the Companys technologies will better position the Company to address
the emerging biomarker R&D and in-vitro and molecular diagnostic markets.
Pursuant to the Merger Agreement, Illumina issued approximately 1.6 million shares (the
Shares) of Illumina common stock, paid approximately $2.3 million in cash and assumed net
liabilities of CyVera. In addition, Illumina assumed the outstanding stock options of CyVera.
Approximately 250,000 of the Shares were deposited into an escrow account with a bank. For a
period of one year from the closing date, these shares will be held by the bank to satisfy any
claims for indemnification made by the Company or CyVera pursuant to the Merger Agreement. To the
extent that some, or all, of these shares are not required to satisfy indemnification claims, then
such shares will be distributed pro rata among the CyVera stockholders.
The results of CyVeras operations have been included in the accompanying consolidated
financial statements from the date of the acquisition. The total cost of the acquisition is as
follows (in thousands):
|
|
|
|
|
Fair market value of securities issued, net |
|
$ |
14,433 |
|
Cash paid |
|
|
2,291 |
|
Estimated transaction costs |
|
|
728 |
|
Fair market value of options assumed |
|
|
394 |
|
|
|
|
|
|
|
|
|
|
|
Total Purchase Price |
|
$ |
17,846 |
|
|
|
|
|
|
The Company issued 1,579,897 shares of Illumina common stock in connection with this
transaction. The fair value of the these shares was determined based on the average closing price
of the Companys common stock for five trading days preceding, and following, February 22, 2005
(the date the transaction was announced). The Company believes that this time period gives proper
consideration to matters such as price fluctuations, quantities traded and issuance costs and
represents a reasonable period before and after the date on which the terms of the acquisition were
agreed. Based on these closing prices, the Company estimated the fair value of its common stock to
be $9.1670 per share, which equates to a total fair value of $14,483,000. This fair value was
reduced by $50,000, which represents the Companys estimate of the costs to register these shares
as required by the Merger Agreement.
The following table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the acquisition date. The final purchase price allocation will differ from
that presented below due to the fact that the Company has yet to identify the exact amount of the
transaction costs incurred.
10
|
|
|
|
|
|
|
At April 8, 2005 |
|
|
(in thousands) |
Cash |
|
$ |
4 |
|
Prepaid expenses |
|
|
12 |
|
Fixed assets |
|
|
349 |
|
Other assets |
|
|
250 |
|
Deferred compensation |
|
|
196 |
|
Accounts payable and accrued liabilities |
|
|
(825 |
) |
Debt assumed |
|
|
(255 |
) |
|
|
|
|
|
Net book value of net assets acquired |
|
|
(269 |
) |
|
In-process research and development |
|
|
15,800 |
|
Goodwill |
|
|
2,315 |
|
|
|
|
|
|
|
|
|
|
|
Net assets acquired |
|
$ |
17,846 |
|
|
|
|
|
|
In accordance with SFAS 142, the goodwill is not amortized, but will be subject to a periodic
assessment for impairment by applying a fair-value-based test. None of this goodwill is expected
to be deductible for tax purposes.
The Company allocated $15.8 million of the purchase price to in-process research and
development projects. In-process research and development (IPR&D) represents the valuation of
acquired, to-be-completed research projects. At the acquisition date, CyVeras ongoing research and
development initiatives were primarily involved with the development of its microbead technology
platform and optical instrumentation / reader concepts.
The value assigned to purchased IPR&D was determined by estimating the costs to develop the
acquired technology into commercially viable products, estimating the resulting net cash flows from
the projects, and discounting the net cash flows to their present value. The revenue projections
used to value the IPR&D were, in some cases, reduced based on the probability of developing a new
technology, and considered the relevant market sizes and growth factors, expected trends in
technology, and the nature and expected timing of new product introductions by the Company and its
competitors. The resulting net cash flows from such projects are based on the Companys estimates
of cost of sales, operating expenses, and income taxes from such projects. The rates utilized to
discount the net cash flows to their present value were based on estimated cost of capital
calculations. Due to the nature of the forecast and the risks associated with the projected growth
and profitability of the developmental projects, discount rates of 30% were considered appropriate
for the in-process research and development. The Company believes that these discount rates were
commensurate with the projects stage of development and the uncertainties in the economic
estimates described above.
If these projects are not successfully developed, the sales and profitability of the combined
company may be adversely affected in future periods. The Company believes that the foregoing
assumptions used in the in-process research and development analysis were reasonable at the time of
the acquisition. No assurance can be given, however, that the underlying assumptions used to
estimate expected project sales, development costs or profitability, or the events associated with
such projects, will transpire as estimated. At the date of acquisition, the development of
11
these projects had not yet reached technological feasibility, and the research and development
in progress had no alternative future uses. Accordingly, these costs were charged to expense in the
second quarter of 2005.
The following unaudited pro forma
information shows the results of the Companys
operations for the three and six months ended July 3, 2005 and June 27, 2004 as though the
acquisition had occurred as of the beginning of the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
Six months ended |
|
|
July 3, |
|
June 27, |
|
July 3, |
|
June 27, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
|
|
(in thousands) |
|
(in thousands) |
Revenue |
|
$ |
15,824 |
|
|
$ |
11,486 |
|
|
$ |
30,972 |
|
|
$ |
22,289 |
|
Loss from continuing operations |
|
|
(2,746 |
) |
|
|
(4,333 |
) |
|
|
(5,225 |
) |
|
|
(8,600 |
) |
Loss per share, basic and diluted |
|
$ |
(0.07 |
) |
|
$ |
(0.12 |
) |
|
$ |
(0.13 |
) |
|
$ |
(0.26 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The pro forma results have been prepared for comparative purposes only and are not necessarily
indicative of the actual results of operations had the acquisition taken place as of the beginning
of the periods presented, or the results that may occur in the future. The pro forma results
exclude the one-time in-process research and development charge recorded upon the acquisition.
Furthermore, the pro forma results do not give effect to all cost savings or incremental costs that
may occur as a result of the integration and consolidation of the acquisition.
3. Segment Information
The Company has determined that, in accordance with SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information, it operates in one segment as it only reports operating
results on an aggregate basis to chief operating decision makers of the Company.
4. Derivative Financial Instruments
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, requires that all
derivatives be recognized on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive income, depending
on whether a derivative is designated as part of a hedge transaction and, if it is, the type of
hedge transaction. The Company assesses, both at their inception and on an on-going basis, whether
the derivatives that are used in hedging transactions are highly effective in offsetting the
changes in cash flows of hedged items. The Company also assesses hedge ineffectiveness on a
quarterly basis and records the gain or loss related to the ineffective portion to current earnings
to the extent significant.
The Company has a foreign exchange hedging program principally designed to mitigate the
potential impact due to changes in foreign currency exchange rates. The Company does not hold any
derivative financial instruments for trading or speculative purposes. The Company primarily uses
forward exchange contracts to hedge foreign currency exposures and they generally have terms of one
year or less. These contracts have been designated as cash flow hedges and accordingly, to the
extent effective, any unrealized gains or losses on these foreign currency forward contracts are
reported in other comprehensive income. Realized gains and losses for the effective portion are
recognized with the underlying hedge transaction. The notional settlement amount of the foreign
currency forward contracts outstanding at July 3, 2005 was $3.0 million. These contracts had a fair
value of approximately $80,000 as of July 3, 2005. For the six months ended July 3, 2005, there
were no amounts recognized in earnings due to hedge ineffectiveness and the Company settled foreign
exchange contracts of $0.3 million. The Company did not hold any derivative financial instruments
prior to July 2004.
12
5. Inventories
Inventories are stated at the lower of standard cost (which approximates actual cost) or
market. Inventory includes raw materials and finished goods that may be used in the research and
development process and such items are expensed as consumed. Provisions for slow moving, excess and
obsolete inventories are provided based on product life cycle and development plans, product
expiration and quality issues; historical experience and inventory levels. The components of net
inventories are as follows:
|
|
|
|
|
|
|
|
|
|
|
July 3, 2005 |
|
January 2, 2005 |
|
|
(in thousands) |
Raw materials |
|
$ |
2,602 |
|
|
$ |
1,487 |
|
Work in process |
|
|
1,929 |
|
|
|
1,714 |
|
Finished goods |
|
|
626 |
|
|
|
606 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,157 |
|
|
$ |
3,807 |
|
|
|
|
|
|
|
|
|
|
6. Intangible Assets
Intangible assets consist of license agreements and acquired technology. In accordance with
APB Opinion No. 17, Accounting for Intangible Assets, intangible assets are recorded at cost. The
rights related to one of the license agreements are amortized over its estimated useful life (five
years) and will be fully amortized in fiscal year 2008. The rights related to other license
agreements are amortized based on sales of related product and are expected to be fully amortized
by the end of fiscal 2005. The cost of these license agreements was $0.8 million and the Company
has amortized $0.7 million through July 3, 2005.
7. Warranties
The Company generally provides a one-year warranty on genotyping and gene expression systems.
At the time revenue is recognized, the Company establishes an accrual for estimated warranty
expenses associated with system sales. This expense is recorded as a component of cost of product
revenue. Estimated warranty expenses associated with extended maintenance contracts are recorded
as cost of revenue ratably over the term of the maintenance contract.
Changes in the Companys warranty liability during the six months ended July 3, 2005 are as
follows (in thousands):
|
|
|
|
|
Balance at January 2, 2005 |
|
$ |
386 |
|
Additions charged to cost of revenue |
|
|
312 |
|
Repairs and replacements |
|
|
(363 |
) |
|
|
|
|
|
Balance at July 3, 2005 |
|
$ |
335 |
|
|
|
|
|
|
13
8. Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
|
July 3, 2005 |
|
|
January 2, 2005 |
|
|
|
(in thousands) |
|
Accounts payable |
|
$ |
4,594 |
|
|
$ |
2,684 |
|
Compensation |
|
|
4,090 |
|
|
|
3,798 |
|
Professional Fees |
|
|
1,893 |
|
|
|
1,488 |
|
Short-term deferred revenue |
|
|
1,164 |
|
|
|
915 |
|
Taxes |
|
|
1,037 |
|
|
|
928 |
|
Customer deposits |
|
|
764 |
|
|
|
1,671 |
|
Reserve for product warranties |
|
|
703 |
|
|
|
577 |
|
Other |
|
|
822 |
|
|
|
1,030 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
15,067 |
|
|
$ |
13,091 |
|
|
|
|
|
|
|
|
|
|
9. Commitments and Long-Term Debt
In July 2000, the Company entered into a ten-year lease to rent space in two newly constructed
buildings in San Diego that are now occupied by the Company. That lease contained an option to
purchase the buildings together with certain adjacent land that has been approved for construction
of an additional building. The Company exercised that option and purchased the properties in
January 2002 and assumed a $26 million, ten-year mortgage on the property at a fixed interest rate
of 8.36%. The Company made monthly payments of $208,974, representing interest and principal,
through August 2004. Interest expense was $0.6 million and $1.1 million, respectively for the
three and six months ended June 27, 2004.
In June 2004, the Company entered into a conditional agreement to sell its land and buildings
for $42.0 million and to lease back such property for an initial term of ten years. The sale was
completed in August 2004 at which time the lease was signed. After the repayment of the remaining
$25.2 million debt and other related transaction expenses, the Company received $15.5 million in
net cash proceeds. The Company removed the land and net book value of the buildings of $36.9
million from its balance sheet, deferred the resulting $3.7 million gain on the sale of the
property, and is amortizing the deferred gain over the ten-year lease term in accordance with SFAS
13, Accounting for Leases.
Operating Leases
In August 2004, the Company entered into a ten-year lease for its San Diego facility after the
land and building were sold (as discussed above). Under the terms of the lease, the Company made a
$1.9 million security deposit and is paying monthly rent of $318,643 for the first year with an
annual increase of 3% in each subsequent year. The lease contains an option to renew for three
additional periods of five years each. The Company records rent expense on a straight-line basis
and the resulting deferred rent is included in other long-term liabilities in the accompanying
condensed consolidated balance sheet. The Company also leases office space under non-cancelable
operating leases that expire at various times through April 2008. These leases contain renewal
options ranging from 2 to 3 years.
14
10. Legal Proceedings
The Company has incurred substantial costs in defending itself against legal claims made
against it, and expects to devote substantial financial and managerial resources to protect its
intellectual property and to defend against the claims described below as well as any future claims
asserted against it.
Termination-of-Employment Lawsuit
In June 2002, the Company recorded a $7.7 million charge to cover total damages and estimated
expenses awarded by a jury related to a termination-of-employment
lawsuit filed against the Company by Dr. Anthony W. Czarnik. The Company appealed
the decision, and in December 2004, the Fourth Appellate District Court of Appeal, in San Diego,
California, reduced the amount of the award. The Company recorded interest expense during the
appeal based on the statutory rate. For the three and six months ended June 27, 2004, the Company
recorded litigation expense of $189,000 and $378,000, respectively, for such interest charges. As
a result of the revised judgment, the Company reduced the $9.2 million liability recorded on its
balance sheet to $5.9 million and recorded a gain of $3.3 million as a litigation judgment in the
statement of operations in the fourth quarter of fiscal 2004.
As a result of the Companys decision to appeal the ruling, the Company filed a surety bond
with the court equal to 1.5 times the judgment amount or $11.3 million. Under the terms of the
bond, the Company was required to maintain a letter of credit for 90% of the bond amount to secure
the bond. Further, the Company was required to deposit $12.5 million of marketable securities as
collateral for the letter of credit and accordingly, these funds were restricted from use for
general corporate purposes until the appeal process was completed. A judgment was rendered in
December 2004 and payment of $5.9 million was made in January 2005 at which time the restricted
funds, which were recorded as restricted investments, were released.
Affymetrix Litigation
In July 2004, Affymetrix, Inc. (Affymetrix) filed a complaint in the U.S. District Court for
the District of Delaware alleging that the Companys BeadArray
products and services, including the Array Matrix and BeadChip products, infringe six Affymetrix
patents. The suit seeks an unspecified amount of monetary damages and a judgment enjoining the
sale of products, if any, that are determined to be infringing these patents. In September 2004,
the Company filed its answer and counterclaims to Affymetrix complaint, seeking declaratory
judgments from the court that it does not infringe the Affymetrix patents, and that such patents
are invalid, and filed counterclaims against Affymetrix for unfair competition and interference
with actual and prospective economic advantage. The court has scheduled a claim interpretation
hearing for March 8, 2006, and a trial date of October 16,
2006. The Company believes it has meritorious defenses against each
of the infringement claims alleged by Affymetrix and intends to
vigorously defend itself against this suit. However, the Company
cannot be sure it will prevail in this matter. Any unfavorable
determination, and in particular, any significant cash amounts
required to be paid by the Company or prohibition of the sale of the
Company's products and services, could result in a material adverse
effect on its business, financial condition and results of operations.
Dr. Anthony W. Czarnik v. Illumina, Inc.
Dr. Czarnik filed suit against
the Company in June 2005 in the U.S. District Court for the District
of Delaware, alleging
that the Company fraudulently omitted Dr. Czarniks name from various
U.S. and foreign patent applications that disclose inventions of
which Dr. Czarnik claims to be a joint inventor. His complaint
alleges that he is entitled to correction of inventorship to identify
him as an inventor on four patents issued in the U.S. and on certain
pending U.S. and foreign patent applications, and that the Company
committed inequitable conduct and fraud in not naming him as an
inventor. Dr. Czarnik seeks (1) an order requiring the Company and the
U.S. Patent and Trademark Office to correct the inventorship of the
U.S. patents and pending U.S. applications by adding Dr. Czarnik as
an inventor, (2) an order requiring the Company to correct inventorship
of several pending foreign patent applications by adding Dr. Czarnik
as an inventor, (3) a judgment declaring all of the issued U.S.
patents and pending U.S. patent applications unenforceable, and (4)
an unspecified amount of compensatory and punitive damages, and an
award of attorneys fees. There has been no trial date set for
this case. The Company believes it has meritorious defenses
against this claim.
11. Collaborative Agreements
In December 2004, the Company entered into a strategic collaboration with Invitrogen
Corporation. The collaboration is expected to expand the
Companys Oligator® DNA synthesis
technology and combine that capability with Invitrogens sales, marketing and distribution
channels. Under the terms of the agreement, Invitrogen has agreed to pay the Company up to $3.4
million, of which $2.3 million has been paid. The current portion totaling $0.3 million is
included in accounts payable and accrued liabilities and the long-term portion totaling $2.0
million is included in other long-term liabilities in the accompanying condensed consolidated
balance sheet as of July 3, 2005. The Company is using these funds to invest in its San Diego
facility to enable implementation of fourth-generation Oligator technology and extend the
technology into tube-based oligo products. In addition, the agreement provides
15
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations
for the transfer of the Companys Oligator technology into two Invitrogen facilities outside North
America. Profit from the sale of collaboration products will be divided equally between the two
companies.
International HapMap Project
The Company was the recipient of a grant from the National Institutes of Health covering its
participation in the first phase of the International HapMap Project, which is a $100 million,
internationally funded successor project to the Human Genome Project that will help identify a map
of genetic variations that may be used to perform disease-related research. The Company received
$9.1 million of funding for this project that covered basic research activities, the development of
SNP assays and the genotyping performed on those assays. As of July 3, 2005, the Company received
all funds related to this project.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis should be read in conjunction with our financial statements and
accompanying notes included in this report and the consolidated financial statements and notes
thereto for the year ended January 2, 2005 included in the Companys Annual Report on Form 10-K.
Operating results are not necessarily indicative of results that may occur in future periods.
The following discussion and analysis and other disclosures in this Quarterly Report on Form
10-Q, contain forward-looking statements that involve risk and uncertainties, such as statements of
our plans, objectives, expectations and intentions. 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 CyVeras technology with our existing technology, the commercial launch of new products,
including products based on CyVeras technology, 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. Factors that could cause or
contribute to these differences include those discussed in Factors Affecting Operating Results
below as well as those discussed elsewhere. Accordingly, you should not unduly rely on these
forward-looking statements, which speak only as of the date of this Quarterly Report. We undertake
no obligation to publicly revise these forward-looking statements to reflect circumstances or
events after the date of this Quarterly Report or to reflect the occurrence of unanticipated
events. You should, however, review the factors and risks we describe in the reports we file from
time to time with the Securities and Exchange Commission.
Overview
Illumina, Inc. was incorporated in April 1998. We develop and market next-generation tools for
the large-scale analysis of genetic variation and function. Understanding genetic variation and
function is critical to the development of personalized medicine, a key goal of genomics. Using
our technologies, we have developed a comprehensive line of products that are designed to provide
the throughput, cost effectiveness and flexibility necessary to enable researchers in the life
sciences and pharmaceutical industries to perform the billions of tests necessary to extract
medically valuable information from advances in genomics. This information is expected to correlate
genetic variation and gene function with particular disease states, enhancing drug discovery,
allowing diseases to be detected earlier and more specifically, and permitting better choices of
drugs for individual patients.
16
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
In 2001, we began commercial sale of short pieces of DNA, or oligos, manufactured using our
proprietary Oligator technology. We believe our Oligator technology is more cost effective than
competing technologies, which has allowed us to market our oligonucleotides under a price
leadership strategy while still achieving attractive gross margins. In 2001, we also initiated our
SNP genotyping services product line. As a result of the increasing market acceptance of our high
throughput, low cost BeadArray technology, we have entered into genotyping services contracts with
many leading genotyping centers, and were awarded $9.1 million from the National Institutes of
Health to play a major role in the first phase of the International HapMap Project.
Our production-scale BeadLab is based on the system we developed that has been operational in
our genotyping service product line since 2001. In addition to our
Sentrix® Array Matrices,
it includes the BeadArray Reader, a proprietary scanner that uses a laser to read the
results of experiments captured on our arrays, as well as the
GoldenGate® SNP genotyping
assay which can analyze up to 1536 SNPs per DNA sample. This system is being marketed to a small
number of high throughput genotyping users. As of July 3, 2005, we have installed and recorded
revenue for ten BeadLabs.
In 2003, we announced the launch of several new products, including 1) a new array format, the
Sentrix BeadChip, which significantly expands market opportunities for our BeadArray technology and
provides increased experimental flexibility for life science researchers; 2) a gene expression
product line on both the Sentrix Array Matrix and the Sentrix BeadChip that allows researchers to
analyze a focused set of genes across eight to 96 samples on a single array; and 3) a benchtop SNP
genotyping and gene expression system, the BeadStation, for performing moderate-scale genotyping
and gene expression using our technology. The BeadStation includes our BeadArray Reader, analysis
software and assay reagents and is designed to match the throughput requirements and variable
automation needs of individual research groups and core labs. Sales of these products began in the
first quarter of 2004 and, as of July 3, 2005, we have shipped 72 BeadStations.
In late 2004, we announced a strategic collaboration with Invitrogen Corporation to synthesize
and distribute oligos. Under the agreement, we are expanding our Oligator DNA synthesis technology
to include both plate and tube based capability and Invitrogen will be responsible for sales,
marketing and technical support. Profits from sales of collaboration products will be divided
equally between the two companies.
In early 2005, we expanded our gene expression portfolio by announcing the launch of a new
assay, DASLÔ, for generating gene expression profiles from RNA samples including those
containing partially degraded RNAs. We also announced a standard DASL cancer panel. Prior to our
DASL assay, degraded RNA samples have been reliably assayed only with expensive, low-multiplex
approaches.
In
2005, we began shipments of Sentrix BeadChips for whole-genome gene expression and
whole-genome genotyping. The whole-genome gene expression BeadChips are designed to enable
high-performance, cost-effective, whole-genome expression profiling of multiple samples on a single
chip, resulting in a dramatic reduction in cost of whole-genome expression analysis while allowing
researchers to expand the scale and reproducibility of large-scale biological experimentation. The
whole-genome genotyping BeadChip is designed to scale to unlimited levels of multiplexing without
compromising data quality and to provide scientists the ability to query hundreds of thousands of
SNPs in parallel. In 2004, we also announced two new versions of the Sentrix Array Matrix designed
for researchers who want to take advantage of our technology, but whose projects require fewer SNPs
per sample than the number utilized on our standard 1536-plex array products. Sales of
these products began in the second quarter of 2005.
On April 8, 2005, we completed the acquisition of CyVera Corporation, a privately-held
Connecticut-based company, pursuant to which CyVera became a wholly-owned subsidiary of Illumina.
We believe that CyVeras digital-microbead platform is highly complementary to our portfolio of
products and services and will become an integral part of our BeadArray technology. The
acquisition is expected to provide us with a comprehensive approach
17
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
to bead-based assays for biomarker R&D and in-vitro and molecular diagnostic opportunities,
including those that require low-complexity as well as high-complexity testing. We expect the
first products based on CyVeras technology to be available in the second half of 2006. The
estimated purchase price associated with the transaction was $17.8 million. We allocated $15.8
million of this purchase price to acquired in-process research and development and charged such
amount against earnings in the second quarter of 2005.
We are seeking to expand our customer base for our BeadArray technology; however, we can give
no assurance that our sales efforts will continue to be successful.
Our revenues are subject to fluctuations due to the timing of sales of high-value products and
service projects, the impact of seasonal spending patterns, the timing and amount of government
grant funding programs, the timing and size of research projects our customers perform, changes in
overall spending levels in the life science industry and other unpredictable factors that may
affect our customer ordering patterns. Approximately 30% of our revenues for the year ended
January 2, 2005 and approximately 8% of our revenues for the six month period ended July 3, 2005
resulted from transactions that were funded under the International HapMap Project. Virtually all
of the activities under this grant involving the Company and its customers were completed in the
first quarter of 2005. We expect that the commercial launch of our whole genome genotyping arrays
and our recently launched whole genome gene expression arrays, combined with the continued
expansion of our existing product lines, will offset the loss of revenues funded by the HapMap
grant and will drive future revenue growth. However, any significant delays in the commercial
launch of new products, unfavorable sales trends in our existing product lines, or impacts from the
other factors mentioned above, could adversely affect our revenue growth in 2005 or cause a
sequential decline in quarterly revenues. Due to the possibility of fluctuations in our revenue
and net income or loss, we believe quarterly comparisons of our operating results are not a good
indication of our future performance.
We have incurred substantial operating losses since our inception. As of July 3, 2005, our
accumulated deficit was $143.5 million, and total stockholders equity was $70.3 million. These
losses have principally occurred as a result of the substantial resources required for the
research, development and manufacturing scale up effort required to commercialize our products and
services, an acquired in-process research and development charge of $15.8 million related to our
acquisition of CyVera as well as a charge of $5.9 million related to a termination-of-employment
lawsuit. We expect to continue to incur substantial costs for research, development and
manufacturing scale up activities over the next several years. We will also need to significantly
increase our selling, general and administrative costs as we build up our sales and marketing
infrastructure to expand and support the sale of systems, other products and services. As a result
of the expected increase in expenses, we will need to increase revenue significantly to achieve
profitability.
Results of Operations
To enhance comparability, the following table sets forth unaudited Condensed Consolidated
Statements of Operations for the three and six months ended July 3, 2005 and June 27, 2004 stated
as a percentage of total revenue.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
Six months ended |
|
|
July 3, |
|
June 27, |
|
July 3, |
|
June 27, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
Revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product |
|
|
80 |
% |
|
|
79 |
% |
|
|
80 |
% |
|
|
81 |
% |
Service |
|
|
18 |
|
|
|
16 |
|
|
|
18 |
|
|
|
13 |
|
Research |
|
|
2 |
|
|
|
5 |
|
|
|
2 |
|
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
|
100 |
|
|
|
100 |
|
|
|
100 |
|
|
|
100 |
|
Costs and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue |
|
|
26 |
|
|
|
24 |
|
|
|
26 |
|
|
|
24 |
|
Cost of service revenue |
|
|
4 |
|
|
|
3 |
|
|
|
4 |
|
|
|
2 |
|
Research and development |
|
|
46 |
|
|
|
46 |
|
|
|
43 |
|
|
|
47 |
|
Selling, general and administrative |
|
|
41 |
|
|
|
52 |
|
|
|
40 |
|
|
|
52 |
|
Acquired in-process research and development |
|
|
100 |
|
|
|
|
|
|
|
51 |
|
|
|
|
|
Amortization of deferred compensation
and other stock-based compensation charges |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
3 |
|
Litigation judgment |
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses |
|
|
217 |
|
|
|
129 |
|
|
|
164 |
|
|
|
130 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations |
|
|
(117 |
) |
|
|
(29 |
) |
|
|
(64 |
) |
|
|
(30 |
) |
Interest income (expense), net |
|
|
|
|
|
|
(2 |
) |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(117 |
)% |
|
|
(31 |
)% |
|
|
(64 |
)% |
|
|
(33 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Three and Six Months Ended July 3, 2005 and June 27, 2004
Our fiscal year is 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, and September 30. The three and six
month periods ended July 3, 2005 and June 27, 2004 are both 13 and 26 weeks, respectively.
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
|
|
|
Six months ended |
|
|
|
|
July 3, |
|
June 27, |
|
|
|
|
|
July 3, |
|
June 27, |
|
|
|
|
2005 |
|
2004 |
|
Change |
|
2005 |
|
2004 |
|
Change |
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
Product |
|
$ |
12,636 |
|
|
$ |
9,045 |
|
|
$ |
3,591 |
|
|
$ |
24,801 |
|
|
$ |
17,984 |
|
|
$ |
6,817 |
|
Service |
|
|
2,783 |
|
|
|
1,815 |
|
|
|
968 |
|
|
|
5,474 |
|
|
|
2,965 |
|
|
|
2,509 |
|
Research |
|
|
405 |
|
|
|
626 |
|
|
|
(221 |
) |
|
|
697 |
|
|
|
1,340 |
|
|
|
(643 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
15,824 |
|
|
$ |
11,486 |
|
|
$ |
4,338 |
|
|
$ |
30,972 |
|
|
$ |
22,289 |
|
|
$ |
8,683 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue increased to $12.6 million and $24.8 million, respectively, for the three and
six month periods ended July 3, 2005 from $9.0 million and $18.0 million, respectively, for the
three and six months ended June 27, 2004. The increase in the second quarter of 2005 resulted
primarily from sales of consumables used with our BeadStation and BeadLab systems including sales
of our whole genome genotyping beadchips which were launched in the second quarter of 2005. In
addition, sales of oligonucleotides as well as our BeadStation benchtop genotyping systems each
increased in the three months ended July 3, 2005 as compared to the three months ended June 27,
2004. The increase for the six-month period ending July 3, 2005 was primarily due to higher
BeadStation, consumable and oligonucleotide sales.
Service revenue increased to $2.8 million for the three months ended July 3, 2005 from $1.8
million for the three months ended June 27, 2004, due primarily to a higher demand for third party
SNP genotyping service contracts during the 2005 period offset by decreased revenue related to the
International HapMap Project. We completed all revenue generating genotyping services for the
International HapMap Project in early 2005. We expect sales from third party SNP genotyping
services contracts to fluctuate from quarter to quarter, depending on the mix and number of
contracts that are completed during the quarter. The timing of completion of a SNP genotyping
services contract is highly dependent on the customers schedule for delivering the SNPs and
samples to us. Service revenue increased to $5.5 million from $3.0 million for the six months
ended July 3, 2005 and June 27, 2004, respectively, due primarily to a higher level of third party
service contracts completed during the 2005 period.
19
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Government grants and other research funding decreased to $0.4 million and $0.7 million,
respectively, for the three and six month periods ended July 3, 2005 from $0.6 million and $1.3
million, respectively, for the three and six months ended June 27, 2004, due primarily to a
decrease in internal research spending for our grants from the National Institutes of Health. We
expect government grants to remain a small percentage of total revenues in the future.
Cost of Product and Service Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
|
|
|
Six months ended |
|
|
|
|
July 3, |
|
June 27, |
|
|
|
|
|
July 3, |
|
June 27, |
|
|
|
|
2005 |
|
2004 |
|
Change |
|
2005 |
|
2004 |
|
Change |
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
Cost of product revenue |
|
$ |
4,033 |
|
|
$ |
2,701 |
|
|
$ |
1,332 |
|
|
$ |
7,970 |
|
|
$ |
5,263 |
|
|
$ |
2,707 |
|
Cost of service revenue |
|
|
701 |
|
|
|
366 |
|
|
|
335 |
|
|
|
1,363 |
|
|
|
606 |
|
|
|
757 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of product
and service revenue |
|
$ |
4,734 |
|
|
$ |
3,067 |
|
|
$ |
1,667 |
|
|
$ |
9,333 |
|
|
$ |
5,869 |
|
|
$ |
3,464 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product and service revenue represents manufacturing costs incurred in the production
process, including component materials, assembly labor and overhead, packaging and delivery cost.
Costs related to research revenue are included in research and development expense. Cost of
product and service revenue increased to $4.7 million and $9.3 million, respectively, for the three
and six months ended July 3, 2005 from $3.1 million and $5.9 million, respectively, for the three
and six months ended June 27, 2004, due primarily to the significant increase in product revenue.
Gross margin on product and service revenue was 69% for both the three and six months ended July 3,
2005, compared to 72% for both the three and six months ended June 27, 2004.
Cost of product revenue increased to $4.0 million and $8.0 million, respectively, for the
three and six months ended July 3, 2005 from $2.7 million and $5.3 million, respectively, for the
three and six months ended June 27, 2004, due to the significant increase in product revenue.
Gross margin on product revenue was 68% for both the three and six months ended July 3, 2005,
compared to 70% and 71%, respectively, for the three and six months ended June 27, 2004. The
decrease for the three months ended July 3, 2005 is primarily due to lower gross margins on our
consumable sales as compared to the prior year. The decrease for the six months ended July 3, 2005
is primarily due to a higher percentage of our revenue being generated from the sale of
BeadStations and lower average pricing for oligos, as compared to the prior year.
Cost of service revenue increased to $0.7 million and $1.4 million, respectively, for the
three and six months ended July 3, 2005 from $0.4 million and $0.6 million, respectively, for the
three and six months ended June 27, 2004 due to higher service revenues. Gross margin on service
revenues was 75% for both the three and six months ended July 3, 2005, from 80% for both the three
and six months ended June 27, 2004 due to a change in the mix of projects completed this quarter
and a higher percentage of our service revenue being generated from extended service contract sales
which have lower margins than our genotyping service projects.
We expect our market will become increasingly price competitive, and over the longer term, our
margins will fluctuate.
20
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
Research and Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
|
|
|
Six months ended |
|
|
|
|
July 3, |
|
June 27, |
|
|
|
|
|
July 3, |
|
June 27, |
|
|
|
|
2005 |
|
2004 |
|
Change |
|
2005 |
|
2004 |
|
Change |
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
Research and development |
|
$ |
7,301 |
|
|
$ |
5,320 |
|
|
$ |
1,981 |
|
|
$ |
13,179 |
|
|
$ |
10,496 |
|
|
$ |
2,683 |
|
Our research and development expenses consist primarily of salaries and other
personnel-related expenses, laboratory supplies and other expenses related to the design,
development, testing and enhancement of our products. We expense our research and development costs
as they are incurred. Research and development expenses increased to $7.3 million and $13.2
million, respectively, for the three and six months ended July 3, 2005 as compared to $5.3 million
and $10.5 million, respectively, for the three and six months ended June 27, 2004.
The cost of BeadArray research activities increased $0.7 million and $1.7 million,
respectively, for the three and six months ended July 3, 2005 as compared to the three and six
months ended June 27, 2004. Research to support our Oligator technology platform increased $0.5
million and $0.2 million, respectively, for the three and six months ended July 3, 2005 as compared
to the three and six months ended June 27, 2004. The increase occurred primarily as a result of
higher overhead absorption to research and development, while incurring lower overhead absorption
to cost of revenue. The increase in overhead absorption in research and development is primarily
related to the development activities associated with our fourth generation Oligator technology
which we intend to use in connection with our collaboration with Invitrogen. In addition, we
experienced an increase in research and development expenses for our newly-acquired Microbead
technology in connection with our acquisition of CyVera Corporation that closed in April 2005
totaling approximately $0.8 million. We believe a substantial
investment in research and development is essential to a long-term
sustainable competitive advantage and critical to expansion into
additional markets.
Stock based compensation related to research and development employees and consultants was
approximately $17,000 and $32,000 for the three and six months ended July 3, 2005 as compared to
approximately $108,000 and $247,000 for the three and six months ended June 27, 2004.
Selling, General and Administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
|
|
|
|
Six months ended |
|
|
|
|
|
|
July 3, |
|
|
June 27, |
|
|
|
|
|
|
July 3, |
|
|
June 27, |
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Selling, general
and administrative |
|
$ |
6,494 |
|
|
$ |
5,993 |
|
|
$ |
501 |
|
|
$ |
12,487 |
|
|
$ |
11,731 |
|
|
$ |
756 |
|
Our selling, general and administrative expenses consist primarily of personnel costs for
sales and marketing, finance, human resources, business development and general management, as well
as professional fees, such as expenses for legal and accounting services. Selling, general and
administrative expenses increased $0.5 million to $6.5 million for the three months ended July 3,
2005 from $6.0 million for the three months ended June 27, 2004. Our sales and marketing expense
increased $1.0 million, of which $0.9 million is attributable to increased personnel related
expenses related to the build out of our sales force and customer support staff, and $0.1 million
is attributable to an increase in facility related expenses. General and administrative expenses
decreased by $0.5 million in the three months ended July 3, 2005 as compared to the three months
ended June 27, 2004 due to a $1.1 million decrease in litigation related expenses, which was
partially offset by a $0.4 million increase in personnel related expenses.
Selling, general and administrative expenses increased $0.8 million to $12.5 million for the
six months ended July 3, 2005 from $11.7 million for the six months ended June 27, 2004.
Approximately $2.1 million of the increase is due to higher sales and marketing costs, of which
$1.7 million is attributable to personnel related expenses, and $0.3 million is attributable to an
increase in facility related expenses. General and administrative expenses decreased by $1.3
million in the six months ended July 3, 2005 as compared to the six months ended June
27, 2004 due to a $2.4 million decrease in outside legal costs, which was partially offset by
a $0.7 million increase in personnel related expenses.
21
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
We expect that our selling,
general and administrative expenses will increase as we expand our
staff, add sales and marketing infrastructure, incur increased
litigation costs as well as additional costs to support the commercialization and support of an increasing number of products.
Stock based compensation related to selling, general and administrative employees, directors
and consultants was approximately $24,000 and $66,000 for the three and six months ended July 3,
2005 as compared to approximately $142,000 and $321,000 for the three and six months ended June 27,
2004.
Amortization of Deferred Compensation and Other Stock-Based Compensation Charges
|
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|
Three months ended |
|
|
|
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|
Six months ended |
|
|
|
|
|
|
July 3, |
|
|
June 27, |
|
|
|
|
|
|
July 3, |
|
|
June 27, |
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
|
|
|
|
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(in thousands) |
|
|
|
|
|
|
|
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|
(in thousands) |
|
|
|
|
|
Amortization of
deferred
compensation and
other stock-based
compensation
charges |
|
$ |
41 |
|
|
$ |
250 |
|
|
$ |
(209 |
) |
|
$ |
98 |
|
|
$ |
568 |
|
|
$ |
(470 |
) |
From our inception through July 27, 2000, in connection with the grant of certain stock
options and sales of restricted stock to employees, founders and directors, we have recorded
deferred stock compensation totaling $17.6 million, representing the difference between the
exercise or purchase price and the fair value of our common stock as estimated for financial
reporting purposes on the date such stock options were granted or such restricted stock was sold.
We recorded this amount as a component of stockholders equity and amortize the amount as a charge
to operations over the vesting period of the restricted stock and options.
We recognize compensation expense over the vesting period for employees, founders and
directors, using an accelerated amortization methodology in accordance with Financial Accounting
Standards Board Interpretation No. 28. For consultants, deferred compensation is recorded as the
fair value of the consideration received or the fair value of the equity instruments issued,
whichever is more reliably measured in accordance with Statement of Financial Accounting Standards
No. 123 and is periodically re-measured and expensed in accordance with Emerging Issues Task Force
No. 96-18.
We recorded amortization of deferred compensation of approximately $41,000 and $98,000,
respectively, for the three and six months ended July 3, 2005 and $250,000 and $568,000,
respectively, for the three and six months ended June 27, 2004. In both the three and six months
ended July 3, 2005, we recorded approximately $16,000 as deferred compensation expense related to
our acquisition of CyVera. We expect expenses related to stock based compensation to increase
significantly beginning in 2006 as we implement the requirements of SFAS 123R. Although the
adoption of SFAS 123Rs fair value method is expected to result in a significant increase in our
reported operating expenses, it will have no impact on our cash flows. SFAS 123R is discussed
further in Note 1 to our condensed consolidated financial statements.
Litigation Judgment
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Three months ended |
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Six months ended |
|
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July 3, |
|
|
June 27, |
|
|
|
|
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|
July 3, |
|
|
June 27, |
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
|
|
|
|
|
(in thousands) |
|
|
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|
|
|
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|
(in thousands) |
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|
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|
|
Litigation judgment |
|
$ |
|
|
|
$ |
189 |
|
|
$ |
(189 |
) |
|
$ |
|
|
|
$ |
378 |
|
|
$ |
(378 |
) |
22
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
A $7.7 million charge was recorded in June 2002 to cover total damages and estimated expenses
related to a jury verdict in a termination-of-employment lawsuit against us. We appealed the
decision, and in December 2004, the Fourth Appellate District Court of Appeal, in San Diego,
California, reduced the amount of the award. During the appeal process, the court required us to
incur interest charges on the judgment amount at statutory rates until the case was resolved. For
the three and six months ended June 27, 2004 we recorded $189,000 and $378,000, respectively, as
litigation expense for such interest charges. As a result of the revised judgment, we reduced the
$9.2 million liability on our balance sheet to $5.9 million and recorded a gain of $3.3 million as
a litigation judgment in the fourth quarter of 2004.
Interest and Other Income (Expense), net
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Three months ended |
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|
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|
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|
Six months ended |
|
|
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|
July 3, |
|
|
June 27, |
|
|
|
|
|
|
July 3, |
|
|
June 27, |
|
|
|
|
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
2005 |
|
|
2004 |
|
|
Change |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Interest and other
income (expense),
net |
|
$ |
7 |
|
|
$ |
(183 |
) |
|
$ |
190 |
|
|
$ |
151 |
|
|
$ |
(694 |
) |
|
$ |
845 |
|
Interest income on our cash and cash equivalents and investments was $0.3 million and $0.7
million, respectively, for the three and six months ended July 3, 2005 as compared to $0.5 million
for both the three and six months ended June 27, 2004. The decrease in the three months ended July
3, 2005 is due to lower effective interest rates compared to the prior year. The
increase in the six months ended July 3, 2005 is due to higher average cash balances compared to
the prior year.
Interest expense was approximately $4,000 and $6,000, respectively, for the three and six
months ended July 3, 2005 as compared to $0.5 million and $1.1 million, respectively, for the three
and six months ended June 27, 2004. Interest expense in the 2004 period relates primarily to a
$26.0 million fixed rate loan that was paid off in August 2004 in connection with the sale of our
San Diego facilities.
Liquidity and Capital Resources
As of July 3, 2005, we had cash, cash equivalents and investments of $54.6 million. We
currently invest our funds in U.S. dollar based investment-grade corporate and government debt
securities, with strong credit ratings or short maturity mutual funds providing similar financial
returns.
Our operating activities used cash of $7.2 million in the six months ended July 3, 2005, as
compared to $5.9 million in the six months ended June 27, 2004. Net cash used in operating
activities in the six months ended July 3, 2005 was primarily the result of a net loss from
operations of $19.8 million, a $5.9 million payment for a litigation judgment and a $1.3 million
increase in inventory, reduced by a $0.5 million increase in accounts payable and accrued
liabilities, a $2.4 million increase in long term liabilities primarily related to payments
received from Invitrogen Corporation recorded as deferred revenue, non-cash charges of $1.7 million
for depreciation and amortization and a non-cash IPR&D charge of $15.8 million related to the
CyVera acquisition. Net cash used in operating activities in the six months ended June 27, 2004
was primarily the result of a net loss from operations of $7.4 million, a $5.4 million increase in
accounts receivable and a $0.7 million increase in inventory, reduced by a $3.8 million increase in
accounts payable and accrued liabilities and non-cash charges of $2.2 million for depreciation and
amortization.
Our investing activities provided cash of approximately $3.6 million in the six months ended
July 3, 2005 as compared to $18.3 million in the six months ended June 27, 2004. Cash provided in
investing activities in the six
23
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
months ended July 3, 2005 was due to $12.2 million from the sale or
maturity of investment securities used to provide operating funds for our business, reduced by $6.2
million for the purchase of property and equipment and $2.4 million paid for the acquisition of
CyVera. Cash provided in investing activities in the six months ended June 27, 2004 was due
primarily to $19.7 million from the sale or maturity of investment securities, net of purchases of
investment securities used to provide operating funds for our business, reduced by $1.4 million for
the purchase of property and equipment.
Our financing activities provided $2.9 million in the six months ended July 3, 2005 as
compared to $29.0 million in the six months ended June 27, 2004. Cash provided in financing
activities in the six months ended July 3, 2005 was due primarily to proceeds from the issuance of
common stock from option exercises. Cash provided in financing activities in the six months ended June 27, 2004 was
primarily due to proceeds from the issuance of common stock reduced by payments on long-term debt
and equipment financings.
Based on our current operating plans, we expect that our current cash, cash equivalents and
investments, and our expected revenues from sales and funding from grants, will be sufficient to
fund our anticipated operating needs for at least 24 months. Operating needs include the planned
costs to operate our business including amounts required to fund working capital and capital
expenditures. At the current time, we have no material commitments for capital expenditures.
However, our future capital requirements and the adequacy of our available funds will depend on
many factors, including our ability to successfully commercialize our SNP genotyping and gene
expression systems and extensions to those products and to expand our oligonucleotide and SNP
genotyping services product lines, scientific progress in our research and development programs,
the magnitude of those programs, competing technological and market developments, the successful
resolution of our legal proceedings with Affymetrix, the success of our acquisition of CyVera, the
success of our collaboration with Invitrogen 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. Therefore, we may require additional funding within this 24 month time frame. In
addition, we may choose to raise additional capital due to market conditions or strategic
considerations, such as an acquisition, even if we believe we have sufficient funds for our current
or future operating plans. Further, any additional equity financing may be dilutive to our then
existing stockholders and may adversely affect their rights and any debt financing may carry
covenants that could restrict our operations.
In December 2003, we filed a shelf registration statement that would allow us to raise up to
$65 million of funding through the sale of common stock in one or more transactions. In May 2004,
we raised $28.7 million, net of offering expenses, through the sale of our common stock under this
shelf registration statement. We currently do not have plans to raise additional funds under this
registration statement.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations is based upon
our consolidated financial statements, which have been prepared in accordance with U.S. generally
accepted accounting principles. The preparation of financial statements requires that management
make estimates, assumptions and judgments with respect to the application of accounting policies
that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosures
of contingent assets and liabilities. Actual results could differ from those estimates.
Certain accounting policies are deemed critical if 1) they require an accounting estimate to
be made based on assumptions that were highly uncertain at the time the estimate was made, and 2)
changes in the estimate that are reasonably likely to occur, or different estimates that we reasonably could have used, would
have a material effect on our consolidated financial statements.
24
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
We believe the following critical accounting policies reflect our more significant estimates
and assumptions used in the preparation of the consolidated financial statements.
Revenue Recognition
Our sales are primarily from two sources: product revenue and services revenue. Product
revenue consists of sales of oligonucleotides, arrays, assay reagents, genotyping systems and gene
expression systems. Services revenue consists of revenue received for performing genotyping
services and extended warranty sales. As described below, significant judgments and estimates must
be made and used in connection with the revenue recognized in any accounting period.
We recognize revenue in accordance with the guidelines established by SEC Staff Accounting
Bulletin (SAB) No. 104. Under SAB 104, revenue cannot be recorded until all of the following
criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred or
services have been rendered; the sellers price to the buyer is fixed or determinable; and
collectibility is reasonably assured.
Product delivery generally occurs when product is delivered to a common carrier or when the
customer receives the product, depending on the nature of the arrangement and provided no
significant obligations remain. BeadLabs are considered delivered upon shipment, installation,
training and fulfillment of contractually defined acceptance criteria and we need to determine the
completion of each of these deliverables before revenue can be recognized. Genotyping services are
considered delivered generally at the time the genotyping data is delivered to the customer. We
were awarded $9.1 million from the National Institutes of Health to perform genotyping services in
connection with the first phase of the International HapMap Project. A portion of the services
related to this project is considered delivered at the time the related costs are incurred while
the remainder is considered delivered upon the delivery of genotyping data.
In order to assess whether the price is fixed and determinable, we ensure there are no refund
rights. If payment terms are based on future performance, we defer revenue recognition until the
price becomes fixed and determinable. We assess collectibility based on a number of factors,
including past transaction history with the customer and the creditworthiness of the customer. If
we determine that collection of a payment is not reasonably assured, we defer revenue recognition
until the time collection becomes reasonably assured, which is generally upon receipt of payment.
Changes in judgments and estimates made in determining whether the criteria of SAB 104 have been
met might result in a change in the timing or amount of revenue recognized.
Sales of our genotyping and gene expression systems include a standard one-year warranty. We
also sell separately priced maintenance (extended warranty) contracts, which are generally for one
or two years, upon the expiration of the initial warranty. Revenue for extended warranty sales is
recognized ratably over the term of the extended warranty. Reserves are provided for estimated
product warranty expenses at the time the associated revenue is recognized. If we were to
experience an increase in warranty claims or if costs of servicing our products under warranty were
greater than our estimates, our gross margins could be adversely affected.
While the majority of our sales agreements contain standard terms and conditions, we do enter
into agreements that contain multiple elements or non-standard terms and conditions. Emerging
Issues Task Force No. 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables,
provides guidance on accounting for arrangements that involve the delivery or performance of
multiple products, services, or rights to use assets within contractually binding arrangements.
Significant contract interpretation is sometimes required to determine the appropriate accounting,
including whether the deliverables specified in a multiple element arrangement should be treated as
separate units of accounting for revenue recognition purposes, and if so, how the price should be
allocated among the deliverable elements, when to recognize revenue for each element, and the period
over which revenue should be recognized. We recognize revenue for delivered elements only when we
believe the fair values of undelivered elements are known and there are no uncertainties regarding
customer acceptance.
25
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
A third source of revenue, research revenue, consists of amounts earned under research
agreements with government grants, which is recognized in the period during which the related costs
are incurred. All revenues are recorded net of any applicable allowances for returns or discounts.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments. We evaluate the collectibility of our
accounts receivable based on a combination of factors. We regularly analyze customer accounts,
review the length of time receivables are outstanding and review historical loss rates. If the
financial condition of our customers were to deteriorate, additional allowances could be required.
Inventory Valuation
We record adjustments to inventory for potentially excess, obsolete or impaired goods in order
to state inventory at net realizable value. We must make assumptions about future demand, market
conditions and the release of new products that will supercede old ones. We regularly review
inventory for excess and obsolete products and components, taking into account product life cycle
and development plans, product expiration and quality issues, historical experience and our current
inventory levels. If actual market conditions are less favorable than anticipated, additional
inventory adjustments could be required.
Contingencies
We are subject to legal proceedings primarily related to intellectual property matters. Based
on the information available at the balance sheet dates and through consultation with our legal
counsel, we assess the likelihood of any adverse judgments or outcomes of these matters, as well as
the potential ranges of probable losses. If losses are probable and reasonably estimable, we will
record a reserve in accordance with Statement of Financial Accounting Standards No. 5, Accounting
for Contingencies. Currently we have no such reserves recorded. Any reserves recorded in the
future may change due to new developments in each matter.
Goodwill and Intangible Asset Valuation
The purchase method of accounting for acquisitions requires extensive use of accounting
estimates and judgments to allocate the purchase price to the fair value of the net tangible and
intangible assets acquired, including in-process research and development, or IPR&D. Goodwill and
intangible assets deemed to have indefinite lives are not amortized, but are subject to annual
impairment tests. The amounts and useful lives assigned to other acquired intangible assets impact
future amortization, and the amount assigned to IPR&D is expensed immediately. Determining the
fair values and useful lives of intangible assets especially requires the exercise of judgment.
While there are a number of different acceptable generally accepted valuation methods to estimate
the value of intangible assets acquired, we primarily use the discounted cash flow method. This
method requires significant management judgment to forecast the future operating results used in
the analysis. In addition, other significant estimates are required such as residual growth rates
and discount factors. The estimates we use to value and amortize intangible assets are consistent
with the plans and estimates that we use to manage our business and are based on available
historical information and industry estimates and averages. These judgments can significantly
affect our net operating results.
During fiscal 2001, we adopted SFAS 142. SFAS 142 requires that goodwill and certain
intangible assets be assessed for impairment using fair value measurement techniques. If the
carrying amount of a reporting unit exceeds its fair value, then a goodwill impairment test is
performed to measure the amount of the impairment loss, if any. The goodwill impairment test
compares the implied fair value of the reporting units goodwill with the carrying
26
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
amount of that goodwill. The implied fair value of goodwill is determined in the same manner as in a business
combination. Determining the fair value of the implied goodwill is judgmental in nature and often
involves the use of significant estimates and assumptions. These estimates and assumptions could
have a significant impact on whether or not an impairment charge is recognized and also the
magnitude of any such charge. Estimates of fair value are primarily determined using discounted
cash flows and market comparisons. These approaches use significant estimates and assumptions,
including projection and timing of future cash flows, discount rates reflecting the risk inherent
in future cash flows, perpetual growth rates, determination of appropriate market comparables, and
determination of whether a premium or discount should be applied to comparables. It is reasonably
possible that the plans and estimates used to value these assets may be incorrect. If our actual
results, or the plans and estimates used in future impairment analyses, are lower than the original
estimates used to assess the recoverability of these assets, we could incur additional impairment
charges. As of July 3, 2005, we had $2.3 million of goodwill.
Factors Affecting Our Operating Results
Our business is subject to various risks, including those described below. In addition to the
other information included in this Form 10-Q, the following issues could adversely affect our
operating results or our stock price.
Litigation or other proceedings or third party claims of intellectual property infringement could
require us to spend significant time and money and could prevent us from selling our products or
services.
Our commercial success depends in part on our non-infringement of the patents or proprietary
rights of third parties and the ability to protect our own intellectual property. Affymetrix filed
a complaint against us in July 2004, alleging infringement of six of its patents, and other third
parties have asserted or may assert that we are employing their proprietary technology without
authorization. As we enter new markets, we expect that competitors will likely assert that our
products infringe their intellectual property rights as part of a business strategy to impede our
successful entry into those markets. In addition, third parties have obtained patents in the
future and claim that use of our technologies infringes these patents. We could incur substantial
costs and divert the attention of our management and technical personnel in defending ourselves
against any of these claims. We may incur the same costs and diversions in enforcing our patents
and other proprietary rights against others. Furthermore, parties making claims against us may be
able to obtain injunctive or other relief, which effectively could block our ability to further
develop, commercialize and sell products, and could result in the award of substantial damages
against us. In the event of a successful claim of infringement against us, we may be required to
pay damages and obtain one or more licenses from third parties, or be prohibited from selling
certain products. We may not be able to obtain these licenses at a reasonable cost, or at all. In
that event, we could encounter delays in product introductions while we attempt to develop
alternative methods or products. Defense of any lawsuit or failure to obtain any of these licenses
on favorable terms could prevent us from commercializing products, and the prohibition of sale of
any of our products could materially affect our ability to grow and to attain profitability.
We expect intense competition in our target markets, which could render our products obsolete,
result in significant price reductions or substantially limit the volume of products that we sell.
This would limit our ability to compete and achieve profitability. If we cannot continuously
develop and commercialize new products, our revenues may not grow as intended.
We compete with life sciences companies that design, manufacture and market instruments for
analysis of genetic variation and function and other applications using technologies such as
two-dimensional electrophoresis, capillary electrophoresis, mass spectrometry, flow cytometry,
microfluidics, and mechanically deposited, inkjet and photolithographic arrays. We anticipate that
we will face increased competition in the future as existing companies develop new or improved
products and as new companies enter the market with new technologies. The markets for
27
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
our products are characterized by rapidly changing technology, evolving industry standards, changes in customer
needs, emerging competition, new product introductions and strong price competition. For example,
Affymetrix, Inc. recently released a 100k SNP genotyping chip and is
testing a 500k SNP
Genotyping chip which will compete with our SNP genotyping service and product offerings and
several competitors have begun selling a single chip for whole human genome expression which may
compete with our gene expression product offerings. One or more of our competitors may render our
technology obsolete or uneconomical. Our competitors have greater financial and personnel
resources, broader product lines, a more established customer base and more experience in research
and development than we have. Furthermore, the life sciences and pharmaceutical companies, which
are our potential customers and strategic partners, could develop competing products. If we are
unable to develop enhancements to our technology and rapidly deploy new product offerings, our
business, financial condition and results of operations will suffer.
We may encounter difficulties in integrating recently completed or future acquisitions and that
could adversely affect our business.
We have recently acquired CyVera Corporation and may in the future acquire technology,
products or businesses related to our current or future business. We have limited experience in
acquisition activities and may have to devote substantial time and resources in order to complete
acquisitions. Further, these potential acquisitions entail risks, uncertainties and potential
disruptions to our business. For example, we may not be able to successfully integrate a companys
operations, technologies, products and services, information systems and personnel into our
business. An acquisition may further strain our existing financial and managerial controls, and
divert managements attention away from our other business concerns. In connection with the CyVera
acquisition, we assumed certain liabilities and hired certain employees of CyVera, which is
expected to result in an increase in research and development expenses and our capital
expenditures. There may also be unanticipated costs and liabilities associated with an acquisition
that could adversely affect our operating results.
We have generated only moderate amounts of revenue from product and service offerings to date. We
expect to continue to incur net losses and we may not achieve or maintain profitability.
We have incurred net losses since our inception and expect to continue to incur net losses
through most of 2005. At July 3, 2005 our accumulated deficit was $143.5 million, and we incurred a
net loss of $19.8 million for the six months ending July 3, 2005. The magnitude of our net losses
will depend, in part, on the rate of growth, if any, of our revenue and on the level of our
expenses. We expect to continue incurring significant expenses for research and development, for
developing our manufacturing capabilities and for sales and marketing efforts to commercialize our
products. We also expect the adoption of SFAS 123R to result in a significant increase in our
operating expenses. In addition, we expect that our selling and marketing expenses will increase
at a higher rate in the future as a result of the launch of new products. As a result, we expect
that our operating expenses will increase significantly as we grow and consequently we will need to
generate significant additional revenue to achieve profitability. Even if we achieve profitability,
we may not be able to sustain or increase profitability on a quarterly or annual basis.
We have a limited history of commercial sales of systems and consumable products, and our success
depends on our ability to develop commercially successful products and on market acceptance of our
new and relatively unproven technologies.
We may not possess all of the resources, capability and intellectual property necessary to
develop and commercialize all the products or services that may result from our technologies.
Sales of our genotyping and gene expression systems only began in 2003, and some of our other
technologies are in the early stages of commercialization or are still in development. You should
evaluate us in light of the uncertainties and complexities affecting similarly situated companies
developing tools for the life sciences and pharmaceutical industries. We must conduct a substantial
amount of additional research and development before some of our products will be ready for
28
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
sale
and we currently have fewer resources available for research and development activities than many
of our competitors. We may not be able to develop or launch new products in a timely manner, or at
all, or they may not meet customer requirements or be of sufficient quality or at a price that
enables us to compete effectively in the marketplace. Problems frequently encountered in
connection with the development or early commercialization of products and services using new and
relatively unproven technologies might limit our ability to develop and successfully commercialize
these products and services. In addition, we may need to enter into agreements to obtain
intellectual property necessary to commercialize some of our products or services, which may not be
available on favorable terms, or at all.
Historically, life sciences and pharmaceutical companies have analyzed genetic variation and
function using a variety of technologies. In order to be successful, our products must meet the
commercial requirements of the life sciences and pharmaceutical industries as tools for the
large-scale analysis of genetic variation and function.
Market acceptance will depend on many factors, including:
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our ability to demonstrate to potential customers the benefits and cost effectiveness of
our products and services relative to others available in the market; |
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the extent and effectiveness of our efforts to market, sell and distribute our products; |
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our ability to manufacture products in sufficient quantities with acceptable quality and
reliability and at an acceptable cost; and |
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|
the willingness and ability of customers to adopt new technologies requiring capital
investments. |
Any inability to adequately protect our proprietary technologies could harm our competitive
position.
Our success will depend in part on our ability to obtain patents and maintain adequate
protection of our intellectual property in the United States and other countries. If we do not
protect our intellectual property adequately, competitors may be able to use our technologies and
thereby erode our competitive advantage. The laws of some foreign countries do not protect
proprietary rights to the same extent as the laws of the United States, and many companies have
encountered significant problems in protecting their proprietary rights abroad. These problems can
be caused by the absence of rules and methods for defending intellectual property rights.
The patent positions of companies developing tools for the life sciences and pharmaceutical
industries, including our patent position, generally are uncertain and involve complex legal and
factual questions. We will be able to protect our proprietary rights from unauthorized use by third
parties only to the extent that our proprietary technologies are covered by valid and enforceable
patents or are effectively maintained as trade secrets. We intend to apply for patents covering our
technologies and products, as we deem appropriate. However, our patent applications may be
challenged and may not result in issued patents or may be invalidated or narrowed in scope after
they are issued. Questions as to inventorship may also arise. For
example, a former employee recently filed a complaint against us, claiming he is entitled to be
named as joint inventor of certain of our U.S. patents and pending U.S. and foreign patents and seeking a judgment that the related patents and applications are unenforceable.
See Item 1. Legal Proceedings for a description of this complaint. Any finding that our patents and applications are
unenforceable could harm our ability to prevent others from practicing the related technology, and a finding that others have inventorship rights to our patents and applications could require us
to obtain licenses to practice the technology, which may not be available on favorable terms, if at all.
In addition, our existing patents and any future patents we obtain may not be sufficiently broad to
prevent others from practicing our technologies or from developing competing products. There also
is risk that others may independently develop similar or alternative technologies or design around
our patented technologies. Also, our patents may fail to provide us with any competitive
advantage. We may need to initiate additional lawsuits to protect or enforce our patents, or
litigate against third party claims, which would be expensive and, if we lose, may cause us to lose
some of our intellectual property rights and reduce our ability to compete in the marketplace.
We also rely upon trade secret protection for our confidential and proprietary information. We
have taken security measures to protect our proprietary information. These measures, however, may
not provide adequate protection for our trade secrets or other proprietary information. We seek to
protect our proprietary information by entering into confidentiality agreements with employees,
29
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
collaborators and consultants. Nevertheless, employees, collaborators or consultants may still
disclose our proprietary information, and we may not be able to meaningfully protect our trade
secrets. In addition, others may independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to our trade secrets.
We have limited experience in manufacturing commercial products.
We have limited experience manufacturing our products in the volumes that will be necessary
for us to achieve significant commercial sales. We have only recently begun manufacturing products
on a commercial-scale and, in the past, we have experienced variations in manufacturing conditions
that have temporarily reduced production yields. Due to the intricate nature of manufacturing
products that contain DNA, we may encounter similar or previously unknown manufacturing
difficulties in the future that could significantly reduce production yields, impact our ability to
launch or sell these products, or to produce them economically, may prevent us from achieving
expected performance levels or cause us to set prices that hinder wide adoption by customers.
Our sales, marketing and technical support organization may limit our ability to sell our products.
We currently have fewer resources available for sales and marketing and technical support
services as compared to our primary competitors and have only recently established a small direct
sales force and customer support team. In order to effectively commercialize our genotyping and
gene expression systems and other products to follow, we will need to expand our sales, marketing
and technical support staff both domestically and internationally. We may not be successful in
establishing or maintaining either a direct sales force or distribution arrangements to market our
products and services. In addition, we compete primarily with much larger companies, that have
larger sales and distribution staffs and a significant installed base of products in place, and the
efforts from a limited sales and marketing force may not be sufficient to build the market
acceptance of our products required to support continued growth of our business.
If we are unable to develop and maintain operation of our manufacturing capability, we may not be
able to launch or support our products in a timely manner, or at all.
We currently possess only one facility capable of manufacturing our products and services for
both sale to our customers and internal use. If a natural disaster were to significantly damage
our facility or if other events were to cause our operations to fail, these events could prevent us
from developing and manufacturing our products and services. Also, many of our manufacturing processes are automated and are controlled
by our custom designed Laboratory Information Management System
(LIMS). Additionally, as part of the decoding step in our
array manufacturing process we record several images of each array to
identify what bead is in each location on the array and to validate
each bead in the array. This requires significant network and storage
infrastructure. If either our LIMS system or our networks or storage
infrastructure were to fail for an extended period of time, it would
adversely impact our ability to manufacture our products on a timely
basis, which may prevent us from achieving our expected shipments in
any given period.
If we are unable to find third-party manufacturers to manufacture components of our products, we
may not be able to launch or support our products in a timely manner, or at all.
The nature of our products requires customized components that currently are available from a
limited number of sources. For example, we currently obtain the fiber optic bundles and BeadChip
slides included in our products from single vendors. If we are unable to secure a sufficient
supply of those or other product components, we will be unable to meet demand for our products. We may need to enter into
contractual relationships with manufacturers for commercial-scale production of some of our
products, or develop these capabilities internally, and we cannot assure you that we will be able
to do this on a timely basis, for sufficient quantities or on commercially reasonable terms.
Accordingly, we may not be able to establish or maintain reliable, high-volume manufacturing at
commercially reasonable costs.
We may encounter difficulties in managing our growth. These difficulties could increase our
losses.
We expect to experience rapid and substantial growth in order to achieve our operating plans,
which will place a strain on our human and capital resources. If we are unable to manage this
growth effectively, our losses could increase. Our ability to manage our operations and growth
effectively requires us to continue to expend funds
30
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
to enhance our operational, financial and
management controls, reporting systems and procedures and to attract and retain sufficient numbers
of talented employees. If we are unable to scale up and implement improvements to our
manufacturing process and control systems in an efficient or timely manner, or if we encounter
deficiencies in existing systems and controls, then we will not be able to make available the
products required to successfully commercialize our technology. Failure to attract and retain
sufficient numbers of talented employees will further strain our human resources and could impede
our growth.
We may need additional capital in the future. If additional capital is not available on acceptable
terms, we may have to curtail or cease operations.
Our future capital requirements will be substantial and will depend on many factors including
our ability to successfully market our genetic analysis systems and services, the need for capital
expenditures to support and expand our business, the progress and scope of our research and
development projects, the filing, prosecution and enforcement of patent claims, the outcome of our
legal proceedings with Affymetrix, the defense of any future litigation against us 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. We anticipate that our current cash, cash
equivalents and investments, and our expected revenues from sales and funding from grants, will
enable us to maintain currently planned operations for at least 24 months. However, we premise this
expectation on our current operating plan, which may change as a result of many factors.
Consequently, we may need additional funding within this timeframe. Our inability to raise capital
would seriously harm our business and product development efforts. In addition, we may choose to
raise additional capital due to market conditions or strategic considerations, such as an
acquisition, even if we believe we have sufficient funds for our current or future operating plans.
To the extent that additional capital is raised through the sale of equity, the issuance of these
securities could result in dilution to our stockholders.
We currently have no credit facility or committed sources of capital available as of July 3, 2005.
To the extent operating and capital resources are insufficient to meet future requirements, we will
have to raise additional funds to continue the development and commercialization of our
technologies. These funds may not be available on favorable terms, or at all. If adequate funds are
not available on attractive terms, we may be required to curtail operations significantly or to
obtain funds by entering into financing, supply or collaboration agreements on unattractive terms.
If we lose our key personnel or are unable to attract and retain additional personnel, we may be
unable to achieve our goals.
We are highly dependent on our management and scientific personnel, including Jay Flatley, our
president and chief executive officer, David Barker, our vice president and chief scientific
officer, and John Stuelpnagel, our senior vice president and chief operating officer. The loss of
their services could adversely impact our ability to achieve our business objectives. We will need
to hire additional qualified personnel with expertise in molecular biology, chemistry, biological
information processing, sales, marketing and technical support. We compete for qualified management
and scientific personnel with other life science companies, universities and research institutions, particularly those focusing on genomics. Competition for these individuals,
particularly in the San Diego area, is intense, and the turnover rate can be high. Failure to
attract and retain management and scientific personnel would prevent us from pursuing
collaborations or developing our products or technologies.
Our planned activities will require additional expertise in specific industries and areas
applicable to the products developed through our technologies, including the life sciences and
healthcare industries. Thus, we will need to add new personnel, including management, and develop
the expertise of existing management. The failure to do so could impair the growth of our business.
31
ILLUMINA. INC.
Managements Discussion and Analysis of Financial
Condition and Results of Operations (continued)
A significant portion of our sales are to international customers.
Approximately
41% of our revenues for the six months ended July 3, 2005 were derived from
customers outside the United States. We intend to continue to expand our international presence
and export sales to international customers and we expect the total amount of non-U.S. sales to
continue to grow. Export sales entail a variety of risks, including:
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currency exchange fluctuations; |
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unexpected changes in legislative or regulatory requirements of foreign countries into
which we import our products; |
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difficulties in obtaining export licenses or other trade barriers and restrictions
resulting in delivery delays; and |
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significant taxes or other burdens of complying with a variety of foreign laws. |
In addition, sales to international customers typically result in longer payment cycles and
greater difficulty in accounts receivable collection. We are also subject to general geopolitical
risks, such as political, social and economic instability and changes in diplomatic and trade
relations. One or more of these factors could have a material adverse effect on our business,
financial condition and operating results.
Our success depends upon the increasing availability of genetic information and the continued
emergence and growth of markets for analysis of genetic variation and function.
We design our products primarily for applications in the life sciences and pharmaceutical
industries. The usefulness of our technology depends in part upon the availability of genetic data
and its usefulness in identifying or treating disease. We are initially focusing on markets for
analysis of genetic variation and function, namely SNP genotyping and gene expression profiling.
Both of these markets are new and emerging, and they may not develop as quickly as we anticipate,
or reach their full potential. Other methods of analysis of genetic variation and function may
emerge and displace the methods we are developing. Also, researchers may not seek or be able to
convert raw genetic data into medically valuable information through the analysis of genetic
variation and function. Also, factors affecting research and development spending generally, such
as changes in the regulatory environment affecting life sciences and pharmaceutical companies, and
changes in government programs that provide funding to companies and research institutions, could
harm our business. If useful genetic data is not available or if our target markets do not develop
in a timely manner, demand for our products may grow at a slower rate than we expect, and we may
not be able to achieve or sustain profitability.
We expect that our results of operations will fluctuate. This fluctuation could cause our stock
price to decline.
Our revenues are subject to fluctuations due to the timing of sales of high-value products and
services projects, the impact of seasonal spending patterns, the timing and amount of government
grant funding programs, the timing and size of research projects our customers perform, changes in
overall spending levels in the life sciences industry and other unpredictable factors that may
affect customer ordering patterns. Given the difficulty in predicting the timing and magnitude of
sales for our products and services, we may experience quarter-to-quarter
fluctuations in revenue resulting in the potential for a sequential decline in quarterly
revenue. A large portion of our expenses is relatively fixed, including expenses for facilities,
equipment and personnel. In addition, we expect operating expenses to continue to increase
significantly. Accordingly, if revenue does not grow as anticipated, we may not be able to reduce
our operating losses. Approximately 30% of our revenues for the year 2004 and 8% of revenues for
the first six months of 2005 resulted from transactions that were funded under the International
HapMap Project. We believe virtually all of the activities under this grant involving us and our
customers were completed in early 2005. Although we expect that the loss of revenues resulting
from the completion of the HapMap grant may be offset by the recent commercial launch of our whole
genome genotyping arrays and our recently launched whole genome gene expression arrays, combined
with the continued expansion of our existing product lines, any significant delays in the
commercial launch of new products, unfavorable sales trends in our existing product lines, or
impacts from the other factors mentioned above, could adversely affect our revenue growth in 2005
or cause a sequential
32
decline in quarterly revenues. Due to the possibility of fluctuations in our
revenue and expenses, we believe that quarterly comparisons of our operating results are not a good
indication of our future performance. If our operating results fluctuate or do not meet the
expectations of stock market analysts and investors, our stock price probably would decline.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Sensitivity
Our exposure to market risk for changes in interest rates relates primarily to our investment
portfolio. The fair market value of fixed rate securities may be adversely impacted by fluctuations
in interest rates while income earned on floating rate securities may decline as a result of
decreases in interest rates. Under our current policies, we do not use interest rate derivative
instruments to manage exposure to interest rate changes. We attempt to ensure the safety and
preservation of our invested principal funds by limiting default risk, market risk and reinvestment
risk. We mitigate default risk by investing in investment grade securities. We have historically
maintained a relatively short average maturity for our investment portfolio, and we believe a
hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield
curve would not materially affect the fair value of our interest sensitive financial instruments.
Foreign Currency Exchange Risk
Although most of our revenue is realized in U.S. dollars, some portions of our revenue are
realized in foreign currencies. As a result, our financial results could be affected by factors
such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.
The functional currencies of our subsidiaries are their respective local currencies. Accordingly,
the accounts of these operations are translated from the local currency to the U.S. dollar using
the current exchange rate in effect at the balance sheet date for the balance sheet accounts, and
using the average exchange rate during the period for revenue and expense accounts. The effects of
translation are recorded in accumulated other comprehensive income as a separate component of
stockholders equity.
Exchange gains and losses arising from transactions denominated in foreign currencies are
recorded in operations. In July 2004, we began hedging significant foreign currency firm sales
commitments and accounts receivable with forward contracts. We only use derivative financial
instruments to reduce foreign currency exchange rate risks; we do not hold any derivative financial
instruments for trading or speculative purposes. Our forward exchange contracts have been
designated as cash flow hedges and accordingly, to the extent effective, any unrealized gains or
losses on these foreign currency forward contracts are reported in other comprehensive income.
Realized gains and losses for the effective portion are recognized with the underlying hedge
transaction. The notional settlement amount of the foreign currency forward contracts outstanding
at July 3, 2005 was $3.0 million. These contracts had a fair value of approximately $80,000,
representing an unrealized gain, and were included in other current assets at July 3, 2005. As of
July 3, 2005, all contracts were set to expire at various times through November 2005 and are with
reputable bank institutions. For the six months ended July 3, 2005, there were no amounts
recognized in earnings due to hedge ineffectiveness and we settled foreign exchange contracts
of $0.3 million. We have hedged all significant firm commitments denominated in foreign
currencies, and as a result, any increase or decrease in the exchange rates of these commitments
should have no net effect to our balance sheet or our results of operations.
Item 4. Controls and Procedures
We have established and maintain disclosure controls and procedures that are designed to
ensure that we record, process, summarize, and report information we are required to disclose in
our periodic reports filed with the Securities and Exchange Commission in the manner and within the
time periods specified in the SECs rules and forms. We also design our disclosure controls to
ensure that the information is accumulated and communicated to
33
our management, including the chief
executive officer and the chief financial officer, as appropriate to allow timely decisions
regarding required disclosure. We also maintain internal controls and procedures that are designed
to ensure that we comply with applicable laws and our established financial policies. 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 accounting principles generally
accepted in the United States.
We have evaluated the design and operation of our disclosure controls and procedures to
determine whether they are effective in ensuring that the disclosure of required information is
timely made in accordance with the Exchange Act and the rules and regulations of the Securities and
Exchange Commission. This evaluation was made under the supervision and with the participation of
management, including our chief executive officer and chief financial officer as of July 3, 2005.
Our management does not expect that our disclosure controls or our internal controls will prevent
all error and all fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty, and that breakdowns can
occur because of a simple error or mistake. Additionally, controls can be circumvented by the
individual acts of some persons, by collusion of two or more people, or by management override of
the control. The design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any design will succeed
in achieving its stated goals under all potential future conditions; over time, controls may become
inadequate because of changes in conditions, or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
The chief executive officer and chief financial officer have concluded, based on their review,
that our disclosure controls and procedures, as defined by Exchange Act Rules 13a-15(e) and
15d-15(e), were effective as of July 3, 2005 to ensure that information required to be disclosed by
us in reports that we file under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange
Commissions rules and forms. In
addition, no change in our internal control over financial reporting that has materially affected,
or is reasonably likely to materially affect, our internal control over financial reporting has
occurred during the quarter ending July 3, 2005.
34
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Termination-of-Employment Lawsuit
In
March 2001, a complaint seeking damages of an unspecified amount was filed against us by Dr. Anthony W. Czarnik, a
former employee, in the Superior Court of the State of California in connection with the employees
termination of employment with Illumina. In June 2002 a California Superior Court judgment was
rendered against the Company and we recorded a $7.7 million charge in our financial results for the
second quarter of 2002 to cover total damages and remaining expenses. We appealed the decision, and
in December 2004, the Fourth Appellate District Court of Appeal, in San Diego, California, reduced
the amount of the award. We recorded interest expense on the $7.7 million during the appeal based
on the statutory rate. As a result of the revised judgment, we reduced the $9.2 million liability
on our balance sheet to $5.9 million and recorded a gain of $3.3 million as a litigation judgment
in the fourth quarter of 2004. In January 2005, we paid the $5.9 million and removed the liability
from our balance sheet.
Affymetrix Litigation
In July 2004, Affymetrix filed a complaint in the U.S. District Court for the District of
Delaware alleging that our BeadArray products and services, including
the Array Matrix and BeadChip products, infringe six Affymetrix patents. The suit seeks an
unspecified amount of monetary damages and a judgment enjoining the sale of products, if any, that
are determined to be infringing these patents. In September 2004, we filed our answer and
counterclaims to Affymetrix complaint, seeking declaratory judgments from the court that we do not
infringe the Affymetrix patents and that such patents are invalid, and filed counterclaims against
Affymetrix for unfair competition and interference with actual and prospective economic advantage.
The court has scheduled a claim interpretation hearing for March 8, 2006 and a trial date of
October 16, 2006. We believe we have meritorious defenses
against each of the infringement claims alleged by Affymetrix and
intend to vigorously defend ourselves against this suit. However, we
cannot be sure we will prevail in this matter. Any unfavorable
determination, and in particular, any significant cash amounts
required to be paid by us or prohibition of the sale of our products
and services, could result in a material adverse effect on our
business, financial condition and results of operations.
Dr. Anthony W. Czarnik v. Illumina, Inc.
Dr.
Czarnik filed suit against Illumina in June 2005 in the U.S. District Court for the District
of Delaware,
alleging that Illumina fraudulently omitted Dr. Czarniks name
from various U.S. and foreign patent applications that disclose
inventions of which Dr. Czarnik claims to be a joint inventor. His
complaint alleges that he is entitled to correction of inventorship
to identify him as an inventor on four patents issued in the U.S. and on
certain pending U.S. and foreign patent applications, and that
Illumina committed inequitable conduct and fraud in not naming him as
an inventor. Dr. Czarnik seeks (1) an order requiring Illumina and
the U.S. Patent and Trademark Office to correct the inventorship of
the U.S. patents and pending U.S. applications by adding Dr. Czarnik
as an inventor, (2) an order requiring Illumina to correct
inventorship of several pending foreign patent applications by adding
Dr. Czarnik as an inventor, (3) a judgment declaring all of the
issued U.S. patents and pending U.S. patent applications
unenforceable, and (4) an unspecified amount of compensatory and punitive damages, and an
award of attorneys fees. There has been no trial date set for
this case. We believe we have meritorious defenses against this claim.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On July 27, 2000, we commenced our initial public offering pursuant to a Registration
Statement on Form S-1 (File No. 333-33922) resulting in net offering proceeds of $101.3 million.
We will continue to use proceeds from our initial public offering to fund operations. Through July
3, 2005, we have used $25.7 million to purchase property, plant and equipment, $2.4 million to
acquire a business and $48.1 million to fund general operating expenses. The remaining balance is
invested in a variety of interest-bearing instruments including U.S. Treasury securities, corporate
debt securities and money market accounts.
On April 8, 2005, we issued 1,579,897 shares of our common stock, $0.01 par value per share,
to acquire 100% of the voting equity interests of CyVera Corporation. The securities were issued
without registration under the Securities Act of 1933, in reliance upon the exemption provided by
Section 4(2) of the Securities Act, and no general solicitation or advertising was made in
connection with such issuance. We filed a registration statement covering the resale of these
shares on May 20, 2005.
Item 3. Defaults Upon Senior Securities
None.
35
Item 4. Submission of Matters to a Vote of Security Holders
The Registrants 2005 Annual Meeting of Stockholders was held on June 28, 2005. At the
meeting, Daniel M. Bradbury and John R. Stuelpnagel, D.V.M. were elected as directors for a term
expiring at the 2008 Annual Meeting of Stockholders. Directors Karin Eastham, Jay T. Flatley and
William H. Rastetter, Ph.D. will continue to serve as directors with terms expiring at the 2006
Annual Meeting of Stockholders and directors Paul Grint, M.D. and David R. Walt, Ph.D. will
continue to serve as directors with terms expiring at the 2007 Annual Meeting of Stockholders.
In addition, the Registrants stockholders ratified the appointment of Ernst & Young LLP as
the Companys independent auditors for the year 2005 and approved the Illumina, Inc. 2005 Stock and
Incentive Plan.
The following numbers of votes were cast for and to withhold authority to vote for the
election of Daniel M. Bradbury, elected director at the meeting:
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For:
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36,283,574 |
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Withhold Authority:
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1,024,309 |
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The following numbers of votes were cast for and to withhold authority to vote for the
election of John R. Stuelpnagel, D.V.M, elected as director at the meeting:
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For:
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36,210,739 |
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Withhold Authority:
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1,097,144 |
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The vote on ratification of the appointment of Ernst & Young LLP as the Companys independent
auditors for the year 2005:
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For:
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37,266,750 |
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Against:
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12,510 |
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Abstain:
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28,623 |
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Non votes:
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Approval of Illumina, Inc. 2005 Stock and Incentive Plan: |
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For:
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14,033,131 |
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Against:
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13,919,381 |
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Abstain:
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89,186 |
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Non votes: |
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9,266,185 |
Item 5. Other Information
None.
Item 6. Exhibits
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Exhibit Number |
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Description of Document |
10.30
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Offer letter for Scott Kahn
dated February 14, 2005. |
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10.31*
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Offer letter for Alan Kersey dated
February 15, 2005. |
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|
10.32
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Offer letter for Paul Grint dated April 8, 2005. |
|
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|
10.33
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Offer letter for Christian O. Henry dated April 26, 2005. |
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31.1
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|
Certification of Jay T. Flatley pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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|
|
31.2
|
|
Certification of Christian O. Henry pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1
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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. |
|
|
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32.2
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|
Certification of Christian O. Henry pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
*
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|
Certain portions of this exhibit
have been omitted pursuant to a request for confidential treatment. |
36
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.
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|
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|
|
Illumina, Inc. |
|
|
|
|
|
(Registrant) |
|
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|
Date:
August 8, 2005
|
|
/s/ Christian O. Henry |
|
|
|
|
|
Christian O. Henry |
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|
Vice President and Chief Financial Officer |
|
|
(Duly Authorized Officer and Principal Financial Officer) |
37