# ILLUMINA, INC. (ILMN) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from ILLUMINA, INC.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1110803/000111080324000010/ilmn-20231231.htm
Accession: 0001110803-24-000010
Filing date: 2024-02-16
Report date: 2023-12-31
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/
Previous year: /company/ILMN/mda/a-0001110803-23-000023/ (FY 2023)
Next year: /company/ILMN/mda/fy2024/ (FY 2024)

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 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussions of 2021 items and year-to-year comparisons between 2022 and 2021 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 2022.

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 a 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.

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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. The acquisition is subject to ongoing legal proceedings, and, currently, GRAIL must be held and operated separately and independently from Illumina pursuant to the transitional measures ordered by the European Commission in the EC Divestment Decision, following the prohibition of our acquisition of GRAIL on September 6, 2022. See note “8. Legal Proceedings” for further details. On December 17, 2023, we announced that we will divest GRAIL. The divestiture of GRAIL is expected to be executed through a third-party sale or capital markets transaction in accordance with the EC Divestment Decision, with the goal of finalizing the terms of the divestiture by the end of the second quarter of 2024. There can be no assurance regarding the ultimate timing of the divestiture of GRAIL.

We have two reportable segments, Core Illumina and GRAIL. Core Illumina relates to our core operations, excluding the results of GRAIL. See note “11. Segments and Geographic Data” for additional details.

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

During fiscal year 2023, macroeconomic factors such as inflation, exchange rate fluctuations and concerns about an economic downturn, competitive challenges in our China region, and the sanctions imposed on Russia as a result of the armed conflict between Russia and Ukraine have impacted both Illumina directly and our customers’ behavior. For example, some customers experienced supply chain pressures that delayed their lab expansions and others are managing inventory and capital more conservatively. We expect these factors to continue to impact our sales and results of operations in 2024, the size and duration of which is significantly uncertain.

Financial highlights for 2023 included the following:

•Revenue decreased 2% in 2023 to $4.5 billion compared to $4.6 billion in 2022 primarily due to decreases in sequencing consumables revenue and sequencing instruments revenue, partially offset by an increase in service and other revenue. We expect revenue for Core Illumina to remain flat in 2024.

•Gross profit as a percentage of revenue (gross margin) was 60.9% in 2023 compared to 64.8% in 2022. The decrease in gross margin was driven primarily by less fixed cost leverage on lower manufacturing volumes and lower instrument margins due to the NovaSeq X launch in 2023. 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 from operations was $(1.1) billion in 2023 compared to $(4.2) billion in 2022. The decrease was primarily due to a decrease in operating expenses of $3.3 billion, which included significant decreases in goodwill and intangible impairment of $3.1 billion and legal contingency and settlement of $599 million, partially offset by a $228 million decrease in gross profit. We continue to focus on our cost reduction initiatives to accelerate progress toward higher margins and create flexibility for further investment in high-growth areas. We expect Core Illumina operating expenses to slightly increase in 2024.

•Our effective tax rate was (3.9)% and (1.6)% in 2023 and 2022, respectively. In 2023, the variance from the U.S. federal statutory tax rate of 21% was primarily because of the income tax expense impacts of the impairment of goodwill, which is nondeductible for tax purposes, the income tax expense impact of capitalizing research and development expense for tax purposes, and the income tax expense impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization of U.S. foreign tax credits. 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.

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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, including future tax legislation that changes existing tax policies, laws, regulations, or rates.

•We ended 2023 with cash, cash equivalents, and short-term investments totaling $1.1 billion, of which approximately $386 million was held by our foreign subsidiaries.

RESULTS OF OPERATIONS

To enhance comparability, the following table sets forth audited consolidated statement of operations data for 2023, 2022, and 2021, stated as a percentage of total revenue.(1)

[[GREPCENT_TABLE]]
[["","2023","","2022","","2021"],["Revenue:"],["Product revenue","84.1","%","","86.2","%","","87.7","%"],["Service and other revenue","15.9","","","13.8","","","12.3"],["Total revenue","100.0","","","100.0","","","100.0"],["Cost of revenue:"],["Cost of product revenue","26.1","","","25.0","","","23.4"],["Cost of service and other revenue","8.7","","","6.4","","","5.3"],["Amortization of acquired intangible assets","4.3","","","3.8","","","1.6"],["Total cost of revenue","39.1","","","35.2","","","30.3"],["Gross profit","60.9","","","64.8","","","69.7"],["Operating expense:"],["Research and development","30.1","","","28.8","","","26.2"],["Selling, general and administrative","35.8","","","28.3","","","46.2"],["Goodwill and intangible impairment","18.3","","","85.4","","","\u2014"],["Legal contingency and settlement","0.4","","","13.5","","","\u2014"],["Total operating expense","84.6","","","156.0","","","72.4"],["Loss from operations","(23.7)","","","(91.2)","","","(2.7)"],["Other income (expense):"],["Interest income","1.3","","","0.2","","","\u2014"],["Interest expense","(1.7)","","","(0.6)","","","(1.3)"],["Other (expense) income, net","(0.7)","","","(3.0)","","","23.5"],["Total other (expense) income, net","(1.1)","","","(3.4)","","","22.2"],["(Loss) income before income taxes","(24.8)","","","(94.6)","","","19.5"],["Provision for income taxes","1.0","","","1.5","","","2.7"],["Net (loss) income","(25.8)","%","","(96.1)","%","","16.8","%"]]
[[/GREPCENT_TABLE]]

_____________

(1)Percentages may not recalculate due to rounding.

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Revenue

[[GREPCENT_TABLE]]
[["","2023-2022"],["Dollars in millions","2023","","2022","","Change","","% Change"],["Core Illumina:"],["Consumables","$","3,106","","","$","3,246","","","$","(140)","","","(4)","%"],["Instruments","706","","","729","","","(23)","","","(3)"],["Total product revenue","3,812","","","3,975","","","(163)","","","(4)"],["Service and other revenue","626","","","578","","","48","","","8"],["Total Core Illumina revenue","4,438","","","4,553","","","(115)","","","(3)"],["GRAIL:"],["Service and other revenue","93","","","55","","","38","","","69"],["Eliminations","(27)","","","(24)","","","(3)","","","13"],["Total consolidated revenue","$","4,504","","","$","4,584","","","$","(80)","","","(2)","%"]]
[[/GREPCENT_TABLE]]

The decrease in Core Illumina consumables revenue in 2023 was primarily due to a decrease in sequencing consumables revenue of $127 million, driven primarily by lower NovaSeq 6000 consumables pull-through as some of our high throughput customers transition to NovaSeq X, as well as the impact of macroeconomic conditions on customer purchasing power and project planning. Core Illumina instruments revenue decreased in 2023, primarily due to a decrease in sequencing instruments revenue of $23 million, which was driven by fewer shipments of our NovaSeq 6000, NextSeq and MiSeq instruments, partially offset by shipments of NovaSeq X that launched in the beginning of 2023. Core Illumina service and other revenue increased in 2023 primarily due to increased revenue from extended maintenance service contracts on a growing installed base. Additionally, Core Illumina revenue was adversely impacted by $7 million in 2023 due to foreign exchange rate fluctuations, which included $18 million reclassified to revenue in 2023 related to our cash flow hedges.

GRAIL service and other revenue increased $38 million, or 69%, in 2023 primarily due to sales of Galleri.

Gross Margin

[[GREPCENT_TABLE]]
[["","2023-2022"],["Dollars in millions","2023","","2022","","Change","","% Change"],["Gross profit (loss):"],["Core Illumina","$","2,856","","","$","3,107","","","$","(251)","","","(8)","%"],["GRAIL","(96)","","","(117)","","","21","","","(18)"],["Eliminations","(16)","","","(18)","","","2","","","(11)"],["Consolidated gross profit","$","2,744","","","$","2,972","","","$","(228)","","","(8)","%"],["Gross margin:"],["Core Illumina","64.4","%","","68.2","%"],["GRAIL","*","","*"],["Consolidated gross margin","60.9","%","","64.8","%"]]
[[/GREPCENT_TABLE]]

_____________

*Not meaningful.

The decrease in Core Illumina gross margin in 2023 was driven primarily by less fixed cost leverage on lower manufacturing volumes, lower instrument margins due to the NovaSeq X launch, which is typical with a new platform introduction until we scale manufacturing and gain operating efficiencies, and increased field services and installation costs, partially offset by lower freight costs.

GRAIL gross loss in 2023 and 2022 was primarily due to amortization of intangible assets of $134 million.

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Operating Expense

[[GREPCENT_TABLE]]
[["","2023-2022"],["Dollars in millions","2023","","2022","","Change","","% Change"],["Research and development:"],["Core Illumina","$","1,030","","","$","1,004","","","$","26","","","3","%"],["GRAIL","338","","","330","","","8","","","2"],["Eliminations","(14)","","","(13)","","","(1)","","","8"],["Consolidated research and development","1,354","","","1,321","","","33","","","2"],["Selling, general and administrative:"],["Core Illumina","1,248","","","1,003","","","245","","","24"],["GRAIL","366","","","296","","","70","","","24"],["Eliminations","(2)","","","(2)","","","\u2014","","","\u2014"],["Consolidated selling, general and administrative","1,612","","","1,297","","","315","","","24"],["Goodwill and intangible impairment:"],["Core Illumina","6","","","\u2014","","","6","","","100"],["GRAIL","821","","","3,914","","","(3,093)","","","(79)"],["Consolidated goodwill and intangible impairment","827","","","3,914","","","(3,087)","","","(79)"],["Legal contingency and settlement:"],["Core Illumina","20","","","619","","","(599)","","","(97)"],["Total consolidated operating expense","$","3,813","","","$","7,151","","","$","(3,338)","","","(47)","%"]]
[[/GREPCENT_TABLE]]

Core Illumina R&D expense increased by $26 million, or 3%, in 2023 primarily due to an increase in compensation related expenses, including performance-based compensation, as we continue to invest in the research and development of new products and enhancements to existing products, and an increase in restructuring charges of $18 million as compared to 2022, which consisted primarily of employee separation costs. The increase in 2023 was partially offset by decreases in expenses related to lab supplies, recruiting, professional services, and travel.

GRAIL R&D expense increased by $8 million, or 2%, in 2023 primarily due to an increase in headcount and employee related compensation costs, as well as an increase in lab and consumables spend, partially offset by a decrease in clinical trial costs.

Core Illumina SG&A expense increased by $245 million, or 24%, in 2023 primarily due to a lower gain recognized on our contingent consideration liability of $181 million in 2023 compared to 2022 (recognized a net gain of $24 million and $205 million in 2023 and 2022, respectively, primarily related to the GRAIL CVRs), an increase in restructuring charges of $94 million as compared to 2022, which consisted primarily of lease and other asset impairments and employee separation costs, and costs related to the proxy contest of $32 million. This increase was partially offset by decreases in professional services, facility related costs, as we exited certain of our facilities, and recruiting costs.

GRAIL SG&A expense increased by $70 million, or 24%, in 2023 primarily due to an increase in headcount and employee related compensation costs, as well as increases in professional services and marketing related spend.

Core Illumina impairment for 2023 consisted of an IPR&D intangible asset impairment. GRAIL impairment for 2023 consisted of goodwill impairment of $712 million and an IPR&D intangible asset impairment of $109 million as a result of an interim impairment test performed in Q3 2023. GRAIL impairment for 2022 consisted of goodwill impairment of $3,914 million. See note “4. Acquisitions, Goodwill, and Intangible Assets” for additional details.

Core Illumina legal contingency and settlement for 2023 consisted of an adjustment to our accrual for the fine imposed by the European Commission in July 2023 and accrued interest on the fine of $5 million, as well as a gain and a loss on two separate patent litigation settlements. Core Illumina legal contingency and settlement for 2022 primarily consisted of an accrual for the fine imposed by the European Commission and a net loss of $145 million related to the settlement of our litigation with BGI. See note “8. Legal Proceedings” for additional details.

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Other Income (Expense)

[[GREPCENT_TABLE]]
[["","2023-2022"],["Dollars in millions","2023","","2022","","Change","","% Change"],["Interest income","$","58","","","$","11","","","$","47","","","427","%"],["Interest expense","(77)","","","(26)","","","(51)","","","196"],["Other expense, net","(29)","","","(142)","","","113","","","(80)"],["Total other expense, net","$","(48)","","","$","(157)","","","$","109","","","(69)","%"]]
[[/GREPCENT_TABLE]]

Total other expense, net primarily relates to Core Illumina for both periods presented.

Interest income consisted primarily of interest on our money market funds, which benefited from higher yields in 2023 due to rising interest rates. Interest expense consisted primarily of interest on our Term Notes and increased in 2023 due to the issuance of our 2025 and 2027 Term Notes in December 2022. The decrease in other expense, net was primarily due to a decrease in net losses recognized on our strategic investments of $82 million (net loss on our strategic investments of $40 million in 2023 compared to a net loss of $122 million in 2022), a favorable impact related to our Helix contingent value right (unrealized gain of $10 million in 2023 compared to an unrealized loss of $7 million in 2022), and a favorable impact related to our deferred compensation plan assets, partially offset by a net unrealized foreign currency loss related to the fine imposed by the European Commission.

Provision for Income Taxes

[[GREPCENT_TABLE]]
[["","2023-2022"],["Dollars in millions","2023","","2022","","Change","","% Change"],["Loss before income taxes","$","(1,117)","","","$","(4,336)","","","$","3,219","","","(74)","%"],["Provision for income taxes","44","","","68","","","(24)","","","(35)"],["Net loss","$","(1,161)","","","$","(4,404)","","","$","3,243","","","(74)","%"],["Effective tax rate","(3.9)","%","","(1.6)","%"]]
[[/GREPCENT_TABLE]]

In 2023, the variance from the U.S. federal statutory tax rate of 21% was primarily because of the $149 million income tax expense impact from the impairment of goodwill, which is nondeductible for tax purposes, the $86 million income tax expense impact of capitalizing research and development expense for tax purposes, and the $61 million income tax expense impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization of the U.S. foreign tax credits. The income tax expense in 2023 was also favorably impacted by the mix of earnings in jurisdictions with lower statutory tax rates than the U.S. federal statutory tax rate, such as in Singapore.

In 2022, the variance from the U.S. federal statutory tax rate of 21% was primarily because of the $822 million income tax expense impact from the impairment of goodwill and the $96 million income tax expense impact from the European Commission fine related to the GRAIL acquisition, both of which are nondeductible for tax purposes, the $87 million income tax expense impact of capitalizing research and development expense for tax purposes beginning in 2022, in accordance with the 2017 Tax Cuts and Jobs Act, and the $60 million income tax expense impact of GRAIL pre-acquisition net operating losses on GILTI and the utilization of the U.S. foreign tax credits. The income tax expense in 2022 was also favorably impacted 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.

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LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2023, we had approximately $1,048 million in cash and cash equivalents, of which approximately $386 million was held by our foreign subsidiaries. Cash and cash equivalents decreased by $963 million from the prior year due primarily to the repayment of our 2023 Term Notes in Q1 2023 of $500 million, the repayment of our 2023 Convertible Notes in Q3 2023 of $750 million, and other 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. Historically, we have liquidated our short-term investments and/or issued debt to finance our business needs as a supplement to cash provided by operating activities. As of December 31, 2023, we had $6 million remaining in short-term investments comprised of marketable equity securities.

On July 12, 2023, as a result of our decision to proceed with the completion of our acquisition of GRAIL during the pendency of the European Commission’s review, the European Commission imposed a €432 million fine on us, representing the maximum fine of 10% of our consolidated annual revenues for fiscal year 2022. As of December 31, 2023, we accrued $484 million, including related foreign currency losses and accrued interest, included in accrued liabilities. We provided guarantees in October 2023 to satisfy the obligation in lieu of cash payment while we appeal the European Commission’s jurisdictional decision and fine decision. The fine is accruing interest at a rate of 5.5% per annum, beginning in October 2023, while it is outstanding. Refer to note “8. Legal Proceedings” for additional details.

In March 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 2023 Term Notes matured and were repaid in cash on March 23, 2023. The 2031 Term Notes, which mature on March 23, 2031, accrue interest at a rate of 2.550% per annum, payable semi-annually in March and September of each year. We may redeem for cash all or any portion of the 2031 Term Notes, at our option, at any time prior to maturity.

Our convertible senior notes, with an aggregate principal amount of $750 million, matured on August 15, 2023, at which time the principal was repaid in cash. We did not issue any shares of common stock.

In December 2022, we issued term notes due 2025 with an aggregate principal amount of $500 million and term notes due 2027 with an aggregate principal amount of $500 million. The 2025 Term Notes and the 2027 Term Notes accrue interest at a rate of 5.800% and 5.750% per annum, respectively, payable semi-annually in June and December of each year. 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 Term Notes, at our option, at any time prior to maturity.

On January 4, 2023, we obtained a new 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 January 4, 2028, subject to two one-year extensions at our option, the consent of the extending lenders, and certain other conditions. As of December 31, 2023, there were no borrowings outstanding under the Credit Facility; however, we may draw upon the facility in the future to manage cash flow or for other corporate purposes, including in connection with the payment of the €432 million European Commission fine. We provided guarantees in October 2023 to satisfy the obligation in lieu of cash payment while we appeal the European Commission’s jurisdictional decision and fine decision.

As of December 31, 2023, the fair value of our contingent consideration liability related to our acquisition of GRAIL was $387 million, of which $385 million was included in other long-term liabilities. The contingent value rights issued as part of the 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. 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. We expect Covered Revenues for Q4 2023 to be approximately $30 million and for related Covered Revenue Payments to total approximately $284,000 in Q1 2024. In 2023, we paid $803,000 in aggregate Covered Revenue Payments related to Covered Revenues for the periods Q4 2022 through Q3 2023 of $85 million in aggregate.

We grant cash incentive equity awards to GRAIL employees that generally have terms of four years and vest in equal annual installments. As of December 31, 2023, the aggregate cash value of awards outstanding and unvested was $292 million, and we accrued an estimated liability of $55 million, included in accrued liabilities. In addition, we have an outstanding performance-based award for which vesting is based on GRAIL’s future revenues. The award has an

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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 December 31, 2023, it was not probable that the performance conditions associated with the award will be achieved.

We had $4 million and up to $71 million, respectively, remaining in our capital commitments to two venture capital investment funds as of December 31, 2023, that are callable through April 2026 and July 2029, respectively.

The impact of the 2017 Tax Cuts and Jobs Act resulted in a one-time transition tax on earnings of certain foreign subsidiaries which we elected to pay in installments. As of December 31, 2023, we owed $71 million, which we expect to pay over the next two years.

Authorizations to repurchase $15 million of our common stock remained available as of December 31, 2023 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. We do not intend to make any share repurchases during fiscal year 2024.

Our other short-term and long-term material cash requirements, from known contractual obligations as of December 31, 2023, 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.

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;

•the payment of the European Commission fine related to our acquisition of GRAIL;

•the requirement to ensure that GRAIL has access to sufficient funds, at the time of a divestment, to cover at least 2.5 years of operations according to its latest long-range plan per the EC Divestment Decision;

•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.

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Cash Flow Summary

[[GREPCENT_TABLE]]
[["In millions","2023","","2022","","2021"],["Net cash provided by operating activities","$","478","","","$","392","","","$","545"],["Net cash used in investing activities","(231)","","","(591)","","","(1,069)"],["Net cash (used in) provided by financing activities","(1,210)","","","1,000","","","(51)"],["Effect of exchange rate changes on cash and cash equivalents","\u2014","","","(22)","","","(3)"],["Net (decrease) increase in cash and cash equivalents","$","(963)","","","$","779","","","$","(578)"]]
[[/GREPCENT_TABLE]]

Operating Activities

Net cash provided by operating activities in 2023 primarily consisted of net adjustments of $1,729 million, less net loss of $1,161 million, and less net changes in operating assets and liabilities of $90 million. The primary non-cash adjustments to net loss included goodwill and IPR&D impairments of $827 million, depreciation and amortization expenses of $432 million, share-based compensation of $380 million, property and equipment and right-of-use asset impairment of $100 million, net losses on strategic investments of $40 million, and an unrealized loss on foreign exchange translation of $22 million, partially offset by deferred income taxes of $33 million and a gain recorded on our contingent consideration liabilities of $24 million. Cash flow impact from changes in net operating assets and liabilities were primarily driven by increases in accounts receivable and inventory, and a decrease in accounts payable.

Net cash provided by operating activities in 2022 primarily consisted of net adjustments of $4,592 million and net changes in operating assets and liabilities of $204 million, less net loss of $4,404 million. The primary non-cash adjustments to net loss included goodwill impairment of $3,914 million, depreciation and amortization expenses of $394 million, share-based compensation of $366 million, and net losses on strategic investments of $122 million, partially offset by a gain recorded on our contingent consideration liabilities of $205 million and deferred income taxes of $23 million. Cash flow impact from changes in net operating assets and liabilities were primarily driven by an increase in accrued liabilities, partially offset by an increase in inventory and a decrease in accounts payable.

Investing Activities

Net cash used in investing activities totaled $231 million in 2023. We invested $195 million in capital expenditures, primarily associated with our investment in facilities, paid $29 million, net of cash acquired, for an acquisition, and used $6 million for net purchases of strategic investments.

Net cash used in investing activities totaled $591 million in 2022. We invested $286 million in capital expenditures, primarily associated with our investment in facilities, paid $180 million for an intangible asset related to our settlement with BGI, $85 million, net of cash acquired, for an acquisition, and $40 million for purchases of strategic investments.

Financing Activities

Net cash used in financing activities totaled $1,210 million in 2023. We repaid our 2023 Term Notes, with an aggregate principal amount of $500 million, in Q1 2023, repaid our 2023 Convertible Notes, with an aggregate principal amount of $750 million, in Q3 2023, and used $40 million to pay taxes related to net share settlement of equity awards, partially offset by $67 million received 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 provided by financing activities totaled $1,000 million in 2022. We received $991 million in net proceeds from the issuance of debt and $63 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, partially offset by $54 million used to pay taxes related to net share settlement of equity awards.

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.

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Though macroeconomic factors such as inflation, exchange rate fluctuations and concerns about an economic downturn present 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.

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. 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.

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Inventory Valuation

Inventory is stated at the 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 generally 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 estimate, an operational leverage ratio and a counterparty credit spread. An income approach utilizes inputs such as anticipated future cash flows, risk-free adjusted discount rates, and nonperformance risk, as well as management judgment regarding the probability of achieving certain future milestones. 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 operations.

We typically use the discounted cash flow method to value our acquired intangible assets. This method requires 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 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.

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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 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.

The IPR&D impairment test is performed by comparing the fair value of the asset to its carrying amount. When testing indefinite-lived intangibles for impairment, we may assess qualitative factors to determine whether it is more likely than not that the asset is impaired. Alternatively, we may bypass this qualitative assessment and perform a quantitative impairment test. We estimate the fair value of IPR&D using a discounted cash flow model, which requires the use of significant estimates and assumptions, including, but not limited to, estimating the timing of future cash flows, growth rates, and discount rates. If the IPR&D is impaired, the carrying value of the IPR&D is written down to the revised fair value with the related impairment charge recognized in the period in which the impairment occurs.

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 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. Management judgment is required to estimate the amount and timing of future cash flows and the relative risk of achieving those cash flows.

We review our operating lease right-of-use (ROU) assets for impairment whenever events or changes in circumstances indicate that the carrying value of the ROU asset may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets

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and liabilities. We consider a triggering event to reassess an ROU asset’s asset group to have occurred if we exit a portion of or the full facility or enter into a sublease. Factors that may indicate potential impairment include a significant decrease in the market price of an underlying leased asset group. If we conclude that the carrying value of affected assets will not be recovered, we estimate the fair value of the assets and record an impairment in an amount equal to the excess of the carrying value over the fair value. We estimate the present value of future cash flows from our assets in order to determine the fair value. There is uncertainty in the projected future cash flows used in our impairment review analysis, which requires the use of estimates and assumptions.

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 results of operations and result in lower asset values on our balance sheet.

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. 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, regulations, or statutory tax rates (including the implementation of global minimum tax rates in certain jurisdictions), 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.