NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unless the context requires otherwise, references in this report to “Illumina,” the “Company,” “we,” “us,” and “our” refer to Illumina, Inc. and its consolidated subsidiaries.
| | |
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES |
Business Overview
We are a provider of sequencing- and array-based solutions, serving customers in the research, clinical and applied markets. Our products are used for applications in the life sciences, oncology, reproductive health, agriculture and other emerging segments. Our customers include leading genomic research centers, academic institutions, government laboratories, and hospitals, as well as pharmaceutical, biotechnology, commercial molecular diagnostic laboratories, and consumer genomics companies.
On August 18, 2021, we acquired GRAIL, a healthcare company focused on early detection of multiple cancers. The acquisition is subject to ongoing legal proceedings, and, currently, GRAIL must be held and operated separately and independently from Illumina pursuant to interim measures ordered by the European Commission, which prohibited our acquisition of GRAIL on September 6, 2022. Refer to note “8. Legal Proceedings” for additional details. We have included the financial results of GRAIL in our consolidated financial statements from the date of acquisition. GRAIL is a separate reportable segment. Refer to note “11. Segments and Geographic Data” for additional information.
Basis of Presentation
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles and include our accounts, our wholly-owned subsidiaries, and majority-owned or controlled companies. All intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation.
Variable Interest Entities (VIEs)
We evaluate our ownership, contractual and other interests in entities that are not wholly-owned to determine if these entities are VIEs, and, if so, whether we are the primary beneficiary of the VIE. In determining whether we are the primary beneficiary of a VIE and therefore required to consolidate the VIE, we apply a qualitative approach that determines whether we have both (1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (2) the obligation to absorb losses of, or the rights to receive benefits from, the VIE that could potentially be significant to that VIE. We continuously perform this assessment, as changes to existing relationships or future transactions may result in the consolidation or deconsolidation of a VIE. As of January 1, 2023 there were no VIEs for which we were the primary beneficiary and for which we were required to consolidate.
Use of Estimates
The preparation of the consolidated financial statements requires that management make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures of contingent assets and liabilities. Though the COVID-19 pandemic, the armed conflict between Russia and Ukraine, and macroeconomic factors such as inflation, exchange rates and concerns about an economic downturn present additional uncertainty, we continue to use the best information available to inform our critical accounting estimates. Actual results could differ from those estimates.
Fiscal Year
Our fiscal year is the 52 or 53 weeks ending the Sunday closest to December 31, with quarters of 13 or 14 weeks ending the Sunday closest to March 31, June 30, September 30, and December 31. References to 2022, 2021, and 2020 refer to fiscal years ended January 1, 2023, January 2, 2022, and January 3, 2021, respectively. Fiscal years 2022 and 2021 were both 52 weeks, and fiscal year 2020 was 53 weeks.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Functional Currency
The U.S. dollar is the functional currency of our international operations. We re-measure foreign subsidiaries’ monetary assets and liabilities to the U.S. dollar and record the net gains or losses resulting from re-measurement in other (expense) income, net in the consolidated statements of operations.
Concentrations of Risk
Customers
We operate in markets that are highly competitive and rapidly changing. Significant technological changes, shifting customer needs, the emergence of competitive products or services with new capabilities, and other factors could negatively impact our operating results. A portion of our customers consist of university and research institutions that management believes are, to some degree, directly or indirectly supported by the United States Government. A significant change in current research funding, particularly with respect to the U.S. National Institutes of Health, could have an adverse impact on future revenues and results of operations.
International sales entail a variety of risks, including currency exchange fluctuations, 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. The risks of international sales are mitigated in part by the extent to which sales are geographically distributed. Shipments to customers outside the United States comprised 50%, 52%, and 49% of total revenue in 2022, 2021, and 2020, respectively. Customers outside the United States represented 54% and 57% of our gross trade accounts receivable balance as of January 1, 2023 and January 2, 2022, respectively.
We had no customers that provided more than 10% of total revenue in 2022, 2021, and 2020. We perform regular reviews of customer activity and associated credit risks and do not require collateral or enter into netting arrangements. Historically, we have not experienced significant credit losses from accounts receivable.
Financial Instruments
We are also subject to risks related to our financial instruments, including cash and cash equivalents, investments, and accounts receivable. Most of our cash and cash equivalents as of January 1, 2023 were deposited with U.S. financial institutions, either domestically or with their foreign branches. Our investment policy restricts the amount of credit exposure to any one issuer to 5% of the portfolio or 5% of the total issue size outstanding at the time of purchase and to any one industry sector, as defined by Clearwater Analytics (Industry Sector Report), to 30% of the portfolio at the time of purchase. There is no limit to the percentage of the portfolio that may be maintained in debt securities, U.S. government-sponsored entities, U.S. Treasury securities, and money market funds. Historically, we have not experienced significant credit losses from financial instruments.
Suppliers
We require customized products and components that currently are available from a limited number of sources. We source certain key products and components included in our products from single vendors. Historically, we have not experienced significant issues sourcing materials to build our products.
Segments
We report segment information based on the management approach. This approach designates the internal reporting used by the Chief Operating Decision Maker (CODM) for making decisions and assessing performance as the source of our reportable segments. The CODM allocates resources and assesses the performance of each operating segment using information about its revenue and income (loss) from operations. Management evaluates the performance of our reportable segments based upon income (loss) from operations. We do not allocate expenses between segments.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Accounting Pronouncements Adopted in 2022
In August 2020, the FASB issued ASU 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). The new standard reduces the number of accounting models for convertible debt instruments, amends the accounting for certain contracts in an entity’s own equity, and modifies how certain convertible instruments and contracts that may be settled in cash or shares impact the calculation of diluted earnings per share. Specifically, the guidance removes certain accounting models that separate the embedded conversion features from the host contract for convertible instruments and requires the use of the if-converted method to calculate diluted earnings per share. We adopted the standard on its effective date in the first quarter of 2022 using a modified retrospective approach by recognizing a cumulative-effect adjustment to retained earnings on January 3, 2022. We did not restate prior periods. As a result of the adoption, we increased our convertible senior notes and retained earnings, on January 3, 2022, by $43 million and $61 million, respectively, and decreased our deferred tax liabilities, included in other long-term liabilities on the consolidated balance sheets, and additional paid-in capital by $11 million and $93 million, respectively. Interest expense recognized post-adoption has decreased as a result of accounting for our convertible senior notes as a single liability measured at amortized cost. See note “5. Debt and Other Commitments” for additional details on the adoption of ASU 2020-06.
Accounting Pronouncements Adopted in 2020
In May 2020, the SEC issued Final Rule Release No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, which amends the disclosure requirements applicable to acquisitions and dispositions of businesses, including the required pro forma financial information. Among other changes, the final amendments revised the investment and income tests used to determine whether a business acquisition is significant and reduced the filing requirements for financial statements and pro forma financial information of a significant acquired business to cover a maximum of two years. We adopted the amendments in 2020 in connection with our acquisition of GRAIL, which is further described in note “4. Acquisitions, Goodwill and Intangible Assets.”
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which amends the impairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables and available-for-sale debt securities. We adopted the standard on its effective date in the first quarter of 2020 using a modified retrospective approach. The cumulative effect of applying the new credit loss standard was not material and, therefore, did not result in an adjustment to retained earnings. There was no material difference to the consolidated financial statements in 2020 due to the adoption of ASU 2016-13.
In accordance with ASU 2016-13, a company no longer evaluates whether available-for-sale debt securities in an unrealized loss position are other than temporarily impaired. Instead, a company assesses whether such unrealized loss positions are credit-related. The credit-related portion of unrealized losses, and any subsequent improvements, are recorded in interest income through an allowance account. Unrealized gains and losses that are not credit-related are included in accumulated other comprehensive income. We estimate our allowance for credit losses on our trade receivables as described in our Accounts Receivable policy, below.
Revenue Recognition
Our revenue is generated primarily from the sale of products and services. Product revenue primarily consists of sales of instruments and consumables used in genetic analysis. Service and other revenue primarily consists of revenue generated from genotyping and sequencing services, instrument service contracts, development and licensing agreements, and cancer detection testing services related to the GRAIL business.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
We recognize revenue when control of our products and services is transferred to our customers in an amount that reflects the consideration we expect to receive from our customers in exchange for those products and services. This process involves identifying the contract with a customer, determining the performance obligations in the contract, determining the contract price, allocating the contract price to the distinct performance obligations in the contract, and recognizing revenue when the performance obligations have been satisfied. Revenue recognition for contracts with multiple deliverables is based on the separate satisfaction of each distinct performance obligation within the contract. A performance obligation is considered distinct from other obligations in a contract when it provides a benefit to the customer either on its own or together with other resources that are readily available to the customer and is separately identified in the contract. We consider a performance obligation satisfied once we have transferred control of a good or service to the customer, meaning the customer has the ability to use and obtain the benefit of the good or service. The contract price is allocated to each performance obligation in proportion to its standalone selling price. We determine our best estimate of standalone selling price using average selling prices over a rolling 12-month period coupled with an assessment of current market conditions. If the product or service has no history of sales or if the sales volume is not sufficient, we rely upon prices set by management, adjusted for applicable discounts.
Revenue from product sales is recognized generally upon delivery to the end customer, which is when control of the product is deemed to be transferred. Invoicing typically occurs upon shipment and payment is typically due within 30 days from invoice. In instances where right of payment or transfer of title is contingent upon the customer’s acceptance of the product, revenue is deferred until all acceptance criteria have been met. Revenue from genotyping and sequencing services, including cancer detection testing services related to the GRAIL business, is recognized when earned, which is generally at the time the genotyping or sequencing analysis data is made available to the customer. Revenue from instrument service contracts is recognized as the services are rendered, typically evenly over the contract term. Revenue from development and licensing agreements generally includes upfront and periodic licensing fees, contract research and development services, or payments for development and regulatory milestones. Revenue for these agreements is recognized when each distinct performance obligation is satisfied.
Revenue is recorded net of discounts, distributor commissions, and sales taxes collected on behalf of governmental authorities. Employee sales commissions are recorded as selling, general and administrative expense when incurred as the amortization period for such costs, if capitalized, would have been one year or less.
In certain markets, products and services are sold to customers through distributors. In most sales through distributors, the product is delivered directly to customers by us. The terms of sales transactions through distributors are consistent with the terms of direct sales to customers.
Earnings (Loss) per Share
Basic earnings (loss) per share is computed based on the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed based on the sum of the weighted average number of common shares and potentially dilutive common shares outstanding during the period. In loss periods, basic loss per share and diluted loss per share are identical since the effect of potentially dilutive common shares is antidilutive and therefore excluded.
Potentially dilutive common shares consist of shares issuable under convertible senior notes and equity awards. On January 3, 2022, we adopted ASU 2020-06. As a result, beginning in Q1 2022, we utilize the if-converted method to calculate the impact of convertible senior notes on diluted earnings (loss) per share. Prior to the adoption of ASU 2020-06, we applied the treasury stock method when calculating the potential dilutive effect, if any, of convertible senior notes which we intended to settle or have settled in cash the principal outstanding. Under the treasury stock method, convertible senior notes would have a dilutive impact when the average market price of our common stock exceeded the applicable conversion price of the respective notes. Potentially dilutive common shares from equity awards are determined using the average share price for each period under the treasury stock method. In addition, proceeds from exercise of equity awards and the average amount of unrecognized compensation expense for equity awards are assumed to be used to repurchase shares.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table presents the calculation of weighted average shares used to calculate basic and diluted earnings (loss) per share:
| | | | | | | | | | | | | | | | | |
| Years Ended |
In millions | January 1, 2023 | | January 2, 2022 | | January 3, 2021 |
Weighted average shares outstanding | 157 | | | 150 | | | 147 | |
Effect of potentially dilutive common shares from: | | | | | |
Equity awards | — | | | 1 | | | 1 | |
| | | | | |
| | | | | |
Weighted average shares used in calculating diluted earnings (loss) per share | 157 | | | 151 | | | 148 | |
| | | | | |
Antidilutive shares: | | | | | |
Convertible senior notes | 2 | | | — | | | — | |
Equity awards | 2 | | | — | | | — | |
Potentially dilutive shares excluded from calculation due to antidilutive effect | 4 | | | — | | | — | |
Fair Value Measurements
The fair value of assets and liabilities are based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. We use a fair value hierarchy with three levels of inputs, of which the first two are considered observable and the last unobservable, to measure fair value:
•Level 1 — Quoted prices in active markets for identical assets or liabilities.
•Level 2 — Inputs, other than Level 1, that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
•Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The carrying amounts of financial instruments such as cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, and accrued liabilities approximate the related fair values due to the short-term maturities of these instruments.
Cash Equivalents and Debt Securities
Cash equivalents are comprised of short-term, highly-liquid investments with maturities of 90 days or less at the date of purchase.
We have historically held and, from time to time, may hold debt securities in U.S. government-sponsored entities, corporate debt securities, and U.S. Treasury securities. In 2021, we sold all of our available-for-sale debt securities in order to fund the GRAIL acquisition, and we did not hold any debt securities in 2022. We have the ability, if necessary, to liquidate such short-term debt securities to meet our liquidity needs. Accordingly, investments with contractual maturities greater than one year from the date of purchase are classified as short-term investments in the consolidated balance sheets. We classify short-term debt investments as available-for-sale at the time of purchase and evaluate such classification as of each balance sheet date. All short-term debt investments are recorded at estimated fair value. We evaluate available-for-sale debt securities in an unrealized loss position to assess whether such unrealized loss positions are credit-related. The credit-related portion of unrealized losses, and any subsequent improvements, are recorded in interest income through an allowance account. Unrealized gains and losses that are not credit-related are included in accumulated other comprehensive income, a component of stockholders’ equity. Realized gains and losses are determined based on the specific identification method and are recorded in interest income in the consolidated statements of operations.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Equity Securities and Investments
We have strategic investments in privately-held companies (non-marketable equity securities) and companies that have completed initial public offerings (marketable equity securities). Our marketable equity securities are measured at fair value. Our non-marketable equity securities without readily determinable market values are initially measured at cost and adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment. Equity investments are classified as current, short-term investments, or noncurrent, recorded in other assets, based on the nature of the securities and their availability for use in current operations. Unrealized gains and losses on our equity investments are recorded in other (expense) income, net in the consolidated statements of operations. Our equity investments are assessed for impairment quarterly. Impairment losses, equal to the difference between the carrying value and the fair value of the investment, are recorded in other (expense) income, net.
We use the equity method to account for investments through which we have the ability to exercise significant influence, but not control, over the investee. Such investments are recorded in other assets, and our share of net income or loss is recognized on a one quarter lag in other (expense) income, net.
Accounts Receivable
Trade accounts receivable are recorded at the net invoice value and are not interest-bearing. Receivables are considered past due based on the contractual payment terms. We reserve a percentage of our trade receivable balance based on collection history and current economic trends that we expect will impact the level of credit losses over the life of our receivables. These reserves are re-evaluated on a regular basis and adjusted, as needed. Once a receivable is deemed to be uncollectible, such balance is charged against the reserve.
Inventory
Inventory is stated at the lower of cost or net realizable value, on a first-in, first-out basis. Inventory includes raw materials and finished goods that may be used in the research and development process, and such items are expensed as consumed or capitalized as property and equipment and depreciated. Inventory write-downs for slow-moving, excess, and obsolete inventories are estimated based on product life cycles, quality issues, historical experience, and usage forecasts.
Property and Equipment
Property and equipment are stated at cost, subject to review for impairment, and depreciated over the estimated useful lives of the assets, using the straight-line method. Depreciation of leasehold improvements is recorded over the shorter of the lease term or the estimated useful life of the related assets. Maintenance and repairs are expensed as incurred. When assets are sold, or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in operating expense.
Costs incurred to develop internal-use software during the application development stage are recorded as computer software costs, at cost. Costs incurred in the development of such internal-use software, including external direct costs of materials and services and applicable compensation costs of employees devoted to specific software application development, are capitalized. Costs incurred outside of the application development stage are expensed as incurred.
The estimated useful lives of the major classes of property and equipment are generally as follows:
| | | | | |
| |
Buildings and leasehold improvements | 4 to 20 years |
Machinery and equipment | 3 to 5 years |
Computer hardware and software | 3 to 9 years |
Furniture and fixtures | 7 years |
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Leases
We lease approximately 3.0 million square feet of office, lab, manufacturing, and distribution facilities under various non-cancellable operating lease agreements (real estate leases). Our real estate leases have remaining lease terms of approximately 1 year to 17 years, which represent the non-cancellable periods of the leases and include extension options that we determined are reasonably certain to be exercised. We exclude extension options that are not reasonably certain to be exercised from our lease terms, ranging from approximately 2 years to 20 years. Our lease payments consist primarily of fixed rental payments for the right to use the underlying leased assets over the lease terms, as well as payments for common-area-maintenance and administrative services. We often receive customary incentives from our landlords, such as reimbursements for tenant improvements and rent abatement periods, which effectively reduce the total lease payments owed for these leases. Leases are classified as operating or financing at commencement. We do not have any material financing leases.
Operating lease right-of-use assets and liabilities on our consolidated balance sheets represent the present value of our remaining lease payments over the remaining lease terms. We do not allocate lease payments to non-lease components; therefore, fixed payments for common-area-maintenance and administrative services are included in our operating lease right-of-use assets and liabilities. We use our incremental borrowing rate to calculate the present value of our lease payments, as the implicit rates in our leases are not readily determinable. Operating lease costs consist primarily of the fixed lease payments included in our operating lease liabilities and are recorded on a straight-line basis over the lease terms. We sublease certain real estate to third parties and this sublease income is also recorded on a straight-line basis.
Business Combinations
Under the acquisition method of accounting, we allocate the fair value of the total consideration transferred to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values on the date of acquisition. These valuations require us to make estimates and assumptions, especially with respect to intangible assets. We record the excess consideration over the aggregate fair value of tangible and intangible assets, net of liabilities assumed, as goodwill. Costs that we incur to complete the business combination, such as legal and other professional fees, are expensed as they are incurred.
In connection with certain acquisitions, contingent consideration can be earned by the sellers upon completion of certain future performance milestones. In these cases, a liability is recorded on the acquisition date, as a component of accrued liabilities and/or other long-term liabilities, for an estimate of the acquisition-date fair value of the contingent consideration. These estimates require management judgment, including probabilities of achieving certain future milestones. Changes in the fair value of the contingent consideration subsequent to the acquisition date are recognized in selling, general and administrative expense in our consolidated statements of operations.
If the initial accounting for a business combination is incomplete by the end of a reporting period that falls within the measurement period (not to exceed a year from the date of acquisition), we report provisional amounts in our financial statements. During the measurement period, we adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. We record these adjustments to the provisional amounts with a corresponding offset to goodwill. Any adjustments identified after the measurement period are recorded in the consolidated statements of operations.
Goodwill, Intangible Assets and Other Long-Lived Assets
Assets acquired, including intangible assets and capitalized in-process research and development (IPR&D), and liabilities assumed are measured at fair value as of the acquisition date. Goodwill, which has an indefinite useful life, represents the excess of cost over fair value of the net assets acquired. Intangible assets acquired in a business combination that are used for IPR&D activities are considered indefinite lived until the completion or abandonment of the associated research and development efforts. Upon reaching the end of the relevant research and development project (i.e., upon commercialization), the IPR&D asset is amortized over its estimated useful life. If the relevant research and development project is abandoned, the IPR&D asset is expensed in the period of abandonment.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Goodwill and IPR&D are not amortized; however, they are reviewed for impairment at least annually during the second quarter, or more frequently if an event occurs indicating the potential for impairment. Goodwill and IPR&D are considered to be impaired if the carrying value of the reporting unit or IPR&D asset exceeds its respective fair value.
We perform our goodwill impairment analysis at the reporting unit level, which aligns with our reporting structure and availability of discrete financial information. During the goodwill impairment review, we assess qualitative factors to determine whether it is more likely than not that the fair values of our reporting units are less than the carrying amounts, including goodwill. The qualitative factors include, but are not limited to, macroeconomic conditions, industry and market considerations, and our overall financial performance. If, after assessing the totality of these qualitative factors, we determine that it is not more likely than not that the fair values of our reporting units are less than the carrying amounts, then no additional assessment is deemed necessary. Otherwise, we proceed to compare the estimated fair values of the reporting units with the carrying values, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, we record an impairment loss based on the difference. We may elect to bypass the qualitative assessment in a period and proceed to perform the quantitative goodwill impairment test.
Our identifiable intangible assets with a finite life are typically comprised of acquired developed technologies, licensed technologies, customer relationships, license agreements, and trade names. The cost of identifiable intangible assets with finite lives is generally amortized on a straight-line basis over the assets’ respective estimated useful lives.
We perform regular reviews to determine if any event has occurred that may indicate that intangible assets with finite useful lives and other long-lived assets are potentially impaired. If indicators of impairment exist, an impairment test is performed to assess the recoverability of the affected assets by determining whether the carrying amount of such assets exceeds the undiscounted expected future cash flows. If the affected assets are not recoverable, we estimate the fair value of the assets and record an impairment loss if the carrying value of the assets exceeds the fair value. Factors that may indicate potential impairment include a significant decline in our stock price and market capitalization compared to the net book value, significant changes in the ability of a particular asset to generate positive cash flows for our strategic business objectives, and the pattern of utilization of a particular asset.
Derivative Financial Instruments
We are exposed to foreign exchange rate risks in the normal course of business and use derivative financial instruments to partially offset this exposure. We do not use derivative financial instruments for speculative or trading purposes. Foreign exchange contracts are carried at fair value in other current assets, other assets, accrued liabilities, or other long-term liabilities, as appropriate, on the consolidated balance sheets.
We use foreign exchange forward contracts to manage foreign currency risks related to monetary assets and liabilities denominated in currencies other than the U.S. dollar. These derivative financial instruments have terms of one month or less and are not designated as hedging instruments. Changes in fair value of these derivatives are recognized in other (expense) income, net, along with the re-measurement gain or loss on the foreign currency denominated assets or liabilities. As of January 1, 2023, we had foreign exchange forward contracts in place to hedge exposures to monetary assets and liabilities denominated in the euro, Japanese yen, Australian dollar, Canadian dollar, Singapore dollar, Chinese Yuan Renminbi, and British pound. As of January 1, 2023 and January 2, 2022, the total notional amounts of outstanding forward contracts in place for these foreign currency purchases were $485 million and $462 million, respectively.
We also use foreign currency forward contracts to hedge portions of our foreign currency exposure associated with forecasted revenue transactions. These derivative financial instruments have terms up to 24 months and are designated as cash flow hedges. Changes in fair value of our cash flow hedges are recorded as a component of accumulated other comprehensive income and are reclassified to revenue in the same period the underlying hedged transactions are recorded. We regularly review the effectiveness of our cash flow hedges and consider them to be ineffective if it becomes probable that the forecasted transactions will not occur in the identified period. Changes in fair value of the ineffective portions of our cash flow hedges, if any, are recognized in other (expense) income, net. As of January 1, 2023, we had foreign currency forward contracts in place to hedge exposures associated with forecasted revenue transactions denominated in the euro, Japanese yen, Australian dollar, and Canadian dollar. As of January 1, 2023 and January 2, 2022, the total notional amounts of outstanding cash flow hedge contracts in place for these foreign currency purchases were $425 million and $450 million, respectively.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
We reclassified $53 million and $10 million to revenue in 2022 and 2021, respectively. No amounts were reclassified to revenue in 2020. As of January 1, 2023, the fair value of the foreign currency forward contracts recorded in total assets and in total liabilities was $8 million and $6 million, respectively. As of January 2, 2022, the fair value of foreign currency forward contracts recorded in total assets was $19 million. The estimated net gains reported in accumulated other comprehensive income that are expected to be reclassified into earnings within the next 12 months are $2 million as of January 1, 2023.
Warranties
We generally provide a one-year warranty on instruments. Additionally, we provide a warranty on consumables through the expiration date, which generally ranges from six to twelve months after the manufacture date. At the time revenue is recognized, an accrual is established for estimated warranty expenses based on historical experience as well as anticipated product performance. We periodically review the warranty reserve for adequacy and adjust the warranty accrual, if necessary, based on actual experience and estimated costs to be incurred. Warranty expense is recorded as a component of cost of product revenue.
Share-Based Compensation
Share-based compensation expense is incurred related to restricted stock, cash-based equity incentive awards, Employee Stock Purchase Plan (ESPP), and stock options.
Restricted stock units (RSU) and performance stock units (PSU) are both considered restricted stock. The fair value of restricted stock is determined by the closing market price of our common stock on the date of grant. Share-based compensation expense is recognized based on the fair value on a straight-line basis over the requisite service periods of the awards. PSU represents a right to receive a certain number of shares of common stock based on the achievement of corporate performance goals and continued employment during the vesting period. At each reporting period, we reassess the probability of the achievement of such corporate performance goals and any increase or decrease in share-based compensation expense resulting from an adjustment in the estimated shares to be released is treated as a cumulative catch-up in the period of adjustment.
Cash-based equity incentive awards are classified as liability awards, as such awards will be settled in cash. For purposes of valuation and performance measurement of the awards, GRAIL’s stand-alone valuation, as determined by GRAIL using a reasonable calculation and based on advice from independent valuation experts and analyses, is used. The fair value of the awards is recorded over the respective vesting periods of the awards, with recognition of a corresponding liability recorded in accrued liabilities in the consolidated balance sheets. The awards are remeasured to fair value at each reporting date until the awards are settled, with changes in fair value recognized in share-based compensation expense.
The Black-Scholes-Merton option-pricing model is used to estimate the fair value of stock purchased under our ESPP and stock options granted. The model assumptions include expected volatility, term, dividends, and the risk-free interest rate. The expected volatility is generally determined by weighing the historical and implied volatility of our common stock. The historical volatility is generally commensurate with the estimated expected term, adjusted for the impact of unusual fluctuations and other relevant factors. The implied volatility is calculated from the implied market volatility of exchange-traded call options on our common stock. The expected term is generally based on historical forfeiture experience, exercise activity, and on the terms and conditions of the stock awards. The expected dividend yield is determined to be 0% given that we have never declared or paid cash dividends on our common stock and do not anticipate paying such cash dividends. The risk-free interest rate is based upon U.S. Treasury securities with remaining terms similar to the expected term of the share-based awards.
Forfeitures are accounted for, as incurred, as a reversal of share-based compensation expense related to awards that will not vest.
Shipping and Handling Expenses
Shipping and handling expenses are included in cost of product revenue.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Research and Development
Research and development expenses include personnel expenses, contractor fees, facilities-related costs, material costs, and license fees. Expenditures relating to research and development are expensed in the period incurred.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs were $53 million, $48 million, and $28 million in 2022, 2021, and 2020, respectively.
Income Taxes
The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for the expected future tax benefit to be derived from tax loss and credit carryforwards. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the years in which those tax assets are expected to be realized. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the provision for income taxes in the period that includes the enactment date.
Deferred tax assets are regularly assessed to determine the likelihood they will be recovered from future taxable income. A valuation allowance is established when we believe it is more likely than not the future realization of all or some of a deferred tax asset will not be achieved. In evaluating the ability to recover deferred tax assets within the jurisdiction which they arise, we consider all available positive and negative evidence. Factors reviewed include the cumulative pre-tax book income for the past three years, scheduled reversals of deferred tax liabilities, history of earnings and reliable forecasting, projections of pre-tax book income over the foreseeable future, and the impact of any feasible and prudent tax planning strategies.
The impact of a tax position is recognized in the consolidated financial statements only if that position is more likely than not of being sustained upon examination by taxing authorities, based on the technical merits of the position. Any interest and penalties related to uncertain tax positions will be reflected in income tax expense.
Our revenue is generated primarily from the sale of products and services. Product revenue primarily consists of sales of instruments and consumables used in genetic analysis. Service and other revenue primarily consists of revenue generated from genotyping and sequencing services, instrument service contracts, development and licensing agreements, and cancer detection testing services related to the GRAIL business.
Revenue by Source | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
In millions | Sequencing | | Microarray | | Total | | Sequencing | | Microarray | | Total | | Sequencing | | Microarray | | Total |
Consumables | $ | 2,919 | | | $ | 306 | | | $ | 3,225 | | | $ | 2,911 | | | $ | 306 | | | $ | 3,217 | | | $ | 2,039 | | | $ | 265 | | | $ | 2,304 | |
Instruments | 709 | | | 19 | | | 728 | | | 734 | | | 17 | | | 751 | | | 417 | | | 14 | | | 431 | |
Total product revenue | 3,628 | | | 325 | | | 3,953 | | | 3,645 | | | 323 | | | 3,968 | | | 2,456 | | | 279 | | | 2,735 | |
Service and other revenue | 543 | | | 88 | | | 631 | | | 464 | | | 94 | | | 558 | | | 423 | | | 81 | | | 504 | |
Total revenue | $ | 4,171 | | | $ | 413 | | | $ | 4,584 | | | $ | 4,109 | | | $ | 417 | | | $ | 4,526 | | | $ | 2,879 | | | $ | 360 | | | $ | 3,239 | |
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Revenue by Geographic Area
| | | | | | | | | | | | | | | | | |
Based on region of destination (in millions) | 2022 | | 2021 | | 2020 |
Americas (1) | $ | 2,479 | | | $ | 2,358 | | | $ | 1,744 | |
Europe, Middle East, and Africa | 1,215 | | | 1,289 | | | 886 | |
Greater China (2) | 472 | | | 502 | | | 342 | |
Asia-Pacific | 418 | | | 377 | | | 267 | |
Total revenue | $ | 4,584 | | | $ | 4,526 | | | $ | 3,239 | |
_____________
(1)Revenue for the Americas region included United States revenue of $2,290 million, $2,195 million, and $1,655 million in 2022, 2021, and 2020, respectively.
(2)Region includes revenue from China, Taiwan, and Hong Kong.
Performance Obligations
We regularly enter into contracts with multiple performance obligations. These contracts are believed to be firm as of the balance sheet date. However, we may allow customers to make product substitutions as we launch new products. The timing of shipments depends on several factors, including agreed upon shipping schedules, which may span multiple quarters. Most performance obligations are generally satisfied within a short time frame, approximately three to six months, after the contract execution date. As of January 1, 2023, the aggregate amount of the transaction price allocated to remaining performance obligations was $1,030 million, of which approximately 89% is expected to be converted to revenue in 2023, approximately 7% in the following twelve months, and the remainder thereafter.
Contract Assets and Liabilities
Contract assets, which consist of revenue recognized and performance obligations satisfied or partially satisfied in advance of customer billing, as of January 1, 2023 and January 2, 2022 were $17 million and $16 million, respectively, all of which were short-term and recorded in prepaid expenses and other current assets.
Contract liabilities, which consist of deferred revenue and customer deposits, as of January 1, 2023 and January 2, 2022 were $308 million and $297 million, respectively, of which the short-term portions of $245 million and $234 million, respectively, were recorded in accrued liabilities and the remaining long-term portions were recorded in other long-term liabilities. Revenue recorded in 2022 included $234 million of previously deferred revenue that was included in contract liabilities as of January 2, 2022.
| | |
3. INVESTMENTS AND FAIR VALUE MEASUREMENTS |
Strategic Investments
Marketable Equity Securities
Our short-term investments consist of marketable equity securities. As of January 1, 2023 and January 2, 2022, the fair value of our marketable equity securities totaled $26 million and $107 million, respectively.
Gains and losses recognized in other (expense) income, net on our marketable equity securities for 2022, 2021, and 2020 were as follows:
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
Net (losses) gains recognized during the period on marketable equity securities | $ | (81) | | | $ | (52) | | | $ | 270 | |
Less: Net losses recognized during the period on marketable equity securities sold during the period | — | | | 89 | | | — | |
Net unrealized (losses) gains recognized during the period on marketable equity securities still held at the reporting date | $ | (81) | | | $ | 37 | | | $ | 270 | |
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Non-Marketable Equity Securities
As of January 1, 2023 and January 2, 2022, the aggregate carrying amounts of our non-marketable equity securities without readily determinable fair values, included in other assets, were $28 million and $40 million, respectively.
Revenue recognized from transactions with our strategic investees was $113 million, $74 million, and $62 million in 2022, 2021, and 2020, respectively.
Venture Funds
We invest in two venture capital investment funds (the Funds) with capital commitments of $100 million, callable through April 2026, and up to $150 million, callable through July 2029, respectively, of which $11 million and up to $88 million, respectively, remained callable as of January 1, 2023. Our investments in the Funds are accounted for as equity-method investments. The aggregate carrying amounts of the Funds, included in other assets, were $183 million and $173 million as of January 1, 2023 and January 2, 2022, respectively. We recorded a net unrealized loss of $25 million in 2022, and net unrealized gains of $55 million and $20 million in 2021 and 2020, respectively, in other (expense) income, net.
Helix Contingent Value Right
In conjunction with the deconsolidation of Helix Holdings I, LLC (Helix) in April 2019, we received a contingent value right with a 7-year term that entitles us to consideration dependent upon the outcome of Helix’s future financing and/or liquidity events. Changes in the fair value of our contingent value right resulted in an unrealized loss of $7 million in 2022 and unrealized gains of $30 million and $7 million in 2021 and 2020, respectively, included in other (expense) income, net.
Fair Value Measurements
The following table presents the hierarchy for assets and liabilities measured at fair value on a recurring basis:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| January 1, 2023 | | January 2, 2022 |
In millions | Level 1 | | Level 2 | | Level 3 | | Total | | Level 1 | | Level 2 | | Level 3 | | Total |
Assets: | | | | | | | | | | | | | | | |
Money market funds (cash equivalents) | $ | 1,642 | | | $ | — | | | $ | — | | | $ | 1,642 | | | $ | 688 | | | $ | — | | | $ | — | | | $ | 688 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Marketable equity securities | 26 | | | — | | | — | | | 26 | | | 107 | | | — | | | — | | | 107 | |
Helix contingent value right | — | | | — | | | 58 | | | 58 | | | — | | | — | | | 65 | | | 65 | |
| | | | | | | | | | | | | | | |
Deferred compensation plan assets | — | | | 52 | | | — | | | 52 | | | — | | | 60 | | | — | | | 60 | |
Total assets measured at fair value | $ | 1,668 | | | $ | 52 | | | $ | 58 | | | $ | 1,778 | | | $ | 795 | | | $ | 60 | | | $ | 65 | | | $ | 920 | |
Liabilities: | | | | | | | | | | | | | | | |
Contingent consideration liabilities | $ | — | | | $ | — | | | $ | 412 | | | $ | 412 | | | $ | — | | | $ | — | | | $ | 615 | | | $ | 615 | |
Deferred compensation plan liability | — | | | 51 | | | — | | | 51 | | | — | | | 56 | | | — | | | 56 | |
Total liabilities measured at fair value | $ | — | | | $ | 51 | | | $ | 412 | | | $ | 463 | | | $ | — | | | $ | 56 | | | $ | 615 | | | $ | 671 | |
Our marketable equity securities are measured at fair value based on quoted trade prices in active markets.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Our deferred compensation plan assets consist primarily of investments in life insurance contracts carried at cash surrender value, which reflects the net asset value of the underlying publicly traded mutual funds. We perform control procedures to corroborate the fair value of our holdings, including comparing valuations obtained from our investment service provider to valuations reported by our asset custodians, validating pricing sources and models, and reviewing key model inputs, if necessary.
We elected the fair value option to measure the contingent value right received from Helix. The fair value of such contingent value right, included in other assets, is derived using a Monte Carlo simulation. Estimates and assumptions used in the Monte Carlo simulation include probabilities related to the timing and outcome of future financing and/or liquidity events, assumptions regarding collectibility and volatility, and an estimated equity value of Helix. These unobservable inputs represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value.
We reassess the fair value of contingent consideration related to acquisitions on a quarterly basis. Changes in the fair value of contingent consideration subsequent to the acquisition date are recognized in selling, general and administrative expense in our consolidated statements of operations.
The contingent value rights issued as part of the GRAIL acquisition entitle the holders to receive future cash payments on a quarterly basis (Covered Revenue Payments) representing a pro rata portion of certain GRAIL-related revenues (Covered Revenues) each year for a 12-year period. As defined in the Contingent Value Rights Agreement, this will reflect a 2.5% payment right to the first $1 billion of revenue each year for 12 years. Revenue above $1 billion each year will be subject to a 9% contingent payment right during this same period. Covered Revenues for Q4 2021, Q1 2022, Q2 2022, and Q3 2022 were $42 million in aggregate, driven primarily by sales of GRAIL’s Galleri test. The aggregate Covered Revenue Payments relating to such periods were approximately $396,000 in 2022; however, pursuant to the Contingent Value Rights Agreement, a portion of the Covered Revenue Payments were applied to reimburse us for certain expenses. We use a Monte Carlo simulation to estimate the fair value of contingent consideration related to the GRAIL acquisition. Estimates and assumptions used in the Monte Carlo simulation include forecasted revenues for GRAIL, a revenue risk premium, a revenue volatility estimate, an operational leverage ratio and a counterparty credit spread. These unobservable inputs represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value. The fair value of our contingent consideration liability related to the GRAIL acquisition was $412 million and $615 million as of January 1, 2023 and January 2, 2022, respectively, of which $411 million and $614 million, respectively, was included in other long-term liabilities, with the remaining balances included in accrued liabilities.
Changes in the estimated fair value of our contingent consideration liabilities were as follows:
| | | | | |
In millions | |
Balance as of January 3, 2021 | $ | — | |
Acquisition of GRAIL | 762 | |
Other acquisition | 14 | |
Measurement period adjustment | (5) | |
Cash payments | (15) | |
Exchange of GRAIL contingent value rights | (145) | |
Change in estimated fair value | 4 | |
Balance as of January 2, 2022 | 615 | |
Acquisition | 2 | |
| |
Change in estimated fair value | (205) | |
Balance as of January 1, 2023 | $ | 412 | |
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
We recorded a measurement period adjustment in Q4 2021 related to the acquisition of GRAIL to reduce the acquisition-date fair value of contingent consideration by $5 million as a result of revised future cash flow estimates. The measurement period adjustment would have resulted in an increase of $7 million to the gain recorded in Q3 2021 for the change in the estimated fair value of the contingent consideration liability. The measurement period adjustment was recorded in our consolidated financial statements as of and for the year ended 2021 and was made to reflect facts and circumstances that existed as of the acquisition date.
We recorded a contingent consideration liability of $14 million as a result of an acquisition completed in Q2 2021. The acquisition-date fair value of the contingent consideration was derived using the income approach. Assumptions used to estimate the liability included the probability of achieving certain milestones and a discount rate. These unobservable inputs represented a Level 3 measurement because they were supported by little or no market activity and reflected our own assumptions in measuring fair value. We recorded an expense of $1 million in selling, general and administrative expense in 2021 due to the change in estimated fair value of the contingent consideration and made a payment of $15 million in Q4 2021 upon achievement of the milestones.
| | |
4. ACQUISITIONS, GOODWILL AND INTANGIBLE ASSETS |
Acquisition of GRAIL, Inc.
On August 18, 2021, we completed our acquisition of GRAIL, a healthcare company focused on early detection of multiple cancers. The acquisition is expected to accelerate access and adoption of GRAIL’s blood test, Galleri, that detects various types of cancers before they are symptomatic. The acquisition is subject to ongoing legal proceedings. Currently, GRAIL must be held and operated separately and independently from Illumina pursuant to interim measures ordered by the European Commission, which prohibited our acquisition of GRAIL on September 6, 2022. Refer to note “8. Legal Proceedings” for further details. As a result of the acquisition, GRAIL stockholders received as consideration (i) cash, (ii) shares of Illumina common stock and (iii) at their election, either a contingent value right or additional shares of Illumina common stock. We issued 9.8 million common shares as part of the consideration.
GRAIL is a separate reportable segment. See note “11. Segment and Geographic Data” for more information. We have included the financial results of GRAIL in the consolidated financial statements from the date of acquisition.
In Q4 2021, we recorded a measurement period adjustment related to the valuations of contingent consideration and our previously held investment in GRAIL that reduced the acquisition-date fair value of each by $5 million and $1 million, respectively, and reduced the acquisition-date fair value of goodwill by $6 million.
The total purchase price consisted of the following:
| | | | | |
In millions | As Adjusted |
Cash | $ | 2,862 | |
Fair value of common stock issued | 4,975 | |
Fair value of contingent consideration | 757 | |
| |
| |
Fair value of previously held investment | 1,149 | |
Settlement of preexisting relationships | 2 | |
Total purchase price | $ | 9,745 | |
The contingent consideration relates to the GRAIL stockholders who elected to receive contingent value rights as part of the acquisition (the Contingent Value Rights Agreement). The contingent value rights entitle the holders to receive future cash payments representing a pro rata portion of certain GRAIL-related revenues each year for a 12-year period starting at the acquisition date. This will reflect a 2.5% payment right to the first $1 billion of revenue each year for 12 years. Revenue above $1 billion each year will be subject to a 9% contingent payment right during this same period. The acquisition-date fair value of the contingent consideration was measured using a Monte Carlo simulation. Estimates and assumptions used in the fair value assessment included forecasted revenues for GRAIL, a revenue risk premium, a revenue volatility estimate, an operational leverage ratio and a counterparty credit spread. In December 2021, we exchanged approximately 73 million contingent value rights, that were issued as part of the acquisition, for an aggregate cash payment of $57 million and the issuance of $2 million in shares of our common stock. As a result of the exchange, we recognized a gain of $86 million in other (expense) income, net in 2021, which
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
represented the difference between the fair value of the contingent consideration liability for the contingent value rights exchanged of $145 million and the total consideration transferred of $59 million.
Prior to the acquisition, we owned a 12% interest in GRAIL. Authoritative guidance on accounting for business combinations requires that an acquirer remeasure its previously held equity investment in the acquiree at its acquisition-date fair value and recognize the resulting gain or loss in earnings. We remeasured our previously held equity investment to its fair value, as of the date of acquisition, based on the fair value of total consideration transferred and a discount for lack of control. Estimates and assumptions used in the remeasurement represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring the fair value. As a result of the remeasurement, we valued our previously held equity investment in GRAIL at $1.1 billion and recognized a gain of $899 million, included in other (expense) income, net, in 2021.
In connection with the acquisition, we accelerated the vesting of certain outstanding and unvested equity awards of GRAIL employees. Approximately $69 million was included in the purchase price related to the fair value of accelerated equity awards attributable to the pre-combination period, with the fair value attributable to the post-combination period of $615 million included in share-based compensation expense in 2021. In addition, we issued Illumina equity awards to GRAIL employees in exchange for any of their remaining outstanding and unvested GRAIL equity awards (the “replacement awards”) at acquisition. The replacement awards consist of restricted stock units and performance stock options. The terms of the replacement awards are substantially similar to the former GRAIL equity awards for which they were exchanged. The fair value of the replacement awards was $48 million, all of which is attributable to post-combination service, and will be recognized as share-based compensation expense over the remaining vesting period subsequent to the acquisition. The weighted-average acquisition-date fair value of the replacement performance stock options was determined using the Black-Scholes option pricing model with the following assumptions: (i) market price of $510.61 per share, which was the closing price of Illumina’s common stock on the acquisition date; (ii) weighted average expected term ranging from 1.6 years to 2.2 years; (iii) weighted-average risk-free interest rate ranging from 0.17% to 0.28%; (iv) weighted average annualized volatility ranging from 40% to 43%; and (v) no dividend yield. The weighted-average acquisition-date fair value per share of the replaced performance stock options was $424.39. Refer to note “6. Stockholders’ Equity” for more information.
We finalized the allocation of the purchase price in August 2022. The fair values of assets acquired and liabilities assumed were:
| | | | | | | | | | | | | | | | | |
In millions | As Initially Reported | | Measurement Period Adjustments | | As Adjusted |
Cash and cash equivalents | $ | 571 | | | $ | — | | | $ | 571 | |
| | | | | |
| | | | | |
| | | | | |
Property and equipment | 89 | | | — | | | 89 | |
Operating lease right-of-use assets | 121 | | | — | | | 121 | |
| | | | | |
Goodwill | 6,082 | | | 9 | | | 6,091 | |
Intangible assets | 3,180 | | | (60) | | | 3,120 | |
Other current and noncurrent assets | 35 | | | — | | | 35 | |
| | | | | |
| | | | | |
| | | | | |
Deferred tax liability | (82) | | | 46 | | | (36) | |
Long-term lease liabilities | (97) | | | — | | | (97) | |
Other current and noncurrent liabilities | (148) | | | (1) | | | (149) | |
Total net assets acquired | $ | 9,751 | | | $ | (6) | | | $ | 9,745 | |
We recorded a measurement period adjustment in Q3 2022 to decrease goodwill and increase deferred tax assets by $6 million, as a result of finalizing GRAIL’s U.S. tax returns. In Q4 2021, we recorded measurement period adjustments to decrease intangible assets, specifically, developed technology, as a result of revised future cash flow estimates and to decrease deferred tax liability as a result of changes in net operating loss estimates from the initial purchase price allocation. These measurement period adjustments were made to reflect facts and circumstances that existed as of the acquisition date. The measurement period adjustment related to the developed technology intangible asset would have resulted in an insignificant decrease in amortization expense recorded in Q3 2021. The measurement period adjustments have been and were recorded in our consolidated financial statements as of and for the years ended 2022 and 2021, as appropriate.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Goodwill is primarily attributable to assembled workforce, expanded market opportunities, and expected synergies to be achieved. The goodwill recognized was assigned to the GRAIL segment and is not deductible for tax purposes.
The fair values assigned to identifiable intangible assets acquired were as follows:
| | | | | | | | |
In millions, except years | Fair Value (as adjusted) | Estimated Useful Life |
Developed technology | $ | 2,410 | | 18 |
Trade name | 40 | | 9 |
In-process research and development (IPR&D) | 670 | | Indefinite |
Total intangible assets | $ | 3,120 | | |
The fair values of the developed technology, trade name and IPR&D were estimated using an income approach. Under the income approach, an intangible asset’s fair value is equal to the present value of future economic benefits to be derived from ownership of the asset. The estimated fair values were developed by discounting future net cash flows to their present value at market-based rates of return and inclusive of an assumption for technology obsolescence. The useful lives of the intangible assets for amortization purposes were determined by considering the period of expected cash flows used to measure the fair values of the intangible assets adjusted as appropriate for entity-specific factors including legal, regulatory, contractual, competitive, economic and other factors that may limit the useful life. The developed technology and trade name assets are amortized on a straight-line basis over their estimated useful lives. As of January 1, 2023, the research and development project had not been completed or abandoned and, therefore, the IPR&D intangible asset is not currently subject to amortization.
The transaction costs associated with the acquisition of GRAIL, excluding any Continuation Payments paid to GRAIL prior to the close of the acquisition, consisted primarily of legal, regulatory and financial advisory fees of approximately $156 million, which were expensed as incurred as selling, general and administrative expense in 2021.
Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information summarizes the combined results of operations of Illumina and GRAIL as if the companies had been combined as of the beginning of our fiscal year 2020.
| | | | | | | | | | | | | | | | | |
In millions | | | | | 2021 | | 2020 |
Revenue | | | | | $ | 4,528 | | | $ | 3,239 | |
Net income | | | | | $ | 661 | | | $ | 351 | |
The unaudited pro forma financial information is presented for information purposes only and is not indicative of the results of operations that would have been achieved had the acquisition been completed at the beginning of our fiscal year 2020. In addition, the unaudited pro forma financial information is not a projection of future results of operations of the combined company nor does it reflect the expected realization of any synergies or cost savings associated with the acquisition. The unaudited pro forma financial information includes adjustments to reflect the elimination of intercompany transactions, incremental amortization and depreciation expense of the identifiable intangible assets and property and equipment acquired, respectively, the additional interest expense associated with the issuance of debt to finance the acquisition, and share-based compensation expense.
Prior to the acquisition, we were required to make monthly cash payments to GRAIL of $35 million (the Continuation Payments) through the earlier of the consummation of the acquisition or termination of the GRAIL Merger Agreement, subject to certain exceptions. We made Continuation Payments to GRAIL totaling $245 million and $35 million in 2021 and 2020, respectively, which were recorded as selling, general and administrative expense. Subsequent to the acquisition, we did not make any additional Continuation Payments.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Goodwill
| | | | | |
In millions | Goodwill |
Balance as of January 3, 2021 | $ | 897 | |
Acquisitions | 6,201 | |
Measurement period adjustments | 15 | |
Balance as of January 2, 2022 | 7,113 | |
Impairment | (3,914) | |
Acquisition | 45 | |
Measurement period adjustments | (5) | |
Balance as of January 1, 2023 | $ | 3,239 | |
Impairment of Goodwill
We test goodwill for impairment annually, as of May, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount. We performed our annual impairment test in Q2 2022, as of May 2022. We performed a qualitative assessment for the Core Illumina reporting unit, noting no impairment. For the GRAIL reporting unit, we performed a quantitative assessment and determined a fair value for the reporting unit using a discounted cash flow model, which included assumptions for projected cash flows and a discount rate of 16.0%. The selected discount rate was determined using a weighted average cost of capital for risk factors specific to GRAIL and other market and industry data. The estimates and assumptions used represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value. Based on the quantitative test performed, the fair value of the GRAIL reporting unit exceeded its carrying value by $700 million and no goodwill impairment was recorded in Q2 2022.
On July 13, 2022, the EU General Court ruled that the European Commission has jurisdiction under the EU Merger Regulation to review our acquisition of GRAIL. Additionally, on September 6, 2022, the European Commission issued its decision prohibiting the acquisition. Refer to note “8. Legal Proceedings” for additional details. These decisions, along with a continued and significant decrease in the Company’s stock price and market capitalization, led us to believe that a triggering event occurred and that an interim goodwill and intangible asset impairment test was required in Q3 2022.
Based on our interim analysis, we concluded that our GRAIL reporting unit’s carrying value exceeded its estimated fair value. As a result, we recorded $3,914 million of goodwill impairment related to our GRAIL reporting unit in Q3 2022, primarily due to the negative impact of current capital market conditions and a higher discount rate selected for the fair value calculation of the GRAIL reporting unit. No impairment was recorded for our Core Illumina reporting unit, noting its fair value exceeded its carrying value by more than $30 billion.
We performed our interim goodwill impairment test using a combination of both an income and a market approach to determine the fair value of each reporting unit. The income approach utilized the estimated discounted cash flows for each reporting unit while the market approach utilized comparable company information. Estimates and assumptions used in the income approach included projected cash flows for both the GRAIL and Core Illumina reporting units and a discount rate for each reporting unit. Discount rates were determined using a weighted average cost of capital for risk factors specific to each reporting unit and other market and industry data. For the GRAIL reporting unit, the discount rate selected was 22.0%. The estimates and assumptions used in our assessment represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value. The assumptions used in our impairment analysis are inherently subject to uncertainty and we note that small changes in these assumptions could have a significant impact on the concluded value. In order to further validate the reasonableness of the fair values concluded for our reporting units, a reconciliation to market capitalization was performed by estimating a reasonable implied control premium and other market factors.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
As a result of the impairment taken in Q3 2022, the carrying value of our GRAIL reporting unit now approximates its fair value. As such, changes in our future operating results, cash flows, share price, market capitalization or discount rates, as well as future regulatory decisions related to our acquisition of GRAIL, used when conducting future goodwill impairment tests could affect the estimated fair values of our reporting units and may result in additional goodwill impairment charges in the future. We will continue to monitor events occurring or circumstances changing which may suggest that goodwill should be reevaluated during interim periods prior to the annual impairment test. No triggering events were identified in Q4 2022 that would indicate the need for an additional interim goodwill and intangible asset impairment test. As of January 1, 2023, remaining goodwill allocated to the GRAIL reporting unit was $2,178 million.
In conjunction with the interim goodwill impairment test in Q3 2022, we also evaluated the IPR&D intangible asset, assigned to the GRAIL reporting unit, for potential impairment. We performed our interim impairment test by comparing the carrying value of the IPR&D intangible asset to its estimated fair value, which was determined by the income approach, using a discounted cash flow model. Estimates and assumptions used in the income approach included projected cash flows and a discount rate. These estimates and assumptions represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value. Based on our interim impairment test, the carrying value of the IPR&D intangible asset did not exceed its estimated fair value. As a result, no impairment for the IPR&D intangible asset was recorded.
We also performed a recoverability test for the definite-lived intangible assets assigned to the GRAIL reporting unit, which includes developed technology and trade name, noting no impairment. Additionally, no impairment was noted for the definite-lived intangible assets assigned to our Core Illumina reporting unit.
Intangible Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| January 1, 2023 | | January 2, 2022 |
In millions | Gross Carrying Amount | | Accumulated Amortization | | Intangible Assets, Net | | Gross Carrying Amount | | Accumulated Amortization | | Intangible Assets, Net |
Developed technologies | $ | 2,812 | | | $ | (449) | | | $ | 2,363 | | | $ | 2,790 | | | $ | (291) | | | $ | 2,499 | |
Licensed technologies | 274 | | | (105) | | | 169 | | | 95 | | | (92) | | | 3 | |
Trade name | 44 | | | (10) | | | 34 | | | 44 | | | (6) | | | 38 | |
Customer relationships | 31 | | | (29) | | | 2 | | | 31 | | | (28) | | | 3 | |
License agreements | 15 | | | (14) | | | 1 | | | 14 | | | (12) | | | 2 | |
Database | 12 | | | (1) | | | 11 | | | — | | | — | | | — | |
Total finite-lived intangible assets, net | 3,188 | | | (608) | | | 2,580 | | | 2,974 | | | (429) | | | 2,545 | |
In-process research and development (IPR&D) | 705 | | | — | | | 705 | | | 705 | | | — | | | 705 | |
Total intangible assets, net | $ | 3,893 | | | $ | (608) | | | $ | 3,285 | | | $ | 3,679 | | | $ | (429) | | | $ | 3,250 | |
As a result of an acquisition in Q2 2022, we recorded a developed technology intangible asset of $23 million, with a useful life of 7 years, and a database intangible asset of $12 million, with a useful life of 7 years. We are still finalizing the allocation of the purchase price as additional information is received to complete our analysis. We expect to finalize the valuation as soon as practicable, but no later than one year after the acquisition date. In addition, we recorded a licensed technology intangible asset of $180 million, with a useful life of 6.5 years, as a result of our litigation settlement with BGI in Q3 2022. Refer to note “8. Legal Proceedings” for additional details. As a result of an acquisition completed in Q2 2021, we recorded an IPR&D intangible asset of $35 million, with an indefinite useful life. As of January 1, 2023, the research and development project had not been completed or abandoned and, therefore, the IPR&D intangible asset is not currently subject to amortization. Additionally, as a result of another acquisition completed in Q3 2021, we recorded a developed technology intangible asset of $28 million, with a useful life of 10 years.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The estimated future annual amortization of finite-lived intangible assets is shown in the following table. Actual amortization expense to be reported in future periods could differ from these estimates as a result of acquisitions, divestitures, and asset impairments, among other factors.
| | | | | |
In millions | Estimated Annual Amortization |
2023 | $ | 197 | |
2024 | 195 | |
2025 | 194 | |
2026 | 183 | |
2027 | 181 | |
Thereafter | 1,630 | |
Total | $ | 2,580 | |
| | |
5. DEBT AND OTHER COMMITMENTS |
Summary of Term Debt Obligations
| | | | | | | | | | |
In millions | January 1, 2023 | January 2, 2022 | | |
| | | | |
| | | | |
Principal amount of 2031 Term Notes outstanding | $ | 500 | | $ | 500 | | | |
Principal amount of 2023 Term Notes outstanding | 500 | | 500 | | | |
Principal amount of 2027 Term Notes outstanding | 500 | | — | | | |
Principal amount of 2025 Term Notes outstanding | 500 | | — | | | |
Unamortized discounts and debt issuance costs | (13) | | (7) | | | |
| | | | |
Net carrying amount of term notes | 1,987 | | 993 | | | |
Less: current portion | (500) | | — | | | |
Term notes, non-current | $ | 1,487 | | $ | 993 | | | |
Fair value of term notes outstanding (Level 2) | $ | 1,913 | | $ | 996 | | | |
Interest expense recognized on the Term Notes, which included amortization of debt discounts and issuance costs, was $21 million and $14 million in 2022 and 2021, respectively.
0.550% Term Notes due 2023 (2023 Term Notes) and 2.550% Term Notes due 2031 (2031 Term Notes)
On March 23, 2021, we issued $500 million aggregate principal amount of term notes due 2023 (2023 Term Notes) and $500 million aggregate principal amount of term notes due 2031 (2031 Term Notes). We received net proceeds from the issuance of $992 million, after deducting discounts and debt issuance costs. The 2023 and 2031 Term Notes accrue interest at a rate of 0.550% and 2.550% per annum, respectively, payable semi-annually. Interest is payable on March 23 and September 23 of each year, beginning on September 23, 2021. The 2023 Term Notes mature on March 23, 2023 and the 2031 Term Notes mature on March 23, 2031.
We may redeem for cash all or any portion of the 2023 or 2031 Term Notes, at our option, at any time prior to maturity. The 2023 Term Notes and, prior to December 23, 2030, the 2031 Term Notes are redeemable at make-whole premium redemption prices as defined in the applicable forms of note. After December 23, 2030, the 2031 Term Notes are redeemable at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus any accrued and unpaid interest up to, but excluding, the redemption date.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
5.800% Term Notes due 2025 (2025 Term Notes) and 5.750% Term Notes due 2027 (2027 Term Notes)
On December 13, 2022, we issued $500 million aggregate principal amount of term notes due 2025 (2025 Term Notes) and $500 million aggregate principal amount of term notes due 2027 (2027 Term Notes). We received net proceeds from the issuance of $991 million, after deducting discounts and debt issuance costs. The 2025 and 2027 Term Notes accrue interest at a rate of 5.800% and 5.750% per annum, respectively, payable semi-annually. Interest for the 2025 Term Notes is payable on June 12 and December 12 of each year, beginning on June 12, 2023. Interest for the 2027 Term Notes is payable on June 13 and December 13 of each year, beginning on June 13, 2023. The 2025 Term Notes mature on December 12, 2025 and the 2027 Term Notes mature on December 13, 2027.
We may redeem for cash all or any portion of the 2025 or 2027 Term Notes, at our option, at any time prior to maturity. Prior to November 12, 2025 for the 2025 Term Notes, and prior to November 13, 2027 for the 2027 Term Notes, the notes are redeemable at make-whole premium redemption prices as defined in the applicable forms of note. After November 12, 2025 for the 2025 Term Notes and after November 13, 2027 for the 2027 Term Notes, the notes are redeemable at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus any accrued and unpaid interest up to, but excluding, the redemption date.
0% Convertible Senior Notes due 2023 (2023 Convertible Notes)
| | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 |
Principal amount outstanding | $ | 750 | | | $ | 750 | |
| | | |
Unamortized debt discount and issuance costs | (2) | | | (48) | |
Net carrying amount of liability component | 748 | | | 702 | |
Less: current portion | (748) | | | — | |
Convertible senior notes, non-current | $ | — | | | $ | 702 | |
| | | |
Carrying value of equity component, net of debt issuance costs | $ | — | | | $ | 126 | |
Fair value of convertible senior notes outstanding (Level 2) | $ | 726 | | | $ | 854 | |
| | | |
In August 2018, we issued $750 million aggregate principal amount of convertible senior notes due 2023 (2023 Convertible Notes). The net proceeds from the issuance, after deducting the offering expenses payable by us, were $735 million. The 2023 Convertible Notes carry no coupon interest and mature on August 15, 2023.
The 2023 Convertible Notes will be convertible into cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, based on an initial conversion rate, subject to adjustment, of 2.1845 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $457.77 per share of common stock), only in the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on September 30, 2018 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price in effect on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of 2023 Convertible Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; (3) if we call any or all of the notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events described in the indenture. Regardless of the foregoing circumstances, the holders may convert their notes on or after May 15, 2023 until August 11, 2023. The 2023 Convertible Notes were not convertible as of January 1, 2023.
It is our intent and policy to settle conversions through combination settlement; this involves repayment of an amount of cash equal to the “principal amount” and delivery of the “share amount” in excess of the conversion value over the principal amount in shares of common stock. In general, for each $1,000 in principal, the “principal amount” of cash upon settlement is defined as the lesser of $1,000 and the conversion value during the 20-day observation period. The conversion value is the sum of the daily conversion value, which is the product of the effective conversion rate divided by 20 days and the daily volume weighted average price (VWAP) of our common stock. The “share amount” is
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
the cumulative “daily share amount” during the observation period, which is calculated by dividing the daily VWAP into the difference between the daily conversion value (i.e., conversion rate x daily VWAP) and $1,000.
We may redeem for cash all or any portion of the 2023 Convertible Notes, at our option, on or after August 20, 2021 if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect (currently $595.10) for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus any accrued and unpaid special interest to, but excluding, the redemption date.
The 2023 Convertible Notes were initially accounted for in accordance with authoritative guidance for convertible debt instruments that may be settled in cash upon conversion. The guidance required the carrying amount of the liability component to be estimated by estimating the fair value of a similar liability that does not have an associated conversion feature. Because at issuance we had no outstanding non-convertible public debt, we determined that market-traded senior, unsecured corporate bonds represented a similar liability without a conversion option. Based on market data available for publicly traded, senior, unsecured corporate bonds issued by companies in our industry, and with similar maturities to the 2023 Convertible Notes, we estimated an implied interest rate of 3.7%, assuming no conversion option. Assumptions used in the estimate represented what market participants would use in pricing the liability component, including market interest rates, credit standing, and yield curves, all of which are defined as Level 2 observable inputs. The estimated implied interest rate was applied to the 2023 Convertible Notes, which resulted in a fair value of the liability component in aggregate of $624 million upon issuance, calculated as the present value of implied future payments based on the $750 million aggregate principal amount. The $126 million difference ($93 million, net of tax) between the aggregate principal amount of $750 million and the estimated fair value of the liability component was recorded in additional paid-in capital as the 2023 Convertible Notes were not considered redeemable. As a policy election under applicable guidance related to the calculation of diluted earnings (loss) per share, we had elected the combination settlement method as our stated settlement policy and applied the treasury stock method in the calculation of the potential dilutive impact of the 2023 Convertible Notes on earnings (loss) per share each period.
As of January 3, 2022, we adopted ASU 2020-06, which removed the requirement to separate the embedded conversion feature from the notes and requires the notes to be accounted for as a single liability measured at amortized cost. Accordingly, we reclassified the unamortized debt discount from additional paid-in capital to convertible senior notes in the consolidated balance sheets on January 3, 2022. This resulted in an increase to our convertible senior notes and retained earnings of $43 million and $61 million, respectively, and a decrease to our deferred tax liabilities, included in other long-term liabilities, and additional paid-in capital of $11 million and $93 million, respectively.
Interest expense recognized on the 2023 Convertible Notes, which included amortization of debt issuance costs, was $3 million in 2022. Interest expense recognized on the 2023 Convertible Notes in 2021 and 2020 was $29 million and $28 million, respectively, which included amortization of the original debt discount and debt issuance costs.
0.5% Convertible Senior Notes due 2021 (2021 Convertible Notes)
In June 2014, we issued $517 million aggregate principal amount of convertible senior notes due 2021 (2021 Convertible Notes). The 2021 Convertible Notes were convertible into cash, shares of common stock, or a combination of cash and shares of common stock, at our election, based on conversion rates as defined in the indenture. The 2021 Convertible Notes matured on June 15, 2021, by which time the principal had been converted and was repaid in cash. The excess of the conversion value over the principal amount was paid in shares of common stock. Interest expense recognized on the 2021 Convertible Notes, which included amortization of debt discount and issuance costs, was $7 million and $18 million in 2021 and 2020, respectively. Our adoption of ASU 2020-06 on January 3, 2022 did not impact the accounting for the 2021 Convertible Notes since they were converted and repaid prior to the date of adoption.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table summarizes information about the conversions during 2021: | | | | | |
In millions | 2021 Notes |
Cash paid for principal of notes converted | $ | 517 | |
Conversion value over principal amount, paid in shares of common stock | $ | 313 | |
Number of shares of common stock issued upon conversion | 0.7 | |
Loss on extinguishment of debt | $ | 1 | |
Credit Agreement
On March 8, 2021, we entered into a credit agreement (the Credit Agreement), which provides us with a $750 million senior unsecured five-year revolving credit facility, including a $40 million sublimit for swingline borrowings and a $50 million sublimit for letters of credit (the Credit Facility). The proceeds of the loans under the Credit Facility may be used to finance working capital needs and for general corporate purposes.
Any loans under the Credit Facility will have a variable interest rate based on either the eurocurrency rate or the alternate base rate, plus an applicable spread that varies with the Company’s debt rating. The Credit Agreement includes an option for us to elect to increase the commitments under the Credit Facility or to enter into one or more tranches of term loans in the aggregate principal amount of up to $250 million, subject to the consent of the lenders providing the additional commitments or term loans, as applicable, and certain other conditions.
The Credit Agreement contains financial and operating covenants. Pursuant to the Credit Agreement, we are required to maintain a ratio of total debt to annual earnings before interest, taxes, depreciation and amortization (EBITDA), calculated based on the four consecutive fiscal quarters ending with the most recent fiscal quarter, of not greater than 3.50 to 1.00 as of the end of each fiscal quarter. Upon the consummation of any Qualified Acquisition (as defined in the Credit Agreement) and us providing notice to the Administrative Agent, the ratio increases to 4.00 to 1.00 for the fiscal quarter in which the acquisition is consummated and the three consecutive fiscal quarters thereafter. The operating covenants include, among other things, limitations on (i) the incurrence of indebtedness by our subsidiaries, (ii) liens on our and our subsidiaries assets, and (iii) certain fundamental changes and the disposition of assets by us and our subsidiaries. The Credit Agreement contains other customary covenants, representations and warranties, and events of default.
The Credit Facility matures, and all amounts outstanding thereunder become due and payable in full, on March 8, 2026, subject to two one-year extensions at our option, the consent of the extending lenders and certain other conditions. We may prepay amounts borrowed and terminate commitments under the Credit Facility at any time without premium or penalty.
As of January 1, 2023, there were no borrowings outstanding under the Credit Facility, and we were in compliance with all financial and operating covenants.
On January 4, 2023, we terminated the Credit Agreement dated as of March 8, 2021 and the commitments thereunder, and we entered into a new credit agreement which provides us with a $750 million senior unsecured five-year revolving credit facility, including a $40 million sublimit for swingline borrowings and a $50 million sublimit for letters of credit (the New Credit Facility). The New Credit Facility matures, and all amounts outstanding thereunder become due and payable in full, on January 4, 2028, subject to two one-year extensions at our option, the consent of the extending lenders, and certain other conditions. The proceeds of the loans under the New Credit Facility may be used to finance working capital needs and for general corporate purposes.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Leases
As of January 1, 2023, the maturities of our operating lease liabilities were as follows:
| | | | | |
In millions | |
2023 | $ | 98 |
2024 | 117 |
2025 | 109 |
2026 | 108 |
2027 | 100 |
Thereafter | 471 |
Total remaining lease payments (1) | 1,003 |
Less: imputed interest | (183) |
Total operating lease liabilities | 820 |
Less: current portion | (76) |
Long-term operating lease liabilities | $ | 744 |
Weighted-average remaining lease term | 9.5 years |
Weighted-average discount rate | 4.1 | % |
| |
| |
| |
| |
_____________
(1)Total remaining lease payments exclude $60 million of legally binding minimum lease payments for leases signed but not yet commenced.
The components of our lease costs were as follows:
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
Operating lease costs | $ | 112 | | | $ | 99 | | | $ | 84 | |
Sublease income | (20) | | | (16) | | | (11) | |
Total lease costs | $ | 92 | | | $ | 83 | | | $ | 73 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Purchase Obligations
In the normal course of business, we enter into agreements to purchase goods or services that are not cancelable without penalty, primarily related to licensing and supply arrangements. For those agreements with variable terms, we do not estimate the total obligation beyond any minimum quantities or pricing as of the reporting date. Licensing agreements under which we commit to minimum royalty payments, some of which are subject to adjustment, may be terminated prior to the expiration of underlying intellectual property under certain circumstances. Annual minimum payments for noncancelable purchase obligations as of January 1, 2023 totaled $139 million, less than half of which are due within the next twelve months.
The 2015 Stock and Incentive Compensation Plan (the 2015 Stock Plan) and the New Hire Stock and Incentive Plan allow for the issuance of stock options, performance stock options, restricted stock units and awards, and performance stock units. As of January 1, 2023, approximately 1.7 million shares remained available for future grants under the 2015 Stock Plan. There is no set number of shares reserved for issuance under the New Hire Stock and Incentive Plan.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Restricted Stock
We issue restricted stock units (RSU) and performance stock units (PSU), both of which are considered restricted stock. We grant restricted stock pursuant to the 2015 Stock Plan and satisfy such grants through the issuance of new shares. RSU are share awards that, upon vesting, will deliver to the holder shares of our common stock. RSU generally vest over a four-year period with equal vesting annually. We issue PSU for which the number of shares issuable at the end of a three-year performance period is based on our performance relative to specified earnings per share targets and continued employment through the vesting period.
Restricted stock activity was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Restricted Stock Units (RSU) (1) | | Performance Stock Units (PSU)(2) | | Weighted-Average Grant- Date Fair Value per Share |
Units in thousands | | | | RSU | | PSU |
Outstanding at December 29, 2019 | | 1,700 | | | 271 | | | $ | 271.49 | | | $ | 258.66 | |
Awarded | | 878 | | | (78) | | | $ | 329.83 | | | $ | 344.22 | |
Vested | | (655) | | | (117) | | | $ | 239.19 | | | $ | 400.74 | |
Cancelled | | (202) | | | (76) | | | $ | 273.13 | | | $ | 266.63 | |
Outstanding at January 3, 2021 | | 1,721 | | | — | | | $ | 313.35 | | | $ | — | |
Awarded | | 259 | | | 456 | | | $ | 438.46 | | | $ | 471.63 | |
Vested | | (606) | | | (72) | | | $ | 303.08 | | | $ | 492.55 | |
Cancelled | | (244) | | | (56) | | | $ | 321.93 | | | $ | 475.38 | |
Outstanding at January 2, 2022 | | 1,130 | | | 328 | | | $ | 345.66 | | | $ | 466.42 | |
Awarded | | 1,370 | | | (108) | | | $ | 302.52 | | | $ | 479.85 | |
Vested | | (707) | | | (99) | | | $ | 341.56 | | | $ | 492.55 | |
Cancelled | | (182) | | | (47) | | | $ | 341.14 | | | $ | 411.78 | |
Outstanding at January 1, 2023 | | 1,611 | | | 74 | | | $ | 311.23 | | | $ | 446.74 | |
_____________(1)In connection with the GRAIL acquisition, replacement awards of 59,000 RSU were awarded to GRAIL employees in 2021.
(2)The number of units reflect the estimated number of shares to be issued at the end of the performance period. Awarded units are presented net of performance adjustments.
Pre-tax intrinsic value and fair value of vested restricted stock was as follows:
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
Pre-tax intrinsic value of outstanding restricted stock: | | | | | |
| | | | | |
RSU | $ | 326 | | | $ | 430 | | | $ | 637 | |
PSU | $ | 15 | | | $ | 125 | | | $ | — | |
| | | | | |
Fair value of restricted stock vested: | | | | | |
| | | | | |
RSU | $ | 162 | | | $ | 247 | | | $ | 206 | |
PSU | $ | 49 | | | $ | 35 | | | $ | 47 | |
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Stock Options
Stock option activity was as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
Units in thousands | Options | | Weighted-Average Exercise Price | | Performance Stock Options(1) | | Weighted-Average Exercise Price |
Outstanding at December 29, 2019 | 58 | | | $ | 56.65 | | | — | | | $ | — | |
Exercised | (48) | | | $ | 56.16 | | | — | | | $ | — | |
| | | | | | | |
Outstanding at January 3, 2021 | 10 | | | $ | 59.11 | | | — | | | $ | — | |
Granted | — | | | $ | — | | | 48 | | | $ | 86.73 | |
Exercised | (2) | | | $ | 20.06 | | | (21) | | | $ | 86.72 | |
Cancelled | — | | | $ | — | | | (10) | | | $ | 89.63 | |
Outstanding at January 2, 2022 | 8 | | | $ | 66.42 | | | 17 | | | $ | 85.54 | |
Granted | 180 | | | $ | 330.25 | | | — | | | $ | — | |
Exercised | (1) | | | $ | 6.55 | | | — | | | $ | — | |
| | | | | | | |
Outstanding at January 1, 2023 | 187 | | | $ | 319.72 | | | 17 | | | $ | 85.54 | |
Exercisable at January 1, 2023 | 8 | | | $ | 71.09 | | | — | | | $ | — | |
_____________
(1)In connection with the GRAIL acquisition, we issued replacement performance stock options to GRAIL employees in 2021. The number of units reflect awards that have been granted and for which it is assumed to be probable that the underlying performance goals will be achieved.
The aggregate intrinsic value of options outstanding as of January 1, 2023 was $38 million. Aggregate intrinsic value represents the product of the number of options outstanding multiplied by the difference between our closing stock price per share on the last trading day of the fiscal period, which was $202.20 as of December 30, 2022, and the exercise price. Total intrinsic value of options exercised was zero, $1 million, and $14 million in 2022, 2021, and 2020, respectively. The weighted-average remaining life of options outstanding was 5.9 years as of January 1, 2023.
The aggregate intrinsic value of performance stock options outstanding as of January 1, 2023 was $3 million. The total intrinsic value of performance stock options exercised was $6 million in 2021. Outstanding performance stock options, in general, have contractual terms of ten years from the respective grant dates.
Liability-Classified Awards
During 2022 and 2021, we granted GRAIL employees cash-based equity incentive awards. For purposes of valuation and performance measurement of the awards, GRAIL’s stand-alone valuation, as determined by GRAIL using a reasonable calculation and based on advice from independent valuation experts and analyses, is used. The awards generally have terms of four years and vest in four equal installments on each anniversary of the grant date, subject to continued employment through the vesting period. These awards are accounted for as liability-classified awards.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Cash-based equity incentive award activity was as follows:
| | | | | |
In millions | |
Outstanding at January 3, 2021 | $ | — | |
Granted | 218 | |
| |
Cancelled | (42) | |
Change in fair value | 8 | |
Outstanding at January 2, 2022 | 184 | |
Granted | 168 | |
Vested and paid in cash | (41) | |
Cancelled | (41) | |
Change in fair value | 23 | |
Outstanding at January 1, 2023 | $ | 293 | |
Estimated liability as of January 1, 2023 (included in accrued liabilities) | $ | 36 | |
We recognized share-based compensation expense of $67 million and $11 million in 2022 and 2021, respectively. As of January 1, 2023, approximately $257 million of total unrecognized compensation cost related to awards issued to date was expected to be recognized over a weighted-average period of approximately 3.1 years.
In connection with the acquisition of GRAIL, we assumed a performance-based award for which vesting is based on GRAIL’s future revenues. The award has an aggregate potential value of up to $78 million and expires, to the extent unvested, in August 2030. As of January 1, 2023, it was not probable that the performance conditions associated with the award will be achieved and, therefore, no share-based compensation expense, or corresponding liability, has been recognized in the consolidated financial statements to-date. We assess the probability of achieving the performance conditions associated with the award on a quarterly basis at each reporting period.
Employee Stock Purchase Plan
A total of 15.5 million shares of our common stock have been reserved for issuance under our 2000 Employee Stock Purchase Plan, or ESPP. The ESPP permits eligible employees to purchase common stock at a discount through payroll deductions during defined offering periods. The price at which stock is purchased under the ESPP is equal to 85% of the fair market value of the common stock on the first day of the offering period or purchase date, whichever is lower. The initial offering period commenced in July 2000.
Approximately 0.3 million shares during 2022 and approximately 0.2 million shares during each of the years 2021 and 2020 were issued under the ESPP. As of January 1, 2023 and January 2, 2022, there were approximately 12.8 million and 13.1 million shares available for issuance under the ESPP, respectively.
Share Repurchases
We did not repurchase any shares during 2022 or 2021. During 2020, we repurchased approximately 2.3 million shares for $735 million. As of January 1, 2023, authorizations to repurchase approximately $15 million of our common stock remained available under the $750 million share repurchase program authorized by our Board of Directors on February 5, 2020. The repurchases may be completed under a 10b5-1 plan or at management’s discretion.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Share-Based Compensation
Share-based compensation expense, which includes expense for both equity and liability-classified awards, reported in our consolidated statements of operations was as follows:
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
| | | | | |
Cost of product revenue | $ | 26 | | | $ | 23 | | | $ | 21 | |
Cost of service and other revenue | 6 | | | 4 | | | 4 | |
Research and development | 153 | | | 276 | | | 74 | |
Selling, general and administrative | 181 | | | 638 | | | 95 | |
Share-based compensation expense, before taxes | 366 | | | 941 | | | 194 | |
| | | | | |
Related income tax benefits | (83) | | | (64) | | | (43) | |
Share-based compensation expense, net of taxes | $ | 283 | | | $ | 877 | | | $ | 151 | |
| | | | | |
In connection with the acquisition of GRAIL, we recognized share-based compensation expense of $615 million in 2021 related to the fair value of accelerated equity awards attributable to the post-combination period, of which $167 million was recorded in research and development expense and $448 million in selling, general and administrative expense. We also recognized $10 million and $24 million of expense in 2022 and 2021, respectively, related to the replacement awards.
In February 2021, we modified the metrics and reduced the maximum potential payouts for our performance stock units granted in 2019 and 2020, which vested at the end of the three-year periods ended January 2, 2022 and January 1, 2023, respectively. The modifications affected 52 employees with units granted in 2019, which resulted in total incremental share-based compensation cost of approximately $41 million, and 72 employees with units granted in 2020, which resulted in total incremental share-based compensation cost of approximately $65 million.
Additionally, in August 2020, we modified the performance period for our performance stock units granted in 2018, which vested at the end of the three-year period ended January 3, 2021. This modification affected 49 employees and resulted in total incremental share-based compensation cost of approximately $47 million in 2020.
The assumptions used for the specified reporting periods and the resulting estimates of weighted-average fair value per share for stock purchased under the ESPP were as follows:
| | | | | | | | | | | | | | | | | |
| 2022 | | 2021 | | 2020 |
Risk-free interest rate | 0.06% - 2.98% | | 0.06% - 0.12% | | 0.11% - 2.04% |
Expected volatility | 37% - 51% | | 37% - 47% | | 30% - 45% |
Expected term | 0.5 - 1.0 year | | 0.5 - 1.0 year | | 0.5 - 1.0 year |
Expected dividends | 0% | | 0% | | 0% |
Weighted-average grant-date fair value per share | $ | 50.22 | | | $ | 134.47 | | | $ | 75.57 | |
As of January 1, 2023, approximately $486 million of total unrecognized compensation cost related to restricted stock, stock options and ESPP shares issued to date was expected to be recognized over a weighted-average period of approximately 2.4 years.
| | |
7. SUPPLEMENTAL BALANCE SHEET AND STATEMENT OF OPERATIONS DETAILS |
Accounts Receivable
| | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 |
| | | |
| | | |
Trade accounts receivable, gross | $ | 675 | | | $ | 651 | |
| | | |
| | | |
Allowance for credit losses | (4) | | | (3) | |
Total accounts receivable, net | $ | 671 | | | $ | 648 | |
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Inventory
| | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 |
Raw materials | $ | 247 | | | $ | 144 | |
Work in process | 386 | | | 333 | |
Finished goods | 28 | | | 32 | |
Inventory, gross | 661 | | | 509 | |
Inventory reserve | (93) | | | (78) | |
Total inventory, net | $ | 568 | | | $ | 431 | |
Property and Equipment
| | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 |
Leasehold improvements | $ | 759 | | | $ | 724 | |
Machinery and equipment | 644 | | | 513 | |
Computer hardware and software | 424 | | | 377 | |
Furniture and fixtures | 50 | | | 49 | |
Buildings | 44 | | | 44 | |
Construction in progress | 132 | | | 113 | |
Total property and equipment, gross | 2,053 | | | 1,820 | |
Accumulated depreciation | (962) | | | (796) | |
Total property and equipment, net | $ | 1,091 | | | $ | 1,024 | |
Property and equipment, net included non-cash expenditures of $16 million, $17 million and $22 million in 2022, 2021, and 2020, respectively, which were excluded from the consolidated statements of cash flows.
Accrued Liabilities
| | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 |
Legal contingencies(1) | $ | 473 | | | $ | — | |
Contract liabilities, current portion | 245 | | | 234 | |
Accrued compensation expenses | 188 | | | 241 | |
Accrued taxes payable | 97 | | | 98 | |
Operating lease liabilities, current portion | 76 | | | 71 | |
Liability-classified equity incentive awards | 36 | | | 11 | |
| | | |
Other, including warranties(2) | 117 | | | 106 | |
Total accrued liabilities | $ | 1,232 | | | $ | 761 | |
_____________
(2)See table below for changes in the reserve for product warranties.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Changes in the reserve for product warranties were as follows:
| | | | | |
In millions | |
Balance as of December 29, 2019 | $ | 14 | |
Additions charged to cost of product revenue | 20 | |
Repairs and replacements | (21) | |
Balance as of January 3, 2021 | 13 | |
Additions charged to cost of product revenue | 33 | |
Repairs and replacements | (24) | |
Balance as of January 2, 2022 | 22 | |
Additions charged to cost of product revenue | 23 | |
Repairs and replacements | (27) | |
Balance as of January 1, 2023 | $ | 18 | |
Other (Expense) Income, Net
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
Gain on previously held investment in GRAIL | $ | — | | | $ | 899 | | | $ | — | |
Gain on exchange of GRAIL contingent value rights | — | | | 86 | | | — | |
(Loss) gain on Helix contingent value right | (7) | | | 30 | | | 7 | |
Gain (loss) on derivative assets related to terminated acquisition | — | | | 26 | | | (25) | |
(Losses) gains on strategic investments, net | (122) | | | 18 | | | 291 | |
| | | | | |
| | | | | |
| | | | | |
Other | (13) | | | 9 | | | 11 | |
Other (expense) income, net | $ | (142) | | | $ | 1,068 | | | $ | 284 | |
We are involved in various lawsuits and claims arising in the ordinary course of business, including actions with respect to intellectual property, employment, and contractual matters. In connection with these matters, we assess, on a regular basis, the probability and range of possible loss based on the developments in these matters. A liability is recorded in the consolidated financial statements if it is believed to be probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly subjective and requires judgments about future events. We regularly review outstanding legal matters to determine the adequacy of the liabilities accrued and related disclosures in consideration of many factors, which include, but are not limited to, past history, scientific and other evidence, and the specifics and status of each matter. We may change our estimates if our assessment of the various factors changes and the amount of ultimate loss may differ from our estimates, resulting in a material effect on our business, financial condition, results of operations, and/or cash flows.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Acquisition of GRAIL
On March 30, 2021, the U.S. Federal Trade Commission (the FTC) filed an administrative complaint and a motion for a preliminary injunction in the United States District Court for the District of Columbia. In both actions, the FTC alleged that our acquisition of GRAIL would violate Section 7 of the Clayton Act, as amended, 15 U.S.C. § 18. We filed an answer to the FTC’s complaint in federal district court on April 6, 2021, and in the administrative court on April 13, 2021. On April 20, 2021, the United States District Court for the District of Columbia granted our motion to transfer venue to the United States District Court for the Southern District of California. On May 28, 2021, the district court granted the FTC’s motion to dismiss the complaint without prejudice. The administrative trial commenced on August 24, 2021. On September 1, 2022, the administrative law judge (the ALJ) ruled in favor of Illumina and found that the acquisition of GRAIL did not violate Section 7 of the Clayton Act. In the decision, the ALJ found that the FTC’s complaint counsel had failed to prove its prima facie case that Illumina’s acquisition of GRAIL would result in harm to competition in a putative market for multi-cancer early detection (MCED) tests. The FTC’s complaint counsel appealed the ALJ’s decision to the full FTC on September 2, 2022. The appeal was fully briefed as of November 10, 2022 and oral argument occurred on December 13, 2022. A decision from the full FTC is pending. We intend to continue to vigorously defend against the FTC action.
On April 19, 2021, the European Commission accepted a request for a referral of the GRAIL acquisition for European Union merger review, submitted by a Member State of the European Union (France), and joined by several other Member States (Belgium, Greece, Iceland, the Netherlands and Norway), under Article 22(1) of Council Regulation (EC) No 139/2004 (the EU Merger Regulation). On April 29, 2021, we filed an action in the General Court of the European Union (the EU General Court) asking for annulment of the European Commission’s assertion of jurisdiction to review the acquisition under Article 22 of the EU Merger Regulation, as the acquisition does not meet the jurisdictional criteria under the EU Merger Regulation or under the national merger control laws of any Member State of the European Union. On December 16, 2021, the EU General Court held a hearing regarding the European Commission’s assertion of jurisdiction. On July 13, 2022, the EU General Court reached a decision in favor of the European Commission, holding that the European Commission has jurisdiction under the EU Merger Regulation to review the acquisition. On September 22, 2022, we filed an appeal in the Court of Justice of the European Union asking for annulment of the EU General Court’s decision.
On October 29, 2021, the European Commission adopted an order imposing interim measures (the Initial Interim Measures Order). As the Initial Interim Measures Order was set to expire on November 3, 2022, the European Commission adopted a new order imposing interim measures (the New Interim Measures Order) on October 28, 2022. On December 1, 2021, we filed an action with the EU General Court asking for annulment of the Initial Interim Measures Order. The hearing of that application has been stayed pending our appeal of the judgment of the EU General Court regarding the European Commission’s assertion of jurisdiction. On January 10, 2023, we filed an action with the EU General Court asking for annulment of the New Interim Measures Order.
On September 6, 2022, the European Commission announced that it had completed its Phase II review of the acquisition of GRAIL and adopted a final decision (the Prohibition Decision), which found that, in its view, our acquisition of GRAIL was incompatible with the internal market in Europe because it results in a significant impediment to effective competition. On November 17, 2022, we filed an action with the EU General Court asking for annulment of the Prohibition Decision.
On December 5, 2022, the European Commission issued a Statement of Objections informing Illumina of the order it intends to adopt requiring us (among other things) to divest GRAIL (the EC Divestment Decision). We filed our response to the Statement of Objections on January 16, 2023. Neither the Prohibition Decision nor such public statements indicate when any such EC Divestment Decision may be adopted. We intend to appeal any EC Divestment Decision (if and when adopted by the European Commission) and, if necessary, to seek interim relief suspending the divestment of GRAIL until the final determination of these appeals.
Additionally, as a result of our decision to proceed with the completion of the acquisition of GRAIL during the pendency of the European Commission’s review, the European Commission will likely seek to impose a fine on us pursuant to Article 14(2)(b) of the EU Merger Regulation of up to 10% of our consolidated annual revenues in Q1 2023. On July 19, 2022, the European Commission issued a Statement of Objections alleging that we breached the EU Merger Regulation by completing our acquisition of GRAIL. As a result, we have accrued $458 million, included in accrued liabilities, as of January 1, 2023, which represents 10% of our consolidated annual revenues for fiscal year 2022 in accordance with ASC 450, Contingencies.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
BGI Genomics Co. Ltd. and its Affiliates
As previously disclosed, we were engaged in litigation in various U.S. jurisdictions with BGI Genomics Co. Ltd (BGI) and certain of its affiliates, including Complete Genomics, Inc. (CGI) since June of 2019. On July 14, 2022, we entered into a Settlement and License Agreement with BGI and CGI (the “Agreement”). The Agreement resolves all claims in Complete Genomics, Inc. v. Illumina, Inc., Case No. C.A. No. 19-970-MN (D. Del.). The Agreement also resolves all claims in Illumina, Inc. and Illumina Cambridge Ltd. v. BGI Genomics Co., Ltd., BGI Americas Corp., MGI Tech Co., Ltd., MGI Americas Inc., and Complete Genomics, Inc., Case No. 3:19-cv-03770-WHO (N.D. Cal.) and Illumina, Inc. and Illumina Cambridge Ltd. v. BGI Genomics Co., Ltd., BGI Americas Corp., MGI Tech Co., Ltd., MGI Americas Inc., and Complete Genomics, Inc., Case No. 3:20-cv-01465-WHO (N.D. Cal.), as well as related Appeal Nos. 2022-1733, 2022-1735 and 2022-1742, 2022-1743 pending in the United States Court of Appeals for the Federal Circuit, with the exception that the permanent injunction entered on April 11, 2022 against BGI remained in effect with a revised expiration date of January 1, 2023, with respect to BGI’s StandardMPS chemistry. The Agreement further resolves all antitrust claims against us in Complete Genomics, Inc., BGI Americas Corp. and MGI Americas, Inc. v. Illumina, Inc. and Illumina Cambridge Ltd., Case No. 21-cv-00217 (N.D. Cal.) and that complaint was dismissed with prejudice. Pursuant to the terms of the Agreement, the Company agreed to pay CGI a one-time payment of $325 million, with the parties agreeing that the judgment against BGI and the judgment against the Company in the above-referenced litigations are satisfied in total. In addition, the Company received from BGI a fully paid-up license to U.S. Patent Nos. 8,617,811, 9,222,132, 9,523,125, 10,662,473, 11,098,356 and 11,214,832, U.S. Patent Application Nos. 61/024,396, 61/024,110, 16/882,461, 17/407,935 and 17/523,706, and U.S. patents and patent applications related to each of the foregoing U.S. patents and patent applications until their expiration (“the 2-channel technology patents”). Our license allows the Company to use the 2-channel technology in all its current and future platforms with no additional royalties owed. BGI received from us a fully paid-up license to U.S. Patent Nos. 9,217,178, 9,303,290 and 9,970,055 (“the image mix patents”) and U.S. patents and applications related to each of the foregoing U.S. patents until their expiration. The parties agreed to a litigation standstill for patent and antitrust actions in the United States and its territories until October 1, 2025, as set forth in the Agreement. The standstill does not apply to the parties’ patents or patent applications related to non-invasive prenatal testing, nor to any intellectual property of Grail, LLC, related to multi-cancer early detection. None of the parties make any admission of liability in entering into the Agreement.
We allocated the $325 million payment on a relative fair value basis, resulting in $180 million capitalized as an intangible asset for the value of the license, which is amortized over a period of 6.5 years on a straight-line basis, $150 million allocated to the release of past damages claimed, and a $5 million gain for damages awarded to us. The fair value of the license was estimated using a discounted cash flow model, which included assumptions for projected revenues covered by the license, an estimated royalty rate and a discount rate. The fair value of the past damages claimed was estimated based on applicable historical revenues and an estimated royalty rate. These inputs represent a Level 3 measurement because they are supported by little or no market activity and reflect our own assumptions in measuring fair value.
RavGen
On December 3, 2020, RavGen filed a patent infringement suit against the Company claiming the Company’s use of Streck, Inc. sample collection tubes in its Verifi, Verifi Plus, and VeriSeq NIPT and liquid biopsy oncology products infringe U.S. Patent Nos. 7,332,277 and 7,727,720 (RavGen, Inc. v. Illumina, Inc., United States District Court for the District of Delaware, Case No. 1:20-cv-01644-UNA). The patents-in-suit are directed to the use of a sample-stabilizing agent that inhibits the lysis of cells. RavGen is seeking, among other things, an unspecified amount of damages, an injunction, and reasonable attorneys’ fees. The patents expire March 13, 2023.
On January 27, 2021, the Company filed its Answer and Counterclaims denying all allegations in the Complaint and seeking declaratory judgment of non-infringement and invalidity.
On July 20, 2021, the Company filed Petitions for Inter Partes Review (IPR) of the ‘277 and ‘720 patents-in-suit with the US Patent Trial and Appeal Board seeking to invalidate certain claims of the patents (PTAB) (IPR2021-01272 and IPR2021-01271). On January 26, 2022, the PTAB instituted the IPRs. On January 25, 2023, the PTAB issued Final Written Decisions in the IPRs that no challenged claim was unpatentable due to anticipation or obviousness.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
On March 1, 2022, the District Court granted the Company’s motion to stay the litigation pending resolution of the IPRs. The Company intends to vigorously defend against RavGen’s claims.
In parallel, on December 15, 2020, the Company requested Streck, Inc. to indemnify the Company in the RavGen litigation. On January 6, 2021, Streck responded, denying any obligation to indemnify the Company. Streck also requested that the Company stay its indemnification request pending resolution of the underlying patent infringement suit. The Company and Streck executed a tolling agreement effective April 2, 2021, staying the Company’s indemnification claim pending resolution of the underlying patent suit.
While we cannot estimate a possible loss, if any, that may result from RavGen’s claims against us, as of January 1, 2023, we have accrued an estimate at the low end of a possible range of loss.
(Loss) income before income taxes summarized by region was as follows:
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
United States | $ | (4,942) | | | $ | (115) | | | $ | 313 | |
Foreign | 606 | | | 999 | | | 543 | |
Total (loss) income before income taxes | $ | (4,336) | | | $ | 884 | | | $ | 856 | |
The provision for income taxes consisted of the following:
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
Current: | | | | | |
Federal | $ | (11) | | | $ | 54 | | | $ | 25 | |
State | 27 | | | 37 | | | 13 | |
Foreign | 75 | | | 107 | | | 45 | |
Total current provision | 91 | | | 198 | | | 83 | |
Deferred: | | | | | |
Federal | 40 | | | (50) | | | 30 | |
State | (47) | | | (23) | | | 94 | |
Foreign | (16) | | | (3) | | | (7) | |
Total deferred (benefit) expense | (23) | | | (76) | | | 117 | |
Total tax provision | $ | 68 | | | $ | 122 | | | $ | 200 | |
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The provision for income taxes reconciles to the amount computed by applying the federal statutory rate to (loss) income before taxes as follows:
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
Tax at federal statutory rate | $ | (911) | | | $ | 186 | | | $ | 180 | |
State, net of federal benefit | (9) | | | 13 | | | 19 | |
Research and other credits | (46) | | | (23) | | | (19) | |
Change in valuation allowance | 62 | | | 33 | | | 69 | |
| | | | | |
| | | | | |
Impact of R&D expense capitalization | 87 | | | — | | | — | |
Impact of net operating losses on GILTI and foreign tax credits | 60 | | | — | | | — | |
Impact of foreign operations | (81) | | | (80) | | | (47) | |
Impact of foreign derived intangible income (FDII) deduction | (1) | | | (12) | | | (11) | |
Cost sharing adjustment | (3) | | | — | | | 28 | |
| | | | | |
| | | | | |
Stock compensation | 20 | | | (10) | | | (18) | |
Officer compensation | 4 | | | 13 | | | 7 | |
Accrual of potential fine | 96 | | | — | | | — | |
Goodwill impairment | 822 | | | — | | | — | |
Impact of acquisition related items | (27) | | | (16) | | | — | |
Other | (5) | | | 18 | | | (8) | |
Total tax provision | $ | 68 | | | $ | 122 | | | $ | 200 | |
We have elected to account for the global intangible low-taxed income (GILTI) as a period cost in our consolidated financial statements.
The impact of foreign operations primarily represents the difference between the actual provision for income taxes for our legal entities that operate primarily in jurisdictions that have statutory tax rates lower than the U.S. federal statutory tax rate of 21%. The most significant tax benefits from foreign operations were from our earnings in Singapore and the United Kingdom, which had statutory tax rates of 17% and 19%, respectively, in 2022. The impact of foreign operations also includes the impact of GILTI and the U.S. foreign tax credit impact of non-U.S. earnings before the tax impact of net operating losses, and uncertain tax positions related to foreign items.
The impact of R&D expense capitalization is primarily the tax impact of capitalizing research and development expenses for tax purposes beginning in 2022, in accordance with the 2017 Tax Cuts and Jobs Act, on GILTI and the utilization of the U.S. foreign tax credits.
The impact of net operating losses on GILTI and foreign tax credits is primarily the tax impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization of the U.S. foreign tax credits.
The impact of acquisition related items includes the tax impact of the gain on our previously held investment in GRAIL, acquisition related compensation, continuation payments, transaction costs, and changes to the contingent value rights associated with the GRAIL acquisition.
On June 22, 2020, the Supreme Court denied petition for certiorari for Altera Corporation v. Commissioner. This effectively means the Ninth Circuit decision that stock-based compensation must be included in intercompany cost sharing is final. As a result, tax expense of $28 million was recorded in 2020. A tax benefit of $3 million was recorded in 2022 due to the reversal of tax expense recorded in prior years after closure of an audit.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Significant components of deferred tax assets and liabilities were as follows:
| | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 |
Deferred tax assets: | | | |
Net operating losses | $ | 408 | | | $ | 513 | |
Tax credits | 157 | | | 128 | |
Other accruals and reserves | 40 | | | 39 | |
Stock compensation | 20 | | | 23 | |
| | | |
| | | |
Capitalized U.S. R&D expenses | 97 | | | — | |
Other amortization | 247 | | | 225 | |
Operating lease liabilities | 156 | | | 173 | |
| | | |
Investments | 5 | | | — | |
Other | 38 | | | 36 | |
Total gross deferred tax assets | 1,168 | | | 1,137 | |
Valuation allowance on deferred tax assets | (203) | | | (134) | |
Total deferred tax assets | 965 | | | 1,003 | |
Deferred tax liabilities: | | | |
Purchased intangible amortization | (800) | | | (828) | |
Convertible debt | — | | | (11) | |
Property and equipment | (11) | | | (21) | |
Operating lease right-of-use assets | (112) | | | (129) | |
Investments | — | | | (29) | |
Other | (18) | | | (12) | |
Total deferred tax liabilities | (941) | | | (1,030) | |
Deferred tax assets (liabilities), net | $ | 24 | | | $ | (27) | |
A valuation allowance is established when it is more likely than not the future realization of all or some of the deferred tax assets will not be achieved. The evaluation of the need for a valuation allowance is performed on a jurisdiction-by-jurisdiction basis and includes a review of all available positive and negative evidence, including operating results and forecasted ranges of future taxable income. Based on the available evidence as of January 1, 2023, we were not able to conclude it is more likely than not certain deferred tax assets will be realized. Therefore, a valuation allowance of $203 million was recorded against certain U.S. and foreign deferred tax assets, of which $7 million was recorded as an adjustment to goodwill as a result of acquisitions that occurred in 2022 and 2021.
As of January 1, 2023, we had net operating loss carryforwards for federal and state tax purposes of $1,162 million and $1,488 million, respectively, which will begin to expire in 2023 and 2029, respectively, unless utilized prior. We also had federal and state tax credit carryforwards of $65 million and $198 million, which will begin to expire in 2032 and 2027, respectively, unless utilized prior.
Pursuant to Section 382 and 383 of the Internal Revenue Code, utilization of net operating losses and credits may be subject to annual limitations in the event of any significant future changes in its ownership structure. These annual limitations may result in the expiration of net operating losses and credits prior to utilization. The deferred tax assets as of January 1, 2023 are net of any previous limitations due to Section 382 and 383.
Our manufacturing operations in Singapore operate under various tax holidays and incentives, a portion of which begin to expire in 2023. These tax holidays and incentives resulted in a $56 million, $82 million, and $30 million decrease to the provision for income taxes in 2022, 2021, and 2020, respectively. These tax holidays and incentives resulted in an increase in diluted (loss) earnings per share of $0.35, $0.55, and $0.20, in 2022, 2021, and 2020, respectively.
As of January 1, 2023, we asserted that $1,210 million of foreign earnings would not be indefinitely reinvested, and accordingly, recorded a deferred tax liability of $19 million.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table summarizes the gross amount of our uncertain tax positions:
| | | | | | | | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 | | January 3, 2021 |
Balance at beginning of year | $ | 131 | | | $ | 80 | | | $ | 79 | |
Increases related to prior year tax positions | 12 | | | 19 | | | 2 | |
Decreases related to prior year tax positions | (3) | | | (1) | | | — | |
Increases related to current year tax positions | 42 | | | 39 | | | 12 | |
Decreases related to lapse of statute of limitations | (29) | | | (6) | | | (13) | |
Balance at end of year | $ | 153 | | | $ | 131 | | | $ | 80 | |
Included in the balance of uncertain tax positions as of January 1, 2023 and January 2, 2022, was $124 million and $111 million, respectively, of net unrecognized tax benefits that, if recognized, would reduce the effective income tax rate in future periods.
Any interest and penalties related to uncertain tax positions are reflected in the provision for income taxes. We recognized income of $3 million in 2022, expense of $1 million in 2021, and income of $1 million in 2020, related to potential interest and penalties on uncertain tax positions. We recorded a liability for potential interest and penalties of $3 million and $7 million as of January 1, 2023 and January 2, 2022, respectively.
Tax years 1997 to 2021 remain subject to future examination by the major tax jurisdictions in which we are subject to tax. The Internal Revenue Service completed an examination of the U.S. Corporation Income Tax Returns for tax years 2017, 2018, and 2020. Given the uncertainty of potential adjustments from examination as well as the potential expiration of the statute of limitations, it is reasonably possible that the balance of unrecognized tax benefits could change significantly over the next 12 months. Due to the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits.
| | |
10. EMPLOYEE BENEFIT PLANS |
Retirement Plan
We have a 401(k) savings plan covering substantially all of our employees in the United States. Our contributions to the plan are discretionary. During 2022, 2021, and 2020, we made matching contributions of $30 million, $26 million, and $22 million, respectively.
Deferred Compensation Plan
The Illumina, Inc. Deferred Compensation Plan (the Plan) allows senior level employees to contribute up to 60% of their base salary and 100% of their variable cash compensation, and members of the board of directors to contribute up to 100% of their director fees and equity awards. Under the Plan, we credit the participants’ contributions with earnings that reflect the performance of certain independent investment funds. On a discretionary basis, we may also make employer contributions to participant accounts in any amount determined by us. The vesting schedules of employer contributions are at the sole discretion of the Compensation Committee. However, all employer contributions shall become 100% vested upon the occurrence of the participant’s disability, death or retirement or a change in control of Illumina. The benefits under this plan are unsecured. Participants are generally eligible to receive payment of their vested benefit at the end of their elected deferral period or after termination of their employment for any reason or at a later date to comply with the restrictions of Section 409A.
We also established a rabbi trust for the benefit of the participants under the Plan and have included the assets of the rabbi trust in the consolidated balance sheets. As of January 1, 2023 and January 2, 2022, the assets of the trust were $52 million and $60 million, respectively, and our liabilities were $51 million and $56 million, respectively. The assets and liabilities are classified as other assets and accrued liabilities, respectively, on the consolidated balance sheets. Changes in the values of the assets held by the rabbi trust are recorded in other (expense) income, net in the consolidated statements of operations, and changes in the values of the deferred compensation liabilities are recorded in cost of revenue or operating expenses.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| | |
11. SEGMENTS AND GEOGRAPHIC DATA |
Reportable Segment Information
We have two reportable segments, Core Illumina and GRAIL. We do not allocate expenses between segments.
On August 18, 2021, we acquired GRAIL and it operates as a separate reportable segment. We have included the results of operations of GRAIL in our consolidated statements of operations from the date of acquisition. See note “4. Acquisitions, Goodwill and Intangible Assets” for further details. Core Illumina sells products and provides services to GRAIL, and vice versa, in accordance with contractual agreements between the entities.
Core Illumina:
Core Illumina’s products and services serve customers in the research, clinical and applied markets, and enable the adoption of a variety of genomic solutions. Core Illumina includes all of our operations, excluding the results of GRAIL.
GRAIL:
GRAIL is a healthcare company focused on early detection of multiple cancers.
| | | | | | | | | | | | | | | | | |
In millions | 2022 | | 2021 | | 2020 |
Revenue: | | | | | |
Core Illumina | $ | 4,553 | | | $ | 4,519 | | | $ | 3,239 | |
GRAIL | 55 | | | 12 | | | — | |
| | | | | |
Eliminations | (24) | | | (5) | | | — | |
Consolidated revenue | $ | 4,584 | | | $ | 4,526 | | | $ | 3,239 | |
| | | | | |
Depreciation and amortization: | | | | | |
Core Illumina | $ | 240 | | | $ | 200 | | | $ | 187 | |
GRAIL | 154 | | | 51 | | | — | |
| | | | | |
| | | | | |
Consolidated depreciation and amortization | $ | 394 | | | $ | 251 | | | $ | 187 | |
| | | | | |
Income (loss) from operations: | | | | | |
Core Illumina | $ | 481 | | | $ | 808 | | | $ | 580 | |
GRAIL | (4,657) | | | (931) | | | — | |
| | | | | |
Eliminations | (3) | | | — | | | — | |
Consolidated (loss) income from operations | $ | (4,179) | | | $ | (123) | | | $ | 580 | |
Total other (expense) income, net primarily relates to Core Illumina, and we do not allocate income taxes to our segments.
ILLUMINA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| | | | | | | | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 | | January 3, 2021 |
Total assets: | | | | | |
Core Illumina | $ | 5,755 | | | $ | 5,571 | | | $ | 7,585 | |
GRAIL | 6,505 | | | 9,649 | | | — | |
| | | | | |
Eliminations | (8) | | | (3) | | | — | |
Consolidated total assets | $ | 12,252 | | | $ | 15,217 | | | $ | 7,585 | |
| | | | | |
Capital expenditures: | | | | | |
Core Illumina | $ | 262 | | | $ | 201 | | | $ | 189 | |
GRAIL | 24 | | | 8 | | | — | |
Eliminations | — | | | (1) | | | — | |
Consolidated capital expenditures | $ | 286 | | | $ | 208 | | | $ | 189 | |
Geographic Data
Net long-lived assets, consisting of property and equipment and operating lease right-of-use assets, by region, were as follows:
| | | | | | | | | | | |
In millions | January 1, 2023 | | January 2, 2022 |
United States | $ | 1,237 | | | $ | 1,281 | |
Singapore | 290 | | | 218 | |
United Kingdom | 149 | | | 146 | |
Other countries | 68 | | | 51 | |
Total net long-lived assets | $ | 1,744 | | | $ | 1,696 | |
Refer to note “2. Revenue” for revenue by geographic area.