ITEM 1. BUSINESS
Forward-Looking Statements
All statements in this Annual Report on Form 10-K that are not historical in nature, are predicative in nature or that depend upon or refer to future events or conditions are "forward-looking statements" within the meaning of Section 21 of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These include statements regarding our strategic initiatives, market expectations, integration of and synergies related to eBioscience, anticipated product and revenue growth, financial strength and regulatory environment, as well as all other "expectations," "beliefs," "hopes," "intentions," "strategies" and words of similar import and the negatives thereof. Such statements are based on our current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. We cannot assure you that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, those discussed in "Risk Factors" contained in Item 1A
ITEM 1A. RISK FACTORS
Risks Related to Our Business
Risks Related to the Growth of Our Business
If we do not continually develop and commercialize new or enhanced products and services, our business may not grow.
Our success depends in large part on our continual, timely development and commercialization of new or enhanced products and services that address evolving market requirements and are attractive to customers. The life science and clinical diagnostic research markets are characterized by rapid and significant technological changes, frequent new product introductions and enhancements, evolving industry standards and changing customer needs. Standardization of tools and systems for genetic research is still ongoing and we cannot assure you that our products will emerge as the standard for genetic research. Other companies may introduce new technologies, techniques, products or services that render our products or services obsolete or uneconomical. If we do not appropriately innovate and invest in new technologies, then our technologies will become dated and our customers could move to new technologies offered by our competitors.
As a result, we are continually looking to develop, license or acquire new or enhanced technologies, products and services to further broaden and deepen our offerings. Some of the factors affecting market acceptance of our products and services include:
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availability, quality and price as compared to competitive technologies, products and services;
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the functionality of new and existing products and services, and whether they address market requirements;
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the timing of introduction of our technologies, products and services as compared to competitive technologies, products and services;
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the existence of product defects;
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scientists' and customers' opinions of the utility of our products and services and our ability to incorporate their feedback into future products and services;
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citation of our products in published research; and
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general trends in life science and clinical diagnostics research and life science informatics software development.
Our new or enhanced technologies, products or services may not be accepted by customers in our target markets. For example, once we have developed or obtained a new technology, we may fail to successfully commercialize new products and services based on that technology, particularly to the extent that our new products and services compete with established technologies or the products and services of more established competitors. Risks relating to product adoptions include the
inability to accurately forecast demand and difficulties in managing different sales and support requirements due to the type or complexity of the new products.
Further, many of our current and potential customers have limited budgets. Accordingly, we cannot assure you that the successful introduction of new or enhanced products or services will not adversely affect sales of our current products and services or that customers which currently purchase our products or services will increase their aggregate spending as a result of the introduction of new products and services.
Emerging opportunities in molecular diagnostics may not develop as quickly as we expect and we depend, in part, on the efforts of our partners to be successful.
The clinical applications of our technologies for diagnosing and enabling informed disease management options in the treatment of disease is an emerging opportunity in molecular diagnostics. At this time, we cannot be certain that molecular diagnostic markets will develop as quickly as we expect. Although we believe that there will be clinical applications of our technologies that will be utilized for diagnosing and enabling informed disease management options in the treatment of disease, there can be no certainty of the technical or commercial success our technologies will achieve in such markets.
Our success in the molecular diagnostics market depends, in part, on our collaborative relationships and the ability of our collaborative partners to achieve regulatory approval for such products in the United States and in overseas markets and successfully market and sell products using our technologies.
Our growth depends, in part, on our ability to acquire new businesses and technologies and successfully integrate acquisitions, which may absorb significant resources and may not be successful.
As part of our strategy to develop and identify new technologies, products and services, we have acquired and may continue to acquire new businesses and technologies. Our integration of the operations of acquired businesses requires significant efforts, including the coordination of information technologies, research and development, sales and marketing, operations, manufacturing and finance. Our efforts to successfully integrate acquisitions may result in additional expenses and divert significant amounts of management's time from other projects.
Our failure to manage successfully and coordinate the growth of the combined company could also have an adverse impact on our business. In addition, there is no guarantee that businesses we acquire will become profitable or remain so. If our acquisitions do not meet our initial expectations, we may record impairment charges.
Factors that will affect the success of our acquisitions include:
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our ability to retain key employees of the acquired company;
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the performance of the acquired business, technology, product or service;
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our ability to integrate operations, financial and other systems;
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the ability of the combined company to achieve synergies among its constituent companies, such as increasing sales of the combined company's products and services, achieving expected cost savings and effectively combining technologies to develop new products and services;
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any disruption in order fulfillment or loss of sales due to integration processes, including relationships with suppliers or distributors;
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the presence or absence of adequate internal controls and/or significant fraud in the financial systems of acquired companies;
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any decrease in customer and distributor loyalty and product orders caused by dissatisfaction with the combined companies' product lines and sales and marketing practices, including price increases; and
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our assumption of known contingent liabilities that are realized, known liabilities that prove greater than anticipated, or unknown liabilities that come to light, to the extent that the realization of any of these liabilities increases our expenses or adversely affects our business or financial position.
Any difficulties and costs associated with the integration of eBioscience could negatively affect our results of operations and ability to execute our strategy.
Risks Related to our Indebtedness
Our indebtedness could materially adversely affect our business, financial condition and results of operations.
As of December 31, 2014, we had an aggregate of $128.0 million of outstanding indebtedness, of which $23.0 million is outstanding under our Senior Secured Credit Facility and $105.0 million is outstanding under our 4.00% Notes. Our indebtedness could materially adversely affect us, including by decreasing our business flexibility and increasing our borrowing costs. Refer to Note 12. "Long Term Debt Obligations" in the financial statements included in this Annual Report on Form 10-K for further information regarding our Senior Secured Credit Facility and 4.00% Notes. Increased levels of indebtedness may reduce funds available for our investment in product development as well as capital expenditures and other activities, increase our borrowing costs and create competitive disadvantages for us relative to other companies with lower debt levels.
In addition, our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness depends on our future performance, which is subject to economic, financial, competitive, regulatory, legal and other known and unknown factors beyond our control. There can be no assurance we can manage these risks successfully. If we are unable to generate cash flow sufficient to service our debt, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
In addition, despite our current consolidated debt levels, we and our subsidiaries may be able to incur substantial additional debt in the future, subject to the restrictions contained in our debt instruments, including our Senior Secured Credit Facility.
We may not be able to finance future needs or adapt our business plan to changes because of restrictions placed on us by the Senior Secured Credit Facility and future instruments governing our indebtedness.
The terms of our Senior Secured Credit Facility include various covenants that limit our ability, and that of our subsidiaries, to, among other things:
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incur additional debt, including guarantees by us or our subsidiaries;
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make investments, pay dividends on our capital stock, redeem or repurchase our capital stock, redeem or repurchase the notes or any subordinated obligations;
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create liens;
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make capital expenditures;
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dispose of assets;
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make acquisitions;
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create or permit restrictions on the ability of our subsidiaries to pay dividends or make other distributions to us;
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engage in transactions with affiliates;
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engage in sale and leaseback transactions; and
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consolidate or merge with or into other companies or sell all or substantially all of our assets.
Our ability to comply with covenants contained in the Senior Secured Credit Facility and any future agreements governing other indebtedness to which we are or may become a party may be affected by events beyond our control, including prevailing economic, financial, regulatory and industry conditions. The Senior Secured Credit Facility requires us to comply with financial performance covenants, including, without limitation, a minimum interest coverage ratio and maximum senior leverage multiple. Any additional indebtedness we incur in the future may subject us to further covenants.
Our failure to comply with these covenants could result in a default under the agreements governing the relevant indebtedness. In addition, unless cured or waived, the default could result in acceleration under our other instruments that contain cross-acceleration or cross-default provisions, including our 4.00% Notes, which could require us to repay or repurchase indebtedness, together with accrued interest, prior to the date it otherwise is due and that could adversely affect our financial condition. We may not be able to repay all amounts due in the event these amounts are declared due upon any event of default. Upon a default or cross-default the lenders under the Senior Secured Credit Facility could foreclose against the collateral.
Risks Related to Our Sales
We face significant competition, and our failure to compete effectively could adversely affect our sales and results of operations.
We compete with companies that develop, manufacture and market genetic analysis tools for the life science and clinical healthcare markets. We face significant competition as our competitors and new companies develop new, improved or more economical products, services and technologies.
The market for our products and services is highly competitive, has high barriers to entry and has several other large companies with significant market share. For example, companies such as Illumina, Agilent Technologies and Life Technologies have products for genetic analysis that are directly competitive with certain of our products. In addition, Illumina, Life Technologies and BGI-Shenzhen also offer DNA sequencing technology which we do not offer. As the costs of DNA sequencing fall, we will face increased competition in certain of our existing and potential markets. We also face competition from established diagnostic companies such as Danaher, Becton, Dickinson and Company, bioMérieux, Celera Diagnostics, Johnson & Johnson, Hologic and Roche Diagnostics, which have made strategic commitments to diagnostics, have financial and other resources to invest in new technologies, and have substantial intellectual property portfolios, substantial experience in new product development and regulatory expertise. In addition, our collaborative partners may compete with us.
Many of our current and potential competitors have significantly greater financial, technical, marketing and other resources than we do. In addition, many current and potential competitors have greater name recognition, more extensive customer bases and access to proprietary genetic content.
Our eBioscience segment competes in the life science research market with companies such as Becton, Dickinson and Company, BioLegend Inc., Abcam plc, Thermo Fisher, Danaher, as well as some smaller companies. A number of competitors employ bundled arrangements in which customers pay for consumable products (such as reagent test kits), services and the related instruments under a single arrangement, including arrangements where the customer commits to purchase a minimum volume of consumable products annually. Since we do not currently produce instruments for this market, and bundled arrangements can allow competitors to offer lower prices for competing products, customer demand for these bundled arrangements could lead to loss of market share or force us to supply products at a discount.
Reduction or delay in research and development budgets and government funding may adversely impact our sales.
We expect that our revenue in the foreseeable future will be derived from products and services provided to pharmaceutical and biotechnology companies, as well as a number of academic, governmental and other research institutions. Our operating results may fluctuate substantially due to reductions and delays in research and development expenditures by these customers.
Factors that could affect the spending levels of our customers include:
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changes in government programs, including available funding, which support research and development expenditures by companies and research institutions;
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weakness in the global economy and changing market conditions that affect our customers;
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changes in the extent to which the pharmaceutical industry may use genetic information and genetic testing as a methodology for drug discovery and development;
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changes in the regulatory environment affecting life science companies and life science research;
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impact of consolidation within the pharmaceutical industry; and
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cost reduction initiatives of customers.
Budgets in the research-use-only market have been particularly challenged in recent periods, which we believe has had an adverse effect on us. A significant or prolonged change in research funding, particularly with respect to the U.S. National Institutes of Health, including funding reductions that may result from scheduled automatic federal budget sequestration provisions, could have an adverse impact on future revenues and results of operations.
As we implement our strategy to expand into new markets, the size and structure of our current sales, marketing and technical support organizations may limit our ability to sell our products and services.
As we implement our strategy to expand into new markets, we may not be able to establish a sales, marketing and technical support organization sufficient to sell, market and support all of our new products, or to cover all of the regions that we target globally. To assist our sales and support activities, we have entered into distribution agreements through certain distributors, principally in markets outside of North America and Europe. In addition, we may enter into distribution arrangements with respect to some of our products that we believe will be better served in such arrangements than our current sales and marketing organizations. We have less control over other third parties on whom we rely for sales, marketing and technical support. In addition, these third parties may decide to develop and sell competitive products or otherwise become our competitors, which could harm our business.
Consolidation trends in both our market and many of our customers' markets have increased competition.
There has been a trend toward industry consolidation in our markets for the past several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in operating results and could harm our business.
Additionally, there has been a trend toward consolidation in many of the customer markets we sell to, in particular the pharmaceutical industry. Consolidation in our customer markets results in increased competition for important market segments and fewer available accounts, and larger consolidated customers may be able to exert increased pricing pressure on companies in our market.
If we are unable to maintain our relationships with collaborative partners and licensors, we may have difficulty developing and selling our products and services.
Our commercial success depends, in part, on our ability to develop and maintain collaborative relationships and licenses with key companies as well as with key academic researchers. In particular, we depend on third parties for in-licensed technology and components for a variety of our product lines. We collaborate with a number of instrumentation and reagent companies, including Danaher Corporation, CapitalBio, Genisphere, Hamilton Robotics, Thermo Fisher, Luminex, Siemens Medical Solutions Diagnostics, Takara Bio Inc., New England Biolabs, and Qiagen. Some of these collaborators, like Thermo Fisher, Takara Bio, New England Biolabs, and Luminex, are currently sole suppliers of components of some of our reagent kits but they are also our competitors. Relying on our collaborative relationships is risky to our future success because:
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our partners may develop technologies or components competitive with our products and services;
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our existing collaborations may preclude us from entering into additional future arrangements or impact the integration of acquired businesses and technologies;
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our partners may not obtain regulatory approvals necessary to continue the collaborations in a timely manner;
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some of our agreements may terminate prematurely due to disagreements between us and our partners or licensors;
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our partners may not devote sufficient resources to the development and sale of our products and services;
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our partners may be unable to provide the resources required for us to progress in the collaboration on a timely basis;
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our collaborations may be unsuccessful; or
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some of our agreements have expired and we may not be able to negotiate future collaborative arrangements or renew current licenses on acceptable terms.
The ability to retain and gain access to technologies necessary to develop new products will depend, in part, on our ability to convince third parties that our combined company can successfully commercialize the technologies we seek to license. The inability to maintain or to acquire any third-party licenses, or integrate the related third-party technologies into these products, could result in delays in our product developments and enhancements. There can be no assurance that we will be able to continue to successfully identify new products developed by others in the life science research and clinical healthcare markets or otherwise and, if identified, to negotiate license agreements on commercially reasonable terms, if at all.
Risks Related to the Manufacturing of Our Products
We depend on a limited number of suppliers. We will be unable to launch or commercialize our products in a timely manner if our suppliers are unable to meet our requirements or if shipments from these suppliers are delayed or interrupted.
We outsource the manufacturing of our instruments to a limited number of suppliers. Some of our instruments and other key parts of our product lines, including components of our manufacturing equipment and certain raw materials used in the manufacture of our products are currently only available from a single supplier. Therefore, we depend on our suppliers to supply our instruments, or components of our products, in required volumes, at appropriate quality and reliability levels, and in compliance with regulatory requirements on a timely basis. If supplies from these vendors do not meet our requirements, or were delayed or interrupted for any reason, we would not be able to commercialize our products successfully or in a timely fashion, and our business could be adversely impacted.
Our business is dependent on our ability to forecast our needs for components and products in our product lines and our suppliers' ability to deliver such components and products in time to meet critical manufacturing and product release schedules. Our business could be adversely affected, for example, if suppliers fail to meet product release schedules, if we experience supply constraints, if we fail to negotiate favorable pricing or if we experience any other interruption or delay in the supply chain which interferes with our ability to manufacture our products or manage our inventory levels.
We may lose customers or sales if we are unable to meet customer demand for our products on a timely and cost-effective basis, or if we are unable to ensure the proper performance and quality of our products.
We produce our products in an innovative and complicated manufacturing process which has the potential for significant variability in manufacturing yields. We have encountered, and may in the future encounter, difficulties in manufacturing our products and, due to the complexity of our products and our manufacturing process, we may experience delays in the manufacture of our products or fail to ensure their proper performance or quality. As we develop new and enhanced products, we must be able to resolve in a timely, cost-effective manner manufacturing issues that may arise from time to time.
We base our manufacturing capabilities on our product mix forecast for the quarter. If the actual product mix varies significantly from our forecast, we may not be able to fill some orders during that quarter, which could adversely impact our financial results. Difficulties in meeting customer, collaborator and internal demand could also cause us to lose customers or require us to delay new product introductions, which could in turn result in reduced demand for our products.
We rely on internal quality control procedures to verify our manufacturing processes. Due to the complexity of our products and manufacturing process, however, it is possible that products that do not meet all of our performance specifications may not be identified before they are shipped. If our products do not consistently meet our customers' performance expectations, demand for our products will decline. In addition, we do not maintain any backup manufacturing capabilities for the production of our products. Any interruption in our ability to continue operations at our existing manufacturing facilities could delay our ability to develop or sell our products, which could result in lost revenue and seriously harm our business, financial condition and results of operations.
We may need to adjust our manufacturing capacity based on business requirements or improvements made to our technological capabilities and there are risks associated with such adjustment.
If demand for our products is reduced or if we implement technologies that increase the density or yields of our wafers, our manufacturing capacity could be under-utilized and some of our long-lived assets, including facilities and
equipment, may be impaired, which would increase our expenses. In addition, factory planning decisions may shorten the useful lives of long-lived assets including facilities and equipment, and cause us to accelerate depreciation. These changes in demand for our products, and changes in our customers' product needs, could have a variety of negative effects on our competitive position and our financial results, and, in certain cases, may reduce our revenue, increase our costs, lower our gross margin percentage or require us to recognize impairments of our assets. In addition, if demand for our products is reduced or we fail to accurately forecast demand, we could be required to write down inventory since certain of our products have a limited shelf life, which would have a negative impact on our gross margin.
We have in the past, and may in the future, adjust our manufacturing capacity based on business requirements, which may include the rationalization of our facilities, including the abandonment of long-lived manufacturing assets and additional charges related to a reduction in capacity. Manufacturing and product quality issues may arise as we launch new products in our Singapore, Ohio, San Diego and Vienna facilities and rely upon manufacturing by third parties. We may lose customers if we are unable to manufacture products or if we experience delays in the manufacture of our products as a result of this transition.
We may not be able to deliver acceptable products to our customers due to the rapidly evolving nature of genetic sequence information upon which our products are based.
The genetic sequence information upon which we rely to develop and manufacture our products is contained in a variety of databases throughout the world. These databases are rapidly expanding and evolving. In addition, the accuracy of these databases and resulting genetic research is dependent on various scientific interpretations and it is not expected that global genetic research efforts will result in standardized genetic sequence databases for particular genomes in the near future.
Although we have implemented ongoing internal quality control efforts to help ensure the quality and accuracy of our products, the fundamental nature of our products requires us to rely on genetic sequence databases and scientific interpretations which are continuously evolving. As a result, these variables may cause us to develop and manufacture products that incorporate sequence errors or ambiguities. The magnitude and importance of these errors will depend upon multiple and complex factors that would be considered in determining the appropriate actions required to remedy any inaccuracies. Our inability to timely deliver acceptable products as a result of these factors would likely adversely affect our relationship with customers, and could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Our Operations
We may not achieve sustained profitability.
Prior to 2002, we incurred losses each year since our inception, and we reported losses in 2006 and from 2008 through 2013. As a result, we had an accumulated deficit of approximately $509.6 million as of December 31, 2014. Our ability to achieve sustained profitability will depend, in part, on the rate of growth of our revenue and on the level of our expenses. We reported year-over-year revenue growth in 2014, 2013 and 2012 compared to a trend of declining revenue in 2011. The 2013 and 2012 revenue growth was primarily due to the acquisition of eBioscience mid-2012 that continues to grow revenues. Revenue growth in 2014 was driven by increased product and service sales across the portfolio offset by declines in our Expression Business Unit. We have reported continued decreases in revenue for Affymetrix Core in the past. There can be no assurance that our revenue will not decrease in future periods. We reported cost savings during fiscal 2013 largely driven by corporate restructuring in early 2013. We have also reported income from operations in 2014 and will continue to explore opportunities to grow our revenue and income from operations; however, there can be no assurance that anticipated growth will materialize. We expect to continue incurring significant expenses related to research and development, sales and marketing efforts to commercialize our products, litigation and non-cash stock based compensation, and we expect to continue to experience fluctuations in our operating results. If our revenue grows more slowly than we anticipate, if our gross margins are lower than we project or if our operating expenses are above what we expect or cannot be reduced in the event of lower revenue, we may not become profitable on a sustained basis, or at all.
If we do not attract and retain key employees, our business could be impaired.
To be successful, we must attract and retain qualified scientific, engineering, manufacturing, sales, marketing and management personnel. To expand our research, product development and sales efforts we need additional people skilled in areas such as bioinformatics, organic chemistry, molecular biology, information services, regulatory affairs, manufacturing, sales, marketing and technical support. Competition for these people is intense, and our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating existing employees. For example, our stock price has been volatile in recent years, resulting in a significant number of stock options granted to our employees having a strike price that is higher than the current trading price of our common stock. We cannot be assured that these equity awards will be successful in retaining and incentivizing key employees. If we are unable to hire, train
and retain a sufficient number of qualified employees, we will not be able to expand our business or our business could be adversely affected.
We also rely on our scientific advisors and consultants to assist us in formulating our research, development and commercialization strategy. All of these individuals are engaged by other employers and have commitments to other entities that may limit their availability to us.
Our results may be impacted by changes in foreign currency exchange rates.
A significant amount of our revenue is currently generated from sales outside the United States, predominantly in Europe and Japan. Although such transactions are denominated in both U.S. dollars and foreign currencies, our future revenue, gross margin, expenses and financial condition are still affected by changes in foreign currency exchange rates. Increases in the value of the U.S. dollar could increase the price of our products so that they become relatively more expensive to customers in a particular country, possibly leading to a reduction in sales and profitability in that country. Also, if our international sales increase, we may enter into a greater number of transactions denominated in foreign currencies, which would expose us to greater foreign currency risks, including changes in currency exchange rates. In particular, given the fluctuations in Euro and Japanese Yen in the second half of 2014, we have been exposed to an increased risk environment. Gains and losses on the conversion to U.S. dollars of such revenues and of other associated monetary assets and liabilities, as well as profits and losses incurred in certain countries, may contribute to fluctuations in the value of our assets and our results of operations. We also have costs and expenses that are denominated in foreign currencies, and decreases in the value of the U.S. dollar could result in increases in such costs that could have a significant negative impact on our results of operations. In addition, fluctuating values between the U.S. dollar and other currencies can result in currency gains which are used in the computation of foreign taxes and can increase foreign taxable income. Additionally, the assets and liabilities of our non-U.S. subsidiaries are denominated in foreign currencies and translated to U.S. dollars at exchange rates in effect at the balance sheet date. Generally, such assets are adversely affected when the U.S. dollar strengthens relative to other currencies.
We enter into foreign currency forward contracts to manage a portion of the volatility related to transactions that are denominated in foreign currencies. We will experience foreign currency gains and losses in certain instances if it is not possible or cost effective to hedge our foreign currency exposure or should we suspend our foreign currency forward contracts. Our ultimate realized loss or gain with respect to currency fluctuations will generally depend on the size and type of cross-currency exposures that we enter into, the currency exchange rates associated with these exposures and changes in those rates, whether we have entered into foreign currency forward contracts to offset these exposures and other factors. If we are unable to address these risks and challenges effectively, our results of operations and financial position could suffer.
Due to the international nature of our business, political or economic changes or other factors could harm our business.
Our international operations are subject to unexpected changes in, or impositions of, legislative or regulatory requirements, including export and trade barriers and taxes; longer payment cycles and greater difficulty in accounts receivable collection.
We also are subject to general geopolitical risks in connection with international operations, such as political, social and economic instability, including austerity measures, potential hostilities, epidemics and changes in diplomatic and trade relationships. We cannot assure investors that one or more of the foregoing factors will not have a material adverse effect on our business, financial condition and operating results or require us to modify our current business practices.
As we expand our development and commercialization activities outside of the United States, we will be subject to an increased risk of inadvertently conducting activities in a manner that violates the U.S. Foreign Corrupt Practices Act and similar laws. If that occurs, we may be subject to civil or criminal penalties which could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
We are subject to the U.S. Foreign Corrupt Practices Act ("FCPA"), which prohibits corporations and individuals from paying, offering to pay, or authorizing the payment of anything of value to any foreign government official, government staff member, political party, or political candidate in an attempt to obtain or retain business or to otherwise influence a person working in an official capacity. We are also subject to the UK Anti-Bribery Act, which prohibits both domestic and international bribery, as well as bribery across both public and private sectors.
In the course of establishing and expanding our commercial operations and seeking regulatory approvals outside of the United States, we will need to establish and expand business relationships with various third parties and we will interact more frequently with foreign officials, including regulatory authorities. Expanded programs to maintain compliance with such laws will be costly and may not be effective. Any interactions with any such parties or individuals where compensation is provided
that are found to be in violation of such laws could result in substantial fines and penalties and could materially harm our business. Furthermore, any finding of a violation under one country's laws may increase the likelihood that we will be prosecuted and be found to have violated another country's laws. If our business practices outside the United States are found to be in violation of the FCPA, UK Anti-Bribery Act or other similar law, we may be subject to significant civil and criminal penalties which could have a material adverse effect on our financial condition and results of operations.
Our effective tax rate may vary significantly.
Our operations are subject to income and transaction taxes in the United States and in multiple foreign jurisdictions. Estimates and judgments are required in determining our worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result.
Changes in overall levels and the geographic mix of pretax earnings may adversely impact our effective tax rate. Certain jurisdictions have lower tax rates, and the amount of earnings in these jurisdictions may fluctuate. If we do not have profitable operations in these jurisdictions, our effective tax rate could be adversely impacted. Changes in tax laws, regulatory requirements, our treasury plans, and applicability of tax holidays and incentive programs in the countries in which we operate could have a material impact on our tax provision. Tax authorities may challenge the allocation of profits between our subsidiaries and conformance with requirements of tax holidays and incentive programs and we may not prevail in any such challenge. If we were not to prevail, we could be subject to higher tax rates or double tax.
Estimates are required in determining any valuation allowance to be recorded against our net deferred tax assets. Changes in the amount of valuation allowance required may significantly impact our financial results of operations.
Changes in other categories of earnings such as discontinued operations and other comprehensive income may affect our tax provision allocated to continuing operations.
In the normal course of business, we are subject to examination by taxing authorities in the U.S. and multiple foreign jurisdictions.
Failure in our information technology systems or unforeseen problems with the implementation and maintenance of our information systems could disrupt our operations and cause the loss of customers or business opportunities.
Information technology ("IT") systems are used extensively in virtually all aspects of our business, including sales forecast, order fulfillment and billing, making payments, shipping products, tracking customers, filling contractual obligations, customer service, logistics and management of data from running samples on our products. Our success depends, in part, on the continued and uninterrupted performance of our IT systems. IT systems may be vulnerable to damage from a variety of sources, including telecommunications or network failures, power loss, human acts and natural disasters. Moreover, despite the security measures we have implemented, our IT systems may be subject to physical or electronic break-ins, computer viruses, computer denial-of-service attacks, unauthorized access to customer or employee data or company trade secrets and similar disruptive problems. We also have taken precautionary measures to prevent unanticipated problems that could affect our IT systems. Nevertheless, we may experience damages to our systems, and system failures and interruptions.
As a part of our ongoing effort to upgrade our current information systems, we are implementing new enterprise resource planning software and other software applications to manage certain of our business operations. As we implement and add functionality, problems could arise that we have not foreseen. Such problems could adversely impact our ability to provide quotes, take customer orders or otherwise run our business in a timely manner. In addition, if our new systems fail to provide accurate and increased visibility into pricing and cost structures, it may be difficult to improve or maximize our profit margins. As a result, our results of operations and cash flows could be adversely affected. When we upgrade or change systems, we may suffer interruptions in service, loss of data, or reduced functionality. Certain of our systems are not redundant, and our disaster recovery planning is not sufficient for every eventuality.
If we experience systems problems, they may interrupt our ability to operate and adversely affect our reputation and result in a loss of customers and revenues.
Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.
In the ordinary course of our business, we collect and store sensitive data, including intellectual property, our proprietary business information, and that of our customers, and personally identifiable information of our customers and employees. The secure maintenance of this information is important to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to
employee error, malfeasance, or other disruptions. Any such breach could compromise our systems and the information stored there could be accessed, publicly disclosed, lost, or stolen. Any such access, disclosure, or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and damage to our reputation.
Risks Related to Our Investments
Our strategic equity investments may result in losses.
We periodically make strategic equity investments in various public and private companies with businesses or technologies that may complement our business. The market values of these strategic equity investments may fluctuate due to market conditions and other conditions over which we have no control. Other-than-temporary declines in the market price and valuations of the securities that we hold in other companies have required us to record losses relative to our ownership interest. This could result in future charges to our earnings. It is uncertain whether or not we will realize any long-term benefits associated with these strategic investments.
Risks Related to Government Regulation
We and our customers are subject to various government regulations, and we may incur significant expenses to comply with, and experience delays in our product commercialization as a result of, these regulations.
The FDA has jurisdiction over medical devices, including in vitro diagnostic test kits and the reagents and instrumentation used to perform these tests. In vitro diagnostic tests, reagents, and instruments may be subject to pre-market review and post-market controls by the FDA. Certain in vitro diagnostic products must also be approved by foreign regulatory agencies before the product can be sold outside the United States. Commercialization of our and our collaborative partners' in vitro diagnostic products outside of the research environment may depend upon successful completion of clinical trials. Clinical development is a long, expensive and uncertain process and we do not know whether we, or any of our collaborative partners, will be permitted to undertake the clinical trial(s) required to support a marketing application for any potential in vitro diagnostic products. It may take us or our collaborative partners many years to complete any such testing, and failure can occur at any stage. Delays or regulatory rejections of potential products may be encountered based on changes in regulatory policy during the period of product development and regulatory agency review. Moreover, if and when our projects reach clinical trials, we, or our collaborative partners, may decide to discontinue development of any or all of these projects at any time for commercial, scientific or other reasons. Any of the foregoing matters could have a material adverse effect on our business, financial condition and results of operations.
Many of our products are labeled “for research use only." Products labeled “for research use only” are not subject to premarket clearance or approval by the FDA, but are subject to limited, specific regulation with respect to their labeling. Merely including a labeling statement that a product is intended for research use only will not necessarily render the product exempt from the FDA’s clearance, approval, or other requirements. FDA may look to the totality of the circumstances surrounding the distribution of the product to determine whether the manufacturer intends for its product to be offered for clinical diagnostic use (versus for research use only). Written or verbal statements in any labeling, advertising or promotion, including performance claims, instructions for clinical interpretation, clinical information, and statements that suggest a clinical laboratory can validate a test through its own procedures and subsequently offer it for clinical use, the manufacturer’s provision of technical support for clinical applications, and solicitation of business from clinical laboratories may be considered by FDA as evidence of intended uses that conflict with research use only labeling.
Even when a product is not otherwise subject to FDA’s clearance or approval requirements, the FDA may impose restrictions as to manner in which we can market and sell our products. Such restrictions may materially and adversely affect our business, financial condition and results of operations.
The FDA, CMS, state authorities and foreign government regulators are increasingly focused on genetic analysis tools, including the use of arrays that are labeled for research use only, by clinical laboratories in LDTs. Historically, the FDA has exercised enforcement discretion with respect to most LDTs and has not required laboratories that furnish LDTs to comply with the agency’s requirements for medical devices. In recent years, however, the FDA has stated it intends to end its policy of general enforcement discretion and regulate certain LDTs as medical devices. To this end, on October 3, 2014, the FDA issued two draft guidance documents, entitled “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs)” and “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs)”, respectively, that set forth a proposed risk-based regulatory framework that would apply varying levels of FDA oversight to LDTs. The FDA has indicated that it does not intend to modify its policy of enforcement discretion until the draft guidance documents are finalized, and even then, the new regulatory requirements are proposed to be phased-in consistent with the schedule set forth in the guidance (in as
little as 12 months after the draft guidance is finalized for certain high-priority LDTs). Nevertheless, the FDA may decide to regulate certain LDTs on a case-by-case basis at any time.
Legislative proposals addressing the FDA’s oversight of LDTs have been introduced in previous Congresses, and we expect that new legislative proposals will be introduced from time-to-time. The likelihood that Congress will pass such legislation and the extent to which such legislation may affect the FDA’s plans to regulate certain LDTs as medical devices is difficult to predict at this time.
We cannot predict the extent of future regulatory requirements with respect to the sale and use of arrays. If regulations or enforcement policies restrict our customers' use of our products, or if we otherwise are required to obtain FDA premarket clearance or approval prior to commercializing our products, our ability to generate revenue from the sale of our products may be delayed or otherwise adversely affected.
Our failure to comply with governmental rules and regulations related to our products could cause us to incur significant adverse publicity, or subject us to investigations, notices of non-compliance, fines, injunctions, civil monetary penalties, recall or seizure of products, operating restrictions, partial suspension or total shutdown of production, delays in or challenges to premarket clearance or approval, restrictions on labeling and promotion of our products, or criminal prosecution.
Medical device laws and regulations are also in effect in many countries, ranging from comprehensive device approval requirements to requests for product data or certifications. The number and scope of these requirements are increasing. We may not be able to obtain regulatory approvals in such countries or may incur significant costs in obtaining or maintaining our foreign regulatory approvals. In addition, the export by us of certain of our products which have not yet been cleared for domestic commercial distribution may be subject to FDA or other export restrictions.
We have agreements to sell certain products to government entities and, as a result, we are subject to various statutes and regulations that apply to companies doing business with the government. Our failure to comply with these requirements might result in suspension of these contracts or administrative or other penalties, and could have a material adverse effect on our ability to compete for future government grants, contracts and programs.
Healthcare reform and restrictions on coverage and reimbursement may limit our returns on molecular diagnostic products that we may develop independently or with our collaborators.
We are currently collaborating with our partners to develop diagnostic and therapeutic products. Our (or our collaborators’) ability to commercialize such products may depend, in part, on the extent to which coverage and reimbursement for these products will be available under U.S. and foreign rules and regulations that govern coverage and reimbursement for clinical testing services by government authorities, private health insurers and other organizations.
Under the Affordable Care Act, expansion in healthcare coverage may expand the market for clinical diagnostic testing while at the same time, various policies aimed at reducing costs or bundling care may reduce the rates paid for such services; the net impact of these factors on the market for our products is not clear. In April 2014, Congress passed the Protecting Access to Medicare Act of 2014, which included substantial changes to the way in which clinical laboratory services will be paid under Medicare. Beginning in 2017, Medicare payments for clinical laboratory services will be paid based upon private payor rates as reported by clinical laboratories across the United States in contrast to the current system, which is based upon fee schedules derived from historical charges for tests from approximately 30 years ago. We cannot predict the impact of the new payment system on rates for tests that may use our products. It is possible that the new system could reduce payment rates for health care products and services, adversely affect the profits of our customers and collaborative partners and thus reduce our royalties and product sales.
Under Medicare rules, diagnostic tests must be ordered by a physician who is treating the beneficiary and who uses the test results in patient management. As such, Medicare may deny coverage for a test, even if the test has been cleared or approved by the FDA, unless the Medicare Administrative Contractor determines that the test is useful in patient management. As such, our (and our collaborators’) ability to successfully commercialize a test may depend on the extent to which clinical data are developed that support the utility of the test in patient management. If we (or our collaborators) are unable to develop clinical data supporting the use of a test in patient management, payors may be unlikely to provide coverage or payment for such test.
We face risks related to handling of hazardous materials and other regulations governing environmental safety.
Our operations are subject to complex and stringent environmental, health, safety and other governmental laws and regulations that both public officials and private individuals may seek to enforce. Our activities that are subject to these
regulations include, among other things, our use of hazardous and radioactive materials and the generation, transportation and storage of waste. We could discover that we or an acquired business is not in material compliance. Existing laws and regulations may also be revised or reinterpreted, or new laws and regulations may become applicable to us, whether retroactively or prospectively, that may have a negative effect on our business and results of operations. It is also impossible to eliminate completely the risk of accidental environmental contamination or injury to individuals. In such an event, we could be liable for any damages that result, which could adversely affect our business.
We may be exposed to liability due to product defects.
The risk of product liability claims is inherent in the testing, manufacturing, marketing and sale of human diagnostic and therapeutic products and we may be subjected to such claims. We have voluntarily recalled products in the past. We may seek to acquire additional insurance for clinical or product liability risks. We may not be able to obtain such insurance or general product liability insurance on acceptable terms or in sufficient amounts. A product liability claim or recall could have a serious adverse effect on our business, financial condition and results of operations.
Ethical, legal and social concerns surrounding the use of genetic information could reduce demand for our products.
Genetic testing has raised ethical issues regarding privacy and the appropriate uses of the resulting information. For these reasons, governmental authorities may call for limits on or regulation of the use of genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Similarly, such concerns may lead individuals to refuse to use genetics tests even if permissible. Any of these scenarios could reduce the potential markets for our molecular diagnostic products, which could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Our Intellectual Property and Litigation Matters
We may be unable to effectively protect or enforce our intellectual property, which could harm our competitive position.
Maintaining a strong patent position is critical to our business. Patent law relating to the scope of claims in the technology fields in which we operate is uncertain, so we cannot be assured the patent rights we have or may obtain will be valuable. Others have filed, and in the future are likely to file, patent applications that are similar or identical to ours or those of our licensors. To determine the priority of inventions, we may have to participate in interference proceedings declared by the United States Patent and Trademark Office that could result in substantial costs in legal fees and could substantially affect the scope of our patent protection. We cannot be assured our patent applications will have priority over those filed by others. Also, our intellectual property may be subject to significant administrative and litigation proceedings. In addition, we may acquire businesses, which may not have developed or maintained a similarly robust patent position. For example, eBioscience currently does not have a patent portfolio, so we must rely on non-patent rights, including third-party licenses that relate to such business operations.
Legal actions to enforce our patent rights can be expensive and may involve the diversion of significant management time. In addition, these legal actions could be unsuccessful and could also result in the invalidation of our patents or a finding that they are unenforceable. We may or may not choose to pursue litigation or interferences against those that have infringed on our patents, or used them without authorization, due to the associated expense and time commitment of monitoring these activities. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could harm our results of operations.
In addition to patent protection, we also rely upon copyright and trade secret protection, as well as non-disclosure agreements with our employees, consultants and third-parties, to protect our confidential and proprietary information. Such measures may not provide adequate protection for our proprietary information.
Litigation or other proceedings or third-party claims of intellectual property infringement could require us to spend significant time and money and could prevent us from selling our products or services or impact our stock price.
We are currently subject to claims from third parties asserting intellectual property infringement and breach of contract. See Note 14. "Legal Proceedings" of the financial statements included elsewhere in this Annual Report on 10-K for further information. Third parties may in the future assert additional claims against us, including claims we are employing their proprietary technology without authorization. As we launch new products and enter new markets, we expect that competitors will claim that our products infringe their intellectual property rights as part of business strategies designed to impede our successful commercialization and entry into new markets. In addition, we are aware of third-party patents that may relate to our technology. We routinely receive notices claiming infringement from third parties as well as invitations to take licenses under
third-party patents. Third parties may have obtained, and may in the future obtain, patents allowing them to claim that the use of our technologies infringes these patents.
We could incur substantial costs and divert the attention of our management and technical personnel in defending ourselves against any of these claims. Any adverse ruling or perception of an adverse ruling in defending ourselves against these claims could have a material adverse impact on our cash position and stock price. Furthermore, parties making claims against us may be able to obtain injunctive or other relief, which could block our ability to develop, commercialize and sell products, and could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to pay damages and obtain one or more licenses from third parties, or be prohibited from selling certain products, all of which could have a material adverse impact on our cash position, business and financial condition.
In addition, we may be unable to obtain these licenses at a reasonable cost, if at all. We could therefore incur substantial costs related to royalty payments for licenses obtained from third parties, which could negatively affect our gross margins. Moreover, we could encounter delays in product introductions while we attempt to develop alternative methods or products. Defense of any lawsuit or failure to obtain any of these licenses on favorable terms could prevent us from commercializing products, and the prohibition of sale of any of our products could materially affect our ability to grow and maintain profitability.
Risks Related to Our Common Stock
The price of our common stock historically has been volatile. This volatility may affect the price at which you could sell your common stock, and the sale of substantial amounts of our common stock could adversely affect the price of our common stock.
The market price for our common stock has varied between a high of $10.15 on December 29, 2014, and a low of $6.37 on April 11, 2014 in the twelve-month period ending on December 31, 2014. Our stock price is likely to continue to be volatile and subject to significant price and volume fluctuations in response to market and other factors, including those listed in this "Risk Factors" section and other, unknown factors. Our stock price also may be affected by comments by securities analysts regarding our business or prospects, our issuance of common stock or other equity securities, our inability to meet analysts' expectations, general fluctuations in the stock market or in the stock prices of our industry peers or our customers and general conditions and publicity regarding the genomics, biotechnology, pharmaceutical or life science industries. This volatility may affect the price of our common stock.
In addition, the sale of substantial amounts of our common stock could adversely impact its price. As of December 31, 2014, we had outstanding approximately 74.3 million shares of our common stock and options to purchase approximately 4.2 million shares of our common stock (of which approximately 2.6 million were exercisable as of that date). We also had outstanding approximately 3.1 million underlying restricted stock units as of December 31, 2014. As of December 31, 2014, we also had outstanding $105.0 million aggregate principal amount of our 4.00% Notes, which are convertible into shares of our common stock. We have reserved a total of approximately 17.9 million shares of our common stock to satisfy the settlement obligations of such notes. The sale or the availability for sale of a large number of shares of our common stock in the public market could cause the price of our common stock to decline.
Volatility in the stock price of other companies often has led to securities class action litigation against those companies. Any future securities litigation against us could result in substantial costs and divert management's attention and resources, which could seriously harm our business, financial condition and results of operations.
Our quarterly results have historically fluctuated significantly and may continue to do so. Failure to meet financial expectations may disappoint securities analysts or investors and result in a decline in our stock price.
Our revenue and operating results may fluctuate significantly due, in part, to factors that are beyond our control and which we cannot predict. The timing of our customers' orders may fluctuate from quarter to quarter. Historically, we have experienced customer ordering patterns for instrumentation and consumables in which the majority of the shipments occur in the last month of the quarter. These ordering patterns limit management's ability to accurately forecast our future revenue or product mix. Additionally, license revenue may also be unpredictable and fluctuates due to the timing of payments of non-recurring licensing fees. Because our expenses are largely fixed in the short to medium term, any material shortfall in revenue may cause us to experience material losses.
Because of this difficulty in predicting future performance, our operating results may fall below our own expectations and the expectations of securities analysts or investors in some future quarter or quarters. Our failure in the past to meet these expectations has adversely affected the market price of our common stock and may continue to do so.
In addition to factors that affect the spending levels of our customers described above, additional factors could cause our operating results to fluctuate, including:
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competition;
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our inability to produce products in sufficient quantities and with appropriate quality;
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the frequency of experiments conducted by our customers;
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our customers' inventory of products;
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the receipt of relatively large orders with short lead times; and
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our customers' expectations as to how long it takes us to fill future orders.
In addition, integrating operations, financial and other systems of acquired businesses, including those in connection with our acquisition of eBioscience, may compound the difficulty of predicting our future performance, for example by decreasing our ability to forecast customer demand and manage our inventory levels, and may therefore increase the fluctuation of our operating results.
Delaware law and our charter documents may impede or discourage a takeover, which could cause the market price of our common stock to decline.
We are a Delaware corporation, and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change in control would be beneficial to our existing stockholders. Our charter and bylaws contain provisions relating to issuance of preferred stock, limitations on written consents, special meetings of stockholders and advance notification procedures for stockholder proposals. In addition, we are subject to Section 203 of the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years after the date that such stockholder became an interested stockholder, unless certain conditions are met.
These and other provisions of our charter documents and Delaware law could prevent or deter mergers, takeovers or other business combinations involving us, discourage potential acquirers from making tender offers for our common stock, or discourage proxy contests for changes in our management, any of which, under certain circumstances, could depress the market price of our common stock.
Future sales of our common stock could cause our share price to fall.
In November 2014, we entered into a sales agreement with Cantor Fitzgerald & Co. to offer shares of our common stock from time to time through “at-the-market” offerings, pursuant to which we offer and sell shares of our common stock for an aggregate offering price of up to $50 million. We are not obligated to make or continue to make any sale of shares of our common stock under the “at-the-market” offerings. We did not make any sales pursuant to the “at-the market” offering in 2014. However, the sale of securities pursuant to the “at-the-market” offerings will result in dilution of our stockholders and could cause our share price to fall.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our corporate headquarters is located in Santa Clara, California, where we lease approximately 200,000 square feet and we have manufacturing facilities located in Singapore, Vienna, Austria and Cleveland, Ohio, where we lease approximately 147,000 square feet, 19,000 square feet and 18,000 square feet, respectively. In addition to our corporate headquarters, we lease approximately 165,000 square feet of administrative and research and development space in California (San Diego, Emeryville and Sunnyvale), Ohio (Cleveland), China (Beijing and Shanghai), Germany (Freiburg), Japan (Tokyo), United Kingdom (Wooburn Green), Brazil (Sao Paulo) and Dubai.
In 2012, we sold our 170,000 square foot facility in West Sacramento, California for $5.8 million, which included $0.3 million in commissions and closing costs paid by us, and recognized a net impairment of $3.5 million during the twelve months ended December 31, 2012.
We believe that our existing properties are in good condition and are suitable for the conduct of our business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Information pertaining to legal proceedings can be found in "Item 8. Financial Statements and Supplementary Data-Note 14. Legal Proceedings" of this Annual Report on Form 10-K, and is incorporated by reference herein.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES
Our common stock is traded on The Nasdaq Global Select Market under the symbol of AFFX. The following table sets forth on a per share basis, for the periods indicated, the low and high closing prices of our common stock as reported by The Nasdaq Global Select Market.
As of February 16, 2015, there were approximately 244 holders of record of our common stock, one of which is Cede & Co., a nominee for Depository Trust Company ("DTC"). All of the shares of common stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC and therefore are considered to be held of record by Cede & Co. as one shareholder.
No cash dividends have been paid on our common stock. We currently intend to retain all future earnings, if any, for use in our business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.
No equity securities were sold during 2014 that were not registered under the Securities Act of 1933, as amended (the "Securities Act"). We did not repurchase any shares of our common stock during the fourth quarter of 2014.
For information regarding compensation plans under which equity securities were authorized for issuance, see the section of the Proxy Statement to be filed in connection with our 2015 Annual Meeting of Shareholders entitled "Equity Compensation Plan Information," incorporated by reference into Item 12 of this Annual Report on Form 10-K.
Performance Graph
The graph below compares the cumulative total return* on our common stock for the period commencing on December 31, 2009 and ending December 31, 2014 compared to the CRSP Total Return Index for the Nasdaq National Market (U.S. companies) and the CRSP Total Return Index for the Nasdaq Pharmaceutical Stocks (SIC 283). The stock price performance shown on the graph below is not necessarily indicative of future price performance.
*Assumes $100 invested on December 31, 2009 in our common stock and in each index listed above. The total return for our common stock and the indices used assumes the reinvestment of dividends, even though dividends have never been declared on our common stock.
The information under the caption "Performance Graph" is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference in any filing of Affymetrix under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (the "Exchange Act"), whether made before or after the date of this Annual Report on Form 10-K and irrespective of any general incorporation language in such filings.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from our audited consolidated financial statements. The information below is not necessarily indicative of our future results of operations and should be read in conjunction with Item 1A. "Risk Factors," Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document.
All statements in this annual report that are not historical are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act as amended, including statements regarding our strategic initiatives, anticipated cost savings, return to profitability and integration of and synergies related to eBioscience, as well as all other statements regarding our "goals," "expectations," "beliefs," "intentions," "strategies" or the like. Such statements are based on our current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Actual results or business conditions may differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, our capacity to identify and capitalize upon emerging market opportunities; risks relating to our ability to acquire new businesses and technologies and successfully integrate and realize the anticipated strategic benefits and cost savings or other synergies thereof, including our acquisition of eBioscience, in a cost-effective manner while minimizing the disruption to our business; risks that eBioscience's future performance may not be consistent with its historical performance; risks relating to our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness; risks relating to our ability to develop and successfully commercialize new products and services; uncertainties related to cost and pricing of our products; fluctuations in overall capital spending in the academic and biotechnology sectors; changes in government funding policies; our dependence on collaborative partners; the size and structure of our current sales, technology and technical support organizations; uncertainties relating to our suppliers and manufacturing processes; risks relating to our ability to achieve and sustain higher levels of revenue, higher gross margins and reduced operating expenses; uncertainties relating to technological approaches; global credit and financial market conditions; personnel retention; uncertainties relating to the FDA and other regulatory approvals; competition; risks relating to intellectual property of others and the uncertainties of patent protection and litigation; volatility of the market price of our common stock; unpredictable fluctuations in quarterly revenues; and the risk factors disclosed under Part I, Item 1A of this Annual Report on Form 10-K for the year ended December 31, 2014. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based, except as required by law.
Overview
Affymetrix is a provider of life science products and molecular diagnostic products that enable parallel analysis of biological systems at the gene, protein and cell level. We sell our products to genomic research centers, academic institutions, government and private laboratories, as well as pharmaceutical, diagnostic and biotechnology companies. Over 94,500 peer-reviewed papers have been published based on work using our products. We have approximately 1,100 employees worldwide and maintain sales and distribution operations across the United States, Europe, Latin America and Asia.
We were incorporated in California in 1992 and reincorporated in Delaware in 1998. Our principal executive offices are located at 3420 Central Expressway, Santa Clara, CA 95051. Our telephone number is (408) 731-5000.
Our Strategy
Our strategy has been to transform the company from one that is highly dependent on its GeneChip® Expression product line that faces intense competition in certain applications, to one with diversified revenue streams and a broad reach into the growing markets for translational medicine, molecular diagnostics and applied sciences, such as AgBio.
Since 2011, under the leadership of Dr. Frank Witney, our President and Chief Executive Officer, we have executed on a strategy to realign our product portfolio, stabilize our business and return our company to growth and profitability. We expect this transformation to take place over three phases, two of which are now completed:
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Phase 1 (2011-2012) -Portfolio Realignment. During this phase, we reorganized ourselves into business units to sharpen our focus based on target markets. We also launched CytoScan®, our cytogenetic microarray product line, and acquired eBioscience. Through eBioscience, we offer flow cytometry reagents and immunoassay products which, aligned with our new product introductions, have enabled us to broaden our reach into the translational medicine, applied, and molecular diagnostics markets. We believe these actions contributed to the stabilization of our business and the realignment of our product portfolio positioned us for growth.
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Phase II (2013-2014) - Profitability, Strengthen Balance Sheet, Development of Newer Product Lines. In the beginning of 2013, we implemented a corporate restructuring which resulted in significant cost savings and accelerated our path to profitability. In addition, we reduced our senior secured debt to $23.0 million as of December 31, 2014. We grew total revenue by 9% in 2014 compared to 2013, after adjustment for the divestiture of our Anatrace product line (which was sold in 2013) and a one-time license payment in 2013. This growth was driven by strong sales of CytoScan and Axiom Genotyping products and services, along with eBioscience products. We trained and refocused our internal research and development, marketing, operations and regulatory teams along with our global commercial organization to expand our reach to customers in the translational medicine, molecular diagnostics and applied markets.
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Phase III (2015 -2016) - Strategic Flexibility, Expansion of Product Lines, Growth. We enter Phase III of our transformation in 2015. In this phase, our goal is to leverage the work we have done in Phase I and II in order to have well established and growing franchises in: (1) translational medicine and molecular diagnostics (with a focus on reproductive health and oncology); (2) genotyping (both human and AgBio); and (3) single cell biology (the analysis of individual cells that comprise the population of cells typically studied by researchers). We intend to continue the growth that we demonstrated in Phase II, as well as improve our profitability. We strengthened our balance sheet in Phase II and are now in position to evaluate complimentary technology acquisitions that may enhance our positions in our target markets.
Reportable Operating Segments
We report operating information on a business unit level to our chief operating decision-maker. Resource allocations and decision-making processes are also made at the business unit level by our chief operating decision-maker. Affymetrix Core accounted for approximately 73% of total revenue and eBioscience accounted for approximately 27% of total revenue during the year ended December 31, 2014.
Affymetrix Core is divided into four business units, with each business unit having its own strategic marketing and research and development groups to better serve customers and respond quickly to market needs. Affymetrix Core manufacturing operations are based on platforms that are used to produce various Affymetrix products that serve multiple applications and markets and similar customer and economic characteristics. Additionally, the business units share certain research and development and common corporate services that provide capital, infrastructure and functional support, including finance, legal and human resources. As such, we have concluded that the four business units represent one reportable operating segment. The following describes the four business units that form Affymetrix Core:
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Expression: This business unit markets the Company's GeneChip® gene expression products and services;
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Genetic Analysis and Clinical Applications: This business unit markets the Company's Axiom® genotyping product line, as well as products with clinical diagnostic and research applications including CytoScan® HD, OncoScan products, and the ViewRNA in-situ hybridization platform for clinical translational research. In addition, the business unit is responsible for managing the PbA clinical partnering and licensing program which enables third-party diagnostic companies to access and develop DNA and RNA-based diagnostic tests on Affymetrix technology
platforms. This business unit also markets the CytoScan Dx product, the recently FDA approved microarray system for post natal diagnostics of children with developmental delays and intellectual disabilities;
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Life Science Reagents: This business unit sells reagents, enzymes, purification kits and biochemicals used by life science researchers and other biological and health care manufacturers, including those developing and marketing Next Generation Sequencing (“NGS”) products and molecular diagnostics; and
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Corporate: This business unit is comprised primarily of incidental revenue from royalty arrangements and field revenue from field-services provided to customers of the Company.
The eBioscience reporting segment operates with its own manufacturing, research and marketing groups. eBioscience does utilize certain Corporate functions such as finance, legal and human resources. This reportable segment specializes in the areas of flow cytometry reagents, immunoassays, microscopic imaging, other protein-based analyses, QuantiGene single and multiplex RNA solution assays (not including the View RNA in-situ hybridization platform) and the Procarta multiplex immunoassay product lines.
During 2014, the Genetic Analysis and Clinical Applications Business Unit began marketing the ViewRNA in-situ hybridization platform for clinical translational research of RNA in tissue sections, whereas these activities were previously part of the Expression Business Unit. In addition, eBioscience began integrating the development and marketing of the remaining QuantiGene (excluding the ViewRNA platform) and Procarta product lines during 2013 with full integration in 2014. These products were previously reported by the Expression Business Unit. Accordingly, segment information for prior periods has been restated to reflect these changes for purposes of comparability.
All of our business units sell their products through our Global Commercial Organization comprised of sales, field application and engineering support personnel. We market and distribute our products directly to customers in North America, Japan and major European markets. In these markets, we have our own sales, service and application support personnel responsible for expanding and managing their respective customer bases. In other markets, such as Mexico, India, Brazil, the Middle East and Asia Pacific, including China, we sell our products principally through third-party distributors that specialize in life science supply. We are selectively expanding our presence in the larger and more attractive markets, such as China. For certain molecular diagnostic and industrial opportunities, we supply our partners with arrays and instruments, which they incorporate into diagnostic products or other routine applications and assume the primary commercialization responsibilities.
Acquisition of eBioscience Holding Company, Inc.
On June 25, 2012, we acquired eBioscience, a privately-held company based in San Diego, California engaged in the development, manufacture and sale of flow cytometry and immunoassay reagents for immunology and oncology research and diagnostics (the "Acquisition") pursuant to an Amended and Restated Agreement and Plan of Merger dated May 3, 2012 (the "Acquisition Agreement"). The Acquisition allowed us to expand our addressable markets and continue to diversify our business beyond genomics discovery into cell and protein analysis.
We operate eBioscience as a separate segment to minimize or avoid any disruption of services, while taking advantage of opportunities to create efficiencies. We continue to seek additional research and development and commercial synergies between the two companies, including cross-selling opportunities, supply chain efficiencies and complementary distribution channels.
The Acquisition purchase price totaled $314.9 million, plus $17.5 million in other fees and expenses, including $8.5 million of underwriting and financing fees. The Acquisition was financed through a combination of cash on hand, the liquidation of available-for-sale securities, proceeds from the Term Loan of an aggregate principal amount of $85.0 million provided under our Senior Secured Credit Facility and the issuance of $105.0 million principal amount of our 4.00% Notes.
CRITICAL ACCOUNTING POLICIES & ESTIMATES
General
The following section of Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles ("US GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of
contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Our significant accounting policies are fully described in "Item 8. Financial Statements and Supplementary Data-Note 2. Summary of Significant Accounting Policies." However, certain accounting policies are particularly important to the reporting of our financial position and results of operations and require the application of significant judgment by our management. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates could have reasonably been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the consolidated financial statements.
REVENUE RECOGNITION
We enter into contracts to sell our products and, while the majority of our sales agreements contain standard terms and conditions, there are agreements that contain multiple elements or non-standard terms and conditions. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting, including whether the deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes, and if so, how the value of the arrangement should be allocated among the deliverable elements, when and how to recognize revenue for each element, and the period over which revenue should be recognized.
INVENTORIES
We enter into inventory purchases and commitments so that we can meet future shipment schedules based on forecasted demand for our products. The business environment in which we operate is subject to rapid changes in technology and customer demand. We perform a detailed assessment of inventory each period, which includes a review of, among other factors, demand requirements, product life cycle and development plans, component cost trends, product pricing, product expiration and quality issues. Based on this analysis, we record adjustments to inventory for potentially excess, obsolete or impaired goods, when appropriate, in order to report inventory at net realizable value. These inventory adjustments may be required if actual demand, component costs, supplier arrangements, or product life cycles differ from our estimates. Any such adjustments would result in a charge to our results of operations.
GOODWILL, INTANGIBLE ASSETS AND OTHER LONG-LIVED ASSETS - IMPAIRMENT ASSESSMENTS
We review goodwill for impairment on an annual basis and whenever events or changes in circumstances indicate that its carrying value may not be recoverable. We first conduct an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we determine that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we then conduct a two-step test for impairment of goodwill. In the first step, the fair value of our reporting units is compared to their carrying values. If the fair values of the reporting units exceed the carrying value of the net assets, goodwill is not considered impaired and no further analysis is required. If the carrying values of the net assets exceed the fair values of the reporting units, then the second step of the impairment test must be performed in order to determine the implied fair value of the goodwill. If the carrying value of the goodwill exceeds the implied fair value, then an impairment loss equal to the difference would be recorded. During the third quarter of 2014, the Company performed an analysis of the qualitative factors and concluded that it was not more likely than not that the fair value of its reporting units are less than their carrying amounts.
We regularly review our finite-lived intangible assets and other long-lived assets to determine if the carrying values are impaired. A review is performed when an event occurs that may indicate the potential for impairment. If indicators of impairment exist, we assess the recoverability of the affected finite-lived intangible assets and other long-lived assets by determining whether the carrying amount of such assets exceeds the undiscounted expected future cash flows associated with such assets. If so, an impairment charge is recorded for the excess.
NON-MARKETABLE EQUITY SECURITIES
As part of our strategic efforts to gain access to potential new products and technologies, we invest in a limited partnership investment fund that is accounted for under the equity method. We periodically review our investment for impairment; however, the impairment analysis requires significant judgment in identifying events or circumstances that would
likely have significant adverse effect on the fair value of the investment. The analysis may include assessment of the investee's (i) revenue and earnings trend, (ii) business outlook for its products and technologies, (iii) liquidity position and the rate at which it is using its cash, and (iv) likelihood of obtaining subsequent rounds of financing. If an investee obtains additional funding at a valuation lower than our carrying value, we presume that the investment is other than temporarily impaired. We have experienced impairments due to the decline in the value of certain of our non-marketable investments over the past few years.
INCOME TAXES
Income tax expense is based on pretax financial accounting income. Under the asset and liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We must assess the likelihood that the resulting deferred tax assets will be realized. To the extent we believe that realization is not more likely than not, we establish a valuation allowance. Significant estimates are required in determining our provision for income taxes, our deferred tax assets and liabilities, any valuation allowance to be recorded against our deferred tax assets, and reserves for income tax related uncertainties. Some of these estimates are based on interpretations of existing tax laws or regulations. Various internal and external factors may have favorable or unfavorable effects on our future effective tax rate. These factors include, but are not limited to, changes in overall levels, character, or geographical mix of pretax earnings, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, changes in the valuation of our deferred tax assets or liabilities, levels of research and development spending, nondeductible expenses, applicability of tax holidays, ultimate outcomes of income tax audits, income tax impacts of any business combination transactions, intraperiod tax allocation provisions, or changes in our equity structure.
CONTINGENCIES
We are subject to legal proceedings principally related to intellectual property matters. Based on the information available at the balance sheet dates, we assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. If losses are probable and reasonably estimable, we will record a reserve which may change in the future due to new developments in each matter.
SHARE-BASED COMPENSATION
We estimate the fair value of our option grants under our equity incentive plan and shares sold under our Employee Stock Purchase Plan using the Black-Scholes-Merton ("BSM") option pricing model. This model requires the use of certain estimates and assumptions such as the expected term of options, estimated forfeitures, expected volatility of our stock price, expected dividends and the risk-free interest rate at the grant date to determine the fair value of the stock options. The fair value of our restricted stock awards, restricted stock units and performance based restricted stock units issued under our equity incentive plan, collectively referred to as restricted stock, is based on the market price of our common stock on the grant date. We recognize the fair value of its share-based compensation as expense on a straight-line basis over the requisite service period of each award, generally four years.
RESULTS OF OPERATIONS
The following discussion compares the historical results of operations for the years ended December 31, 2014, 2013 and 2012.
REVENUE
Product sales
For the year ended December 31, 2014, product sales increased $7.8 million or 3% as compared to 2013. The increase was primarily due to higher volume of Cytogenetics, Axiom, OncoScan, and Procarta Plex products. These increases were partially offset by a decline in our legacy in vitro transcription (IVT) expression product sales and a decrease in revenue of $4.5 million due to the divestiture of our Anatrace-branded reagents in October of 2013. Instrument revenue increased due to a higher volume of genotyping instrument sales.
For the year ended December 31, 2013, product sales increased $36.6 million or 14% as compared to 2012. The increase was primarily due to a full year revenue from eBioscience in 2013 as compared to half a year revenue from eBioscience in 2012 and a $13.9 million increase in our Genetic Analysis and Clinical Applications business unit as a result of
increased volume of sales in our Cytogenetics and Axiom® products. The increase is partially offset by a $17.7 million decline in our Expression business unit revenue.
Services and other revenue
For the year ended December 31, 2014, services and other revenue increased $10.8 million or 39% as compared to 2013. The increase was primarily due to increased Axiom genotyping services of $15.4 million and OncoScan services of $1.0 million. These increases were partially offset by lower royalties and license revenue of $5.7 million.
For the year ended December 31, 2013, services and other revenue decreased $1.8 million or 6% as compared to 2012. The decrease was primarily due to decreased Axiom services and field services, partially offset by a $5.3 million one-time licensing payment from a diagnostic partner in 2013.
Expression
For the year ended December 31, 2014, Expression revenue decreased $13.4 million or 15% as compared to 2013. The decrease was primarily due to lower IVT product sales of $10.4 million, lower Exon array sales of $7.1 million, and lower Gene array sales of $1.7 million. These decreases were partially offset by higher human transcriptome array (HTA) sales of $5.9 million.
For the year ended December 31, 2013, Expression revenue decreased $17.7 million or 17% as compared to 2012. The decrease was primarily driven by a decline in GeneChip revenue of $15.4 million, which was related to lower sales of IVT products. Instrument-related revenue also decreased $2.3 million as compared to the prior year.
Genetic Analysis and Clinical Applications
For the year ended December 31, 2014, Genetic Analysis and Clinical Applications revenue increased $39.5 million or 40% as compared to 2013. The increase was primarily due to increased Axiom® product sales and services of $23.8 million, increased Cytogenetics product sales of $7.9 million, increased instrument sales of $2.4 million, increased sales to PbA partners of $3.7 million, and increased OncoScanTM product sales and services of $3.7 million, partially offset by a decline in sales of SNP 6.0, our legacy genotyping product, of $2.5 million.
For the year ended December 31, 2013, Genetic Analysis and Clinical Applications revenue increased $13.9 million or 16% as compared to 2012. The increase was primarily due to increases in our CytoGenetics products of $7.4 million and Axiom product and service of $14.6 million. These increases were partially offset by a decline in sales of our legacy genotyping product, SNP 6.0, of $5.2 million and instruments of $1.7 million.
Life Science Reagents
For the years ended December 31, 2014 and 2013, Life Science Reagents revenue decreased $4.1 million or 13% and $1.8 million or 6%, respectively, when compared to prior year periods primarily due to the divestiture of our Anatrace-branded reagents in October 2013 and lower volume of sales.
Corporate
For the year ended December 31, 2014, Corporate revenue decreased $6.9 million or 27% as compared to 2013 due to a decrease in royalties and license revenue of $5.7 million and a decrease in freight revenue of $1.6 million related to change in classification.
For the year ended December 31, 2013, Corporate revenue increased by $1.9 million or 8% as compared to 2012 due to an increase in royalties and licensing fees of $4.4 million, partially offset by decrease in field service revenue of $1.4 million.
eBioscience
For the year ended December 31, 2014, eBioscience revenue increased $3.5 million or 4% as compared to 2013. The increase was primarily due to increase in our Procarta Plex sales of $6.2 million and Flow Cytometry sales of $1.2 million. These increases were offset by a decrease in our legacy Procarta product sales of $2.5 million and a decrease in Flowcytomics sales of $1.8 million.
For the year ended December 31, 2013, eBioscience revenue increased $38.4 million or 76% as compared to 2012. The increase was due to a full year of revenue in 2013 compared to six months in 2012.
GROSS MARGIN
Product gross profit
For the year ended December 31, 2014, product gross profit increased $24.3 million as compared to 2013, primarily due to increased sales, favorable factory absorption on higher manufacturing volume to support increased sales, and the cost savings arising from using materials available internally in the manufacture of our products. The increase is also due to the decline in amortization of step-up in inventory fair value that was recognized when we acquired eBioscience in 2012 and was fully amortized as of June 30, 2014. Product gross profit for 2014 included $4.7 million of amortization of step-up in inventory fair value compared to $14.9 million in 2013. In addition, the increase is due to lower instrument and array warranty expense of $2.3 million and reduction in inventory reserve of $1.4 million related to an inventory write-off for a quality issue in the same period of 2013 and improved product shelf lives.
For the year ended December 31, 2013, product gross profit increased $18.8 million as compared to 2012, primarily due to the inclusion of eBioscience product margins. The increase is also due to headcount reduction savings following our first quarter restructuring effort, favorable cost absorption and material cost savings. These increases were partially off-set by lower product pricing and a shift to lower margin products.
Services and other gross profit
For the year ended December 31, 2014, services and other gross profit increased $0.5 million as compared to 2013, primarily due to favorable impact of revenue recognized from a large biobank project in 2014, offset by a decrease in royalty and license revenue.
For the year ended December 31, 2013, services and other gross profit decreased $1.3 million as compared to 2012, primarily due to decreased Axiom services and field services, partially offset by $5.3 million one-time licensing payment from a diagnostic partner.
OPERATING EXPENSES
Research and development
For the year ended December 31, 2014, research and development expenses increased $2.6 million or 5% as compared to 2013. The increase was primarily due to consulting services of $2.8 million related to the development of our new instrument and increased compensation and benefits of $0.4 million, partially offset by lower spending on supplies of $0.7 million.
For the year ended December 31, 2013, research and development expenses decreased $10.2 million or 18% as compared to 2012. The decrease was primarily due to lower spending on supplies of $4.4 million, savings in headcount-related costs due to restructuring totaling $4.1 million and savings in allocated costs associated with IT and facilities of $3.4 million and consulting of $2.9 million. These decreases were partially offset by an increase in eBioscience research and development expenses and an increase in variable compensation costs of $1.1 million. eBioscience research and development expense increased approximately $5.0 million because 2013 represents a full year of expenses compared to half a year in 2012.
Selling, general and administrative
For the year ended December 31, 2014, selling, general and administrative expenses increased $7.0 million or 5% as compared to 2013. The increase was primarily due to increases in compensation and benefits of $5.0 million due to increased headcount, increased bonus attainment and commission accelerators, increased stock-based compensation of $2.2 million, and additional legal fees of $3.0 million incurred during 2014 primarily related to on-going litigation activities, partially offset by lower depreciation and amortization expense of $2.2 million due to assets becoming fully depreciated and amortized.
For the year ended December 31, 2013, selling, general and administrative expenses decreased $1.4 million or 1% as compared to 2012. The decrease was primarily due to savings in headcount related costs totaling $7.2 million, lower facilities and rent expense of $1.6 million, lower consulting fees of $1.0 million, lower depreciation and amortization expense of $1.5 million due to assets becoming fully amortized, and lower allocated costs associated with IT and facilities of $3.2 million. The decrease was mostly offset by an increase in eBioscience selling, general and administrative expenses of $18.2 million, and an increase in variable compensation costs of $3.5 million. Selling, general and administrative expenses for eBioscience increased approximately $18.2 million because 2013 represents a full year of expenses compared to half a year in 2012. In addition, in 2012, we incurred non-recurring acquisition-and integration-related costs of $16.5 million as compared to $0.8 million incurred in 2013.
Litigation settlement
On April 22, 2014, the Company entered into a settlement agreement with Enzo with respect to our dispute with Enzo brought in the Southern District Court of New York. Pursuant to the agreement the Company agreed to pay Enzo $5.1 million as consideration for both parties agreeing to release each other from all liabilities and claims arising under both lawsuits. As the settlement related to past claims with no ongoing benefit, these costs were recognized during the first three months of 2014 when the amount was determined to be probable and estimable.
Restructuring charges
During 2012, the Company initiated a cost reduction action that included workforce reductions to realign the Company's organization to support its strategy to stabilize its core business and position the Company for growth. Restructuring charges of $4.5 million and $1.8 million were recognized during the first half of 2013 and fourth quarter of 2012, respectively. The restructuring activities were completed in the second quarter of 2013.
OPERATING INCOME (LOSS)
Other income (expense), net, decreased $0.2 million for the year ended December 31, 2014 as compared to 2013. The decrease was primarily due to currency losses related to the fluctuations in Euros and Japanese Yen, offset by the gains recorded in 2014 related to the liquidation of non-marketable securities.
Other income (expense), net, increased $1.1 million for the year ended December 31, 2013 as compared to 2012. The increase was primarily due to a property tax refund of approximately $0.6 million, receipt of $0.2 million for a private biotechnology company investment that was fully impaired, and lower impairment loss recorded in 2013.
Interest expense decreased in 2014 as compared to 2013, primarily due to a combination of lower outstanding borrowings in 2014 as well as lower interest rates following the refinancing of our Senior Secured Credit Facility in October 2013 and the further modification in July 2014.
Interest expense increased in 2013 as compared to 2012 due to a full year of interest expense in 2013 compared to six months in 2012 on our Term Loan. The Company also refinanced the Senior Secured Credit Facility and wrote off unamortized debt issuance costs of $2.5 million associated with the original Term Loan during 2013.
SALE OF PRODUCT LINE
Effective October 11, 2013, the Company sold its Anatrace-branded reagents and the related group of assets used to manufacture the product line for net proceeds of approximately $11.8 million. The carrying value of the group of assets sold was approximately $2.5 million at the date of disposition and was primarily comprised of inventory. The Company recorded a gain on the sale of Anatrace product line of $9.3 million during the fourth quarter of 2013.
INCOME TAX PROVISION (BENEFIT)
The income tax expense in 2014 of approximately $0.2 million consisted primarily of foreign taxes, offset by a benefit resulting from a reduction in valuation allowance for net deferred tax assets arising from other comprehensive income recorded in accordance with intraperiod tax allocation provisions, as well as a benefit related to uncertain tax benefits resulting from
lapses of statute of limitations and effective settlements. The income tax expense in 2013 of approximately $1.2 million consisted primarily of foreign taxes, offset by an income tax benefit of approximately $0.3 million resulting from a reduction in valuation allowance for net deferred tax assets arising from other comprehensive income recorded in accordance with intraperiod tax allocation provisions. The income tax benefit in 2012 of approximately $35.9 million consisted primarily of a $37.1 million one-time benefit resulting from a change in valuation allowance for our previously existing deferred tax assets as a result of the Acquisition, offset by an income tax provision for foreign taxes.
Deferred tax assets are recognized if the realization of such assets is more likely than not. As of December 31, 2014, we provided for a valuation allowance of $138.0 million against our net deferred tax assets. As a result of negative evidence based on our cumulative net loss position, we have placed a full valuation allowance on U.S. and certain foreign deferred tax assets. We intend to maintain the valuation allowance until sufficient positive evidence exists to assure realization of these tax benefits through future taxable income.
As of December 31, 2014, we had U.S. federal net operating loss carryforwards of $178.2 million which begin to expire in 2022 if not utilized, and California net operating loss carryforwards of $115.4 million which begin to expire in 2015 if not utilized. As certain of our net operating loss and tax credit carryforwards as of December 31, 2014 were generated by entities we previously acquired, they are subject to annual limitations due to the ownership change provisions under Internal Revenue Code Section 382 and similar state provisions. We expect our cash payments of U.S. taxes will be minimal as long as we are able to offset our taxable income by U.S. net operating losses and credits. If we have an ownership change subsequent to December 31, 2014, utilization of our net operating loss and tax credit carryforwards may be subject to an annual limitation against taxable income in future periods.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Historically, we have financed our operations primarily through product sales; borrowings under credit arrangements; sales of equity and debt securities, collaborative agreements; interest income; and licensing of our technology.
Our cash outflows have generally been as follows: cash used in operating activities such as research and development programs, sales and marketing activity, compensation and benefits of our employees and other working capital needs; cash paid for acquisitions; cash paid for litigation activity and settlements; and cash used for the payment of principal on debt obligations and repurchases of our convertible notes as well as interest payments on our long-term debt obligations.
As of December 31, 2014, we had cash and cash equivalents of approximately $79.9 million. We anticipate that our existing capital resources along with the cash to be generated from operations will enable us to maintain currently planned operations, debt service, convertible notes repurchases, and capital expenditures for at least the next twelve months. These expectations are based on our current operating and financing plans, which are subject to change, and therefore we could require further funding. Factors that may cause us to require additional funding may include, but are not limited to: costs associated with defending third party claims; adverse ruling in any of our current litigation proceedings; investments required to commercialize our products; investments required to upgrade our older product lines; a decline in cash generated by sales of our products and services; our ability to maintain existing collaborative and customer arrangements and establish and maintain new collaboration and customer arrangements; arrangements that we may enter into in connection with future acquisitions; the progress of our research and development programs; initiation or expansion of research programs and collaborations; the costs involved in preparing, filing, prosecuting and enforcing intellectual property rights; the purchase of patent licenses; and other factors.
On June 25, 2012, we completed our acquisition of eBioscience for approximately $307.8 million, representing the purchase price of $314.9 million less $7.1 million cash transferred from eBioscience. The Acquisition was financed through a combination of cash on hand, the liquidation of available-for-sale securities, the proceeds, net of debt issuance costs, from our Term Loan of $80.5 million provided under our Senior Secured Credit Facility and the proceeds from the issuance, net of underwriting fees, of our 4.00% Notes of $101.1 million. During the year ended December 31, 2012, we made $8.2 million of cash payments for legal, advisory and other costs related to the Acquisition. As part of the terms of the Senior Secured Credit Facility, we are required to meet certain financial and other negative covenants.
On October 17, 2013, we amended the Credit Agreement and refinanced our Senior Secured Credit Facility to provide, among other things, for new term loans in the aggregate principal amount of $38.0 million and new revolving loan commitments in the aggregate principal amount of $10.0 million.
During the year ended December 31, 2014, we prepaid $16.5 million of our Senior Secured Credit Facility with cash provided by operations. In July 2014, we entered into the Fifth Amendment, which provides, among other things, for (1) an uncommitted incremental term loan facility in an aggregate amount not to exceed $50.0 million and (2) the reduction of interest rate margins. As of December 31, 2014, the carrying amount of the senior secured debt was $23.0 million.
As part of the terms of the Senior Secured Credit Facility, we are required to meet certain financial and other negative covenants. As of December 31, 2014, we were in compliance with the amended covenants. Refer to Note 12. "Long-Term Debt Obligations" for further details regarding our Senior Secured Credit Facility and 4.00% Notes.
From time to time, we may seek to retire, repurchase or exchange common stock or convertible notes in open market purchases, privately negotiated transactions dependent on market conditions, liquidity, and contractual obligations and other factors. We did not retire, repurchase or exchange any of our common stock or 4.00% Notes during the years ended December 31, 2014 or 2013. During the first quarter of 2012, we repurchased approximately $91.6 million of aggregate principal amount of our 3.50% Notes at par plus accrued and unpaid interest for total cash consideration of $92.1 million, including accrued interest of $0.5 million. In January 2013, we redeemed the remaining $3.9 million of outstanding aggregate principal amount of our 3.50% Notes at par plus accrued and unpaid interest of $0.1 million.
On November 18, 2014, we entered into a Sales Agreement with Cantor Fitzgerald & Co. (“Cantor Fitzgerald”) to offer shares of our common stock from time to time through Cantor Fitzgerald, as the Company’s sales agent for the offer and sale of the shares. The Company may offer and sell shares for an aggregate offering price of up to $50 million. We did not make any sales under the Sales Agreement in 2014.
Cashflow (in thousands)
Operating Activities
Net cash provided by operating activities for the year ended December 31, 2014 was comprised of net loss of $3.8 million, non-cash charges of $44.3 million, and an increase related to changes in operating assets and liabilities of $3.0 million. Adjustments for non-cash expenses include depreciation and amortization expense of $30.7 million, $4.7 million of amortization on the fair value step-up of inventory, share-based compensation expense of $12.4 million and gain on sales of securities of $2.5 million.
Net cash provided by operating activities for the year ended December 31, 2013 was comprised of net loss of $16.3 million, non-cash charges of $57.6 million including a gain on the sale of the Anatrace product line of $9.3 million, and an increase related to changes in operating assets and liabilities of $12.3 million. Adjustments for non-cash expenses include depreciation and amortization expense of $39.0 million, $14.9 million of amortization on the fair value step-up of inventory, and share-based compensation expense of $7.7 million.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2014 included proceeds from sale of non-marketable securities of $3.1 million and capital expenditures of $7.9 million.
During the first quarter of 2013, we sold our remaining available-for-sale securities for $9.4 million in cash proceeds. Investing activities for the year ended December 31, 2013 included $11.8 million proceeds from the sale of the Anatrace product line, capital expenditures of $4.8 million and purchases of technology rights of $0.7 million.
Financing Activities
Net cash used in financing activities for the year ended December 31, 2014 included $16.5 million of early payments on the outstanding principal amount of borrowings under our Term Loan agreement. Other financing activities generally
consisted of stock option exercise activity under our employee stock plan. Cash used in the paying withholding taxes in connection with issuance of stock under our employee stock plan, net of treasury shares withheld for taxes, was $1.2 million for the year ended December 31, 2014.
In 2012, to fund the acquisition of eBioscience, we obtained a Term Loan of an aggregate principal amount of $85.0 million. On October 17, 2013, we amended the Credit Agreement and refinanced our Senior Secured Credit Facility, which is subject to certain financial and operating covenants and amortizes over a 5 year period. The Fourth Amendment provides, among other things, for new term loans in the aggregate principal amount of $38.0 million and new revolving loan commitments in the aggregate principal amount of $10.0 million. The proceeds from the debt refinancing were used to pay off existing senior debt. The existing unamortized deferred debt issuance costs with a carrying value of approximately $2.5 million were written off during the fourth quarter of 2013 as the modified terms of the arrangement are substantially different. Refer to Note 12. "Long-Term Debt Obligations" in this Annual Report on Form 10-K for further details regarding the Term Loan, our Senior Secured Credit Facility and our 4.00% Notes.
In addition to certain mandatory payments, from time to time, we also may make early payments on the outstanding principal amount of our Term Loan.
Other financing activities generally consist of stock option exercise activity under our employee stock plan. Cash used in the issuance of stock under our employee stock plan, net of treasury shares withheld for taxes, was $0.8 million for the year ended December 31, 2013. In addition, during the first quarter of 2013, we redeemed the remaining outstanding 3.50% Notes for $3.9 million in total cash consideration, including accrued interest of $0.1 million.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
As of December 31, 2014, we had no off-balance sheet arrangements. The impact that our contractual obligations as of December 31, 2014 are expected to have on our liquidity and cash flow in future periods is as follows (in thousands):
(1)
Our 4.00% Notes may be converted into shares at the option of holder prior to maturity date. On or after July 1, 2017, the Company may redeem all or part of the 4.00% Notes for cash following certain events. Refer to "Item 8. Financial Statements and Supplementary Data-Note 12. Long Term Debt Obligation" for additional discussion.
(2)
Reflects anticipated principal payment obligations that will be made each year.
(3)
Purchase commitments include agreements to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.
The above table does not reflect unrecognized tax benefits of approximately $21.9 million, the timing of which is uncertain. Refer to "Item 8. Financial Statements and Supplementary Data-Note 15. Income Taxes" for additional discussion on unrecognized tax benefits.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are exposed to foreign currency exchange rate, interest rate and equity price risks that could impact our financial position and results of operations. Our risk management strategy with respect to these three market risks may include the use of derivative financial instruments. We use derivative contracts only to manage existing underlying exposures of Affymetrix. Accordingly, we do not use derivative contracts for speculative purposes. Our risks, risk management strategy and a sensitivity analysis estimating the effects of changes in fair values for each of these exposures are outlined below.
Actual gains and losses in the future may differ materially from the sensitivity analyses based on changes in the timing and amount of interest rate, foreign currency exchange rate and equity price movements and our actual exposures and hedges.
Interest Rate Risk
We are exposed to market risk from changes in interest rates on long-term debt obligations. We have a combination of fixed and variable rate debt. Refer to "Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AFFYMETRIX, INC.
Page No.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Loss
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Affymetrix, Inc.
We have audited the accompanying consolidated balance sheets of Affymetrix, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Affymetrix, Inc. at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Affymetrix, Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 18, 2015 expressed an unqualified opinion thereon.
AFFYMETRIX, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
See Accompanying Notes
AFFYMETRIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
See Accompanying Notes
AFFYMETRIX, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
See Accompanying Notes
AFFYMETRIX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
See Accompanying Notes
AFFYMETRIX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See Accompanying Notes
AFFYMETRIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2014
NOTE 1-NATURE OF OPERATIONS
Affymetrix, Inc. ("Affymetrix" or the "Company") is a provider of life science products and molecular diagnostic products that enable multiplex and parallel analysis of biological systems at the gene, protein and cell level. The Company sells products to genomic research centers, academic institutions, government and private laboratories, as well as pharmaceutical, diagnostic and biotechnology companies. The Company also sells its products principally through third party distributors that specialize in life science supply in Mexico, India, Brazil, the Middle East and Asia Pacific, including China.
In June 2012, the Company acquired eBioscience Holdings, Inc. ("eBioscience") for approximately $315 million (the "Acquisition"). eBioscience is based in San Diego, California, and engaged in the development, manufacture and sale of flow cytometry and immunoassay reagents for life science research and diagnostics.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Affymetrix and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The consolidated financial statements include the results of companies acquired by us from the date of each acquisition for the applicable reporting periods.
USE OF ESTIMATES
The preparation of the consolidated financial statements is in conformity with U.S. generally accepted accounting principles ("US GAAP") which require management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates.
BUSINESS COMBINATIONS
The Company's consolidated financial statements include the operations of an acquired business after the completion of the acquisition. The Company accounts for acquired businesses using the acquisition method of accounting which requires, among other things, that assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date, while transaction costs are expensed as incurred, except for any debt and equity issuance costs. The measurement of the fair value of assets acquired and liabilities assumed requires significant judgment. Any excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill.
FOREIGN CURRENCY
Certain operations from foreign subsidiaries of the Company have a functional currency other than the U.S. dollar. All other subsidiaries have the U.S. dollar as their functional currency.
Assets and liabilities of non-U.S. subsidiaries that use the local currency as their functional currency are translated to U.S. dollars at exchange rates in effect at the balance sheet date with the resulting translation adjustments directly recorded to a separate component of accumulated other comprehensive income (loss) within stockholders' equity. Income and expense accounts are translated at average exchange rates during the year. Foreign currency transaction gains and losses are recognized, net of hedging activity, in interest income and other, net and were comprised of net loss of $2.5 million for the year ended December 31, 2014, net gain of $0.1 million for the year ended December 31, 2013, and net loss of $1.3 million for the year ended December 31, 2012.
The Company's subsidiaries that use the U.S. dollar as their functional currency remeasure monetary assets and liabilities at exchange rates in effect at the end of each period, and inventories, property and other nonmonetary assets and liabilities at historical rates. Gains and losses from these remeasurements were insignificant and have been included in the Company's results of operations.
CASH EQUIVALENTS, AVAILABLE-FOR-SALE SECURITIES AND INVESTMENTS
Marketable Securities
As of December 31, 2012 and during 2013, the Company held investments that consisted of marketable equity and debt securities, including U.S. government notes and bonds; corporate notes, bonds and asset-backed securities; mortgage-backed securities, municipal notes and bonds; and publicly traded equity securities. The Company reported all securities with maturities at the date of purchase of 90 days or less that were readily convertible into cash and have insignificant interest rate risk as cash equivalents. The Company's investments in marketable securities were carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss) in stockholders' equity. The cost of marketable securities is adjusted for the amortization of premiums and discounts to maturity and is included in interest income and other, net. Realized gains and losses, as well as interest income, on available-for-sale securities are also included in interest income and other, net. The cost of securities sold is based on the specific identification method. The fair values of securities are based on quoted market prices. As of December 31, 2014 and 2013, the company did not hold any marketable securities.
Other-than-temporary Impairment
All of the Company's non-marketable securities are subject to quarterly reviews for impairment that is deemed to be other-than-temporary ("OTTI"). An investment is considered other-than-temporarily impaired when its fair value is below its amortized cost and (1) the Company intends to sell the security; (2) it is "more likely than not" that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not expected to recover the entire amortized cost basis. Below is a summary of the Company's analysis:
During the years ended December 31, 2014, 2013 and 2012, the Company recorded no impairment charges on its marketable securities. Refer to Note 5. "Financial Instruments - Investments in Debt and Equity Securities" for further information.
The Company monitors the liquidity and financing activities of its non-marketable securities to determine if any impairment exists and accordingly writes down, to the extent necessary, the carrying value of the non-marketable equity securities to their estimated fair values. In order to determine whether a decline in value is other-than-temporary, the Company evaluates, among other factors: the duration and extent to which the fair value has been less than the carrying value; the financial condition of and business outlook of the issuer, including key operational and cash flow metrics, current market conditions; and the Company's intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in estimated fair value. The Company recognized impairment changes of $0.1 million and $0.5 million on its non-marketable securities during the years ended December 31, 2014 and 2013, respectively. During the year ended December 31, 2012, no impairment charges were recognized. Refer to Note 5. "Financial Instruments - Non-Marketable Securities" for further information.
ACCOUNTS RECEIVABLE
Trade accounts receivable are recorded at net invoice value. The Company considers amounts past due based on the related terms of the invoice. The Company reviews its exposure to amounts receivable and provides an allowance for specific amounts if collectability is no longer reasonably assured. The Company also provides an allowance for a percentage of the gross trade receivable balance (excluding any specifically reserved amounts) based on its collection history. The allowance for doubtful accounts was not significant at either December 31, 2014 or 2013.
DERIVATIVE INSTRUMENTS
The Company accounts for its derivative instruments as either assets or liabilities and carries them at fair value. Derivatives that are not defined as hedges must be adjusted to fair value through earnings at each reporting date.
For derivative instruments that hedge the exposure to variability in expected future cash flows that are designated as cash flow hedges, the Company measures the effectiveness of the derivative instruments by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item. The effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) ("OCI") in stockholders' equity and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of the gain or loss on the derivative instrument is recognized in current earnings. To receive hedge accounting treatment, cash flow hedges must be highly effective in offsetting changes to expected future cash flows on hedged transactions. The net gain or loss on the effective portion of a derivative instrument that is designated as an economic hedge of the foreign currency translation
exposure of the net investment in a foreign operation is reported in the same manner as a foreign currency translation adjustment. Refer to Note 5. "Financial Instruments - Derivative Financial Instruments" for further information.
INVENTORIES
Inventory cost is computed on an adjusted standard basis (which approximates actual cost on a first-in, first-out basis). Provisions for slow moving, potentially excess and obsolete inventories are provided based on estimated demand requirements, product life cycle and development plans, component cost trends, product pricing, product expiration and quality issues.
Inventory that is not expected to be utilized until more than 12 months from the balance sheet date is classified as long-term. Estimating the level of inventory utilization for the upcoming 12 months requires management to exercise significant judgment. The Company maintains inventory levels in excess of 12 months for certain components of work-in-progress that have useful lives of up to 10 years. Carrying such levels of inventory impacts the Company's liquidity and cash flows since the inventory will not be converted to cash for more than one year.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter. Equipment and furniture is depreciated over useful lives generally ranging from 3 to 7 years and leasehold improvements are depreciated over the shorter of the expected life of the asset or lease terms generally ranging from 3 to 15 years. Maintenance and repair costs are expensed as incurred. The Company reassesses the useful life of its property and equipment on a periodic basis and may adjust the lives accordingly.
In the fourth quarter of 2012, the Company sold its facility located in West Sacramento, California to a third-party for $5.8 million, which included $0.3 million of commissions and closing costs paid by the Company, and received $5.5 million in cash.
GOODWILL, INTANGIBLE ASSETS AND OTHER LONG-LIVED ASSETS
Goodwill represents the excess of the fair value of an acquired entity over the fair value of the net tangible and identifiable intangible assets acquired and liabilities assumed in a business combination. Finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives, which range from one to twelve years, with the amortization recognized in either cost of revenue or operating expenses, as appropriate.
Goodwill is not subject to amortization, but is tested for impairment on an annual basis during the third quarter or whenever events or changes in circumstances indicate the carrying amount of these assets may not be recoverable. Goodwill impairment testing is a two-step process and performed on a reporting unit level. In the first step, the Company conducts an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company determines that it is more likely than not that the fair value of its reporting unit is less than its carrying amount, it then conducts the second step, a two-part test for impairment of goodwill. The Company first compares the fair value of its reporting units to their carrying values. If the fair values of the reporting units exceed the carrying value of the net assets, goodwill is not considered impaired and no further analysis is required. If the carrying values of the net assets exceed the fair values of the reporting units, then the second part of the impairment test must be performed in order to determine the implied fair value of the goodwill. If the carrying value of the goodwill exceeds the implied fair value, then an impairment loss equal to the difference would be recorded. During the third quarter of 2014, the Company performed an analysis of the qualitative factors and concluded that it was not more likely than not that the fair value of its reporting units are less than their carrying amounts.
Finite-lived intangible assets and other long-lived assets are reviewed for impairment when facts or circumstances suggest that the carrying value of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. In the event that such cash flows are not expected to be sufficient to recover the carrying amount of the assets, the assets are written down to their estimated fair values. Additionally, during each period, the Company evaluates the estimated remaining useful lives of purchased finite-lived intangible assets and other long-lived assets to determine whether events or changes in circumstances warrant a revision to the remaining period of amortization. For the years ended December 31, 2014, 2013 and 2012, no impairment charges on long-lived assets were recognized.
INCOME TAXES
Income tax expense is based on pre-tax financial accounting income. Under the liability method, deferred tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company must then assess the likelihood that the resulting deferred tax assets will be realized. To the extent the Company believes that realization of the deferred tax assets is not more likely than not, the Company establishes a valuation allowance. Significant estimates are required in determining the Company's provision for income taxes, deferred tax assets and liabilities, any valuation allowance to be recorded against net deferred tax assets, and reserves for income tax related uncertainties. Some of these estimates are based on interpretations of existing tax laws or regulations. Various internal and external factors may have favorable or unfavorable effects on the Company's future effective tax rate. These factors include, but are not limited to, changes in overall levels of characterization and geographical mix of pretax earnings (losses), changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, changes in the valuation of deferred tax assets or liabilities, levels of research and development spending, nondeductible expenses, applicability of tax holidays, ultimate outcomes of income tax audits, income tax impacts of any business combination transactions, intraperiod tax allocation provisions, or changes in our equity structure. Relative to uncertain tax positions, the Company only recognizes the tax benefit if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the Company's financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
CONTINGENCIES
The Company is subject to various legal proceedings principally related to intellectual property matters. Based on the information available at the most recent balance sheet date, the Company assesses the likelihood of any material adverse judgments or outcomes that may result from these matters, as well as the range of possible or probable loss, if any. If losses are probable and reasonably estimable, the Company will recognize a liability. Any liability recognized may change in the future due to new developments in each matter.
REVENUE RECOGNITION
Overview
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured. In instances where final acceptance of the product or system is required or performance obligations remain, revenue is deferred until all the acceptance criteria or performance obligations have been met.
The Company derives the majority of its revenue from product sales of probe arrays, reagents, and related instrumentation that may be sold individually or combined with any of the Company's products, services or other sources of revenue. When a sale combines multiple elements upon delivery or performance of multiple products, services and/or rights to use assets, the Company allocates revenue for transactions or collaborations that include multiple elements to each unit of accounting based on its relative fair value or best estimate of selling price, and recognizes revenue for each unit of accounting when all revenue recognition criteria have been met. The price charged when an element is sold separately generally determines fair value.
Product Sales
Product sales include sales of probe arrays, antibodies, reagents and related instrumentation. Probe array, reagent and instrumentation revenue is recognized when earned, which is generally upon shipment and transfer of title to the customer and fulfillment of any significant post-delivery obligations. Accruals are provided for anticipated warranty expenses at the time the associated revenue is recognized.
Services
Services revenue includes equipment service revenue; scientific services revenue, which includes associated consumables; and revenue from custom probe array design fees. Revenue from equipment service contracts is recognized ratably over the life of the contract.
Revenue from scientific and DNA analysis services is recognized upon shipment of the required data to the customer.
Revenue from custom probe array design fees associated with the Company's GeneChip® CustomExpress™ and CustomSeq™ products is recognized when the associated products are shipped.
Royalties and Other Revenue
Royalties and other revenue include license revenue; royalties earned from third party license agreements; milestones and royalties earned from collaborative product development and supply agreements; subscription fees earned under GeneChip® array access programs; and research revenue, which mainly consists of amounts earned under government grants.
License revenue is generally recognized upon the execution of an agreement or is recognized ratably over the period of expected performance.
Revenue from royalties is recognized under the terms of the related agreement.
The Company enters into collaborative arrangements which generally include a research and product development phase and a manufacturing and product supply phase. These arrangements may include up-front nonrefundable license fees, milestones, the rights to royalties based on the sale of final product by the partner, product supply agreements and distribution arrangements.
Any up-front, nonrefundable payments from collaborative product development agreements are recognized ratably over the research and product development period and at-risk based milestones are recognized when earned. Any payments received which are not yet earned are included in deferred revenue.
Transactions with Distributors
The Company recognizes revenue from transactions with distributors when the product is delivered either to customers or distributors. The Company's agreements with distributors do not include rights of return.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist of costs incurred for internal, collaborative and grant-sponsored research and development. Research and development expenses include salaries, contractor fees, building costs, utilities and allocations of shared corporate services. In addition, the Company funds research and development at other companies and research institutions under agreements which are generally cancelable. All such costs are charged to research and development expense as incurred.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising expense for the years ended December 31, 2014, 2013 and 2012 was $2.7 million, $2.2 million, and $2.0 million, respectively.
SHARE-BASED COMPENSATION
The Company estimates the fair value of its option grants and shares sold under its Employee Stock Purchase Plan using the BSM option pricing model. This model requires the use of certain estimates and assumptions such as the expected term of options, estimated forfeitures, expected volatility of the Company's stock price, expected dividends and the risk-free interest rate at the grant date to determine the fair value of stock-based payments. The fair value of restricted stock awards, restricted stock units and performance based restricted stock units, collectively referred to as restricted stock, is based on the market price of the Company's common stock on the grant date. The Company recognizes the fair value of its share-based compensation as expense on a straight-line basis over the requisite service period of each award, generally four years. Refer to Note 13. "Stockholders' Equity and Share-Based Compensation Expense" for further information.
Performance-Based Awards
The Company's share-based awards program includes performance-based restricted stock awards ("PRSUs") that vest based upon the achievement of certain performance criteria and a service vesting criteria following the achievement of performance criteria. Performance criteria include various operational criteria of the Company such as revenues, earnings before interest, taxes, depreciation and amortization, product launches, and similar criteria, either on a Company-wide or business unit specific basis. The service vesting criteria ranges from six months to four years. The Company recognizes the fair value of these awards to the extent the achievement of the related performance criteria is estimated to be probable. If a performance criteria is subsequently determined to not be probable of achievement, any related expense is reversed in the period such determination is made. Conversely, if a performance criteria is not currently expected to be achieved but is later determined to be probable of achievement, a “catch-up” entry is recorded in the period such determination is made for the
expense that would have been recognized had the performance criteria been probable of achievement since the grant of the award.
SALE OF PRODUCT LINE
Effective October 11, 2013, the Company sold its Anatrace-branded reagents and the related group of assets used to manufacture the product line for net proceeds of approximately $11.8 million. The carrying value of the group of assets sold was approximately $2.5 million at the date of disposition and was primarily comprised of inventory. The Company recorded a gain on the sale of Anatrace product line of $9.3 million during the fourth quarter of 2013.
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is comprised of net loss and other comprehensive income (loss). Other comprehensive income (loss) includes foreign currency translation adjustments, unrealized gains and losses on the Company's non-marketable securities that are excluded from net loss and unrealized gains and losses on cash flow hedges. Total comprehensive income (loss) has been disclosed in the Company's Consolidated Statements of Comprehensive Loss.
At December 31, 2014 and 2013, the components of accumulated other comprehensive income (loss), net of tax, are as follows (in thousands):
The following table summarizes the amounts reclassified out of accumulated other comprehensive income (loss), net of tax, for the year ended December 31, 2014 (in thousands):
NET LOSS PER COMMON SHARE
Basic net loss per common share is calculated using the weighted-average number of common shares outstanding during the period less the weighted-average shares subject to repurchase. Diluted net loss per common share gives effect to dilutive restricted stock, stock options (calculated based on the treasury stock method), shares purchased under the employee stock purchase plan and convertible debt (calculated using an as-if-converted method).
Diluted earnings per share, if any, include certain potential dilutive securities from restricted stock, outstanding stock options (on the treasury stock method), shares purchased under the employee stock purchase plan and convertible notes (on the as-if-converted basis). The potentially dilutive securities excluded from diluted earnings per common share on an actual outstanding basis, were as follows (in thousands):
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (ASU 2014-15). ASU 2014-15 requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, companies will have reduced diversity in the timing and content of footnote disclosures than under today’s guidance. ASU 2014-15 is effective for the Company in the first quarter of 2016 with early adoption permitted. The Company does not believe the impact of adopting ASU 2014-15 on its consolidated financial statements will be significant.
In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09) to provide guidance on revenue recognition. ASU 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company in the first quarter of 2017. Early adoption is not permitted. Upon adoption, ASU 2014-09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retained earnings in the most current period presented. The Company is currently evaluating the impact of adopting ASU 2014-09 on its consolidated financial statements.
NOTE 3-CONCENTRATIONS OF RISK
Cash equivalents and investments are financial instruments that potentially subject Affymetrix to concentrations of risk to the extent of amounts recorded in the accompanying Consolidated Balance Sheets. Company policy restricts the amount of credit exposure to any one issuer and to any one type of investment, other than securities issued by the United States Government.
The Company has not experienced significant credit losses from its accounts receivable. Affymetrix performs a regular review of its customer activity and associated credit risks and does not require collateral from its customers. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectability of accounts receivable.
Certain raw materials or components used in the synthesis of probe arrays or the assembly of instrumentation are currently available only from a single source or limited sources. No assurance can be given that these raw materials or other components of the GeneChip® system will be available in commercial quantities at acceptable costs from other vendors should the need arise. If the Company is required to seek alternative sources of supply, it could be time consuming and expensive.
In addition, the Company is dependent on its vendors to provide components of appropriate quality and reliability and to meet applicable regulatory requirements. Consequently, in the event that supplies from these vendors are delayed or interrupted for any reason, the Company's ability to develop and supply its products could be impaired, which could have a material adverse effect on the Company's business, financial condition and results of operations.
For the years ended December 31, 2014, 2013 and 2012, approximately 39%, 39% and 42%, respectively, of the Company's total revenue was generated from sales outside the United States. The Company's results of operations are affected by such factors as changes in foreign currency exchange rates, trade protection measures, longer accounts receivable collection patterns and changes in regional or worldwide economic or political conditions. The risks of the Company's international operations are mitigated in part by the extent to which its sales are geographically distributed.
NOTE 4-FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions and risk of nonperformance.
A fair value hierarchy was established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument's categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of inputs that may be used to measure fair value are as follows:
Level 1: quoted prices in active markets for identical assets or liabilities;
Level 2: inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or
Level 3: unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The Company considers an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and views an inactive market as one in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate the Company's or the counterparty's non-performance risk is considered in determining the fair values of liabilities and assets, respectively.
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table represents the Company's fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013 (in thousands):
Derivative financial instruments
The Company's derivative financial instruments are measured at fair value on a recurring basis utilizing Level 2 inputs as determined based on review of third-party sources. The fair value of the Company's derivative assets and liabilities is determined based on the estimated consideration the Company would pay or receive to terminate these agreements on the reporting date. The derivative assets and liabilities are classified in Prepaid expenses and other current assets and Accounts payable and accrued expenses, respectively, in the accompanying Consolidated Balance Sheets.
Non-Marketable Securities
The Company believes the carrying amounts of its non-marketable securities approximated their fair values at the dates presented above. These non-marketable securities consist of an investment in a limited partnership investment fund that invests in companies in the life science industry and are located in the United States. The investments were initially valued at purchase price and subsequently on the basis of inputs that market participants would use in pricing such investments. The portfolio of investments includes Level 1 publicly-traded equity securities and Level 3 equity securities and notes.
During the years ended December 31, 2014 and 2013, other-than-temporary impairment charges of $0.1 million and $0.5 million, respectively, were recognized on the Company's non-marketable securities. During the year ended December 31, 2012, no impairment charges were recognized. Net investment losses are included in Other income (expense), net in the accompanying Consolidated Statements of Operations. Depending on market conditions, the Company may incur additional losses on this investment in the future.
The following table summarizes the change in the fair value of the Company's non-marketable securities during the year ended December 31, 2014 (in thousands).
Fair Value of Long-Term Debt Obligations
As further discussed in Note 12. "Long-Term Debt Obligations," are not measured at fair value on a recurring basis and are carried at amortized cost. The Company believes the fair value of the Term Loan approximates its carrying value, or amortized cost, due to the short-term nature of this obligation and the market rates of interest rates they bear. Such inputs are classified as Level 3 of the fair value hierarchy. The fair value of the Company's 4.00% Notes is based on quoted market prices as of the respective balance sheet date and therefore is classified as Level 1 of the fair value hierarchy. As of December 31, 2014, the fair value of the Company's 4.00% Notes was $188.3 million.
NOTE 5-FINANCIAL INSTRUMENTS
Investments in Debt and Equity Securities
During the first quarter of 2013, the Company liquidated its entire portfolio of available-for-sale securities. The available-for-sale securities were sold for total cash consideration of $9.4 million and the resulting net gain on sale of $0.1 million was recognized in Interest income and other, net in the accompanying Consolidated Statements of Operations.
Realized gain for the year ended December 31, 2013 was $0.1 million. No realized losses were incurred for the year ended December 31, 2013. Realized gains and losses are included in Interest income and other, net in the accompanying Consolidated Statements of Operations.
Derivative Financial Instruments
The Company derives a portion of its revenues in foreign currencies, predominantly in Europe and Japan, as part of its ongoing business operations. In addition, a portion of its assets are held in the nonfunctional currencies of its subsidiaries. The Company enters into foreign currency forward contracts to manage a portion of the volatility related to transactions that are denominated in foreign currencies. The Company's foreign currency forward contracts are entered into for periods consistent with the related underlying exposures and do not constitute positions that are independent of those exposures.
In accordance with the terms of the Credit Agreement in Note 12. "Long-Term Debt Obligations", the Company had previously maintained an interest rate swap (the "Interest Rate Swap"). As of December 31, 2013, the notional amount of the Interest Rate Swap was $10.3 million. In July 2014, the Company amended the terms of the Credit Agreement such that the interest rate swap is no longer required. Accordingly, the Company settled the Interest Rate Swap on September 30, 2014.
The Company is exposed to the risk that the counterparties to its hedges may be unable to meet the terms of these agreements. To mitigate the risk, only contracts with carefully selected highly-rated major financial institutions are entered into.
In the event of non-performance by these counterparties, the asset position carrying values of the financial instruments represent the maximum amount of loss that can be incurred; however, no losses as a result of counterparty defaults are expected. The Company does not require and is not required to pledge collateral for these financial instruments. The Company does not enter into foreign currency forward contracts for trading or speculative purposes and is not party to any leveraged derivative instruments.
As of December 31, 2014 and 2013, the total notional values of the Company's derivative assets and liabilities were as follows (in thousands):
The Company recognizes derivative on the accompanying Consolidated Balance Sheets at fair value. The following table shows the Company's derivatives as of December 31, 2014 and 2013 (in thousands):
The effective portions of designated cash flow hedges are recorded in OCI until the hedged item is recognized in operations. Derivatives that are not designated as hedging instruments and the ineffective portions of cash flow hedges are adjusted to fair value through operations.
Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur in the initially identified time period or within a subsequent two-month time period. Deferred gains and losses associated with such derivative instruments are reclassified immediately into operations through Other income (expense), net on the Consolidated Statements of Operations. Any subsequent changes in fair value of such derivative instruments are reflected in Other income (expense), net unless they are re-designated as hedges of other transactions.
As of December 31, 2013, the Interest Rate Swap was not designated as a hedging relationship. All other derivative assets and liabilities were designated as hedging relationships as of December 31, 2014 and 2013.
The following table shows the effect, net of tax, of the Company's derivative instruments on the accompanying Consolidated Statements of Operations and OCI for the years ended December 31, 2014, 2013 and 2012 (in thousands):
As of December 31, 2014, the Company's existing foreign currency forward exchange contracts mature within 12 months. The deferred amounts related to the Company's derivatives recorded in OCI as of December 31, 2014 and 2013, and expected to be recognized into earnings over the next 12 months are net gain (loss) of $1.1 million and $(0.8) million, respectively.
NOTE 6-INVENTORIES
Inventories consist of the following at December 31, 2014 and 2013 (in thousands):
Inventory at December 31, 2013 included $4.7 million of fair value step-up in basis that was recognized when the Company acquired eBioscience in 2012. Amortization expense related to the fair value step-up during the years ended December 31, 2014, 2013 and 2012 was approximately $4.7 million, $14.9 million and $9.4 million, respectively. The inventory fair value step-up was fully amortized as of June 30, 2014.
NOTE 7-PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31, 2014 and 2013 (in thousands):
(1) Includes assets received not yet in service.
For the years ended December 31, 2014, 2013 and 2012, the Company recognized depreciation expense of $8.5 million, $13.8 million and $15.8 million, respectively.
NOTE 8-GOODWILL AND INTANGIBLE ASSETS
The gross carrying amounts and net book values of the Company's definite-lived intangible assets are as follows (in thousands):
(1)
Includes a decrease in carrying value of $5.1 million related to foreign currency translation.
(2)
The impact of foreign currency translation on accumulated amortization was a decrease of $1.0 million.
The expected future annual amortization expense of the Company's intangible assets is as follows (in thousands):
The Company recognized goodwill of $157.1 million in connection with the Acquisition. Information in regards to changes in the Company's goodwill as of December 31, 2014 is as follows (in thousands):
During the year ended December 31, 2014, the Company concluded that there were no indicators of impairment during its annual impairment test of goodwill and the balance as of December 31, 2014 is expected to be recoverable.
NOTE 9-ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities as of December 31, 2014 and 2013 consist of the following (in thousands):
NOTE 10-COMMITMENTS
Operating Leases
The Company leases laboratory, office and manufacturing facilities under non-cancelable operating leases that expire at various times through 2023. Some of these leases contain renewal options ranging from two to five years and escalation clauses. Rent expense related to operating leases for the years ended December 31, 2014, 2013 and 2012 was approximately $10.1 million, $10.6 million, and $11.3 million, respectively. In connection with some of these facility leases, the Company has made security deposits totaling $2.5 million, which are included in other long-term assets in the accompanying Consolidated Balance Sheets.
Future minimum lease obligations, net of sublease income, at December 31, 2014 under all non-cancelable operating leases are as follows (in thousands):
No sublease income is expected for the year ended December 31, 2015 and thereafter.
Non-Cancelable Supply Agreements
As of December 31, 2014, the Company had approximately $3.3 million of non-cancelable inventory supply agreements that are in effect through 2016.
Indemnifications
From time to time the Company has entered into indemnification provisions under certain of its agreements with other companies in the ordinary course of business, typically with business partners, customers, and suppliers. Pursuant to these agreements, the Company generally indemnifies, holds harmless, and agrees to reimburse the indemnified parties on a case by case basis for losses suffered or incurred by the indemnified parties in connection with any U.S. patent or other intellectual property infringement claim by any third party with respect to its products. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited in some cases. In addition, the Company has entered into indemnification agreements with its officers and directors. The Company has not incurred significant costs to defend lawsuits or settle claims related to these indemnification provisions. As of December 31, 2014, the Company had not accrued a liability for this guarantee, because the likelihood of incurring a payment obligation in connection with this guarantee is remote.
NOTE 11-WARRANTIES
The Company provides for anticipated warranty costs at the time the associated revenue is recognized. Product warranty costs are estimated based upon the Company's historical experience and the warranty period. The Company periodically reviews the adequacy of its warranty reserve and adjusts, if necessary, the warranty percentage and accrual based on actual experience and estimated costs to be incurred. Information regarding changes in the Company's product warranty liability for the years ended December 31, 2014 and 2013 is as follows (in thousands):
NOTE 12-LONG-TERM DEBT OBLIGATIONS
The following table summarizes the carrying amount of the Company's borrowings (in thousands):
Term Loan and Revolving Credit Facility
On June 25, 2012, in conjunction with the acquisition of eBioscience, Inc., the Company entered into a five-year $100.0 million Senior Credit Facility credit agreement (the "Credit Agreement"). The Credit Agreement provided for a Term Loan in an aggregate principal amount of $85.0 million and a revolving credit facility in an aggregate principal amount of $15.0 million.
On October 17, 2013 the Company refinanced its Senior Secured Credit Facility and entered into the Fourth Amendment to Credit Agreement (the "Fourth Amendment"). The Fourth Amendment provided, among other things, for a term loan in the aggregate principal amount of $38.0 million and revolving loan commitments in the aggregate principal amount of $10.0 million, each with a term of five years. The Company borrowed a total of $38.0 million under the Term Loan and $10.0 million under the revolving loan upon refinancing.
On July 28, 2014, the Company entered into the Fifth Amendment to Credit Agreement (the "Fifth Amendment" and the Credit Agreement as so amended, the "Amended Credit Agreement"). The Fifth Amendment provides, among other things, for (1) an uncommitted incremental term loan facility in an aggregate amount not to exceed $50.0 million and (2) the reduction of interest rate margins. As of December 31, 2014, the applicable interest rate was approximately 3.04%.
At the option of the Company (subject to certain limitations), borrowings under the Fourth Amendment bear interest at either a base rate or at the London Interbank Offered Rate ("LIBOR"), plus, in each case, an applicable margin. Under the Base Rate Option, interest will be at the base rate plus 1.50% to 1.75% dependent on the senior leverage ratio then in effect calculated on the basis of the actual number of days elapsed in a year of 365 or 366 days (as applicable) and payable quarterly in arrears. The base rate will be equal to the greatest of (a) the rate last quoted by The Wall Street Journal (or another national publication described in the Fourth Amendment) as the U.S. "Prime Rate", (b) the federal funds rate, plus 0.50% per annum, and (c) LIBOR for an interest period of one month plus, 1.00% per annum. Under the LIBOR Option, interest will be
determined based on interest periods to be selected by Affymetrix of one, two, three or six months (and, to the extent available to all relevant lender, nine or 12 years) and will be equal to LIBOR plus 2.50% to 2.75% dependent on the senior leverage ratio then in effect, calculated based on the actual number of days elapsed in a 360-day year. Interest will be paid at the end of each interest period or in the case of interest periods longer than three months, quarterly.
The loans and other obligations under the Senior Secured Credit Facility are (i) guaranteed by substantially all of the Company's domestic subsidiaries (subject to certain exceptions and limitations) and (ii) secured by substantially all of the assets of Affymetrix and each guarantor (subject to certain exceptions and limitations).
The Amended Credit Amendment requires the Company to maintain an interest coverage ratio of at least 3.5 to 1.0 and a senior leverage ratio not exceeding initially 1.75 to 1.00 and stepping down to 1.20 to 1.00. The Amended Credit Agreement also includes other covenants, including negative covenants that, subject to certain exceptions, limit Affymetrix’, and that of certain of its subsidiaries’, ability to, among other things: (i) incur additional debt, including guarantees by the Company or its subsidiaries, (ii) make investments, pay dividends on capital stock, redeem or repurchase capital stock, redeem or repurchase the Company’s senior convertible notes or any subordinated obligations, (iii) create liens and negative pledges, (iv) make capital expenditures, (v) dispose of assets, (vi) make acquisitions, (vii) create or permit restrictions on the ability of Affymetrix’ subsidiaries to pay dividends or make distributions to Affymetrix, (viii) engage in transactions with affiliates, (ix) engage in sale and leaseback transactions, (x) consolidate or merge with or into other companies or sell all or substantially all the Company’s assets and (xi) change their nature of business, their organizational documents or their accounting policies.
The Company is required to make the following mandatory prepayments: (a) annual prepayments in an amount equal to 50% of excess cash flow (as defined in the Credit Agreement), subject to a leverage-based step down, (b) prepayments in an amount equal to 100% of the net cash proceeds of issuances or incurrences of debt obligations of Affymetrix and its subsidiaries (other than debt incurrences expressly permitted by the Credit Agreement), (c) prepayments in an amount equal to 100% of the net proceeds of asset sales in excess of $2.5 million annually (subject to certain reinvestment rights) and (d) prepayments in an amount equal to any indemnification payments or similar payments received under the Acquisition Agreement, subject to certain exclusions.
The Amended Credit Agreement also contains events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-default and cross-acceleration to other indebtedness in excess of specified amounts, monetary judgment defaults in excess of specified amounts, bankruptcy or insolvency, actual or asserted invalidity or impairment of any part of the credit documentation (including the failure of any lien on a material portion of the collateral to remain perfected) and change of ownership or control defaults. In addition, the occurrence of a "fundamental change" under the indenture governing the 4.00% Notes would be an event of default under the Credit Agreement. As of December 31, 2014, the Company was in compliance with the covenants.
The proceeds received on June 25, 2012 from the original Term Loan were net of debt issuance costs of approximately $4.5 million that were being amortized over the 5-year term of the Senior Secured Credit Facility. Following the refinance under the Fourth Amendment, the Company wrote off unamortized debt issuance costs of $2.5 million associated with the original Term Loan, and received proceeds on October 17, 2013 from the new Term Loan and Revolver, net of debt issuance costs of approximately $0.8 million that amortize on the effective interest rate method beginning October 17, 2013.
As of December 31, 2014, the Company had an outstanding principal balance of approximately $23.0 million under the Term Loan and incurred $1.6 million and $7.9 million in interest expense under the Senior Secured Credit Facility for the years ended December 31, 2014 and 2013, respectively. There were no amounts outstanding under the Revolving Credit Facility as of December 31, 2014.
Quarterly, principal payments are due under the Term Loan, which amortizes such that 10% of the outstanding principal is due during the first four years and the remaining 60% is due in the fifth year, including any remaining principal balance and any outstanding revolver balance at such time. The principal amount of unpaid maturities per the Credit Agreement is as follows (in thousands):
The Company intends to continue making quarterly payments during 2015 and classified $4.0 million as current on the accompanying Consolidated Balance Sheet as of December 31, 2014.
4.00% Convertible Senior Notes
On June 25, 2012, the Company issued $105.0 million principal amount of 4.00% Convertible Senior Notes ("4.00% Notes") due July 1, 2019. The net proceeds, after debt issuance costs totaling $3.9 million from the 4.00% Notes offering, were $101.1 million. The 4.00% Notes bear interest of 4.00% per year payable semi-annually in arrears on January 1 and July 1 of each year, beginning on January 1, 2013 until the maturity date of July 1, 2019, unless converted, redeemed or repurchased earlier. The debt issuance costs are being amortized over the effective life of the 4.00% Notes, which is 7 years.
Holders of the 4.00% Notes may convert their 4.00% Notes into shares of the Company's stock at their option any time prior to the close of business on the business day immediately preceding the maturity date. The 4.00% Notes are initially convertible into approximately 170.0319 shares of the Company's common stock per $1,000 principal amount of notes, which equates to 17,857,143 shares of common stock, or an initial conversion price of $5.88 per share of common stock. The conversion rate is subject to certain customary anti-dilution adjustments. In addition, following certain corporate events that occur prior to the maturity date, the Company will increase the conversion rate for a holder who elects to convert its notes in connection with such a corporate event in certain circumstances. Holders may also require the Company to repurchase for cash their notes upon certain fundamental changes.
On or after July 1, 2017, the Company can redeem for cash all or part of the 4.00% Notes if the last reported sale price per share of the Company's common stock has been at least 130% of the conversion price then in effect for at least 20 trading days during any 30 consecutive trading day period ending within 5 trading days prior to the date on which the Company provides notice of redemption. The redemption price will be equal to 100% of the principal amount of the 4.00% Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. If the Company calls the 4.00% Notes for redemption, a holder of notes may convert its notes only until the close of business on the scheduled trading day immediately preceding the redemption date unless the Company fails to pay the redemption price (in which case a holder of notes may convert such notes until the redemption price has been paid or duly provided for).
As of December 31, 2014, the outstanding balance on the 4.00% Notes was $105.0 million. Interest incurred was $4.8 million, $4.8 million, and $2.5 million for the years ended December 31, 2014, 2013 and 2012.
3.50% Senior Convertible Notes
During the first quarter of 2012, the Company repurchased approximately$91.6 million of aggregate principal amount of its 3.50% Notes in private transactions for total cash consideration of $92.1 million, including accrued interest of $0.5 million. Such notes were purchased at par and accelerated amortization of deferred financing costs of $0.3 million was recognized. The remaining $3.9 million aggregate principal amount of the 3.50% Notes was redeemed during the first quarter of 2013.
NOTE 13-STOCKHOLDERS' EQUITY AND SHARE-BASED COMPENSATION EXPENSE
Convertible Preferred Stock
The Company's Board of Directors has authorized 5.0 million shares of convertible preferred stock, $0.01 par value. At December 31, 2014 and 2013, there were no such shares issued or outstanding.
At the Market Offering
On November 18, 2014, we entered into a Sales Agreement with Cantor Fitzgerald & Co. (“Cantor Fitzgerald”) to offer shares of our common stock from time to time through Cantor Fitzgerald, as the Company’s sales agent for the offer and sale of the shares. The Company may offer and sell shares for an aggregate offering price of up to $50 million. We did not make any sales under the Sales Agreement in 2014.
Share-based Compensation Plans
The Company has a share-based compensation program that provides the Board of Directors broad discretion in creating equity incentives for employees, officers, directors and consultants. This program includes incentive and non-qualified stock options and restricted stock, granted under various stock plans. Stock options are issued at a price of at least 100% of the fair value of the Company's common stock on the date of grant (110% in certain circumstances), as determined by the Board of
Directors. Options generally expire 7 to 10 years from the grant date and may be granted with different vesting terms from time to time as determined by the Board of Directors, usually over a period of four years on each anniversary of the grant date. In general, restricted stock vest on an annual basis over a period of three to four years on each anniversary of the grant date, are subject to the employees' continued employment and are paid upon vesting in shares of the Company's common stock on a one-for-one basis. As of December 31, 2014, the Company had approximately 5.0 million shares of common stock reserved for future issuance under its share-based compensation plans. A more detailed description of the Company's current share-based compensation plans follows below:
In 1998, the Board of Directors adopted the Affymetrix 1998 Stock Incentive Plan (the "1998 Stock Plan") under which nonqualified stock options and restricted stock may be granted to employees and outside consultants, except that members of the Board of Directors and individuals who are considered officers of the Company under the rules of the National Association of Securities Dealers shall not be eligible. Options granted under the 1998 Stock Plan expire no later than ten years from the date of grant. A total of 3.6 million shares of common stock are authorized for issuance under the 1998 Stock Plan.
In 2000, the Board of Directors adopted the Amended and Restated 2000 Equity Incentive Plan (the "2000 Stock Plan"), which was amended and restated in 2001, under which restricted stock, stock options, and stock appreciation rights may be granted to employees, outside directors and consultants. In the second quarter of 2010, 4.5 million shares of common stock were added under the 2000 Stock Plan bringing the total shares of common stock authorized for issuance under the 2000 Stock Plan to 16.2 million.
In June 2012, the Board of Directors adopted the 2012 Inducement Plan (the "2012 Inducement Plan"), under which restricted stock, stock options, and stock appreciation rights may be granted to employees. A total of 2.0 million shares of common stock are authorized for issuance under the 2012 Inducement Plan.
The following table sets forth the share-based compensation expense included in the accompanying Consolidated Statements of Operations (in thousands):
(1) Includes $8.3 million of share-based compensation expense related to the acceleration of unvested stock options in connection with the Acquisition during the year ended December 31, 2012.
As of December 31, 2014, $15.2 million of total unrecognized share-based compensation expense related to non-vested awards is expected to be recognized over the respective vesting terms of each award through 2018. The weighted-average term of the unrecognized share-based compensation expense are 2.2 years for stock options and 1.9 years for restricted stock.
Stock Options
The fair value of options was estimated at the respective dates of grant using the BSM option pricing model with the following weighted-average assumptions:
The risk free interest rate for periods within the contractual life of the Company's stock options is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term is derived from an analysis of the Company's historical exercise trends over ten years. The expected volatility for the years ended December 31, 2014, 2013 and 2012 is based on a blend of historical and market-based implied volatility. Using the assumptions above, the weighted-average grant date fair
value of options granted during the years ended December 31, 2014, 2013 and 2012 was $4.59, $2.42 and $2.14 per option, respectively.
Activity under the Company's stock plans for the year ended December 31, 2014 is as follows (in thousands, except per share amounts):
The following table summarizes information concerning currently outstanding and exercisable options at December 31, 2014:
The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between the Company's closing stock price on the last trading day of its fourth quarter of 2014 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2014. The aggregate intrinsic value changes based on the fair market value of the Company's common stock. For the years ended December 31, 2014, 2013 and 2012, total intrinsic value of options exercised was $2.8 million, $0.8 million and $0.1 million, respectively.
Reserved Shares
At December 31, 2014, the Company has shares reserved for future issuance as follows (in thousands):
Restricted Stock
The following tables summarize the Company's restricted stock activity for the year ended December 31, 2014 (in thousands, except per share amounts):
For the years ended December 31, 2014 and 2013, total fair value of restricted stock vested was $5.9 million and $3.9 million, respectively.
Performance-Based Restricted Stock
The Company's share-based awards program includes performance-based restricted stock awards that reference performance criteria.
2011 CEO grants In 2011, the Compensation Committee of the Company's Board of Directors approved a grant of performance-based restricted stock units ("PRSUs") under the Plan to the Company's Chief Executive Officer ("CEO") that is earned annually in four equal tranches based on his performance in the applicable fiscal year (the "Performance Period"). The PRSUs entitle the CEO to receive a certain number of shares of the Company's common stock based on the Company's satisfaction of certain financial and strategic performance goals as set and approved by the Board of Directors annually during the first quarter of the Company's fiscal year. Based on the achievement of the performance conditions during each Performance Period, the final settlement of the PRSU award will vest twelve months following the end of each Performance Period. The PRSU award will be forfeited if the performance goals are not met or if the executive officer is no longer employed at the vest date.
The number of shares underlying the PRSUs that were granted to the CEO during 2011 totaled 240,000 of which (i) 60,000 PRSUs relating to the Performance Period ended December 31, 2011 and with a grant date fair value of $6.71 per PRSU vested at December 31, 2012; (ii) 25,000 PRSUs relating to the Performance Period ended December 31, 2012 and with a grant date fair value of $4.63 per PRSU vested at December 31, 2013; (iii) 42,000 PRSUs relating to the Performance Period ended December 31, 2013 and with a grant date fair value of $4.67 per PRSU vested at December 31, 2014. The Company expects that an additional 27,000 shares of the PRSUs, with a grant date fair value of $7.22 per PRSU, will vest with respect to the Performance Period ended December 31, 2014 and the fair value of such PRSU's is being amortized on a straight-line basis over the related service period ending December 31, 2015. The total compensation cost related to PRSUs granted but not yet recognized was $0.1 million as of December 31, 2014.
2012 Program During July 2012, the Compensation Committee granted certain PRSUs following the acquisition of eBioscience referred to as an Acquisition Performance Share Program (the "2012 Program"). The purpose of the 2012 Program was to align key management and senior leadership with stockholders' interests and to retain key employees. The measurement periods for the 2012 Program were the twelve month periods ended June 30, 2013 and June 30, 2014, respectively. Members of eBioscience management and other key employees were participating in the 2012 Program. Awards granted under the 2012 Program were granted in the form of performance shares pursuant to the terms of our 2012 Inducement Plan. If pre-determined
eBioscience specific performance goals were met, shares of stock would be granted to the recipient, vesting one month following the performance period representing the date of certification of achievement, contingent upon the recipient's continued service to the Company.
In 2012, the Company awarded 911,500 PRSUs under the 2012 Program at a grant date fair value of $4.16 per PRSU of which (i) 164,255 PRSUs relating to the twelve month period ended June 30, 2013 vested at July 31, 2013; (ii) 144,100 PRSUs relating to the twelve-month period ended June 30, 2014 vested at July 31, 2014.
2013 Program During the first quarter of 2013, the Compensation Committee granted certain PRSUs following the most recent restructuring referred to as the 2013 Program. The purpose of the 2013 Program was to retain key employees. The measurement period for the 2013 Program was the twelve month period ended December 31, 2013 and the awards granted under the 2013 Program were granted in the form of performance shares pursuant to the terms of our 2000 Plan. Dependent on the level of achievement of pre-determined financial performance goals, shares of stock would vest in equal installments over two or four years. The level of achievement of financial performance was assessed during the first quarter of 2014 after which the shares of stock were issued to the participants, contingent upon the recipient’s continued service to the Company.
In 2013, the Company awarded 340,000 PRSUs under the 2013 Program at a grant date fair value of $3.84 per PRSU of which 104,500 PRSUs relating to the twelve month period ended December 31, 2013 vested at February 25, 2014. The Company expects 100,000 PRSUs will vest with the fair value of these PRSUs being amortized on a straight-line basis over the related service period. The total compensation cost related to PRSUs granted but not yet recognized was $0.1 million as of December 31, 2014.
2013 Product Launch Initiative Program During the third quarter of 2013, the Compensation Committee granted certain PRSUs associated with product launch and promotion initiatives referred to as the 2013 Product Launch Initiative Program. The purpose of the 2013 Product Launch Initiative Program was to incentivize specific employees to sell specific products. The measurement period for the 2013 Product Launch Initiative Program was the six month period ended December 31, 2013 and the awards granted under the 2013 Product Launch Initiative Program were granted in the form of performance shares pursuant to the terms of our 2000 Plan. Dependent on the level of achievement of pre-determined financial performance goals, shares of stock would vest in equal installments over eight to twelve months. The level of achievement of financial performance was assessed during the first quarter of 2014 after which the shares of stock were issued to the participants, contingent upon the recipient’s continued service to the Company.
In 2013, the Company awarded 146,750 PRSUs under the 2013 Product Launch Initiative Program at a grant date fair value of $5.51 per PRSU of which 63,750 and 15,000 PRSUs relating to the six month period ended December 31, 2013 vested at February 27, 2014 and August 7, 2014, respectively.
2014 Program During the first quarter of 2014, the Compensation Committee granted certain PRSUs associated with performance criteria referred to as the 2014 Program. The purpose of the 2014 Program was to retain key employees. The measurement period for the 2014 Program was the twelve month period ended December 31, 2014 and the awards granted under the 2014 Program were granted in the form of performance shares pursuant to the terms of our 2000 Plan. Dependent on the level of achievement of pre-determined financial performance goals, shares of stock would vest in equal installments over two or four years. The level of achievement of 2014 financial performance will be assessed during the first quarter of 2015 after which the shares of stock will be issued to the participants, contingent upon the recipient’s continued service to the Company.
In 2014, the Company awarded 564,100 PRSUs under the 2014 Program at a grant date fair value of $7.71 per PRSU and expect 507,100 PRSUs will vest with the fair value of these PRSUs being amortized on a straight-line basis over the related service period. The total compensation cost related to PRSUs granted but not yet recognized was approximately $1.9 million as of December 31, 2014.
The following table summarizes the Company's PRSU activity for the year ended December 31, 2014 (in thousands, except per share amounts):
For the years ended December 31, 2014 and 2013, the total fair value of PRSUs vested was $1.6 million and $0.8 million, respectively. The total compensation cost related to all PRSUs granted but not yet recognized was approximately $2.0 million as of December 31, 2014 which will be recognized over the next 4 years. Changes in the Company’s assessment of the probability of achievement of performance criteria could have a material effect on the results of operations in future periods. There were no material changes in estimate related to the probability of vesting or recognition of expense related to PRSUs during either of the periods ended December 31, 2014 or 2013.
Employee Stock Purchase Plan
In August 2011, the Company's Board of Directors adopted the 2011 Employee Stock Purchase Plan ("ESPP") that was approved by the Company's stockholders on May 11, 2012. A total of 7.0 million shares of the Company's common stock are reserved for issuance under the ESPP, which permits eligible employees to purchase common stock at a discount through payroll deductions.
The price at which stock is purchased under the ESPP is equal to 85% of the fair market value of the common stock on the first day of the offering period or the last day of the purchase period, whichever is lower. The offering periods are twelve months and include two six month purchase periods that result in a look-back for determining the purchase price of up to 12 months. Employees can invest up to 15% of their gross compensation through payroll deductions. In no event would an employee be permitted to purchase more than 750 shares of common stock during any six-month purchase period. The initial offering period commenced in November 2011. As of December 31, 2014, there were 451 participants in the ESPP and approximately 0.3 million shares were issued under the ESPP during 2014 at an average subscription date fair value of $6.49 per share. Included in total share-based compensation expense for the years ended December 31, 2014, 2013 and 2012 was $1.8 million, $0.7 million and $0.6 million, respectively, related to the ESPP.
During the years ended December 31, 2014 and 2013, the fair value of shares issued under the ESPP was estimated using the following assumptions:
NOTE 14-LEGAL PROCEEDINGS
The Company has been in the past, and continues to be, a party to litigation, which has consumed, and may continue to consume, substantial financial and managerial resources. The Company could incur substantial costs and divert the attention of management and technical personnel in defending against litigation, and any adverse ruling or perception of an adverse ruling could have a material adverse impact on the Company’s stock price. In addition, any adverse ruling could have a material adverse impact on the Company’s cash flows and financial condition. The results of any litigation or any other legal proceedings are uncertain and as of the date of this report, the Company has not accrued any liability with respect to any of the litigation matters listed below:
Enzo Litigation
Southern District of New York Case: On October 28, 2003, Enzo Life Sciences, Inc., a wholly-owned subsidiary of Enzo Biochem, Inc. (collectively "Enzo"), filed a complaint against the Company that is pending in the United States District Court for the Southern District of New York for breach of contract, injunctive relief and declaratory judgment. The Enzo complaint relates to a 1998 distributorship agreement with Enzo under which the Company served as a non-exclusive distributor of certain reagent labeling kits supplied by Enzo. On November 10, 2003, the Company filed a complaint against Enzo in the United States District Court for the Southern District of New York for declaratory judgment, breach of contract and injunctive relief relating to the 1998 agreement. On April 22, 2014, the Company entered into a settlement agreement with Enzo with respect to these two lawsuits. Pursuant to the agreement the Company agreed to pay Enzo $5.1 million and recognized a litigation settlement charge during the first three months of 2014. The settlement agreement does not include the Delaware Case described below.
Delaware Case: On April 6, 2012, Enzo filed a complaint against the Company in the United States District Court for the District of Delaware. In the complaint, plaintiff alleges that Affymetrix is infringing U.S. Patent No. 7,064,197 by making and selling certain GeneChip® products. The plaintiff seeks a preliminary and permanent injunction enjoining the Company from further infringement and unspecified monetary damages. The Company will vigorously defend against the plaintiff’s case. No trial date is set for this action.
Administrative Proceedings
The Company's intellectual property is subject to a number of significant administrative actions. These proceedings could result in the Company's patent protection being significantly modified or reduced, and the incurrence of significant costs and the consumption of substantial managerial resources. For the years ended December 31, 2014, 2013, and 2012, the Company did not incur significant costs in connection with administrative proceedings.
NOTE 15-INCOME TAXES
The following table summarizes the U.S. and foreign components of consolidated loss before income taxes (in thousands):
The provision (benefit) for income taxes consisted of the following (in thousands):
The difference between the provision (benefit) for income taxes and the amount computed by applying the federal statutory income tax rate (35%) to loss before taxes from continuing operations is explained as follows (in thousands):
During the year ended December 31, 2014 and 2013, the Company recognized a reduction in the valuation allowance recorded against the Company's net deferred tax assets of approximately $0.2 million and $0.3 million, respectively. The reductions related to net deferred tax liabilities recorded for unrealized gains reflected as other comprehensive income. In accordance with U.S. GAAP intraperiod tax allocation provisions, the reductions are reported as an element of deferred income tax expense (benefit) attributable to continuing operations. During the year ended December 31, 2012, the Company recognized a reduction in the valuation allowance recorded against the Company's net deferred tax assets of $37.1 million. The reduction was related to net deferred tax liabilities recognized for the difference between the fair value and carrying basis of certain tangible and intangible assets obtained as part of the Acquisition, which can be used as a source of income to support realization of certain domestic deferred tax assets. Under US GAAP, changes in an acquirer's valuation allowances that stem from a business combination should be recognized as an element of the acquirer's deferred income tax expense (benefit) in the reporting period that includes the business combination.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities were as follows (in thousands):
Deferred tax assets are recognized if the realization of such assets is more likely than not. As of December 31, 2014, the Company provided for a valuation allowance of $138.0 million against our net deferred tax assets. As a result of negative evidence based on the cumulative three year net loss position, the Company has placed a full valuation allowance on U.S. and certain foreign deferred tax assets. The Company intends to maintain the valuation allowance until sufficient positive evidence exists to assure realization of these tax benefits through future taxable income. As of December 31, 2014, the Company has recorded a full valuation allowance against all U.S. and certain foreign net deferred tax assets. The valuation allowance increase of $2.3 million in 2014 is primarily attributable to the decrease in deferred tax liabilities for amortization of certain tangible and intangible assets acquired in the Acquisition and cancellation of debt income, offset by a decrease in deferred tax assets due to the utilization of net operating loss carryforwards. The valuation allowance increase of $4.7 million in 2013 is primarily attributable to the decrease in deferred tax liabilities associated with amortization of certain tangible and intangible assets acquired in the Acquisition, and an increase in deferred tax assets for research and development tax credit carryforwards. Approximately $25.7 million of the valuation allowance as of December 31, 2014, is attributable to the income tax benefits of share-based compensation, the benefit of which will be credited to stockholders' equity when, and if, realized. Not included in the deferred tax assets as of December 31, 2014 is approximately $7.3 million of tax benefits related to share-based compensation. When, and if, realized the tax benefit of these assets will be accounted for as a credit to stockholders' equity, rather than a reduction of the income tax provision. Of the total tax benefits realized from the share-based compensation, nominal amounts were recorded to stockholders' equity for the years ended December 31, 2014 and 2013, respectively.
As of December 31, 2014, the Company had U.S. net operating loss carryforwards of $178.2 million which begin to expire in 2022 if not utilized, and federal research and development tax credit carryforwards of approximately $25.6 million, which begin to expire in 2018 if not utilized. The Company also had California net operating loss carryforwards of $115.4 million which begin to expire in 2015 if not utilized, and California research and development tax credit and other tax credit carryforwards of $42.5 million, which can be carried forward indefinitely. As certain of the net operating loss and tax credit carryforwards were generated by entities previously acquired by the Company, they are subject to annual limitations due to the ownership change provision under the Internal Revenue Code Section 382 and similar state provisions. The limitations will not result in significant expirations of the net operating loss or research tax credit carryforwards before utilization. If the Company
has an ownership change subsequent to December 31, 2014, utilization of its net operating loss and tax credit carryforwards may be subject to an annual limitation against taxable income in future periods.
The Company provides for U.S. income tax and foreign withholding taxes on the undistributed earnings of foreign subsidiaries unless the earnings are considered indefinitely reinvested outside the U.S. As of December 31, 2014, the Company has approximately $0.9 million of previously untaxed earnings from its foreign subsidiaries which were indefinitely reinvested outside the U.S. Due to unutilized net operating loss carryforwards, the potential federal and state taxes on these repatriations is nominal.
A portion of the Company's operations in Singapore operate under various tax holidays and tax incentive programs, which expire in whole or in part at various dates through 2016. There was a minimal net impact of these tax holidays and tax incentive programs for the year ended December 31, 2014.
The following table presents the Company's total amount of gross unrecognized tax benefits (in thousands):
As of December 31, 2014 and 2013, if recognized, the amount of unrecognized tax benefits that would impact income tax expense is approximately $5.0 million and $5.6 million, respectively. The Company classifies interest and penalties related to tax positions as components of income tax expense. For the year ended December 31, 2014, the amount of accrued interest and penalties related to tax uncertainties was approximately $0.1 million for a total cumulative amount included in non-current income taxes payable of approximately $1.1 million as of December 31, 2014. The Company completed its IRS examination for the years 2009 through 2012 in 2014 with no adjustments to its reported tax liabilities. The Company is currently under examination by the state of California for the years 2006 through 2009. Given the potential for statute expirations and finalization of current examinations, it is reasonably possible that the amount of unrecognized tax benefits could change in the next 12 months as a result, with an estimated range from zero to approximately $1.6 million.
The Company files U.S. federal, state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The Company's major tax jurisdictions are the U.S. federal, California, Singapore, the United Kingdom and Austria. The federal and California statute of limitations on assessments remain open for years after 2010 and 2008 respectively; however adjustments may be made to prior years due to the carryforward of unutilized net operating losses and research credit carryforwards. The major foreign jurisdictions statute of limitations remain open from tax years 2007.
NOTE 16-SEGMENT AND GEOGRAPHIC INFORMATION
The Company reports segment information on the "management" approach which designates the internal reporting used by management for making decisions and assessing performance as the source of the Company's reportable segments. The Company has determined that its Chief Executive Officer is the Company's chief operating decision maker ("CODM") as he is responsible for reviewing and approving investments in the Company's technology platforms and manufacturing infrastructure. The Company is organized into two reportable operating segments: Affymetrix Core and eBioscience.
Affymetrix Core is divided into four business units, with each business unit having its own strategic marketing and research and development groups to better serve customers and respond quickly to market needs. Affymetrix Core manufacturing operations are based on platforms that are used to produce various Affymetrix Core products that serve multiple applications and markets and similar customer and economic characteristics. Additionally, the business units share certain research, development and common corporate services that provide capital, infrastructure and functional support. As such, the Company concluded that the four business units represent one reportable operating segment. The following describes the four business units that form Affymetrix Core:
•
Expression: This business unit markets the Company's GeneChip® gene expression products and services;
•
Genetic Analysis and Clinical Applications: This business unit markets the Company's Axiom® genotyping product line, as well as products with clinical diagnostic and research applications including CytoScan® HD, OncoScan products, and the ViewRNA in-situ hybridization platform for clinical translational research. In addition, the business unit is responsible for managing the PbA clinical partnering and licensing program which enables third-party diagnostic companies to access and develop DNA and RNA-based diagnostic tests on Affymetrix technology platforms. This business unit also markets the CytoScan Dx product, the recently FDA approved microarray system for post natal diagnostics of children with developmental delays and intellectual disabilities;
•
Life Science Reagents: This business unit sells reagents, enzymes, purification kits and biochemicals used by life science researchers and other biological and health care manufacturers, including those developing and marketing Next Generation Sequencing (“NGS”) products and molecular diagnostics; and
•
Corporate: This business unit is comprised primarily of incidental revenue from royalty arrangements and field revenue from field-services provided to customers of the Company.
The eBioscience business unit operates with its own manufacturing, research and marketing groups. The business unit does utilize certain Corporate functions such as finance, legal and human resources. This reportable segment specializes in the areas of flow cytometry reagents, immunoassays, microscopic imaging, other protein-based analyses, QuantiGene single and multiplex RNA solution assays (not including the View RNA in-situ hybridization platform) and the Procarta multiplex immunoassay product lines.
eBioscience began integrating the development and marketing of the QuantiGene (excluding the ViewRNA in-situ hybridization platform) and Procarta product lines during 2013 with full integration in 2014. These products were previously reported by the Expression Business Unit of the Affymetrix Core reportable segment. Accordingly, segment information for prior periods has been restated to reflect these changes for purposes of comparability.
The Company evaluates the performance of its reportable operating segments based on revenue and income (loss) from operations. Revenue is allocated to each business unit based on product codes. The eBioscience business is operated on a stand-alone basis.
The following table shows revenue and income (loss) from operations by reportable operating segment for the years ended December 31, 2014, 2013, or 2012 (in thousands):
The Company reported total revenue by region as follows (in thousands):
There were no customers representing 10% or more of total revenue in 2014, 2013 or 2012.
The Company's long-lived assets other than purchased intangible assets, which the Company does not allocate to specific geographic locations as it is impracticable to do so, are composed principally of net property and equipment.
Net property and equipment, classified by major geographic areas in which the Company operates was as follows (in thousands):
NOTE 17-DEFINED-CONTRIBUTION SAVINGS PLANS
The Company maintains a defined-contribution savings plan which is qualified under Section 401(k) of the Internal Revenue Code. The plan covers substantially all full-time U.S. employees. Participating employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit. The Company's expense associated with matching employee contributions, including eBioscience, for the years ended December 31, 2014, 2013 and 2012 totaled $2.7 million, $2.8 million, and $3.0 million respectively. Company contributions to employees vest ratably over four years.
NOTE 18-RELATED PARTY TRANSACTIONS
In December 2011, the Company entered into an agreement under which it assigned one patent application and related know-how to Cellular Research, Inc. ("Cellular Research"), a company founded by the Company's Chairman, Dr. Stephen P.A. Fodor. Dr. Fodor also owns a majority of the shares of Cellular Research. Pursuant to the agreement, Cellular Research shall pay single digit royalties to Affymetrix on sales of products covered by the assigned technology, and starting in December 2015, an annual minimum fee of $100,000. Affymetrix shall also have a right of first refusal to collaborate with Cellular Research for the development of certain new products and to supply arrays to Cellular Research under certain terms and conditions. As of December 31, 2014, no significant royalties have been earned under this agreement.
NOTE 19-RESTRUCTURING
During the fourth quarter of 2012, the Company initiated a cost reduction action that included downsizing its workforce to realign the Company's organization to support its strategy to stabilize its core business and position the Company for growth. In January 2013, approximately 100 employees were notified of their involuntary termination. The total restructuring charge associated with the plan was $6.3 million, substantially all of which is compensation and benefits afforded to terminated employees. Restructuring charges of $4.5 million and $1.8 million were recognized during the years ended December 31, 2013 and 2012, respectively. The restructuring activities were completed in the second quarter of 2013.
NOTE 20-UNAUDITED QUARTERLY FINANCIAL INFORMATION
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15, Affymetrix' management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of Affymetrix' disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) and 15d-15(e). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that Affymetrix' disclosure controls and procedures were effective as of the end of the period covered by this report.
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision of our Chief Executive Officer and Chief Financial Officer and with the participation of our management, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014 based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) ("COSO"). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2014.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting.
The effectiveness of our internal control over financial reporting as of December 31, 2014, has been audited by Ernst & Young LLP, our independent registered public accounting firm, as stated in their report which is included as follows.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Affymetrix, Inc.
We have audited Affymetrix, Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the "COSO criteria"). Affymetrix, Inc.'s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Affymetrix, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Affymetrix, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2014 of Affymetrix, Inc. and our report dated February 18, 2015 expressed an unqualified opinion thereon.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information regarding our directors and executive officers is incorporated by reference to the sections of the Company's proxy statement for the 2015 Annual Meeting of Stockholders (the "Proxy Statement") entitled "Election of Directors" and "Management."
The information concerning our corporate governance, including our audit committee, required by this Item is incorporated by reference to the sections of the Proxy Statement entitled "Governance of the Company" and "Report of the Audit Committee."
The information concerning compliance with Section 16(a) of the Exchange Act required by this Item is incorporated by reference to the section of the Proxy Statement entitled "Section 16(a) Beneficial Ownership Reporting Compliance."
CODE OF ETHICS
Affymetrix has adopted a code of business conduct and ethics for directors, officers (including Affymetrix' Chief Executive Officer, Chief Financial Officer and Corporate Controller) and employees, known as the Code of Business Conduct and Ethics. The Code of Business Conduct and Ethics is available on Affymetrix' website at www.affymetrix.com in the Corporate Governance section under the "Investors" link. Stockholders may request a free copy of the Code of Business Conduct and Ethics by sending an email request to investor@affymetrix.com.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the sections of the Proxy Statement entitled "Executive Compensation," "Compensation Discussion and Analysis," "Compensation Committee Report," "Certain Transactions" and "Compensation of Directors."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated by reference to the section of the Proxy Statement entitled "Stock Ownership of Principal Stockholders and Management."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Incorporated by reference to the sections of the Proxy Statement entitled "Certain Transactions" and "Governance of the Company."
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information about principal accountant fees and services as well as related pre-approval policies appears under "Fees Paid to Ernst & Young LLP" and "Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accounting Firm" in the Proxy Statement. Those portions of the Proxy Statement are incorporated by reference into this report.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements. The financial statements as set forth under Item 8 of this Report on Form 10-K are incorporated herein by reference.
(a)(2) Financial Statement Schedule-Schedule II-Valuation and Qualifying Accounts. All other schedules have been omitted as they are not required, not applicable or the information is otherwise included.
(a)(3) Exhibits. The exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this Report on Form 10-K.
AFFYMETRIX, INC.
Schedule II-Valuation and Qualifying Accounts
(in thousands)
(1)
Activity in 2012 includes the addition of eBioscience since the Acquisition Date
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Each individual whose signature appears below constitutes and appoints Frank Witney, Gavin H.J. Wood, and Siang H. Chin and each of them singly, his or her true and lawful attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the U.S. Securities and Exchange Commission, hereby ratifies and confirms all that said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue thereof.
INDEX TO EXHIBITS
(1)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on February 28, 2012 (File No. 000-28218).
(2)
Incorporated by reference to Registrant's Current Report on Form 8-K as filed on May 31, 2012 (File No. 000-28218).
(3)
Incorporated by reference to Registrant's Current Report on Form 8-K as filed on June 13, 2000 (File No. 000-28218).
(4)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on August 7, 2009 (File No. 000-28218).
(5)
Incorporated by reference to Registrant's Current Report on Form 8-K as filed on June 25, 2012 (File No. 000-28218).
(6)
Incorporated by reference to Registrant's Registration Statement on Form S-1 (File No. 333-3648), as amended.
(7)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on March 31, 1999 (File No. 000-28218).
(8)
Incorporated by reference to Registrant's Registration Statement on Form S-3 as filed on July 12, 1999 (File No. 333-82685), as amended.
(9)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on May 15, 2001 (File No. 000-28218).
(10)
Incorporated by reference to Registrant's Registration Statement on Form S-8 as filed on May 17, 2010 (File No. 333-166894).
(11)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on November 9, 2004 (File No. 000-28218).
(12)
Incorporated by reference to Registrant's Registration Statement on Form S-8 as filed on April 18, 2001 (File No. 333-59158).
(13)
Incorporated by reference to Registrant's Registration Statement on Form S-8 as filed on September 1, 2011 (File No. 333-176638).
(14)
Incorporated by reference to Registrant's Registration Statement on Form S-8 as filed on June 29, 2012 (File No. 333-182456).
(15)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on August 14, 1996 (File No. 000-28218).
(16)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on March 16, 2005 (File No. 000-28218).
(17)
Incorporated by reference to Registrant's Current Report on Form 8-K as filed on July 15, 2011 (File No. 000-28218).
(18)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on March 15, 2004 (File No. 000-28218).
(19)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on March 9, 2006 (File No. 000-28218).
(20)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on February 28, 2011 (File No. 000-28218).
(21)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on March 1, 2010 (File No. 000-28218).
(22)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on May 6, 2010 (File No. 000-28218).
(23)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on March 4, 2013 (File No. 000-28218).
(24)
Incorporated by reference to Registrant's Current Report on Form 8-K/A as filed on August 4, 2011 (File No. 000-28218).
(25)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on May 1, 2013 (File No. 000-28218).
(26)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on August 6, 2013 (File No. 000-28218)
(27)
Incorporated by reference to Registrant's Current Report on Form 8-K as filed on May 18, 2010 (File No. 000-28218).
(28)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on August 9, 2012 (File No. 000-28218).
(29)
Incorporated by reference to Registrant's Annual Report on Form 10-K as filed on February 29, 2008 (File No. 000-28218).
(30)
Incorporated by reference to Registrant's Current Report on Form 8-K as filed on October 21, 2013 (File No. 000-28218).
(31)
Incorporated by reference to Registrant's Current Report on Form 8-K as filed on June 25, 2014 (File No. 000-28218).
(32)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on August 4, 2014 (File No. 000-28218).
(33)
Incorporated by reference to Registrant's Quarterly Report on Form 10-Q as filed on October 30, 2014 (File No. 000-28218).
‡
Management contract, compensatory plan, contract or arrangement