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AFFX > SEC Filings for AFFX > Form 10-Q on 4-Aug-2014All Recent SEC Filings

Show all filings for AFFYMETRIX INC

Form 10-Q for AFFYMETRIX INC


4-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management's Discussion and Analysis of Financial Condition and Results of Operations as of June 30, 2014 and for the three and six months ended June 30, 2014 and 2013 should be read in conjunction with our financial statements and accompanying notes thereto included in this Quarterly Report on Form 10-Q and with the Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013.

All statements in this quarterly 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 Food & Drug Administration (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 and molecular diagnostic products that enable parallel analysis of biological systems at the gene, protein and cell level. We sell our products to life science 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.

Reportable Segments

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 in two reportable 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 the market needs. Affymetrix Core manufacturing operations are based on platforms that are used to produce various Affymetrix products that serve multiple applications and markets. Additionally, the business units share certain research, development and common corporate services that provide capital, infrastructure and functional support, and have similar customers and economic


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characteristics. As such, the Company has 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 rapidly growing Axiom® genotyping product line, as well as products with clinical diagnostic and research applications including the CytoScan® Dx and OncoScan products, as well as the QuantiGene ViewRNA in-situ hybridization platform for clinical translational research. In addition, the business unit is responsible for development and marketing of 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 disorders;

• Life Science Reagents: This business unit sells reagents, enzymes, purification kits and biochemicals used by life science researchers and other tool provider businesses, including those developing and marketing Next Generation Sequencing 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 eBioscience 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 QuantiGeneRNA View in-situ hybridization platform) and Procarta multiplex immunoassay product lines.

Effective 2014, the Genetic Analysis and Clinical Applications Business Unit market the QuantiGene ViewRNA in-situ hybridization platform for clinical translational research of RNA in tissue sections that was previously part of the Expression Business Unit. In addition, eBioscience began integrating the development and marketing of the remaining QuantiGene (excluding the QuantiGene ViewRNA in-situ hybridization platform) and Procarta product lines during 2013 with full integration in 2014. These products were also 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 service 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, Brazil, the Middle East and Asia Pacific, including China, we sell our products principally, through third party distributors that specialize in life science supply. In China and Brazil, we are investing in local management, sales, service and application support. In certain of these markets we also have focused and dedicated sales, service and application support as well to increase the reach and effectiveness of our distributors. For certain molecular diagnostic and industrial applications market opportunities, we supply our PbA partners with arrays, assays, reagents and instruments, which they incorporate into diagnostic products and assume the primary commercialization responsibilities.

See Note 11, "Segment Information", of the accompanying condensed consolidated financial statements for more information on our reportable operating segments.

Overview of the second quarter of 2014 and strategic initiatives

Traditionally, a significant portion of our revenue came from the well-established gene expression business, specifically our GeneChip® Expression product line and our legacy genotyping products, and we concentrated on selling these products in the basic research market focused on discovery activities. Declining sales and intense competition from newer technologies such as next generation sequencing in the gene expression business led to decreasing gene expression revenue and our legacy genotyping products also experienced declines due to competition and shifting customer priorities.


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Since Frank Witney became our President and Chief Executive Officer in July 2011, we have begun shifting our resources and focus from a dependency on our Expression business unit products to a more diversified portfolio with broader and growing revenue streams that reach into the growing markets for translational medicine, molecular diagnostics and applied sciences. Revenue from the Expression business unit was reduced to approximately 20% of total revenue in the second quarter of 2014 as compared to 26% in the same period of 2013 while revenue from our Genetic Analysis and Clinical Applications business unit increased to 40% of total revenue in the second quarter of 2014 as compared to 30% in the same period of 2013. Our eBioscience business was approximately 27% and 28% of our consolidated revenue for the second quarter of 2014 and 2013, respectively.

As we progress through 2014, we continue to focus on the strategy developed by Dr. Witney and the management team where we continue to 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 reagents and immunoassay
          products which, aligned with our new product introductions, enable us
          to broaden our reach into the translational medicine, applied, 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, pay down a significant portion of our senior secured
          debt, successfully commercialize our newer product lines (for example,
          CytoScan®, Axiom®, OncoScanTM, 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
          growing product lines in translational medicine, clinical diagnostics
          and applied science such as Ag Bio. We also intend to have a strong
          balance sheet that will provide us with strategic flexibility.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Condensed Consolidated Financial Statements, which we have prepared in accordance with U.S. generally accepted accounting principles ("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.

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 reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, refer to Note 1, "Summary of Significant Accounting Policies", in the Notes to the Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q. During the three and six months ended June 30, 2014, there have been no significant changes in our critical accounting policies and estimates compared to the disclosures in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013.


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RESULTS OF OPERATIONS

The following discussion compares the historical results of operations for the three and six months ended June 30, 2014 and 2013.

REVENUE
               Three Months Ended June 30,                              Six Months Ended June 30,
                    2014            2013       $ Change    % Change         2014            2013        $ Change    % Change
Total revenue
($ in
thousands):
Consumables   $       72,601     $ 69,973     $  2,628        4%      $      142,488     $ 138,099     $  4,389        3%
Instruments            3,279        4,197         (918 )    (22)%              7,088         7,629         (541 )     (7)%
Product sales         75,880       74,170        1,710        2%             149,576       145,728        3,848        3%
Services and
other revenue          9,552        5,294        4,258       80%              18,827        11,681        7,146       61%
Total revenue $       85,432     $ 79,464     $  5,968        8%      $      168,403     $ 157,409     $ 10,994        7%

Segment
revenue ($ in
thousands):
Affymetrix
Core:
Expression    $       17,103     $ 20,441     $ (3,338 )    (16)%     $       35,652     $  39,874     $ (4,222 )    (11)%
Genetic
analysis and
clinical
applications          34,233       23,611       10,622       45%              64,454        45,856       18,598       41%
Life science
reagents               6,851        8,292       (1,441 )    (17)%             13,794        16,600       (2,806 )    (17)%
Corporate              3,898        4,893         (995 )    (20)%              7,632        10,827       (3,195 )    (30)%
Total
Affymetrix
Core                  62,085       57,237        4,848        8%             121,532       113,157        8,375        7%
eBioscience           23,347       22,227        1,120        5%              46,871        44,252        2,619        6%
Total revenue $       85,432     $ 79,464     $  5,968        8%      $      168,403     $ 157,409     $ 10,994        7%

Segment
revenue (% of
revenue):
                    2014            2013                                    2014            2013
Expression          20%             26%                                     21%              25%
Genetic
analysis and
clinical
applications        40%             30%                                     38%              29%
Life science
reagents             8%             10%                                      8%              11%
Corporate            5%              6%                                      5%              7%
Total
Affymetrix
Core                73%             72%                                     72%              72%
eBioscience         27%             28%                                     28%              28%
Total revenue       100%            100%                                    100%            100%

Product sales

For the three months ended June 30, 2014, total product sales increased $1.7 million as compared to the same period in 2013. The increase was primarily due to higher volume of Cytogenetics, Axiom 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


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in revenue of $1.4 million due to the divestiture of our Anatrace-branded reagents in October of 2013. Instrument revenue decreased due to a lower volume of clinical instrument sales.

For the six months ended June 30, 2014, total product sales increased $3.8 million as compared to the same period in 2013. The increase was primarily due to higher revenues from our Cytogenetics, Axiom and ProCarta Plex product lines. These increases were partially offset by a decline in our legacy in vitro transcription (IVT) expression product sales and a decrease in revenue of $3.0 million due to the divestiture of our Anatrace-branded reagents in October of 2013.

Services and other revenue

For the three months ended June 30, 2014, services and other revenue increased $4.3 million as compared to the same period in 2013, primarily due to increased Axiom genotyping services of $4.0 million and OncoScan services of $0.2 million.

For the six months ended June 30, 2014, services and other revenue increased $7.1 million as compared to the same period in 2013, primarily due to increased Axiom genotyping services of $6.8 million and OncoScan services of $0.6 million. These increases were partially offset by lower royalties and licensing revenue of $0.5 million.

Expression

For the three months ended June 30, 2014, Expression revenue decreased $3.3 million as compared to the same period in 2013, primarily due to lower IVT sales of $3.4 million and lower Expression instrument sales of $0.7 million, partially offset by higher sales of Whole Transcriptome (WT) products of $0.9 million.

For the six months ended June 30, 2014, Expression revenue decreased $4.2 million as compared to the same period in 2013, primarily due to lower IVT sales of $5.1 million and lower Expression instrument sales of $0.7 million, partially offset by higher sales of WT products of $1.1 million.

Genetic Analysis and Clinical Applications

For the three months ended June 30, 2014, Genetic Analysis and Clinical Applications revenue increased $10.6 million as compared to the same period in 2013, primarily due to increased Axiom® product sales and services of $8.4 million, $1.4 million increased CytoScan sales, and $1.1 million increased OncoScan product sales and services, partially offset by a decline in sales of our legacy genotyping product SNP 6.0 of $1.1 million.

For the six months ended June 30, 2014, Genetic Analysis and Clinical Applications revenue increased $18.6 million as compared to the same period in 2013, primarily due to increased Axiom® product sales and services of $11.3 million, $3.5 million increased CytoScan sales, and $2.4 million increased OncoScan product sales and services, partially offset by a decline in sales of our legacy genotyping product SNP 6.0 of $0.4 million.

Life Science Reagents

For the three and six months ended June 30, 2014, Life Science Reagents revenue decreased $1.4 million and $2.8 million, respectively, as compared to the same periods in 2013, primarily due to the divestiture of our Anatrace-branded reagents in October of 2013.

Corporate

For the three months ended June 30, 2014, Corporate revenue decreased $1.0 million, as compared to the same period in 2013, primarily due to a net realized loss from designated cash flow hedges.

For the six months ended June 30, 2014, Corporate revenue decreased $3.2 million, as compared to the same period in 2013, primarily due to a decrease in royalty and license revenue, as well as a net realized loss from designated cash flow hedges.

eBioscience


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For the three and six months ended June 30, 2014, eBioscience revenue increased $1.1 million and $2.6 million, respectively, as compared to the same period in 2013, primarily due to higher volume of ProCarta Plex product sales.

GROSS MARGIN
Dollars in thousands                 Three Months Ended June 30,         $/Point         Six Months Ended June 30,
                                       2014               2013           Change           2014               2013         $/Point Change
Total gross profit on product
sales                            $      45,320       $      40,583     $   4,737     $     89,505       $     77,707     $       11,798
Total gross profit on services
and other revenue                        3,524               1,588         1,936            5,895              4,468              1,427

Product gross margin                        60 %                55 %           5               60 %               53 %                7
Service and other revenue gross
margin                                      37 %                30 %           7               31 %               38 %               (7 )

Product gross profit

For the three months ended June 30, 2014, product gross profit increased $4.7 million as compared to the same period in 2013, primarily due to favorable costs on higher manufacturing volume to support higher sales and cost savings impact of material in-sourcing projects. Product gross profit also improved 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 during the quarter ended June 30, 2014. The gross profit for the second quarter of 2014 includes $1.8 million of amortization of step-up in inventory fair value compared to $4.5 million in the same period of 2013. The increases are partially offset by a $0.7 million write-off of material for a discontinued product line in the second quarter of 2014.

For the six months ended June 30, 2014, product gross profit increased $11.9 million as compared to the same period in 2013, primarily due to favorable factory absorption on higher manufacturing volume to support higher sales and cost savings impact of material in-sourcing projects. Product gross profit also improved 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 during the quarter ended June 30, 2014. Gross profit for the first half of 2014 includes $4.7 million of amortization of step-up in inventory fair value compared to $9.1 million in the same period of 2013. Also, gross profit for the first half of 2013 included a $0.3 million charge for the transfer of a product line to our Singapore facility which is not recurring in the first half of 2014.

Service gross profit

For the three months ended June 30, 2014, service gross profit increased $1.9 million as compared to the same period in 2013, due to the favorable impact of revenue recognized from a large biobank project in the second quarter of 2014.

For the six months ended June 30, 2014, service gross profit increased $1.3 million as compared to the same period in 2013, due to the favorable impact of revenue recognized from a large biobank project in the second quarter of 2014, partially offset by a decrease in royalty and license revenue.

OPERATING EXPENSES
Dollars in
thousands       Three Months Ended June 30,                              Six Months Ended June 30,
                     2014            2013       $ Change     % Change        2014            2013       $ Change     % Change
Research and
development    $       12,882     $ 11,959     $     923        8%      $      24,517     $ 24,207     $     310        1%
Selling,
general and
administrative
expenses               36,266       33,518         2,748        8%             74,828       68,638         6,190        9%
Litigation
settlement                  -            -             -        0%              5,100            -         5,100       100%
Restructuring
charges                     -         (355 )         355      (100)%                -        4,487        (4,487 )    (100)%

Research and development Research and development expense increased $0.9 million and $0.3 million for the three and six months ended June 30, 2014, respectively, as compared to the same periods in 2013. The increases are primarily due


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to increased variable compensation and consulting services in respect of the development of our new instrument, partially offset by lower spending of supplies.

Selling, general and administrative Selling, general and administrative expenses increased $2.7 million and $6.2 million for the three and six months ended June 30, 2014, respectively, as compared to the same periods in 2013. The increases are primarily due to increases in compensation and benefits due to headcount increase and additional legal fees incurred during the current periods primarily related to litigation.

Litigation settlement On April 22, 2014, the Company entered into a settlement agreement with Enzo with respect to our dispute with Enzo Life Sciences, Inc. 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 . . .

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