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AFFX > SEC Filings for AFFX > Form 10-K on 3-Mar-2014All Recent SEC Filings

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Annual Report

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 Affymetrix 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, 2013. 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
We are 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 65,000 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.
Our operations consist of two reportable segments, Affymetrix Core and eBioscience. Affymetrix Core accounted for approximately 76% of total revenue and eBioscience accounted for approximately 24% of total revenue during the year ended December 31, 2013.
Affymetrix Core is divided into four business units, with each business unit having its own research and marketing groups to better serve customers and respond quickly to the market needs. In addition, the business units share some research and development resources and common corporate services that provide capital, infrastructure, resources and functional support, allowing them to focus on core technological strengths to compete and innovate in their markets. Affymetrix Core manufacturing operations are based on platforms that are used to produce various Affymetrix products that serve multiple applications and markets. 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 genotyping product line, such as the Axiom®
              product line, and arrays and assays with clinical research
              applications, such as the CytoScan® and OncoScan products.
              Effective 2014, this unit will market the QuantiGene ViewRNA
              in-situ hybridization platform for clinical translational research
              of RNA in tissue sections. QuantiGene ViewRNA was previously part
              of the Expression Business Unit.

•             Life Science Reagents: This business unit sells reagents, enzymes,
              purification kits and biochemicals used by life science

•             Corporate: This business unit is comprised primarily of incidental
              revenue from royalty arrangements and field revenue from services
              provided to customers of the Company.

Acquired in 2012, eBioscience is operated as a separate business unit with its own research and marketing and manufacturing groups:

•             eBioscience: This reportable segment specializes in the
              development, manufacturing, marketing and distribution of research
              products in the areas of flow cytometry, immunoassays, microscopic
              imaging and other protein-based analyses. During the second half of
              2013, eBioscience started integrating the development and marketing
              of the remaining QuantiGene and Procarta product line (not
              including the QuantiGene ViewRNA in-situ platform) previously
              reported by the Expression Business Unit. This change is expected
              to have a material impact in 2014 when compared to 2013 results for
              the eBioscience Business Unit and Expression Business Unit.

All of our business units sell their products through our Global Commercial Organization comprised of sales, field application and engineering support, and marketing 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, the Middle East and Asia Pacific, including China, we sell our products principally through third party distributors that specialize in life science supply. For molecular diagnostic and industrial applications market opportunities, we supply our partners with arrays, assays, reagents and instruments, which they incorporate into diagnostic products 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 business unit to minimize or avoid any disruption of services, while taking advantage of opportunities to create efficiencies. We expect to continue to achieve certain research and development and commercial synergies between the two companies, including cross-selling opportunities and complementary distribution channels, as well as realize benefits from certain research and development synergies.
The Acquisition purchase price totaled $314.9 million, plus $17.5 million in other fees and expenses incurred since the transaction began, including $8.5 million of underwriting and financing fees, and was financed through a combination of cash on hand, the liquidation of available-for-sale securities, proceeds from the Term Loan of 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. Reportable Operating Segments
To better serve our markets subsequent to our acquisition of eBioscience, we have organized our business units into two reportable operating segments:
Affymetrix Core and eBioscience.
Affymetrix Core represents the aggregate of the Expression, Genetic Analysis and Clinical Applications, Life Science Reagents and Corporate business units. Each of these business units have their own marketing groups. The business units share

common corporate services that provide capital, infrastructure, resources and functional support. These corporate services are included in the Corporate business unit.
eBioscience is organized as a separate business unit in order to minimize disruption of its existing operations, and we evaluate the performance of eBioscience separately from Affymetrix Core's performance based on its revenue and income (loss) from operations. For the year ended December 31, 2013, the eBioscience reportable operating segment had $78.2 million in net revenue and $13.1 million in operating loss, from the Acquisition Date. See "Item 8. Financial Statements and Supplementary Data-Note 16. Segment and Geographic Information" for more information on our reportable operating segments. Overview of Fiscal Year 2013 and Strategic Initiatives We have faced declining financial performance over the past several years. Traditionally, a significant portion of our business was in the well-established gene expression business where our GeneChip® Expression product line comprised at least 50% of our revenue as we concentrated on selling these products in the basic research market focused on discovery research. Declining sales and intense competition from newer technologies such as next generation sequencing in this business has led to decreasing revenue annually since 2007.
Since Frank Witney became our President and Chief Executive Officer in July 2011, we have begun shifting our resources and focus areas from a dependency on our Expression business unit to a more diversified portfolio with broader revenue stream capabilities that can reach into the growing markets for translational medicine, molecular diagnostics and applied sciences. In 2013, Affymetrix Core reported a decrease in revenue of $6.4 million as compared to 2012, primarily due to a $20.2 million decrease in our Expression business unit resulting from a lower volume of sales, offset by a $13.6 million increase in our Genetic Analysis and Clinical Applications business unit due to an increase in volume of sales in our Cytogenetics and Axiom line of products. Revenue from our Expression business unit was approximately 30% of our business in 2013 as compared to over 40% in 2012.
As we enter 2014, we continue to execute on a strategy developed by Dr. Witney and our management team where we will realign our product portfolio, stabilize our core business and position our company for growth and increasing profitability. We expect this transformation to take several years, and have categorized this plan into three phases.

•             Phase 1 (2011-2012) -Portfolio Realignment. During this phase, we
              reorganized ourselves into business units to sharpen our business
              focus based on target markets. We also launched CytoScan®, our
              growing cytogenetic microarray product line and acquired
              eBioscience. Through eBioscience, we now offer flow cytometry and
              immunoassay products that enable us to broaden our reach into the
              translational medicine and molecular diagnostics markets. We
              believe these actions have and will promote stabilization of our
              core business and the realignment of our product portfolio has
              positioned us for growth.

•             Phase II (2013-2014) - Profitability, Strengthen Balance Sheet,
              Development of Newer Product Lines. In the beginning of 2013, we
              implemented a corporate restructuring with a goal of accelerating
              our path to profitability. Our priorities for this phase are to
              achieve profitability, repay our senior secured debt, successfully
              commercialize our newer product lines (CytoScan®, Axiom®, OncoScan,
              Human Transcriptome Array and QuantiGene® View RNA lines, as well
              as our eBioscience products) and invest in new product offerings.
              In addition, we are training and refocusing our global commercial
              organization to expand our reach to customers in the translational
              medicine, molecular diagnostics and applied markets.

•             Phase III (2015 -2016) - Strategic Flexibility, Expansion of
              Product Lines; Growth. In this phase our goal is to have well
              established product lines in translational medicine, clinical
              diagnostics and applied science such as Ag Bio. We also intend to
              have a strong balance sheet in this phase that will provide us with
              the flexibility to make strategic acquisitions.

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, and if different estimates that reasonably could have 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.
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.
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. For 2013, we conducted our annual goodwill impairment analysis during the third quarter of 2013 and concluded that the carrying amount of goodwill is less than its implied fair value. 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.
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 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.
The total amount of unrecognized tax benefits as of December 31, 2013 was approximately $22.4 million. If recognized, the amount of unrecognized tax benefits that would impact income tax expense is approximately $5.6 million. Given the potential outcome of the current examinations, it is reasonably possible that the balance of unrecognized tax benefits, the tax reserve for tax contingencies, could significantly change within the next twelve months. We classify interest and penalties related to tax positions as components of income tax expense. For the year ended December 31, 2013, the amount of accrued interest and penalties related to tax uncertainties was approximately $0.1 million for a total cumulative amount of approximately $1.1 million of non-current income taxes payable as of December 31, 2013.
We file U.S. federal, state, and foreign income tax returns in jurisdictions with varying statutes of limitations. In significant foreign jurisdictions, the 2007 through 2013 tax years generally remain subject to examination by their respective tax authorities.
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.
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 Black­Scholes-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, restricted stock units and performance based restricted stock units issued under our equity incentive plan, collectively referred to as restricted stock awards ("RSAs"), 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.
The following discussion compares the historical results of operations for the years ended December 31, 2013, 2012 and 2011.

The components of product sales are as follows:
Dollars in thousands                                                Dollar              Percentage
                           Year ended December 31,               change from           change from
                        2013         2012         2011         2012        2011        2012     2011
Consumables          $ 288,208    $ 247,687    $ 224,972    $ 40,521     $ 22,715       16  %    10 %
Instruments             14,410       18,376       16,301      (3,966 )      2,075      (22 )%    13 %
Product sales        $ 302,618    $ 266,063    $ 241,273    $ 36,555     $ 24,790       14  %    10 %

Excluding eBioscience revenue of $78.2 million and $37.0 million for 2013 and 2012 respectively, Product sales for 2013 decreased by $4.7 million or 2% compared to 2012. The decrease in revenue from Affymetrix Core was primarily due to a $20.2 million decline in our Expression business unit revenue offset by a $13.6 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. Additionally, eBioscience revenue has increased each quarter since its acquisition.
Excluding eBioscience revenue of $37.0 million for 2012, product sales for 2012 decreased $12.2 million or 5% compared to 2011 primarily due to lower volume of Genechip® chips and reagents sales. This decrease was partially offset by higher instrument revenue from clinical Genechip® Scanner 3000Dx sales due to greater volumes partially offset by lower overall average selling price.
Dollars in thousands Dollar Percentage Year ended December 31, change from change from 2013 2012 2011 2012 2011 2012 2011 Services and other $ 27,781 $ 29,560 $ 26,201 $ (1,779 ) $ 3,359 (6 )% 13 %

Excluding $5.3 million one-time licensing payment from a diagnostic partner in 2013, Services and other decreased $7.1 million or 24% in 2013 as compared to 2012 due to lower revenue from scientific services and royalties revenue due to decreased royalties and research activities.
In 2012, services and other was higher as compared to 2011 primarily due to higher revenue from scientific services.

The following table summarizes total revenue by business unit:
Dollars in thousands                                                     Dollar             %             Dollar             %
                                   Year ended December 31,            change from      change from     change from      change from
                              2013          2012          2011            2012            2012             2011            2011
Affymetrix Core reportable
. . .
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