AFFX-2013.06.30-10Q

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

(MARK ONE)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM          TO          .

COMMISSION FILE NO. 0-28218

AFFYMETRIX, INC.

(Exact name of Registrant as specified in its charter)
DELAWARE
 
77-0319159
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification Number)
 
 
 
3420 CENTRAL EXPRESSWAY
SANTA CLARA, CALIFORNIA 95051
(Address of principal executive offices and Zip Code)

Registrant’s telephone number, including area code: (408) 731-5000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer x
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

COMMON SHARES OUTSTANDING ON JULY 31, 2013: 71,571,365
 


AFFYMETRIX, INC.

TABLE OF CONTENTS

 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AFFYMETRIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
June 30,
2013
 
December 31,
2012
 
(Unaudited)
 
(See Note 1)
ASSETS:
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
43,674

 
$
25,671

Restricted cash
412

 
699

Available-for-sale securities
—

 
9,366

Accounts receivable, net
46,962

 
53,893

Inventories—short-term portion
69,210

 
72,691

Deferred tax assets—short-term portion
294

 
359

Prepaid expenses and other current assets
8,632

 
10,126

Total current assets
169,184

 
172,805

Property and equipment, net
23,330

 
28,663

Inventories—long-term portion
6,454

 
11,772

Goodwill
159,108

 
159,736

Intangible assets, net
140,610

 
152,718

Deferred tax assets—long-term portion
401

 
3,394

Other long-term assets
13,086

 
15,206

Total assets
$
512,173

 
$
544,294

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY:
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
38,977

 
$
50,355

Convertible notes—short-term portion
—

 
3,855

Term loan—short-term portion
12,750

 
12,713

Deferred revenue—short-term portion
19,382

 
8,498

Total current liabilities
71,109

 
75,421

Deferred revenue—long-term portion
3,303

 
3,450

Convertible notes
105,000

 
105,000

Term loan—long-term portion
54,150

 
60,563

Other long-term liabilities
20,813

 
22,689

Stockholders’ equity:
 
 
 
Common stock
714

 
710

Additional paid-in capital
763,176

 
759,549

Accumulated other comprehensive income
4,842

 
6,302

Accumulated deficit
(510,934
)
 
(489,390
)
Total stockholders’ equity
257,798

 
277,171

Total liabilities and stockholders’ equity
$
512,173

 
$
544,294

See accompanying Notes to the Condensed Consolidated Financial Statements

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Table of Contents

AFFYMETRIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2013
 
2012
 
2013
 
2012
REVENUE:
 
 
(See Note 1)
 
 
 
(See Note 1)
Product sales
$
74,170

 
$
58,505

 
$
145,728

 
$
116,996

Services and other
5,294

 
7,898

 
11,681

 
14,654

Total revenue
79,464

 
66,403

 
157,409

 
131,650

COSTS AND EXPENSES:
 
 
 
 
 
 
 
Cost of product sales
33,587

 
24,363

 
68,021

 
47,928

Cost of services and other
3,706

 
3,319

 
7,213

 
7,098

Research and development
11,959

 
13,588

 
24,207

 
26,919

Selling, general and administrative
33,518

 
40,526

 
68,638

 
68,450

Restructuring charges
(355
)
 
—

 
4,487

 
—

Total costs and expenses
82,415

 
81,796

 
172,566

 
150,395

Loss from operations
(2,951
)
 
(15,393
)
 
(15,157
)
 
(18,745
)
Interest income and other, net
89

 
2,276

 
432

 
2,302

Interest expense
2,724

 
218

 
5,622

 
1,198

Loss before income taxes
(5,586
)
 
(13,335
)
 
(20,347
)
 
(17,641
)
Income tax provision (benefit)
521

 
(36,984
)
 
1,196

 
(37,073
)
Net (loss) income
$
(6,107
)
 
$
23,649

 
$
(21,543
)
 
$
19,432

 
 
 
 
 
 
 
 
Basic net (loss) income per common share
$
(0.09
)
 
$
0.34

 
$
(0.30
)
 
$
0.28

Diluted net (loss) income per common share
$
(0.09
)
 
$
0.33

 
$
(0.30
)
 
$
0.27

 
 
 
 
 
 
 
 
Shares used in computing basic net (loss) income per common share
71,154

 
70,161

 
71,038

 
70,069

Shares used in computing diluted net (loss) income per common share
71,154

 
71,918

 
71,038

 
72,263

See accompanying Notes to the Condensed Consolidated Financial Statements

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Table of Contents

AFFYMETRIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(In thousands)
(Unaudited)

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
(See Note 1)
 
 
 
(See Note 1)
Net (loss) income
$
(6,107
)
 
$
23,649

 
$
(21,543
)
 
$
19,432

Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustment
1,268

 
(111
)
 
(1,856
)
 
(266
)
Unrealized change in available-for-sale and non-marketable securities
(55
)
 
(214
)
 
(331
)
 
391

Unrealized change in cash flow hedges
(361
)
 
248

 
727

 
(268
)
Net change in other comprehensive income (loss), net of tax
852

 
(77
)
 
(1,460
)
 
(143
)
Comprehensive (loss) income
$
(5,255
)
 
$
23,572

 
$
(23,003
)
 
$
19,289

See accompanying Notes to the Condensed Consolidated Financial Statements

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Table of Contents

AFFYMETRIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended June 30,
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
(See Note 1)
Net (loss) income
$
(21,543
)
 
$
19,432

Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
20,427

 
14,210

Amortization of inventory step-up in fair value
9,084

 
—

Share-based compensation
3,110

 
12,598

Deferred tax assets
—

 
(44,643
)
Other non-cash transactions
479

 
(263
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
6,253

 
140

Inventories
(1,128
)
 
2,625

Prepaid expenses and other assets
1,704

 
2,006

Accounts payable and accrued liabilities
(5,796
)
 
(10,585
)
Deferred revenue
10,783

 
553

Other long-term liabilities
(1,661
)
 
393

Net cash provided by (used in) operating activities
21,712

 
(3,534
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Acquisition of business, net of cash acquired
—

 
(308,011
)
Proceeds from sales of available-for-sale securities
9,364

 
52,063

Proceeds from maturities of available-for-sale securities
—

 
388

Capital distribution from non-marketable investments
—

 
681

Capital expenditures
(2,271
)
 
(5,174
)
Purchase of non-marketable investment
(200
)
 
—

Purchase of technology rights
(440
)
 
(1,950
)
Net cash provided by (used in) investing activities
6,453

 
(262,003
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Issuance of common stock, net
521

 
338

Payments of term loan
(6,376
)
 
—

Net proceeds from term loan
—

 
80,500

Net proceeds from issuance of 4.00% convertible senior notes
—

 
101,062

Bond and loan issuance costs
(228
)
 
—

Repurchase of 3.50% senior convertible notes
(3,855
)
 
(91,614
)
Net cash (used in) provided by financing activities
(9,938
)
 
90,286

Effect of exchange rate changes on cash and cash equivalents
(224
)
 
46

Net increase (decrease) in cash and cash equivalents
18,003

 
(175,205
)
Cash and cash equivalents at beginning of period
25,671

 
201,937

Cash and cash equivalents at end of period
$
43,674

 
$
26,732

See accompanying Notes to the Condensed Consolidated Financial Statements

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Table of Contents

AFFYMETRIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2013
(UNAUDITED)
NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The condensed consolidated financial statements include the accounts of Affymetrix, Inc. and its wholly owned subsidiaries (“Affymetrix” or the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, all adjustments (consisting of normal recurring entries) considered necessary for a fair presentation have been included.

Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying Condensed Consolidated Balance Sheet as of June 30, 2013, and the Condensed Consolidated Statements of Operations, Comprehensive (Loss) Income and Cash Flows for the three and six month periods ended June 30, 2013 and 2012 are unaudited. The Condensed Consolidated Balance Sheet as of December 31, 2012 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC on March 1, 2013. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and the accompanying notes to those financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

The accompanying Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 2012 includes adjustments that were made during the three months ended September 30, 2012 upon finalization of the valuation of certain assets acquired and liabilities assumed from the acquisition of eBioscience Holdings, Inc. ("eBioscience") discussed in Note 2. “Acquisition”. Such adjustments are considered to have occurred as of June 25, 2012 (the "Acquisition Date"). Thus, the Company's comparative financial statements as of June 30, 2012 and for the three and six months then ended have been recast to reflect these adjustments. Refer to Note 12. "Income Taxes" for further information.

There have been no material changes to the Company’s significant accounting policies as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 except as otherwise described below:

Comprehensive (Loss) Income

Comprehensive (loss) income is comprised of net loss and other comprehensive (loss) income. Other comprehensive (loss) income includes foreign currency translation adjustments, unrealized gains and losses on the Company’s available-for-sale securities that are excluded from net loss, and unrealized gains and losses on cash flow hedges. Total comprehensive (loss) income has been disclosed in the accompanying Condensed Consolidated Statements of Comprehensive (Loss) Income.


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Table of Contents

During the first quarter of 2013, the Company adopted Accounting Standards Update (“ASU”) 2013-2, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income which requires filers to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net loss. The following table summarizes the amounts reclassified out of accumulated other comprehensive income, net of tax, for the six months ended June 30, 2013 (in thousands):
 
December 31, 2012
 
(Decrease)/ Increase
 
Reclassification
Adjustments
 
June 30, 2013
Foreign currency translation adjustments
$
5,374

 
$
(1,857
)
 
$
—

 
$
3,517

Unrealized change in available-for-sale and non-marketable securities
896

 
(231
)
 
(99
)
(1
)
566

Unrealized change in cash flow hedges
32

 
1,424

 
(697
)
(2
)
759

Total accumulated other comprehensive income, net of tax
$
6,302

 
$
(664
)
 
$
(796
)
 
$
4,842

(1)
Net gain recognized in Interest income and other, net.
(2)
Net gain recognized in Revenue, except for $0.2 million gain that was recognized in Interest income and other, net due to hedging ineffectiveness. See Note 4. “Financial Instruments–Derivative Financial Instruments” for further information.

NOTE 2—ACQUISITION

On June 25, 2012 (the “Acquisition Date”), pursuant to the terms of an Amended and Restated Agreement and Plan of Merger (the "Acquisition Agreement"), a wholly-owned subsidiary of the Company merged with and into eBioscience, Inc. (“eBioscience”) with eBioscience surviving as a wholly-owned subsidiary of the Company (the "Acquisition"). eBioscience specializes in the development, manufacturing, marketing and distribution of research tools in the areas of flow cytometry, immunoassays, microscopic imaging and other protein-based analyses.

The results of operations of the acquired eBioscience business and the fair values of the assets acquired and liabilities assumed have been included in the accompanying Condensed Consolidated Financial Statements since the Acquisition. During the three and six months ended June 30, 2013, revenue recognized from eBioscience was $18.8 million and $37.9 million, respectively. For the three and six months ended June 30, 2013, the Company recorded a net loss from eBiosciences of $4.2 million and $8.2 million, respectively. The Company considered the eBioscience fair value analysis to be final as of December 31, 2012.

NOTE 3—FAIR VALUE

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.


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Table of Contents

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table details the Company’s financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2013 and December 31, 2012 (in thousands):
 
Quoted
Prices
In Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Total
June 30, 2013
 
 
 
 
 
Assets:
 
 
 
 
 
Derivative assets
$
—

 
$
804

 
$
804

 
 
 
 
 
 
Liabilities:
 
 
 
 
 
Derivative liabilities
$
—

 
$
93

 
$
93

 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
Assets:
 
 
 
 
 
U.S. government obligations and agency securities
$
—

 
$
6,829

 
$
6,829

U.S. corporate debt
—

 
664

 
664

Foreign corporate debt and equity securities
—

 
1,873

 
1,873

Total
$
—

 
$
9,366

 
$
9,366

 
 
 
 
 
 
Derivative assets
$
—

 
$
842

 
$
842

 
 
 
 
 
 
Liabilities:
 
 
 
 
 
Derivative liabilities
$
—

 
$
829

 
$
829


The Company’s Level 2 input assumptions are determined based on review of third-party sources.

The fair value of the Company’s derivative assets and liabilities is based on the estimated consideration the Company would pay or receive to terminate these agreements on the reporting date as determined by quoted prices for such instruments in active markets. The derivative assets and liabilities are located in Other current assets and Accrued liabilities, respectively, in the accompanying Condensed Consolidated Balance Sheets.

As of June 30, 2013 and December 31, 2012, the Company had no financial assets or liabilities measured on a recurring basis requiring Level 3 classification, including those that have unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets and liabilities.

Debt Obligations

Debt obligations are not recorded at fair value on a recurring basis and are carried at amortized cost. The fair value of the Company's 4.00% Convertible Senior Notes (“4.00% Notes”) is based on quoted market prices at the balance sheet date and categorized within Level 1 of the fair value hierarchy. At June 30, 2013, the fair value of the 4.00% notes was approximately $106.1 million. The fair value of the third-party financing (“Term Loan”) approximated its carrying value and is categorized within Level 3 of the fair value hierarchy. At June 30, 2013, the fair value of the Term Loan was $66.9 million. See Note 9. “Debt Obligations” for further information on the Company’s debt obligations.


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NOTE 4—FINANCIAL INSTRUMENTS

Investments in Debt and Equity Securities

The fair values of the Company’s available-for-sale securities are based on quoted market prices and are included in cash and cash equivalents and available-for-sale securities on the accompanying Condensed Consolidated Balance Sheets based on each respective security’s maturity.

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 Condensed Consolidated Statements of Operations.

The following is a summary of available-for-sale securities as of December 31, 2012 (in thousands):

 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
U.S. government obligations and agency securities
$
6,775

 
$
54

 
$
—

 
$
6,829

U.S. corporate debt
651

 
13

 
—

 
664

Foreign corporate debt and equity securities
1,837

 
36

 
—

 
1,873

Total available-for-sale securities
$
9,263

 
$
103

 
$
—

 
$
9,366


Non-Marketable Securities

As of June 30, 2013 and December 31, 2012, the carrying amounts of the Company’s non-marketable securities, totaling $4.3 million and $4.4 million, respectively, equaled their estimated fair values. They consist primarily of an investment in a limited partnership investment fund who invests in companies in the life science industry and are located in the United States. The investments are initially valued at the 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. There was no other-than-temporary impairment recognized during the six months ended June 30, 2013 and 2012. Net investment results are included in Interest income and other, net in the accompanying Condensed Consolidated Statements of Operations. Depending on market conditions, the Company may incur additional charges on this investment portfolio in the future.

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 is held in the non US-Dollar functional 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. The Company’s accounting policies for these instruments are based on whether the instruments are classified as designated or non-designated hedging instruments. The Company recognizes derivatives on its accompanying Condensed Consolidated Balance Sheets at fair value. The effective portions of designated cash flow hedges are recorded in Other Comprehensive Income (“OCI”) until the hedged item is recognized in earnings. As of June 30, 2013, the Company’s existing foreign currency forward exchange contracts mature within 12 months. The deferred amount related to the Company’s derivatives currently recorded in OCI and expected to be recognized into earnings over the next 12 months is a net gain of $0.8 million. Derivatives that are not designated as hedging instruments and the ineffective portions of cash flow hedges are adjusted to fair value through earnings.

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 in OCI associated with such derivative instruments are reclassified immediately into operations through Interest income and other, net. Any subsequent changes in fair value of such derivative instruments are

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reflected in Interest income and other, net unless they are re-designated as hedges of other transactions. During the six months ended June 30, 2013, the Company recognized $0.2 million in net gains in Interest income and other, net, related to the loss of hedge designation on a portion of cash flow hedges related to the Japanese yen that were deemed ineffective due to lower-than-forecasted revenue from Japan. No additional hedges are deemed ineffective as of June 30, 2013. No cash flow hedges were de-designated during the six months ended June 30, 2013.

Under the Credit Agreement as defined in Note 9. “Long-Term Debt Obligations”, the Company is required to maintain derivative contracts to protect against fluctuations in interest rates with respect to at least 35% of the aggregate principal amount of the Term Loan, as defined in Note 9. “Long-Term Debt Obligations,” then outstanding, with such derivative contracts being required to have at least a three-year term. Accordingly, the Company has entered into an interest rate swap (the “Interest Rate Swap”) for which the notional amount was originally set at $27.5 million, with quarterly reduction to the notional amount consistent with the mandatory amortization schedule of the Term Loan. The Interest Rate Swap calls for quarterly fixed rate payments of 1.70% of the notional amount in exchange for a variable rate quarterly receipts equal to a 3-month LIBOR rate with a floor of 1.50%. The Interest Rate Swap terminates on June 25, 2015.

The Company did not designate the Interest Rate Swap as a hedging instrument and will recognize adjustments to fair value through Interest and other income on the accompanying Condensed Consolidated Statements of Operations at each reporting date. As of June 30, 2013, the fair value of the Interest Rate Swap was $0.1 million.

As of June 30, 2013 and December 31, 2012, the total notional values of the Company’s derivative assets and liabilities were as follows (in thousands):

 
June 30, 2013
 
December 31, 2012
Euro
$
18,363

 
$
16,933

Japanese Yen
3,677

 
10,542

British Pound
4,373

 
4,278

Interest rate swap
27,519

 
27,519

Total
$
53,932

 
$
59,272


Other than the Interest Rate Swap, the Company did not have any derivative assets or liabilities that were not designated or qualifying as hedges at either June 30, 2013 or December 31, 2012.

As a result of the use of derivative instruments, the Company is exposed to the risk that the counterparties may be unable to meet the terms of the underlying agreements. To mitigate this 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 derivative contracts for trading or speculative purposes and is not party to any leveraged derivative instruments.

The following table shows the Company’s derivative assets and liabilities measured at fair value as reflected on the accompanying Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012 (in thousands):

 
June 30, 2013
 
December 31, 2012
 
Balance Sheet
Classification
Derivative assets:
 
 
 
 
 
Foreign exchange contracts
$
804

 
$
842

 
Other current assets
Derivative liabilities:
 
 
 
 
 
Foreign exchange contracts
19

 
752

 
Accrued liabilities
Interest rate swap
74

 
77

 
Accrued liabilities


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The following table shows the effect, net of tax, of the Company’s derivative instruments on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income (OCI) for the three and six months ended June 30, 2013 and 2012 (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
Net (loss) gain recognized in OCI, net of tax (1)
$
(361
)
 
$
248

 
$
725

 
$
(268
)
Net gain reclassified from accumulated OCI into Revenue, net of tax (2)
254

 
697

 
1,081

 
1,215

Net gain reclassified from accumulated OCI into Interest income and other, net, net of tax (3)
—

 
—

 
158

 
—

Net gain recognized in Interest income and other, net, net of tax (4)
30

 
3

 
45

 
28

Derivatives not designated as hedging relationships:
 
 
 
 
 
 
 
Net gain (loss) recognized in Interest income and other, net, net of tax (5)
4

 
22

 
147

 
(126
)

(1)
Net change in the fair value of the effective portion classified in OCI
(2)
Effective portion classified as Revenue
(3)
Ineffective portion classified as Interest income and other, net
(4)
Amount excluded from effectiveness testing classified as Interest income and other, net
(5)
Classified in Interest and other, net

NOTE 5—STOCKHOLDERS’ EQUITY AND SHARE-BASED COMPENSATION EXPENSE

Share-based Compensation Plans

The Company has a share-based compensation program, most recently, the 2000 Amended and Restated Equity Incentive Plan (the “Plan”), 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 non-vested stock awards (also known as restricted stock) granted under various stock plans. As of June 30, 2013, the Company had approximately 5.3 million shares of common stock reserved for future issuance under its share-based compensation plans including 2.0 million shares of common stock authorized for issuance under the Company’s 2012 Inducement Plan that was adopted by the Board of Directors in June 2012. New shares are issued as a result of stock option exercises, restricted stock units vesting and restricted stock award grants.

The Company recognized share-based compensation expense as follows (in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Costs of product sales
$
262

 
$
340

 
$
429

 
$
712

Research and development
202

 
306

 
531

 
673

Selling, general and administrative
812

 
9,560

 
2,150

 
11,213

Total share-based compensation expense
$
1,276

 
$
10,206

 
$
3,110

 
$
12,598


As of June 30, 2013, $10.9 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 2017. The weighted‑average terms of the unrecognized share-based compensation expense are 2.6 years for stock options and 2.2 years for restricted stock.


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Stock Options

The fair value of options was estimated at the date of grant using the Black Scholes Merton option pricing model with the following weighted‑average assumptions:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Risk free interest rate
0.9
%
 
0.7
%
 
0.9
%
 
0.8
%
Expected dividend yield
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Expected volatility
68
%
 
67
%
 
68
%
 
67
%
Expected option term (in years)
4.6

 
4.6

 
4.6

 
4.6


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 10 years. The expected volatility 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 three months ended June 30, 2013 and 2012, was $2.10 and $2.55, respectively, and during the six months ended June 30, 2013 and 2012, was $2.10 and $2.48, respectively.

Performance-Based Awards

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 0.2 million shares. As of June 30, 2013, performance conditions pertaining to 0.1 million shares of the PRSUs were achieved. The Company expects that an additional 45,400 shares of the PRSUs, with a grant date fair value of $4.67 per PRSU, will vest with respect to the Performance Period ending December 31, 2013 and the fair value of such PRSU’s is 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 $0.2 million as of June 30, 2013.

During July 2012, the Compensation Committee granted certain PRSUs following the acquisition of eBioscience referred to as an Acquisition Performance Share Program (the “Program”). The purpose of the Program is to align key management and senior leadership with stockholders’ interests and to retain key employees. The measurement periods for the Program are the twelve month periods ended June 30, 2013 and June 30, 2014, respectively. Members of eBioscience management and other key employees are participating in the Program. Awards granted under the Program are granted in the form of performance shares pursuant to the terms of the Company’s 2012 Inducement Plan. If pre-determined eBioscience specific performance goals are met, shares of stock will 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 0.9 million PRSUs under the Program at a grant date fair value of $4.16 per PRSU and expects 28% of the PRSUs will vest. The fair value of the PRSUs is 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 $0.3 million as of June 30, 2013.

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 is to retain key employees. The measurement period for the 2013 Program is the twelve month period ended December 31, 2013 and the awards granted under the 2013

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Program are 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 will vest in equal installments over two or four years. The level of achievement of financial performance will be assessed during the first quarter of fiscal 2014 after which the share of stock will be issued to the participants, contingent upon the recipient’s continued service to the Company.

In 2013, the Company awarded 0.3 million PRSUs under the 2013 Program at a grant date fair value of $3.84 per PRSU and does not expect these PRSUs will vest.

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. The ESPP reserved a total of 7.0 million shares of the Company’s common stock for issuance under the plan and 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 12 months and include two 6 months 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 June 30, 2013, there were 308 participants in the plan. Included in total share-based compensation cost for the three and six months ended June 30, 2013 was $0.1 million and $0.3 million, respectively, related to the ESPP.

During the three and six months ended June 30, 2013 and 2012, the fair value of shares under the ESPP was estimated using the following assumptions:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Risk free interest rate
0.1
%
 
0.1
%
 
0.1
%
 
0.1
%
Expected dividend yield
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Expected volatility
52.6
%
 
67
%
 
52.6
%
 
67
%
Expected term (in years)
0.6

 
0.8

 
0.6

 
0.8


NOTE 6—INVENTORIES

At June 30, 2013 and December 31, 2012, inventories consisted of the following (in thousands):

 
June 30, 2013
 
December 31, 2012
Raw materials
$
12,007

 
$
11,167

Work-in-process
30,843

 
35,562

Finished goods
32,814

 
37,734

Total
$
75,664

 
$
84,463

 
 
 
 
Short-term portion
69,210

 
72,691

Long-term portion
6,454

 
11,772


Inventory at June 30, 2013 includes unamortized fair value step-up in basis of $10.5 million as a result of the Acquisition. Amortization expense on the fair value step-up during the six months ended June 30, 2013 was $9.1 million.


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NOTE 7—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):

 
 
Carrying Value, Gross
 
Accumulated Amortization
 
Intangible Assets, Net
 
Weighted
Average
Useful Life
 
 
December 31,
2012
 
(Decrease)/ Increase (1)
 
June 30,
2013
 
December 31,
2012
 
(Increase)/
Decrease (2)
 
June 30,
2013
 
December 31,
2012
 
June 30,
2013
 
Customer relationships
 
$
76,874

 
$
(294
)
 
$
76,580

 
$
(14,346
)
 
$
(3,529
)
 
$
(17,875
)
 
$
62,528

 
$
58,705

 
11 years
Developed technologies
 
76,814

 
(304
)
 
76,510

 
(18,489
)
 
(2,902
)
 
(21,391
)
 
58,325

 
55,119

 
10 years
Trademarks and tradenames
 
17,818

 
(4
)
 
17,814

 
(3,009
)
 
(1,694
)
 
(4,703
)
 
14,809

 
13,111

 
5 years
Other contractual agreements
 
3,055

 
(14
)
 
3,041

 
(785
)
 
(756
)
 
(1,541
)
 
2,270

 
1,500

 
2 years
Licenses
 
81,156

 
481

 
81,637

 
(66,370
)
 
(3,092
)
 
(69,462
)
 
14,786

 
12,175

 
14 years
Total definite-lived intangible assets
 
$
255,717

 
$
(135
)
 
$
255,582

 
$
(102,999
)
 
$
(11,973
)
 
$
(114,972
)
 
$
152,718

 
$
140,610

 
 

(1)
Includes a decrease in carrying value of $0.6 million related to foreign currency translation
(2)
The impact of foreign currency translation on accumulated amortization was not significant.

The expected future annual amortization expense of the Company’s intangible assets is as follows (in thousands):
For the Year Ending December 31,
Amortization
Expense
2013, remainder thereof
$
11,577

2014
20,843

2015
14,696

2016
13,173

2017
11,498

Thereafter
68,823

Total
$
140,610


Change in the Company’s goodwill during the six months ended June 30, 2013 is as follows (in thousands):

Balance at December 31, 2012
$
159,736

Effects of foreign currency change
(628
)
Balance at June 30, 2013
$
159,108



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NOTE 8—WARRANTIES

The Company provides for anticipated warranty costs at the time the associated product revenue is recognized. Product warranty costs are estimated based upon the Company’s historical experience and the applicable 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 in regards to the changes in the Company’s product warranty liability for the six months ended June 30, 2013 is as follows (in thousands):

Balance at December 31, 2012
$
802

Additions charged to cost of product sales
353

Repairs and replacements
(205
)
Balance at June 30, 2013
$
950


NOTE 9—LONG-TERM DEBT OBLIGATIONS

Term Loan

On June 25, 2012, the Company entered into a credit agreement (the “Credit Agreement”) by, and among, Affymetrix and its domestic subsidiaries, and General Electric Capital Corporation (“GE Capital”), Silicon Valley Bank and other financial institutions party thereto from time to time (collectively, the “Lenders”), as well as certain securities affiliates of the Lenders. The Credit Agreement provides for the 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 (the “Revolving Credit Facility” and, together with the Term Loan, the “Senior Secured Credit Facility”), each with a term of 5 years. As of June 30, 2013, the Company had borrowed a total of $85.0 million under the Term Loan which was used to finance a portion of the Acquisition.

At the option of the Company (subject to certain limitations), borrowings under the Credit Agreement 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 4.00% per annum, 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 selected by GE Capital) 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. However, the base rate will not be less than a floor of 2.50% 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 lenders, nine or 12 years) and will be equal to LIBOR, plus 5.00%, calculated based on the actual number of days elapsed in a 360-day year. However, LIBOR will be deemed not to be less than a floor of 1.50% per annum. Interest will be paid at the end of each interest period or, in the case of interest periods longer than three months, quarterly. In 2012, the Company entered into its Interest Rate Swap as required by the terms of the Credit Agreement with a third-party lending institution. Refer to Note 4. “Financial Instruments–Derivative Financial Instruments” for further information. At June 30, 2013, the applicable interest rate was approximately 6.50%.

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 Credit Agreement requires the Company to maintain a fixed charge coverage ratio of at least 1.5 to 1.0, a senior leverage ratio (which is the ratio of senior debt to trailing 12 months’ earnings before interest, taxes, depreciation, amortization and other one-time items (“EBITDAO”) not exceeding initially 2.00 to 1.00 and stepping down to 1.50 to 1.00; and a total leverage ratio (which is the ration of total debt to trailing 12 months’ EBITDAO) not exceeding initially 4.75 to 1.00 and stepping down to 3.50 to 1.00. The 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)

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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.

Following the restructuring activity discussed in Note 15. “Restructuring” and lower-than-expected revenue in the first quarter of 2013, on April 8, 2013, the Company and the Lenders amended Credit Agreement to provide a limited waiver and to amend certain covenants with respect to fiscal year 2013 (the “Amendment”). Under the Amendment, the Lenders agreed to waive any event of default arising from the failure of the Company to comply with the total leverage ratio and senior leverage ratio for the three months ended March 31, 2013. For the quarters ended March 31, 2013 through September 30, 2013, the definition of EBITDAO was amended to allow the add back of up to $11.0 million of trailing twelve month restructuring and integration charges in the calculation of EBITDAO compared to an add back of up to $7 million prior to the Amendment. In addition, the quarterly senior leverage ratio was revised to not exceeding 1.80 to 1.00 for June 30, 2013 and September 30, 2013 compared to 1.75 and 1.00 for these periods prior to the Amendment. The total senior leverage multiple was revised to not exceeding 4.50 to 1.00, 4.75 to 1.00 and 4.50 to 1.00 for the quarters ending March 31, June 30 and September 30, 2013, respectively, as compared to the original total leverage ratio not exceeding 4.25 to 1.00 for each of these periods. As of June 30, 2013, the Company was in compliance with the covenants.

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 stepdown, (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 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 June 30, 2013, the Company was in compliance with the covenants.

Additionally, the proceeds from the Term Loan are net of debt issuance costs of approximately $4.5 million which are being amortized using the effective interest method.

As of June 30, 2013, the Company had an outstanding principal balance of $66.9 million and incurred $1.7 million and $3.4 million, respectively, in interest expense under the Senior Secured Credit Facility for the three and six months ended June 30, 2013.

The Term Loan is scheduled to amortize in quarterly installments in amounts resulting in an annual amortization of 10% during the first year, 15% during the second year, 15% during the third year, 20% during the fourth year and 40% during the fifth year after June 25, 2012. The principal amount of unpaid maturities per the Credit Agreement is as follows (in thousands):
2013, remainder thereof
$
—

2014
9,563

2015
13,813

2016
17,000

2017
26,524

Total
$
66,900



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4.00% Convertible Senior Notes

On June 25, 2012, the Company issued $105.0 million principal amount of 4.00% Convertible Senior 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.

As of June 30, 2013, the outstanding balance on the 4.00% Notes was $105.0 million and interest incurred for the three and six months ended June 30, 2013 was $1.2 million and $2.4 million, respectively.

3.50% Senior Convertible Notes

During the first quarter of 2012, the Company redeemed its remaining outstanding 3.50% Senior Convertible Notes for $3.9 million in total cash consideration, including accrued interest of $0.1 million. The notes were redeemed at par and the related deferred financing costs were written off.

NOTE 10—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 common stock subject to repurchase, stock options (calculated based on the treasury stock method), shares under the Company’s ESPP and convertible debt (calculated using an as-if-converted method). Potentially dilutive securities are excluded from shares used in computing diluted net loss per common share if their effect would be anti-dilutive.

The potential dilutive securities excluded from diluted earnings per common share were as follows (in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Employee stock compensation plans
5,646

 
5,780

 
5,646

 
5,785

ESPP
14

 
—

 
14

 
—

Restricted stock subject to repurchase
3,887

 
2,026

 
3,887

 
2,057

Convertible notes
17,857

 
—

 
17,868

 
—

Total
27,404

 
7,806

 
27,415

 
7,842



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NOTE 11—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 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 flow 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:

E8 Pharmaceuticals LLC

On July 1, 2008, the Company was named as a defendant in a complaint filed by plaintiffs E8 Pharmaceuticals LLC and Massachusetts Institute of Technology ("MIT") in the United States District Court of Massachusetts. In the complaint, the plaintiffs allege that the Company is infringing one patent owned by MIT and licensed to E8 Pharmaceuticals by making and selling the Company’s GeneChip® products to customers and teaching its customers how to use the products. The plaintiffs seek a permanent injunction enjoining the Company from further infringement, unspecified monetary damages, enhanced damages pursuant to 35 U.S.C. §284, costs, attorneys’ fees and other relief as the court deems just and proper. On September 4, 2012, the District Court issued its ruling construing key claims of the patent at issue. The parties thereafter stipulated to the dismissal of plaintiff’s claims and in September, the District Court dismissed the lawsuit in its entirety. On September 26, 2012, the plaintiffs filed an appeal with the United States Court of Appeals for the Federal Circuit appealing the District Court’s dismissal of the lawsuit. The Company will continue to vigorously defend against the plaintiffs’ claims.

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. In its complaint, Enzo seeks monetary damages and an injunction against the Company from using, manufacturing or selling Enzo products and from inducing collaborators and customers to use Enzo products in violation of the 1998 agreement. Enzo also seeks the transfer of certain Affymetrix patents to 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. In its complaint, the Company alleges that Enzo has engaged in a pattern of wrongful conduct against it and other Enzo labeling reagent customers by, among other things, asserting improperly broad rights in its patent portfolio, improperly using the 1998 agreement and distributorship agreements with others in order to corner the market for non-radioactive labeling reagents, and improperly using the 1998 agreement to claim ownership rights to the Company’s proprietary technology. The court has not set a trial date for these actions, but has advised the parties to clear time for trials at the end of 2013 or the beginning of 2014, to potentially try these actions as well as other related actions between Enzo and other third parties.

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. 7064197 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 six months ended June 30, 2013, the Company did not incur significant costs in connection with administrative proceedings.


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NOTE 12—INCOME TAXES

During the three and six months ended June 30, 2013, the Company recorded a provision for income taxes of approximately $0.5 million and $1.2 million, respectively. The provision for income taxes primarily consisted of foreign taxes.

Due to the Company’s history of cumulative operating losses, management concluded that, after considering all the available objective evidence, it is not more likely than not that all the Company’s net deferred tax assets will be realized. Accordingly, all of the U.S. deferred tax assets continue to be subject to a valuation allowance as of June 30, 2013.

As of June 30, 2013, there have been no material changes to the total amount of unrecognized tax benefits.

During the three and six months ended June 30, 2012, the company recorded an income tax benefit of approximately $37.0 million and $37.1 million, respectively. The income tax benefit resulted primarily from a reduction in the valuation allowance recorded against the Company's net deferred tax assets of $37.5 million recorded during the second quarter of 2012, due to 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.    

As described in the Company's Quarterly Report on Form 10-Q for the nine months ended September 30, 2012 in Note 2. "Acquisition", the Condensed Consolidated Statements of Operations for the six months ended June 30, 2012 includes adjustments that were made upon finalization of the valuation of certain assets acquired and liabilities assumed from the acquisition of eBioscience Holdings, Inc. ("eBioscience"). 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 can be used as a source of income when utilizing certain domestic deferred tax assets. The aforementioned purchase accounting adjustments that reduced certain tangible and intangible assets and reduced the related deferred tax liabilities resulted in an increase in the valuation allowance recorded against the Company's consolidated net deferred tax assets. Under Accounting Standards Codification ("ASC") 805-740, 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.  Such purchase accounting adjustments (also referred to as “measurement period adjustments”) are considered to have occurred as of June 25, 2012 (the "Acquisition Date"). As a result of the retrospective purchase accounting and related income tax valuation adjustments from the Acquisition, the Company recast its income tax benefit for the second quarter of 2012, lowering it by $7.2 million from net $44.3 million with a corresponding increase in valuation allowance. The Company's Condensed Consolidated Financial Statements as of and for the period ended June 30, 2012, were recast to reflect these adjustments.

NOTE 13—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. Prior to 2012, the Company was organized as one reportable operating segment. Subsequent to the Acquisition, the Company’s business was reorganized into two reportable operating segments for financial reporting purposes, Affymetrix Core and eBioscience.

In 2012, the Company reorganized its business in the following four business units: Expression, Genetic Analysis and Clinical Applications, Life Science Reagents and Corporate. The Expression business unit markets the Company’s gene expression products and services, including in vitro transcription and other whole transcript arrays and associated reagents and software and our QuantiGene line comprised of low-to-mid-plex RNA analysis products. The Genetic Analysis and Clinical Applications business unit markets the Company’s genotyping and clinical array-systems, including cytogenetics products. The Life Science Reagents business unit targets the life science reagent markets, marketing reagents, enzymes, purification kits and biochemicals used by life science researchers. The Corporate business unit is comprised primarily of revenue from royalty arrangements, and field revenue from services provided to customers by the Company. The Company determined that its manufacturing operations are centralized and based on platforms that are used to produce various products that serve multiple applications and markets. Additionally, the business units share research, development and common

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corporate services that provide capital, infrastructure and functional support. Based on the facts and circumstances, the Company concluded that the four business units represent one reportable operating segment, Affymetrix Core.

The Company’s other reportable operating segment, eBioscience, was acquired in the second quarter of 2012 and operates as a separate business unit. eBioscience specializes in the development, manufacturing, marketing and distribution of research tools in the areas of flow cytometry reagents, immunoassays, microscopic imaging and other protein-based analyses. The Acquisition allows the Company to expand addressable markets and continue to diversify the business beyond genomics discovery into cell and protein analysis.

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 excluding eBioscience whose business is primarily operated on a stand-alone basis.

The following table shows revenue and loss from operations by reportable operating segment for the three and six months ended June 30, 2013 and 2012 (in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Revenue:
 
 
 
 
 
 
 
Affymetrix Core
$
60,618

 
$
65,027

 
$
119,555

 
$
130,274

eBioscience
18,846

 
1,376

 
37,854

 
1,376

Totals
$
79,464

 
$
66,403

 
$
157,409

 
$
131,650

Loss from operations:
 
 
 
 
 
 
 
Affymetrix Core
$
1,251

 
$
(15,552
)
 
$
(6,590
)
 
$
(18,904
)
eBioscience
(4,202
)
 
159

 
(8,567
)
 
159

Totals
$
(2,951
)
 
$
(15,393
)
 
$
(15,157
)
 
$
(18,745
)

NOTE 14—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 June 30, 2013, no royalties had been earned pertaining to this agreement.

NOTE 15—RESTRUCTURING

In the fourth quarter of 2012, the Company initiated a cost reduction action that included workforce. During the first quarter of 2013, approximately 100 employees were notified of their involuntary termination. The Company estimates that the total restructuring charge associated with the plan will be approximately $6.3 million, substantially all of which is compensation and benefits afforded to terminated employees. During the year ended December 31, 2012, $1.8 million of restructuring expense related to employees who were notified prior to the end of the year was recognized. During the six months ended June 30, 2013, the Company recognized $4.5 million in restructuring expense and made substantially all of the cash payments, except for $0.3 million which was recorded at June 30, 2013 in Accounts payable and accrued liabilities on the accompanying Condensed Consolidated Balance Sheets. No additional costs are expected to be incurred, and the Company anticipates the remaining cash payments will be made during the third quarter of 2013.


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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, 2013 and for the three and six months ended June 30, 2013 and 2012 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, 2012.

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 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 our Annual Report on Form 10-K for the year ended December 31, 2012. 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 leading provider of life science research and molecular diagnostic products that enable multiplex and parallel analysis of biological systems at the gene, protein and cellular level. We sell our products to genomic research centers, academic institutions, government and private laboratories, as well as pharmaceutical, diagnostic and biotechnology companies. Over 48,000 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 Operating Segments

Our operations consist of two reportable operating segments, Affymetrix Core and eBioscience. During both the three and six months ended June 30, 2013, Affymetrix Core accounted for approximately 76% of total revenue and eBioscience accounted for approximately 24% of total revenue.


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Affymetrix Core is divided into four business units, with each unit having its own marketing groups to better serve customers and respond quickly to the market needs. In addition, the business units share 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 Core 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, and the QuantiGene® line of low-to-mid-plex RNA measurement products.

•
Genetic Analysis and Clinical Applications: This business unit markets the Company’s genotyping products, such as the Axiom® product line, and products with clinical research applications, such as the CytoScan® cytogenetics arrays.

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

•
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, 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 reagents, immunoassays, microscopic imaging and other protein-based analyses.

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, Brazil, the Middle East and Asia Pacific, including the People’s Republic of China, we sell our products principally, but not exclusively, through third party distributors that specialize in life science supply. For molecular diagnostic and industrial applications market opportunities, we supply our partners with arrays, reagents and instruments, which they incorporate into diagnostic products or other routine applications and assume the primary commercialization responsibilities.

See Note 13. “Segment and Geographic Information” for more information on our reportable operating segments.

Overview of the Second Quarter of 2013

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 more than half of our revenue as we concentrated on selling these products in the basic research market focused on discovery research. Declining sales in our Expression business resulting from intense competition from alternative technologies such as next generation sequencing has been a primary reason for annual decreases in revenue since 2007.

Affymetrix Core reported revenue of $60.6 million for the three months ended June 30, 2013, as compared to $65.0 million during the same period in 2012. Revenue reported from eBiosciences was $18.8 million and $1.4 million for the three months ended June 30, 2013 and 2012, respectively. The decrease in revenue from Affymetrix Core was primarily due to a $5.4 million decline in our Expression business unit revenue compared to the same period in 2012 across all regions, particularly in Japan, due to a challenging business environment coupled with $1.2 million lower royalties revenue. These decreases were partially offset by a $2.9 million increase in our Genetic Analysis and Clinical Applications business unit as a result of increased sales in our Cytogenetics line of products which has been steadily growing since its launch in 2012 and our Axiom® products that more than doubled in revenue compared to the three months ended June 30, 2012.  The increase in revenue from eBioscience reflects the closing of our acquisition of eBioscience, which occurred on June 25, 2013.


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Since Dr. Frank Witney became our President and Chief Executive Officer in July 2011, we have focused on reducing our dependency on our Expression business unit by building a more diversified portfolio with broader revenue streams, including products that reach into the growing markets for translational medicine and molecular diagnostics. Excluding eBioscience, revenue from the Expression business unit was approximately 40% of Affymetrix Core business in the second quarter of 2013 as compared to 46% in the same period of 2012 while revenue from our Genetic Analysis and Clinical Applications business unit was 38% in the second quarter of 2013 as compared to 31% in the same period of 2012.

As we progress through 2013, we continue to execute on the 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, grew our Axiom® genotyping platform aggressively and acquired eBioscience. We believe these actions will lead to a stabilization of our core business and the realignment of our product portfolio will position us for growth.

•
Phase II (2013-2014) – Profitability, Strengthen Balance Sheet, Development of Newer Product Lines. In the beginning of 2013, we communicated a corporate restructuring with a goal of accelerating our path to profitability. The corporate restructuring is expected to result in annualized savings of approximately $25 million based on 2013 run rates, of which $5 million is expected to be in cost of goods sold. Our priorities for this phase will be to achieve profitability, repay our senior secured debt, successfully commercialize our newer product lines (CytoScan®, Axiom® and QuantiGene® lines, as well as our eBioscience products) and invest in new product offerings. In addition, we will train and refocus 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. Our goal is to have a strong balance sheet in this phase that will provide us with the flexibility to make strategic acquisitions. In addition, we aim to grow revenues with developed product lines and new product offerings in the translational medicine and molecular diagnostic markets.

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 it believes 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. Management has discussed the development, selection and disclosure of significant estimates with the Audit Committee of our Board of Directors. 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, 2013, 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, 2012.

RESULTS OF OPERATIONS

The following discussion compares the historical results of operations for the three and six months ended June 30, 2013 and 2012.


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REVENUE

The components of revenue are as follows:
Dollars in thousands
Three Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
Six Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
2013
 
2012
 
 
 
2013
 
2012
 
 
Consumables
$
69,973

 
$
54,691

 
$
15,282

 
28%
 
$
138,099

 
$
108,479

 
$
29,620

 
27%
Instruments
4,197

 
3,814

 
383

 
10
 
7,629

 
8,517

 
(888
)
 
(10)
Product sales
74,170

 
58,505

 
15,665

 
27
 
145,728

 
116,996

 
28,732

 
25
Services and other revenue
5,294

 
7,898

 
(2,604
)
 
(33)
 
11,681

 
14,654

 
(2,973
)
 
(20)
Total revenue
$
79,464

 
$
66,403

 
$
13,061

 
20%
 
$
157,409

 
$
131,650

 
$
25,759

 
20%

Excluding second quarter revenue from eBioscience of $18.8 million, total product sales decreased $1.8 million in the three months ended June 30, 2013 as compared to the same period in 2012. The decrease in revenue from Affymetrix Core was primarily due to a $5.4 million decline in our Expression business unit revenue across all regions, particularly in Japan, due to a challenging business environment. This decrease was partially offset by a $2.9 million increase in our Genetic Analysis and Clinical Applications business unit as a result of increased volume of sales in our Cytogenetics line of products which has been steadily increasing since its launch in 2012 and our Axiom® products which more than doubled compared to the three months ended June 30, 2012.

Total product sales increased in the six months ended June 30, 2013 as compared to the same period in 2012 primarily due to period revenue from eBiosciences of $37.9 million. Excluding eBiosciences revenue, product sales were down $7.7 million. The decrease in revenue from Affymetrix Core was primarily due to a $14.8 million decline in our Expression business unit revenue across all regions, particularly in Japan, due to a challenging business environment. This decrease was partially offset by a $5.8 million increase in our Genetic Analysis and Clinical Applications business unit as a result of increased volume of sales in our Cytogenetics line of products which has been steadily increasing since its launch in 2012 and our Axiom® products that more than doubled compared to the six months ended June 30, 2012.

Services and other revenue decreased for the three and six months ended June 30, 2013 as compared to 2012 due to decreased royalties and research activities.

TOTAL REVENUE BY BUSINESS UNIT

The following table summarizes revenue by business unit:

Dollars in thousands
Three Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
Six Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
2013
 
2012
 
 
 
2013
 
2012
 
 
Expression
$
24,370

 
$
29,808

 
$
(5,438
)
 
(18)%
 
$
47,334

 
$
62,122

 
$
(14,788
)
 
(24)%
Genetic analysis and clinical applications
23,063

 
20,140

 
2,923

 
15
 
44,794

 
38,970

 
5,824

 
15
Life science reagents
8,292

 
7,998

 
294

 
4
 
16,600

 
16,199

 
401

 
2
Corporate
4,893

 
7,081

 
(2,188
)
 
(31)
 
10,827

 
12,983

 
(2,156
)
 
(17)
eBioscience
18,846

 
1,376

 
17,470

 
1,270
 
37,854

 
1,376

 
36,478

 
2,651
Total product sales
$
79,464

 
$
66,403

 
$
13,061

 
20%
 
$
157,409

 
$
131,650

 
$
25,759

 
20%


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Table of Contents

Percentage of revenue
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Expression
31
%
 
45
%
 
30
%
 
47
%
Genetic analysis and clinical applications
29

 
30

 
28

 
30

Life science reagents
10

 
12

 
11

 
12

Corporate
6

 
11

 
7

 
10

eBioscience
24

 
2

 
24

 
1

Total product sales
100
%
 
100
%
 
100
%
 
100
%

Expression During the three months ended June 30, 2013, Expression revenue decreased by $5.4 million primarily due to a decline in Genechip revenue of $4.9 million, which was driven by a lower volume of sales on our in vitro transcription (IVT) array products primarily in Japan and decreased instrument sales of $0.5 million.

The decrease of $14.8 million in Expression revenue for the six months ended June 30, 2013 was driven primarily by a decline in sales of $12.4 million of our IVT array products. Additionally, revenue from Expression instruments declined $1.0 million.

Genetic Analysis and Clinical Applications Genetic Analysis and Clinical Applications revenue increased $2.9 million for the three months ended June 30, 2013 as compared to the same period in 2012, primarily due to $1.3 million and $2.8 million increases in revenue on our Cytogenetics and Axiom® products, respectively, partially offset by a decline in sales of our SNP 6.0 arrays of $1.2 million. Additionally, Instrument revenue increased by $0.9 million.

For the six months ended June 30, 2013, revenue also increased over the prior year primarily due to increased revenue on our Clinical Applications of $2.4 million and on our Axiom® products of $8.0 million, partially offset by a decline in sales of our SNP 6.0 arrays of $4.0 million.

Life Science Reagents For the three and six months ended June 30, 2013, Life Science Reagents revenue increased slightly as compared to the same period in 2012.

Corporate Corporate revenue decreased between the three months ended June 30, 2013 and 2012, partially due to a $0.8 million one-time royalty payment received in 2012.

GROSS MARGIN
Dollars in thousands
Three Months Ended June 30,
 
Dollar/Point change from 2012
 
Six Months Ended June 30,
 
Dollar/Point change from 2012
 
2013
 
2012
 
 
2013
 
2012
 
Total gross margin on product sales
$
40,583

 
$
34,142

 
$
6,441

 
$
77,707

 
$
69,068

 
$
8,639

Total gross margin on services and other revenue
1,588

 
4,579

 
(2,991
)
 
4,468

 
4,968

 
(500
)
 
 
 
 
 
 
 
 
 
 
 
 
Product gross margin as a percentage of products sales
55
%
 
58
%
 
(3
)
 
53
%
 
59
%
 
(6
)
 
 
 
 
 
 
 
 
 
 
 
 
Service and other revenue gross margin as a percentage of services and other revenue
30
%
 
58
%
 
(28
)
 
38
%
 
34
%
 
4


Excluding eBioscience product gross margin of $6.8 million or 36%, that includes $4.5 million of amortization of inventory step-up in fair value, product margin improved 300 basis points during the three months ended June 30, 2013 as compared to same period in 2012, primarily due to headcount reduction savings following our most recent restructuring effort and favorable cost absorption off-set by lower product pricing and a mix shift to lower margin products.


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Excluding eBioscience product gross margin of $14.0 million or 37%, that includes $9.0 million of amortization of inventory step-up in fair value, product margin remained unchanged during the six months ended June 30, 2013 as compared to same period in 2012. During the six months ended June 30, 2013, headcount reduction savings following our most recent restructuring effort and favorable cost absorption was off-set by lower product pricing and a mix shift to lower margin products.

Service gross margin decreased in the three months ended June 30, 2013, as compared to the same period in 2012 primarily due to decreased scientific service revenue.

For the six months ended June 30, 2013, service gross margin decreased slightly, partially due to a $0.8 million one-time royalty payment received in 2012.

RESEARCH AND DEVELOPMENT EXPENSES
Dollars in thousands
Three Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
Six Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
2013
 
2012
 
 
 
2013
 
2012
 
 
Research and development
$
11,959

 
$
13,588

 
$
(1,629
)
 
(12)%
 
$
24,207

 
$
26,919

 
$
(2,712
)
 
(10)%

Excluding eBioscience Research and development expenses of $2.1 million and $4.3 million for the three and six months ended June 30, 2013, respectively, the decrease in research and development expenses for the three and six months ended June 30, 2013 as compared to the three and six months ended June 30, 2012 was primarily due to savings in headcount-related and variable compensation costs totaling $1.3 million and $3.0 million, respectively. The decrease in research and development expense is also attributed to lower spending on consulting of $0.6 million and $1.0 million and supplies of $0.5 million and $0.3 million, respectively. Additionally, allocated costs associated with IT and facilities spending decreased by $0.9 million and $1.8 million, respectively, during the three and six months ended June 30, 2013 as compared to 2012.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Dollars in thousands
Three Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
Six Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
2013
 
2012
 
 
 
2013
 
2012
 
 
Selling, general and administrative
$
33,518

 
$
40,526

 
$
(7,008
)
 
(17)%
 
$
68,638

 
$
68,450

 
$
188

 
0%

Excluding eBioscience selling, general and administrative expenses of $8.9 million and $18.0 million for the three and six months ended June 30, 2013, respectively, the decrease for the three and six months ended June 30, 2013 as compared to the same period in 2012 was primarily due to less non-recurring acquisition- and integration-related costs incurred of $13.0 million and $13.5 million, respectively. Additionally, for the three and six months ended June 30, 2013, we recognized lower headcount-related and variable compensation costs of $2.2 million and $2.9 million, respectively. We also incurred less spending on IT and facilities costs of $0.4 million and $0.9 million, respectively. For the period ending June 30, 2013, stock compensation expense was lowered by $0.8 million as a result of revised expectations on the achievement of performance conditions related to the Acquisition Performance Share Program.

RESTRUCTURING EXPENSES

During the six months ended June 30, 2013, we recognized $4.5 million in restructuring charges due to a cost reduction program that included workforce initiated during the year ended December 31, 2012. The restructuring charge primarily represents compensation and benefits afforded to terminated employees. We do not expect any further material restructuring expenses for the remainder of 2013.


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Table of Contents

INTEREST INCOME AND OTHER, NET
Dollars in thousands
Three Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
Six Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
2013
 
2012
 
 
 
2013
 
2012
 
 
Interest income
$
5

 
$
282

 
$
(277
)
 
(98)%
 
$
(11
)
 
$
579

 
$
(590
)
 
(102)%
Realized (loss) income on equity investments, net
(16
)
 
477

 
(493
)
 
103
 
51

 
522

 
(471
)
 
90
Currency income (loss), net
72

 
(751
)
 
823

 
110
 
(521
)
 
(1,069
)
 
548

 
51
Other
28

 
2,268

 
(2,240
)
 
(99)
 
913

 
2,270

 
(1,357
)
 
(60)
Total interest income and other, net
$
89

 
$
2,276

 
$
(2,187
)
 
(96)%
 
$
432

 
$
2,302

 
$
(1,870
)
 
81%

During the three months ended June 30, 2013, Interest income and other, net decreased primarily due to the receipt in cash of $2.2 million of notes receivable including accrued interest in 2012. In addition, the Company's liquidated its entire portfolio of available-for-sale securities in the first quarter of 2013 and as a result experienced a $0.5 million decrease in Realized (loss) income on equity investments. These decreases were partially offset by a decrease in Currency income (loss), net due to the strengthening of the U.S. dollar.

The change in Interest income and other, net in the six months ended June 30, 2013 as compared to the same period in 2012 was primarily due to the receipt in cash of $2.2 million including accrued interest of a notes receivable in 2012 and a gain of $0.7 million recognized on the release of accrued deferred rent associated with the exit of one of our San Diego properties during the first quarter of 2013. This increase was partially offset by lower interest income as a result of the sale of most of our available-for-sale securities during the eBioscience acquisition in the second quarter of fiscal 2012 and the remaining amounts in the first quarter of 2013.

We continue to monitor the liquidity and financing activities of strategic non-marketable investments to determine if any impairment exists. It is uncertain whether or not we will realize any long-term benefits associated with these strategic investments.

INTEREST EXPENSE
Dollars in thousands
Three Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
Six Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
2013
 
2012
 
 
 
2013
 
2012
 
 
Interest expense
$
2,724

 
$
218

 
$
2,506

 
1,150%
 
$
5,622

 
$
1,198

 
$
4,424

 
369%

Interest expense increased during the three and six months ended June 30, 2013 as compared to the same periods in 2012 due to the interest costs on the debt obligations incurred in connection with the Acquisition partially offset by the redemption of the remaining aggregate principal amount of our 3.50% Notes in the first quarter of 2012.

INCOME TAX PROVISION
Dollars in thousands
Three Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
Six Months Ended June 30,
 
Dollar change from 2012
 
Percentage change from 2012
 
2013
 
2012
 
 
 
2013
 
2012
 
 
Income tax provision (benefit)
$
521

 
$
(36,984
)
 
$
37,505

 
(101)%
 
$
1,196

 
$
(37,073
)
 
$
38,269

 
(103
)%

During the three and six months ended June 30, 2013, we recognized a provision for income tax of $0.5 million and $1.2 million, respectively. The provision for income tax primarily consists of foreign taxes. During the three and six months ended June 30, 2012, the benefit for income tax resulted from reducing our domestic deferred tax asset valuation allowance in connection with the eBioscience acquisition partially offset by a provision for foreign income tax.


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Due to our history of cumulative operating losses, management concluded that, after considering all the available objective evidence, it is not more likely than not that all our net deferred tax assets will be realized. Accordingly, all of our U.S. deferred tax assets continue to be subject to a valuation allowance as of June 30, 2013.

As of June 30, 2013, there have been no material changes to our total amount of unrecognized tax benefits.

LIQUIDITY AND CAPITAL RESOURCES

Historically, we have financed our operations primarily through product sales; borrowings under credit arrangements; sales of equity and debt securities such as our 4.00% Notes, 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 June 30, 2013, we had cash and cash equivalents of approximately $44.1 million. During the first quarter of 2013, we liquidated our portfolio of available-for-sale securities for $9.4 million in cash proceeds. 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 repayments or convertible notes repurchases, and capital expenditures for the foreseeable future. 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 or depositions; 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.

In 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.

As part of the terms of the Senior Secured Credit Facility, we are required to meet certain financial and other negative covenants. After a significant restructuring and lower-than-expected revenues in the first quarter of 2013, we and the lenders amended the Senior Secured Credit Facility to (1) provide limited waiver of defaults arising from our failure to comply with the senior leverage ratio and total leverage ratio as of March 31, 2013; (2) amend the covenants to increase the amount of restructuring and integration charges in the trailing 12 months that we can add back in the calculation of EBITDAO for purposes of determining the total leverage and senior leverage ratios for the first three quarters of 2013; and (3) increase both our total leverage to EBITDAO ratio and our senior leverage to EBITDAO ratio for the first three quarters of 2013. As of June 30, 2013, we were in compliance with the amended covenants. Refer to Note 9. “Long-Term Debt Obligations” for further details regarding the Term Loan, our Senior Secured Credit Facility and the 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 during the three and six months ended June 30, 2013. During the first quarter of 2013, we redeemed the remaining outstanding aggregate principal of our 3.50% Notes at par plus unpaid interest.


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Cashflow (in thousands)
 
Six Months Ended June 30,
 
2013
 
2012
Net cash provided by (used in) operating activities
$
21,712

 
$
(3,534
)
Net cash provided by (used in) investing activities
6,453

 
(262,003
)
Net cash (used in) provided by financing activities
(9,938
)
 
90,286

Effect of exchange rate changes on cash and cash equivalents
(224
)
 
46

Net increase (decrease) in cash and cash equivalents
$
18,003

 
$
(175,205
)

Operating Activities

Net cash provided by operating activities for the six months ended June 30, 2013 was comprised of net loss of $21.5 million, non-cash charges of $33.1 million and a decrease in operating assets of $10.2 million. Adjustments for non-cash expenses include depreciation and amortization expense of $20.4 million, amortization expense related to the inventory step-up in fair value of $9.1 million, and share-based compensation expense of $3.1 million.

Investing Activities

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 six months ended June 30, 2013, included capital expenditures of $2.3 million, purchase of non-marketable investments of $0.2 million, and purchase of technology rights of $0.4 million.

Financing Activities

During the first quarter of 2013, we redeemed our 3.50% Notes for $3.9 million, including unpaid accrued interest. Investing activities for the six months ended June 30, 2013 included pre-payments of $6.4 million on our Term Loan. 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 $0.5 million for the six months ended June 30, 2013.

OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS

As of June 30, 2013, we had no off-balance sheet arrangements. Other than the debt obligations related to the Acquisition disclosed in Note 9. “Long-Term Debt Obligations” and the redemption of the remaining outstanding aggregate principal balance of our 3.50% Notes during the first quarter of 2013, there have been no significant changes to our aggregate contractual obligations as compared to the disclosures in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2012.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Rate Risk

We derive a portion of our revenues in foreign currencies, predominantly in Europe and Japan. In addition, a portion of our assets are held in nonfunctional currencies of our subsidiaries. We use currency forward contracts to manage a portion of the currency exposures created from our activities denominated in foreign currencies. Our hedging program is designed to reduce, but does not entirely eliminate, the impact of currency exchange rate movements. See Note 2. “Summary of Significant Accounting Policies – Derivative Instruments” in the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2012 for further information.


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Interest Rate Risk

In addition to our market risk disclosed in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2012, we also face interest rate risk relating to the increase or decrease in the amount of interest we must pay on our outstanding debt instruments. In 2012, we entered into a Senior Secured Credit Facility, which provides for a Term Loan and revolving credit facility. As further explained in Note 9. “Long-Term Debt Obligations,” outstanding borrowings under the Senior Secured Credit Facility bear interest at variable interest rates and therefore the interest we pay will fluctuate as changes occur in certain benchmark interest rates. As of June 30, 2013, we had borrowed a total of $85.0 million under the Term Loan provided under the Senior Secured Credit Facility. Under the Credit Agreement, we are required to maintain derivative contracts to protect against fluctuations in interest rates with respect to at least 35% of the aggregate principal amount of the Term Loan then outstanding and such derivative contracts shall provide for not less than a three year term. Accordingly, we entered into an interest rate swap (the “Interest Rate Swap”) for which the notional amount was originally set at $27.0 million, with quarterly reduction to the notional amount consistent with the mandatory amortization schedule of the Term Loan. The Interest Rate Swap calls for quarterly fixed rate payments of 1.70% of the notional amount in exchange for a variable rate receipts equal to a 3-month LIBOR rate with a floor of 1.50%. The Interest Rate Swap terminates on June 25, 2015. We do not believe a hypothetical 10% increase in interest rates as of June 30, 2013 would have a material impact on our interest expense.

ITEM 4. CONTROLS AND PROCEDURES

(a) Disclosure controls and procedures.

Affymetrix’s management carried out an evaluation, as required by Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)), as of the end of our last fiscal quarter. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q, such that the information relating to Affymetrix and its consolidated subsidiaries required to be disclosed in our Exchange Act reports filed with the SEC (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to Affymetrix’s management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in internal control over financial reporting.

Affymetrix’s management carried out an evaluation, as required by Rule 13a-15(d) of the Exchange Act, with the participation of our Chief Executive Officer and our Chief Financial Officer, of changes in Affymetrix’s internal control over financial reporting. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that there were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS

Information pertaining to legal proceedings can be found in Note 11. “Legal Proceedings” to our Condensed Consolidated Financial Statements elsewhere in this Quarterly Report on Form 10-Q, and is incorporated by reference herein.

ITEM 1A. RISK FACTORS

Risks Related to Our Business

Risks Related to the Growth of Our Business

If our GeneChip expression business continues to decline significantly and if we do not continually develop and commercialize new or enhanced products and services, our business may continue to decline rather than grow.

Our GeneChip expression business has been declining at a significant rate over the past several years, and we have to stabilize our expression business and grow the other parts of our business in order to return the whole business to growth. Our GeneChip expression business faces intense competition from sequencing technologies and we believe it will continue to decline significantly for the foreseeable future and we cannot assure you that we will stabilize this business readily. Our success will depend 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 factors affecting market acceptance of our products and services:

•
availability, quality and price as compared to competitive technologies, products and services;

•
the functionality of new and existing products and services, and whether they address market requirements;

•
the timing of introduction of our technologies, products and services as compared to competitive technologies, products and services;

•
the existence of product defects;

•
scientists' and customers' opinions of the utility of our products and services and our ability to incorporate their feedback into future products and services;

•
citation of our products in published research; and

•
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.

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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 whether customers that 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. In particular, the success of our acquisition of eBioscience will depend, in part, on our ability to successfully integrate eBioscience's business and operations and fully realize the anticipated benefits and synergies from combining our businesses and eBioscience. Such anticipated benefits and synergies of the Acquisition may not be realized fully or at all or may take longer to realize than expected, which could materially adversely affect our business, results of operations and financial condition. 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:

•
our ability to retain key employees of the acquired company;

•
the performance of the acquired business, technology, product or service;

•
our ability to integrate operations, financial and other systems;

•
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;

•
any disruption in order fulfillment or loss of sales due to integration processes, including relationships with suppliers or distributors;

•
the presence or absence of adequate internal controls and/or significant fraud in the financial systems of acquired companies;

•
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.

If we experience difficulties in integrating eBioscience with our existing operations or are not able to achieve the anticipated benefits and synergies of the Acquisition, our business and results of operations could be negatively affected. In addition, it is possible that the ongoing integration process could result in the loss of key employees, errors or delays in systems implementation, the disruption of our ongoing business or the acquired business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with customers and employees or to achieve the anticipated benefits and synergies of the Acquisition. Integration efforts also may divert management attention and resources. In addition, we will incur transaction fees and costs related to formulating and implementing integration plans. For example, pursuant to certain of our agreements with a collaborative partner, we will be required to migrate certain eBioscience products to incorporate our collaborative partner’s technologies. We continue to assess the magnitude of these costs and additional unanticipated costs may be incurred in the integration of eBioscience. Although we expect that the elimination of duplicative costs, as well as the realization of other efficiencies or synergies related to the integration of the businesses, should allow us to offset incremental transaction and acquisition-related costs over time, this net benefit may not be achieved in the near term, or at all.

Risks Related to our Indebtedness

Our indebtedness could materially adversely affect our business, financial condition and results of operations.

We funded the Acquisition, in part, by incurring a substantial amount of indebtedness from the Term Loan provided under our Senior Secured Credit Facility and issuance of the 4.00% Notes. Refer to Note 9. “Long Term Debt Obligations” in this Quarterly Report on Form 10-Q for further information regarding the Term Loan, the Senior Secured Credit Facility and the 4.00% Notes.

This substantial amount of indebtedness could materially adversely affect us, including by decreasing our business flexibility and increasing our borrowing costs. The indebtedness we incurred in connection with the Acquisition is expected to significantly increase our interest expense, leverage and debt service requirements. 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, the agreements governing the Senior Secured Credit Facility contain restrictive covenants imposing operating and financial restrictions on us, including restrictions that may limit our ability to finance future operations or capital needs or to engage in other business activities. See the risk factor below entitled "We may not be able to finance future needs or adapt our business plan to changes because of restrictions placed on us by our Senior Secured Credit Facility and future instruments governing our indebtedness." In April 2013, following a restructuring and lower than expected revenues in the first quarter of 2013, we and the Lenders amended the Senior Secured Credit Facility to (1) provide a limited waiver of defaults arising from our failure to comply with the senior leverage ratio and total leverage ratio as of March 31, 2013; (2) amend the covenants to increase our leverage ratios under the Senior Credit Facility. Refer to Note 9. “Long-Term Debt Obligations” for further details regarding this amendment. If our revenue continues to decline, we may have to make further amendments to the Senior Secured Credit Facility and we cannot assure you that the Lenders will agree to amend the Senior Secured Credit Facility in such situations and if they do, whether they will require us to pay significant consideration for such amendment.

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 and other factors beyond our control. Our business may not continue to generate cash flow from operations in the future sufficient to service our debt. We may also incur expenditures that are outside of our control, such as costs associated with legal proceedings brought by other parties, or costs resulting from compliance with changes in laws. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional

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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.

If an event of default occurs under the Senior Secured Credit Facility, the 4.00% Notes, or any other debt financing agreement, we may be required to immediately repay all outstanding borrowings, together with accrued interest and other fees. We may not be able to repay all amounts due in the event these amounts are declared due upon an event of default.

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:

•
incur additional debt, including guarantees by us or our subsidiaries;

•
make investments, pay dividends on our capital stock, redeem or repurchase our capital stock, redeem or repurchase the notes or any subordinated obligations;

•
create liens;

•
make capital expenditures;

•
dispose of assets;

•
make acquisitions;

•
create or permit restrictions on the ability of our subsidiaries to pay dividends or make other distributions to us;

•
engage in transactions with affiliates;

•
engage in sale and leaseback transactions; and

•
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 and industry conditions. The Senior Secured Credit Facility will require us to comply with financial performance covenants, including, without limitation, a minimum fixed charge coverage ratio, maximum senior leverage multiple and maximum total leverage multiple. Additionally, the Senior Secured Credit Facility contains numerous affirmative covenants, including covenants regarding payment of taxes and other obligations, maintenance of insurance, reporting requirements and compliance with applicable laws and regulations. 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 an acceleration under our other instruments that contain cross-acceleration or cross-default provisions, 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. If a default occurs under the Senior Secured Credit Facility, the lenders could cause all of the outstanding debt obligations under the facility to become due and payable, which would result in a default under our 4.00% Notes and could lead to an acceleration of obligations related to such notes. Upon a default or cross-default, the agent, at the direction of some or all of the lenders under the Senior Secured Credit Facility, could foreclose against the collateral. Even if we are able to comply with all of the applicable covenants, the restrictions on our ability to manage our business in our sole discretion could

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adversely affect our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities that we believe would be beneficial to us.

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, Inc., Agilent Technologies and Life Technologies Corporation have products for genetic analysis that are directly competitive with certain of our products. In addition, Illumina, Inc., Life Technologies Corporation, Roche Diagnostics and Complete Genomics, Inc. 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 Beckman Coulter, Becton, Dickinson and Company, bioMérieux, Celera Diagnostics, Johnson & Johnson, Gen-Probe Incorporated 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, Abcam plc, Life Technologies Corporation, Bio-Rad Laboratories, BioLegend, Inc., and Danaher Corporation/Beckman Coulter. 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, including anticipated revenue from our eBioscience segment, will be derived from products and services provided to pharmaceutical and biotechnology companies, as well as a relatively small 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:

•
changes in government programs, including available funding, which support research and development expenditures by companies and research institutions;

•
weakness in the global economy and changing market conditions that affect our customers;

•
changes in the extent to which the pharmaceutical industry may use genetic information and genetic testing as a methodology for drug discovery and development;

•
changes in the regulatory environment affecting life science companies and life science research;

•
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, including our eBioscience segment. 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/Beckman Coulter, CapitalBio Corporation, Genisphere LLC, Hamilton Robotics, Life Technologies Corporation, Luminex Corporation, Siemens Medical Solutions Diagnostics, Takara Bio Inc., New England Biolabs, Inc. and Qiagen GmbH. Some of these collaborators, like Life Technologies Corporation, Takara Bio Inc., New England Biolabs, Inc. and Luminex Corporation, 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:

•
our partners may develop technologies or components competitive with our products and services;

•
our existing collaborations may preclude us from entering into additional future arrangements or impact the integration of acquired businesses and technologies;

•
our partners may not obtain regulatory approvals necessary to continue the collaborations in a timely manner;

•
some of our agreements may terminate prematurely due to disagreements between us and our partners or licensors;

•
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;

•
our collaborations may be unsuccessful; or

•
some of our agreements have expired and we may not be able to negotiate future collaborative arrangements or renew current licenses on acceptable terms.

In addition, our eBioscience segment relies on licensing as a basis for many of its products and intellectual property, and the ability to maintain and renew current licenses as well as license new technologies from third parties is and will continue to be important such unit’s ability to offer and introduce products. 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 forecasted product mix 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

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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 increasingly 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, from 2008 through 2012. As a result, we had an accumulated deficit of approximately $510.9 million as of June 30, 2013. Our ability to achieve sustained profitability will depend, in part, on the rate of growth, if any, of our revenue and on the level of our expenses. In 2012 and the first half of 2013, our business was affected by a drop in the volume of sales of our in-vitro transcription arrays in our Expression business that was partially offset by an increase in our Cytogenetics and Axiom® products in our Genetic Analysis and Clinical Applications business. This led to an overall decrease in revenue as compared to the same prior-year period. There can be no assurance that our revenue will not continue to decrease in future periods. We announced a corporate restructuring program to reduce our costs, however, there can be no assurance that the anticipated cost savings 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, or if our

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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, 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. In addition, following the Acquisition, in order to retain and incentivize key eBioscience employee as we integrate the business, we granted certain employees performance-based restricted stock units (“PRSUs”) as further described in Note 5. “Stockholders’ Equity and Share-Based Compensation Expense”; we cannot be assured that these equity awards will be successful in retaining and incentivizing such 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.

Due to the international nature of our business, political or economic changes or other factors could harm our business.

A significant amount of our revenue is currently generated from sales outside the United States. 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 such factors as changes in foreign currency exchange rates; 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.

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Our effective tax rate may vary significantly.

Our operations are subject to income 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, levels of research and development spending, and/or nondeductible expenses 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. Adjustments to estimated taxes upon finalization of various tax returns could materially affect our effective tax rate. We are subject to examination by taxing authorities in the U.S. and multiple foreign jurisdictions. 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.

Failure in our information technology 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, 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, 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 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.

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.

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 and Litigation

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 the commercialization of medical devices, including in vitro diagnostic test kits and the reagents and instrumentation used in 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 the

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regulatory agencies of foreign governments or jurisdictions 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 clinical trials of 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 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 intended for research use only are not subject to clearance or approval by the FDA. However, research use only products may fall under the FDA's jurisdiction if these are used for clinical rather than research purposes. Even when a product is exempted from FDA clearance or approval, the FDA may impose restrictions as to the types of customers to 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, the U.S. Department of Health and Human Services and foreign government regulators are increasingly focused on genetic analysis tools, including the use of arrays, which are labeled for research use only, by clinical laboratories in laboratory-developed tests ("LDTs") offered by these laboratories, including labs certified under the Clinical Laboratory Improvement Amendments ("CLIA"). We cannot predict the extent of the FDA's future efforts in regulation and enforcement policies with respect to the sale and use of arrays for the development of LDTs by CLIA-certified laboratories. If regulations or enforcement policies restrict our customers' development of LDTs using our products labeled for research use only, or if we otherwise are required to obtain FDA premarket clearance or approval prior to commercializing these products, our ability to generate revenue from the sale of our products may be delayed or otherwise adversely affected. Moreover, our failure to comply with governmental rules and regulations related to our products could cause us to incur significant adverse publicity, subject us to investigations and notices of non-compliance or lead to fines or restrictions upon our ability to sell our products. We also may be at risk for liability related to government reimbursement of tests involving the use of our products if it is determined that these tests require FDA-clearance or approval and no such clearance or approval has been obtained.

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 relating to the sale of our 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. A failure to comply with these regulations 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 reimbursements 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. The ability of our collaborators to commercialize such products may depend, in part, on the extent to which reimbursement for these products will be available under U.S. and foreign regulations that govern reimbursement for clinical testing services by government authorities, private health insurers and other organizations. In the United States, third-party payer price resistance, the trend towards managed health care and the implementation of the Patient Protection and Affordable Care Act of 2010 could reduce payment rates for health care products and services, adversely affecting the profits of our customers and collaborative partners and reducing our future royalties. 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. Under this rule, some Medicare contractors may deny coverage for a test, even if the test has been cleared or approved by the FDA, without proof, as determined sufficient by the contractor, that the test is useful in patient management.


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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

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, our eBioscience subsidiary does not have a patent portfolio at the current time, 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.


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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.

Third parties have asserted and may in the future assert that 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. We are currently engaged in litigation with third parties who allege that we have infringed their intellectual property rights. See Note 11. "Legal Proceedings" found in this Quarterly Report on 10-Q for further information. 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 will have a material adverse impact on our cash position and 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 the common stock you receive upon conversion, 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 $4.84 on April 8, 2013, and a low of $2.96 on November 16, 2012 in the twelve-month period ending on June 30, 2013. 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 at which you could sell the common stock you receive upon conversion of your notes.

In addition, the sale of substantial amounts of our common stock could adversely impact its price. As of June 30, 2013, we had outstanding approximately 71.6 million shares of our common stock and options to purchase approximately 5.6 million shares of our common stock (of which approximately 2.9 million were exercisable as of that date). We also had outstanding approximately 3.9 million shares underlying restricted stock awards and restricted stock units as of June 30, 2013. As of June 30, 2013, 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.


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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:

•
competition;

•
our inability to produce products in sufficient quantities and with appropriate quality;

•
the frequency of experiments conducted by our customers;

•
our customers' inventory of products;

•
the receipt of relatively large orders with short lead times; and

•
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 and the value of the notes.
 
ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.


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ITEM 5. OTHER INFORMATION

On June 28, 2013, we entered into a separation agreement with our former Chief Financial Officer and Executive Vice President, Timothy Barabe. The separation agreement is filed as Exhibit 10.52 to this quarterly report. In addition, we entered into a letter of agreement with Gavin Wood with respect to his promotion as our Chief Financial Officer and Executive Vice President effective on May 20, 2013. The letter of agreement is filed as Exhibit 10.51 to this quarterly report.

ITEM 6. EXHIBITS
Exhibit
Number
 
Description of Document
 
 
 
10.51 ‡
 
Offer Letter from the Company to Gavin Wood dated May 20, 2013.
10.52 ‡
 
Separation Agreement between the Company and Timothy Barabe dated June 28, 2013.
31.1
 
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2
 
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32
 
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
EX-101.INS
 
XBRL Instance Document(1)
EX-101.SCH
 
XBRL Taxonomy Extension Schema Document(1)
EX-101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document(1)
EX-101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document(1)
EX-101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document(1)
EX-101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document(1)

(1)
Pursuant to applicable securities laws and regulations, we are deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and are not subject to liability under any anti-fraud provisions of the federal securities laws as long as we have made a good faith attempt to comply with the submission requirements and promptly amend the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. Users of this data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

‡ Management contract, compensatory plan, contract or arrangement


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SIGNATURES

Pursuant to the requirements 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.

 
By:
/s/ GAVIN WOOD
 
Name:
Gavin H. J. Wood
 
Title:
Executive Vice President and Chief Financial Officer
 
 
 
August 6, 2013
 
 
 
 
 
 
 
Duly Authorized Officer and Principal Financial
And Accounting Officer

 
 
 
 
 


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