# ILLUMINA, INC. (ILMN) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from ILLUMINA, INC.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1110803/000111080322000013/ilmn-20220102.htm
Accession: 0001110803-22-000013
Filing date: 2022-02-18
Report date: 2022-01-02
Extracted from a later financial-section MD&A body after the formal Item 7 span was a short reference.
Confidence: high

Company profile: /company/ILMN/
All MD&A years: /company/ILMN/mda/
Next year: /company/ILMN/mda/a-0001110803-23-000023/ (FY 2023)

MANAGEMENT’S DISCUSSION & ANALYSIS

Our Management’s Discussion and Analysis (MD&A) will help readers understand our results of operations, financial condition, and cash flow. It is provided in addition to the accompanying consolidated financial statements and notes. This MD&A is organized as follows:

•Management’s Overview and Outlook. High level discussion of our operating results and significant known trends that affect our business.

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

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

•Critical Accounting Policies and Estimates. Discussion of critical accounting policies and the significant assumptions, estimates, and judgments we make in applying such policies.

•Quantitative and Qualitative Disclosure about Market Risk. Discussion of our financial instruments’ exposure to market risk.

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

This MD&A generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended 2020.

This MD&A discussion contains forward-looking statements that involve risks and uncertainties. See “Consideration Regarding Forward-Looking Statements” preceding the Business & Market Overview section of this report for additional factors relating to such statements. See “Risk Factors” within the Business & Market Information section of this report for a discussion of certain risk factors applicable to our business, financial condition, and results of operations. Operating results are not necessarily indicative of results that may occur in future periods.

MANAGEMENT’S OVERVIEW AND OUTLOOK

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

About Illumina

Our focus on innovation has established us as the global leader in DNA sequencing and array-based technologies, serving customers in the research, clinical and applied markets.  Our products are used for applications in the life sciences, oncology, reproductive health, agriculture and other emerging segments.

Our customers include leading genomic research centers, academic institutions, government laboratories, and hospitals, as well as pharmaceutical, biotechnology, commercial molecular diagnostic laboratories, and consumer genomics companies.

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

On August 18, 2021, we acquired GRAIL, a healthcare company focused on early detection of multiple cancers. GRAIL’s Galleri blood test detects various types of cancers before they are symptomatic. We believe our acquisition of GRAIL will accelerate the adoption of next-generation sequencing based early multi-cancer detection tests,

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enhance our position in Clinical Genomics, and increase our directly accessible total addressable market. The acquisition is subject to ongoing legal proceedings and pending the European Commission’s ongoing merger review. GRAIL is currently being held and operated as a separate company, with oversight provided by an appointed, independent monitoring trustee during the European Commission’s ongoing merger review. See note “4. Acquisitions, Goodwill and Intangible Assets” and note “8. Legal Proceedings” for further details.

We have two reportable segments, Core Illumina and GRAIL, as of January 2, 2022. The results of operations of GRAIL have been included in our consolidated financial statements from the date of acquisition. Core Illumina relates to our core operations. Prior to the Helix deconsolidation on April 25, 2019, our reportable segments included Core Illumina and Helix. For information on Helix, refer to note “3. Investments and Fair Value Measurements” within the Consolidated Financial Statements section of this report. Also see note “11. Segments and Geographic Data.”

Our financial results have been, and will continue to be, impacted by several significant trends, which are described below. While these trends are important to understanding and evaluating our financial results, this discussion should be read in conjunction with our consolidated financial statements and the notes thereto within the Consolidated Financial Statements section of this report, and the other transactions, events, and trends discussed in “Risk Factors” within the Business & Market Information section of this report.

Financial Overview

Beginning in 2020, the COVID-19 pandemic and international efforts to control its spread have significantly curtailed the movement of people, goods, and services worldwide, including in the regions in which we sell our products and services and conduct our business operations. We expect the COVID-19 pandemic to continue to impact our sales and results of operations in 2022, the size and duration of which is significantly uncertain.

Consolidated financial highlights for 2021 included the following:

•Revenue increased 40% in 2021 to $4.5 billion compared to $3.2 billion in 2020 primarily due to growth in sequencing consumables and instruments, as our customers experience a broader recovery from the COVID-19 pandemic, as well as an increase in service and other revenue. We expect our revenue to continue to increase in 2022.

•Gross profit as a percentage of revenue (gross margin) was 69.7% in 2021 compared to 68.0% in 2020. The increase in gross margin was driven primarily by higher revenue, which generated increased fixed cost leverage, partially offset by less favorable product mix. Our gross margin depends on many factors, including: market conditions that may impact our pricing; sales mix changes among consumables, instruments, services, and development and licensing revenue; product mix changes between established products and new products; excess and obsolete inventories; royalties; our cost structure for manufacturing operations relative to volume; freight costs; and product support obligations.

•(Loss) income from operations as a percentage of revenue decreased to (2.7)% in 2021 compared to 17.9% in 2020. The decrease was primarily due to share-based compensation expense recorded in 2021 related to the acceleration of outstanding equity awards as part of the GRAIL acquisition, other GRAIL acquisition-related expenses and an increase in performance-based compensation. When excluding the additional share-based compensation expense recorded in 2021 related to the GRAIL acquisition, we expect our operating expenses to continue to grow on an absolute basis in 2022.

•Our effective tax rate was 13.8% and 23.3% in 2021 and 2020, respectively. In 2021, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom.

Our future effective tax rate may vary from the U.S. federal statutory tax rate due to the mix of earnings in tax jurisdictions with different statutory tax rates and the other factors discussed in the risk factor “We are subject to risks related to taxation in multiple jurisdictions” in “Risk Factors” within the Business & Market Information section of this report. We anticipate that our future effective tax rate will be lower than the U.S. federal statutory tax rate of 21% due to the portion of our earnings that will be subject to lower statutory tax rates.

•We ended 2021 with cash, cash equivalents, and short-term investments totaling $1.3 billion, of which approximately $446 million was held by our foreign subsidiaries.

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RESULTS OF OPERATIONS

To enhance comparability, the following table sets forth audited consolidated statement of operations data for 2021, 2020, and 2019, stated as a percentage of total revenue(1).

[[GREPCENT_TABLE]]
[["","2021","","2020","","2019"],["Revenue:"],["Product revenue","87.7","%","","84.4","%","","82.7","%"],["Service and other revenue","12.3","","","15.6","","","17.3"],["Total revenue","100.0","","","100.0","","","100.0"],["Cost of revenue:"],["Cost of product revenue","23.4","","","24.3","","","22.6"],["Cost of service and other revenue","5.3","","","6.8","","","6.8"],["Amortization of acquired intangible assets","1.6","","","0.9","","","1.0"],["Total cost of revenue","30.3","","","32.0","","","30.4"],["Gross profit","69.7","","","68.0","","","69.6"],["Operating expense:"],["Research and development","26.2","","","21.1","","","18.3"],["Selling, general and administrative","46.2","","","29.0","","","23.5"],["Total operating expense","72.4","","","50.1","","","41.8"],["(Loss) income from operations","(2.7)","","","17.9","","","27.8"],["Other income (expense):"],["Interest income","\u2014","","","1.3","","","2.1"],["Interest expense","(1.3)","","","(1.5)","","","(1.5)"],["Other income, net","23.5","","","8.7","","","3.2"],["Total other income, net","22.2","","","8.5","","","3.8"],["Income before income taxes","19.5","","","26.4","","","31.6"],["Provision for income taxes","2.7","","","6.1","","","3.6"],["Consolidated net income","16.8","","","20.3","","","28.0"],["Add: Net loss attributable to noncontrolling interests","\u2014","","","\u2014","","","0.3"],["Net income attributable to Illumina stockholders","16.8","%","","20.3","%","","28.3","%"]]
[[/GREPCENT_TABLE]]

_____________

(1)Percentages may not recalculate due to rounding.

Revenue

[[GREPCENT_TABLE]]
[["","2021-2020"],["Dollars in millions","2021","","2020","","Change","","% Change"],["Core Illumina:"],["Consumables","$","3,220","","","$","2,304","","","$","916","","","40","%"],["Instruments","753","","","431","","","322","","","75"],["Total product revenue","3,973","","","2,735","","","1,238","","","45"],["Service and other revenue","546","","","504","","","42","","","8"],["Total Core Illumina revenue","4,519","","","3,239","","","1,280","","","40"],["GRAIL:"],["Service and other revenue","12","","","\u2014","","","12","","","100"],["Eliminations","(5)","","","\u2014","","","(5)","","","100"],["Total consolidated revenue","$","4,526","","","$","3,239","","","$","1,287","","","40","%"]]
[[/GREPCENT_TABLE]]

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The increase in Core Illumina consumables revenue in 2021 was primarily due to an increase in sequencing consumables revenue of $875 million, driven primarily by growth in the instrument installed base, as our customers experience a broader recovery from the COVID-19 pandemic. Core Illumina instruments revenue increased in 2021, primarily due to an increase in sequencing instruments revenue of $319 million, which was driven by increased shipments of our NovaSeq and NextSeq instruments. Core Illumina service and other revenue increased in 2021, primarily due to increased revenue from extended maintenance service contracts and sequencing services, and a patent litigation settlement, partially offset by a decrease in development and licensing agreements. GRAIL service and other revenue, for the period subsequent to the acquisition, relates to cancer detection services.

Gross Margin

[[GREPCENT_TABLE]]
[["","2021-2020"],["Dollars in millions","2021","","2020","","Change","","% Change"],["Gross profit (loss):"],["Core Illumina","$","3,195","","","$","2,203","","","$","992","","","45","%"],["GRAIL","(41)","","","\u2014","","","(41)","","","100"],["Consolidated gross profit","$","3,154","","","$","2,203","","","$","951","","","43","%"],["Gross margin:"],["Core Illumina","70.7","%","","68.0","%"],["GRAIL","*","","\u2014"],["Consolidated gross margin","69.7","%","","68.0","%"]]
[[/GREPCENT_TABLE]]

_____________

*Not meaningful.

The increase in Core Illumina gross margin in 2021 was driven primarily by higher revenue, which generated increased fixed cost leverage, and increased revenue from a patent litigation settlement, partially offset by less favorable product mix. GRAIL gross loss, for the period subsequent to the acquisition, was primarily due to amortization of intangible assets of $45 million.

Operating Expense

[[GREPCENT_TABLE]]
[["","2021-2020"],["Dollars in millions","2021","","2020","","Change","","% Change"],["Research and development:"],["Core Illumina","$","885","","","$","682","","","$","203","","","30","%"],["GRAIL","300","","","\u2014","","","300","","","100"],["Consolidated research and development","$","1,185","","","$","682","","","$","503","","","74","%"],["Selling, general and administrative:"],["Core Illumina","$","1,502","","","$","941","","","$","561","","","60","%"],["GRAIL","590","","","\u2014","","","590","","","100"],["Consolidated selling, general and administrative","2,092","","","941","","","1,151","","","122"],["Total consolidated operating expense","$","3,277","","","$","1,623","","","$","1,654","","","102","%"]]
[[/GREPCENT_TABLE]]

Core Illumina R&D expense increased by $203 million, or 30%, primarily due to increases in headcount and licensing fees related to co-development agreements, as we continue to invest in the research and development of new products and enhancements to existing products, and an increase in performance-based compensation.

GRAIL R&D expense, for the period subsequent to the acquisition, consisted primarily of $167 million of share-based compensation expense related to the acceleration of outstanding equity awards as part of the acquisition, as well as other compensation costs related to the acquisition, and expenses related to headcount and clinical trials.

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Core Illumina SG&A expense increased by $561 million, or 60%, primarily due to expenses related to our acquisition of GRAIL, including $245 million in Continuation Payments paid to GRAIL prior to the close of the acquisition, and increases in headcount, performance-based compensation, and outside services, partially offset by expenses for fees and other payments to PacBio of $92 million in 2020.

GRAIL SG&A expense, for the period subsequent to the acquisition, consisted primarily of $448 million of share-based compensation expense related to the acceleration of outstanding equity awards as part of the acquisition, as well as other compensation and transaction costs related to the acquisition, and expenses related to headcount.

Total Other Income, Net

[[GREPCENT_TABLE]]
[["","2021-2020"],["Dollars in millions","2021","","2020","","Change","","% Change"],["Interest income","$","\u2014","","","$","41","","","$","(41)","","","(100)","%"],["Interest expense","(61)","","","(49)","","","(12)","","","24"],["Other income, net","1,068","","","284","","","784","","","276"],["Total other income, net","$","1,007","","","$","276","","","$","731","","","265","%"]]
[[/GREPCENT_TABLE]]

Total other income, net primarily relates to Core Illumina for all periods presented.

Interest income decreased in 2021 as a result of selling all of our available-for-sale debt securities in Q1 2021. Interest expense consists primarily of accretion of discount on our convertible senior notes. The increase in 2021 primarily relates to accrued interest on our Term Notes and amortization of debt issuance costs on our bridge facility, which we terminated in 2021. The increase in other income, net was primarily due to the gain of $899 million from our previously held investment in GRAIL as part of the acquisition, a gain of $86 million related to the exchange of certain GRAIL contingent value rights, fair value adjustments to our Helix contingent value right and to our contingent considerations liabilities, and a $26 million gain on our derivative assets related to the terminated PacBio acquisition, partially offset by a decrease in net gains recognized on strategic investments in 2021 compared to 2020.

Provision for Income Taxes

[[GREPCENT_TABLE]]
[["","2021-2020"],["Dollars in millions","2021","","2020","","Change","","% Change"],["Income before income taxes","$","884","","","$","856","","","$","28","","","3","%"],["Provision for income taxes","122","","","200","","","(78)","","","(39)"],["Consolidated net income","$","762","","","$","656","","","$","106","","","16","%"],["Effective tax rate","13.8","%","","23.3","%"]]
[[/GREPCENT_TABLE]]

In 2021, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom. In 2020, the variance from the U.S. federal statutory tax rate of 21% was primarily attributable to tax expense related to the valuation allowance recorded against the deferred tax asset for California research and development credits and the finalization of the Altera court case which determined stock-based compensation must be included in intercompany cost sharing payments. This was partially offset by the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore and the United Kingdom, tax benefits related to the derivative assets recorded as a result of the terminated PacBio acquisition, and tax benefits related to share-based compensation.

LIQUIDITY AND CAPITAL RESOURCES

At January 2, 2022, we had approximately $1.2 billion in cash and cash equivalents, of which approximately $446 million was held by our foreign subsidiaries. Cash and cash equivalents decreased by $578 million from prior year due to the factors described in the “Cash Flow Summary” below. Our primary source of liquidity, other than our holdings of cash, cash equivalents, and investments, has been cash flows from operations and, from time to time, issuances of debt. Our ability to generate cash from operations provides us with the financial flexibility we need to meet operating, investing, and financing needs.

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Historically, we have liquidated our short-term investments and/or issued debt and equity securities to finance our business needs as a supplement to cash provided by operating activities. During 2021, we sold all of our available-for-sale debt securities and a portion of our marketable equity securities primarily to fund the GRAIL acquisition. As of January 2, 2022, we had $107 million remaining in short-term investments comprised of marketable equity securities.

On August 18, 2021, we acquired GRAIL for total cash and other consideration of $9.7 billion, which included cash of $2.9 billion and $757 million in fair value of contingent consideration in the form of a contingent value right. As of January 2, 2022, the estimated fair value of the contingent consideration was $615 million. The cash consideration was funded using existing cash of both Illumina and GRAIL, including the $1 billion in capital raised in Q1 2021 through the issuance of term debt. 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. 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. Prior to the acquisition, we were required to make monthly Continuation Payments to GRAIL of $35 million 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 in 2021. Subsequent to the acquisition, we did not make any additional monthly payments.

During 2021, we granted certain GRAIL employees cash incentive awards that generally have terms of four years and vest in equal annual installments. As of January 2, 2022, the aggregate cash value of awards outstanding and unvested was $184 million. In addition, we have an outstanding 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, which is expected to be settled in cash, and expires, to the extent unvested, in August 2030. As of January 2, 2022, it was not probable that the performance conditions associated with the award will be achieved.

On March 23, 2021, we issued term notes due 2023 with an aggregate principal amount of $500 million and term notes due 2031 with an aggregate principal amount of $500 million. The net proceeds from the issuance were $992 million. The 2023 Term Notes and the 2031 Term Notes accrue interest at a rate of 0.550% and 2.550% per annum, respectively, payable semi-annually on March 23 and September 23 of each year. 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 Term Notes, at our option, at any time prior to maturity.

On March 8, 2021, we obtained a Credit Facility, 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 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 and the consent of the extending lenders and certain other conditions. As of January 2, 2022, there were no borrowings outstanding under the Credit Facility.

Our 2021 Convertible Senior Notes matured on June 15, 2021, by which time the $517 million in 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. Our convertible senior notes due in 2023, with an aggregate principal amount of $750 million, were not convertible as of January 2, 2022.

On February 5, 2020, our Board of Directors authorized a new share repurchase program, which supersedes all prior and available repurchase authorizations, to repurchase $750 million of outstanding common stock. The repurchases may be completed under a 10b5-1 plan or at management’s discretion. Authorizations to repurchase $15 million of our common stock remained available as of January 2, 2022. We do not intend to make any share repurchases during fiscal year 2022.

We had $20 million and up to $118 million, respectively, remaining in our capital commitments to two venture capital investment funds as of January 2, 2022, that are callable through April 2026 and July 2029, respectively.

The impact of the Tax Cuts and Jobs Act, enacted on December 22, 2017, resulted in a one-time transition tax on earnings of certain foreign subsidiaries of $105 million, which we elected to pay in installments, and expect to pay over the next four years.

Our other short-term and long-term material cash requirements, from known contractual obligations as of January 2, 2022, include operating lease liabilities, uncertain tax positions, and amounts due under our executive deferred compensation plan, as discussed in the Consolidated Financial Statements section of this report.

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We anticipate that our current cash, cash equivalents, and short-term investments, together with cash provided by operating activities and available borrowing capacity under the Credit Facility, are sufficient to fund our near-term capital and operating needs for at least the next 12 months. Operating needs include the planned costs to operate our business, including amounts required to fund working capital and capital expenditures. Our primary short-term needs for capital, which are subject to change, include:

•support of commercialization efforts related to our current and future products;

•acquisitions of equipment and other fixed assets for use in our current and future manufacturing and research and development facilities;

•the continued advancement of research and development efforts;

•potential strategic acquisitions and investments;

•repayment of debt obligations; and

•the expansion needs of our facilities, including costs of leasing and building out additional facilities.

We expect that our revenue and the resulting operating income, as well as the status of each of our new product development programs, will significantly impact our cash management decisions.

Our future capital requirements and the adequacy of our available funds will depend on many factors, including:

•our ability to successfully commercialize and further develop our technologies and create innovative products in our markets;

•scientific progress in our research and development programs and the magnitude of those programs;

•competing technological and market developments; and

•the need to enter into collaborations with other companies or acquire other companies or technologies to enhance or complement our product and service offerings.

Cash Flow Summary

[[GREPCENT_TABLE]]
[["In millions","2021","","2020","","2019"],["Net cash provided by operating activities","$","545","","","$","1,080","","","$","1,051"],["Net cash (used in) provided by investing activities","(1,069)","","","(554)","","","745"],["Net cash used in financing activities","(51)","","","(766)","","","(897)"],["Effect of exchange rate changes on cash and cash equivalents","(3)","","","8","","","(1)"],["Net (decrease) increase in cash and cash equivalents","$","(578)","","","$","(232)","","","$","898"]]
[[/GREPCENT_TABLE]]

Operating Activities

Net cash provided by operating activities in 2021 primarily consisted of net income of $762 million less net adjustments of $65 million and net changes in operating assets and liabilities of $152 million. The primary non-cash adjustments to net income included a gain on our previously held investment in GRAIL of $899 million, a gain on the exchange of GRAIL contingent value rights of $86 million, deferred income taxes of $76 million, a gain on our Helix contingent value right of $30 million, a gain on derivative assets related to a terminated acquisition of $26 million, and net gains on strategic investments of $18 million, partially offset by share-based compensation of $754 million, depreciation and amortization expenses of $251 million, and accretion of debt discount on our convertible senior notes of $32 million. Cash flow impact from changes in net operating assets and liabilities were primarily driven by increases in accounts receivable, prepaid expenses and other current assets, inventory, and other assets, partially offset by increases in accrued liabilities and accounts payable.

Net cash provided by operating activities in 2020 primarily consisted of net income of $656 million plus net adjustments of $351 million and net changes in operating assets and liabilities of $73 million. The primary non-cash adjustments to net income included share-based compensation of $194 million, depreciation and amortization expenses of $187 million, deferred income taxes of $117 million, a loss on derivative assets related to a terminated acquisition of $116 million, and accretion of debt discount of $40 million, partially offset by net gains on strategic

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investments of $291 million. Cash flow impact from changes in net operating assets and liabilities were primarily driven by a decrease in accounts receivable and increases in accounts payable and other long-term liabilities, partially offset by increases in other assets and prepaid expenses and other current assets.

Investing Activities

Net cash used in investing activities totaled $1,069 million in 2021. We paid $2,444 million, net of cash acquired, for acquisitions, invested $208 million in capital expenditures, primarily associated with our investment in facilities, and purchased $77 million of available-for-sale debt securities and $52 million of strategic investments. We received $1,362 million related to maturities and sales of our available-for-sale debt securities, $298 million related to sales of our strategic investments and $52 million from PacBio for repayment of Continuation Advances.

Net cash used in investing activities totaled $554 million in 2020. We purchased $1,802 million of available-for-sale securities and $1,791 million of our available-for-sale securities matured or were sold during the period. We paid $132 million for derivative assets, consisting of a $98 million Reverse Termination Fee and $34 million in Continuation Advances, associated with the terminated acquisition of PacBio. We purchased strategic investments of $124 million and completed acquisitions for total cash consideration of $98 million, net of cash acquired. We invested $189 million in capital expenditures, primarily associated with our investment in facilities and equipment.

Financing Activities

Net cash used in financing activities totaled $51 million in 2021. We made payments on our convertible senior notes due in 2021 of $517 million and used $511 million to pay taxes related to net share settlement of equity awards, of which $419 million was for taxes paid for the common stock issued related to the GRAIL acquisition. In addition, we paid $71 million related to our contingent consideration liabilities, of which $57 million related to the exchange of GRAIL contingent value rights. We received $988 million in net proceeds from the issuance of debt and $60 million in proceeds from the sale of shares under our employee stock purchase plan and the issuance of common stock through the exercise of stock options.

Net cash used in financing activities totaled $766 million in 2020. We used $736 million to repurchase our common stock, and $91 million to pay taxes related to net share settlement of equity awards. We received $61 million in proceeds from the issuance of common stock through the exercise of stock options and the sale of shares under our employee stock purchase plan.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Management bases its estimates on historical experience, market and other conditions, and various other assumptions it believes to be reasonable. Although these estimates are based on management’s best knowledge of current events and actions that may impact us in the future, the estimation process is, by its nature, uncertain given that estimates depend on events over which we may not have control. Though the impact of the COVID-19 pandemic to our business and operating results presents additional uncertainty, we continue to use the best information available to inform our critical accounting estimates. If market and other conditions change from those that we anticipate, our consolidated financial statements may be materially affected. In addition, if our assumptions change, we may need to revise our estimates, or take other corrective actions, either of which may also have a material effect on our consolidated financial statements.

We believe that the following critical accounting policies and estimates have a higher degree of inherent uncertainty and require our most significant judgments. In addition, had we used estimates different from any of these, our consolidated financial statements could have been materially different from those presented. Members of our senior management have discussed the development and selection of our critical accounting policies and estimates, and our disclosure regarding them, with the audit committee of our board of directors. Our accounting policies are more fully described in note “1. Organization and Significant Accounting Policies” in the Consolidated Financial Statements section of this report.

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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.

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. Most performance obligations are generally satisfied within a short time frame, approximately three to six months, after the contract execution date. 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 60 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.

Investments

We invest in marketable and non-marketable equity securities and have historically invested in debt securities in government-sponsored entities, corporate debt securities and U.S. Treasury securities. As of January 2, 2022, we had $107 million in short-term investments, consisting of marketable equity securities. We classify our investments as Level 1, 2, or 3 within the fair value hierarchy. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets that we have the ability to access. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points for the asset.

In 2020, approximately 27% of our security holdings were classified as Level 2, as discussed in note “3. Investments and Fair Value Measurements” in the Consolidated Financial Statements section of this report. Such securities are initially valued at the transaction price and subsequently valued utilizing a third-party service provider who assesses the fair value using inputs other than quoted prices that are observable either directly or indirectly, such as yield curve, volatility factors, credit spreads, default rates, loss severity, current market and contractual prices for the underlying instruments or debt, broker and dealer quotes, as well as other relevant economic measures. We perform certain

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procedures to corroborate the fair value of these holdings, and in the process, we apply judgment and estimates that if changed, could significantly affect our statement of financial positions.

Inventory Valuation

Inventory is stated at lower of cost or net realizable value. We regularly review inventory for excess and obsolete products and components, taking into account product life cycles, quality issues, historical experience, and usage forecasts. We record write-downs of inventory for potentially excess, obsolete, or impaired goods in order to state inventory at net realizable value. We make assumptions about future demand, market conditions, and the release of new products that may supersede old ones. However, if actual market conditions are less favorable than anticipated, additional inventory write-downs could be required.

Contingencies

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.

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. The fair values assigned, defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants, are based on estimates and assumptions determined by management. 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. We use a Monte Carlo simulation or an income approach to estimate the fair value of contingent consideration. Estimates and assumptions used in a Monte Carlo simulation include forecasted revenues, a revenue risk premium, a revenue volatility, an operational leverage ratio and a counterparty credit spread. An income approach utilizes variable inputs such as anticipated future cash flows, risk-free adjusted discount rates, and nonperformance risk. This method requires significant management judgment, including the probability of achieving certain future milestones and discount rates. Future changes in our estimates could result in expenses or gains. 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 income.

We typically use the discounted cash flow method to value our acquired intangible assets. This method requires significant management judgment to forecast future operating results and establish residual growth rates and discount factors. The estimates we use to value and amortize intangible assets are consistent with the plans and estimates that we use to manage our business and are based on available historical information and industry estimates and averages. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, we could experience impairment charges. In addition, we have estimated the economic lives of certain acquired assets and these lives are used to calculate depreciation and amortization expense. If our estimates of the economic lives change, depreciation or amortization expense could be accelerated or extended. We capitalize in-process research and development (IPR&D), which is 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

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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.

If the initial accounting for a business combination is incomplete by the end of a reporting period that falls within the measurement period, 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 income.

Goodwill and Intangible Assets with Indefinite Lives — Impairment Assessment

Goodwill and other intangible assets with indefinite useful lives (i.e., IPR&D) are not amortized, however they are tested annually for impairment, in the second quarter of our fiscal year, and whenever events or changes in circumstances indicate that it is more likely than not that the fair value is less than the carrying value. Events that would indicate impairment and trigger an interim impairment test include, but are not limited to, current economic and market conditions, including a decline in market capitalization, a significant adverse change in legal factors, business climate or operational performance of the business, and an adverse action or assessment by a regulator.

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 amounts of the reporting units exceed the fair values, we record an impairment loss based on the difference. If a quantitative assessment is performed, the evaluation includes management estimates of cash flow projections based on internal future projections and/or use of a market approach by looking at market values of comparable companies. Key assumptions include, but are not limited to, future revenue growth, operating margins, capital expenditures, terminal growth rates and discount rates. We also consider our market capitalization as a part of our analysis. We may elect to bypass the qualitative assessment in a period and proceed to perform the quantitative goodwill impairment test.

Intangible Assets and Other Long-Lived Assets — Impairment Assessment

We perform regular reviews to determine if any event has occurred that may indicate that the carrying values of our intangible assets with finite lives and other long-lived assets are impaired. If indicators of impairment exist, we assess the recoverability of the affected assets by determining whether their carrying amounts exceed their 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 exceeds the fair value. Factors that may indicate potential impairment include a significant decline in our stock price and market capitalization compared to net book value, significant changes in the ability of an asset to generate positive cash flows and the pattern of utilization of a particular asset.

In order to estimate the fair values of identifiable intangible assets with finite lives and other long-lived assets, we estimate the present value of future cash flows from those assets. The key assumptions that we use in our discounted cash flow model are the amount and timing of estimated future cash flows to be generated by the asset over an extended period of time and a rate of return that considers the relative risk of achieving the cash flows, the time value of money, and other factors that a willing market participant would consider. Significant judgment is required to estimate the amount and timing of future cash flows and the relative risk of achieving those cash flows.

Assumptions and estimates about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. For example, if our future operating results do not meet current forecasts or if we experience a sustained decline in our market capitalization that is determined to be indicative of a reduction in fair value of our reporting units, we may be required to record future impairment charges for purchased intangible assets with finite lives. Impairment charges could materially decrease our future net income and result in lower asset values on our balance sheet.

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Share-Based Compensation

We measure and recognize compensation expense for all share-based payments based on estimated fair value. Share-based compensation expense is recognized based on the fair value on a straight-line basis over the requisite service periods of the awards. The fair value of our restricted stock and performance stock units is based on the market price of our common stock on the date of grant. The determination of the amount of share-based compensation expense for our performance stock units requires the use of certain estimates and assumptions that affect the amount of share-based compensation expense recognized in our consolidated statements of income. At each reported period, we reassess the probability of the achievement of corporate performance goals to estimate the amount of shares to be released. 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. If any of the assumptions or estimates used change significantly, share-based compensation expense may differ materially from what we have recorded in the current period.

Income Taxes

Our provision for income taxes, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect our best assessment of estimated future taxes to be paid. Significant judgments and estimates based on interpretations of existing tax laws or regulations in the United States and the numerous foreign jurisdictions where we are subject to income tax are required in determining our provision for income taxes. Changes in tax laws, statutory tax rates, and estimates of our future taxable income could impact the deferred tax assets and liabilities provided for in the consolidated financial statements and would require an adjustment to the provision for income taxes.

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 our 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, our history of earnings and reliability of our forecasts, projections of pre-tax book income over the foreseeable future, and the impact of any feasible and prudent tax planning strategies.

We recognize the impact of a tax position in our 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. Tax authorities regularly examine our returns in the jurisdictions in which we do business and we regularly assess the tax risk of our return filing positions. Due to the complexity of some of the uncertainties, the ultimate resolution may result in payments that are materially different from our current estimate of the tax liability. These differences, as well as any interest and penalties, will be reflected in the provision for income taxes in the period in which they are determined.