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3 Warning Signs from Illumina, Inc.'s Q3 Preview

By Keith Speights – Oct 12, 2016 at 4:26PM

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There could be more problems in store for Illumina based on its disappointing sneak peek at Q3 revenue.

Image source: Getty Images.

Illumina, Inc. (ILMN -0.29%) doesn't release its third-quarter results until Nov. 1, but investors won't have to wait until then to know that those results won't be good. The genomic-sequencing company announced estimated third-quarter revenue on Oct. 10. That estimate was so disappointing that Illumina's stock plunged over 25%. Here are three warning signs from Illumina's third-quarter preview.

1. Something's going on with high-throughput sales

Revenue for third quarter is now projected to be around $607 million, far below the previous guidance Illumina gave for revenue of $625 million to $630 million. The company said that the main culprit behind this big miss was a 26% year-over-year decline in high-throughput sequencing instrument sales.

There are a couple of reasons to be particularly concerned about this disappointment. First, Illumina CEO Francis deSouza stated that HiSeq 2500 and 4000 orders in the Americas were below expectations. In the past, Illumina's challenges were with Europe. However, the Americas region generated over half of the company's total revenue last year. Problems in the region with the most sales are more worrisome than problems elsewhere.

Second, this isn't just a third-quarter issue. DeSouza said that Illumina now projects fourth-quarter revenue will be either flat or up only slightly. The company apparently doesn't have confidence that it will be able to close the deals that it was previously counting on. Something is going on with sales of Illumina's high-throughput systems, and it's not good.

2. There could be issues with consumable sales 

DeSouza said that sequencing consumables revenue in the third quarter generally met expectations. However, he also stated that HiSeq utilization was at the low end of the projected range.

Even a seeming bright spot came with an asterisk. HiSeq X consumables sales were at the high end of Illumina's guidance range, but that was mainly because of a single large restocking order. The same scenario occurred in the third quarter of last year.

Consumable sales accounted for a whopping two-thirds of Illumina's total revenue in 2015. Any hiccup with consumables has a significant impact on the company's overall financial results. While things look all right for now, investors will want to pay close attention to any hints of weakness when Illumina provides more information in its third-quarter conference call. 

3. Management's forecasting capability is highly suspect

If I had to identify the single most troubling aspect of Illumina's latest announcement, it would be that the company's management team doesn't seem to be able to forecast its business performance very well. This will be the third time in four quarters that Illumina missed expectations.

All of the blame can't be put on deSouza, who became CEO in July. Illumina provided a similar disappointing preview in the third quarter of 2015 when Jay Flatley was still at the helm.

Illumina's management team has a lot of work to do to rebuild credibility with investors. Perhaps the biggest thing to be concerned about is that they might not know what went wrong. Canaccord Genuity analyst Mark Massaro wrote about speaking with the company after the disappointing announcement. Massaro said that Illumina was "still searching for answers to explain the miss."

Takeover target?

Could the latest development make Illumina a more tempting takeover target? Maybe. It wasn't long ago that rumors swirled about a possible acquisition of the company by Thermo Fisher Scientific (TMO 0.79%). As is usually the case with rumors, nothing happened.

Thermo Fisher certainly is no stranger to wheeling and dealing. It became a direct competitor to Illumina by acquiring Life Technologies for $13.6 billion in 2014. The company recently completed a $4.2 billion buyout of high-performance electron microscopy provider FEI Company.And if Thermo Fisher was truly interested in Illumina back in August when the acquisition rumors first surfaced, the lower price tag for the genomic-sequencing leader should be even more appealing now.

Buying Illumina would require a lot more money than the Life Technologies and FEI deals cost, though. Even after the huge plunge in its share price, Illumina's market cap still stands at over $20 billion. Thermo Fisher would no doubt have to pay a hefty premium above that price to pull off an acquisition.

Thermo Fisher doesn't have nearly enough cash and cash equivalents on hand to fund another big acquisition. If the company wanted to buy Illumina, it would likely have to rely on borrowing more money and add to its already significant debt load. 

Illumina investors probably shouldn't get their hopes too high for a buyout anytime soon. They should probably instead hope that the company rights the ship quickly and that management figures out how to restore confidence in its projections.

Keith Speights has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Illumina. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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