AFFX-2015.03.31-10Q
 

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 MARCH 31, 2015

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 April 27, 2015: 77,323,772
 



AFFYMETRIX, INC.

TABLE OF CONTENTS

 
 
Page No.
 
 
 
 
 
 
 
Condensed Consolidated Balance Sheets at March 31, 2015 and December 31, 2014
 
 
 
 
 
 
 
 
Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2015 and 2014
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2015 and 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
29
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AFFYMETRIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
March 31,
2015
 
December 31,
2014
 
(Unaudited)
 
(Note 1)
ASSETS:
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
104,009

 
$
79,923

Accounts receivable, net
48,526

 
46,896

Inventories, net—short-term portion
50,701

 
50,676

Deferred tax assets—short-term portion
3,781

 
3,778

Prepaid expenses and other current assets
11,969

 
9,197

Total current assets
218,986

 
190,470

Property and equipment, net
18,576

 
18,087

Inventories, net—long-term portion
4,809

 
5,956

Goodwill
151,789

 
156,178

Intangible assets, net
99,479

 
106,183

Deferred tax assets—long-term portion
308

 
303

Other long-term assets
9,343

 
9,371

Total assets
$
503,290

 
$
486,548

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY:
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
43,110

 
$
53,063

Current portion of long-term debt
4,000

 
4,000

Deferred revenue—short-term portion
8,748

 
9,210

Total current liabilities
55,858

 
66,273

Deferred revenue—long-term portion
2,515

 
2,372

Convertible notes
105,000

 
105,000

Term loan—long-term portion
17,950

 
18,950

Other long-term liabilities
20,643

 
21,626

Total liabilities
201,966

 
214,221

Stockholders’ equity:
 
 
 
Common stock
773

 
743

Additional paid-in capital
812,438

 
781,747

Accumulated other comprehensive loss
(6,722
)
 
(612
)
Accumulated deficit
(505,165
)
 
(509,551
)
Total stockholders’ equity
301,324

 
272,327

Total liabilities and stockholders’ equity
$
503,290

 
$
486,548

See accompanying Notes to the Condensed Consolidated Financial Statements

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

 
Three Months Ended 
 March 31,
 
2015
 
2014
REVENUE:
 
 
 
Product sales
$
79,367

 
$
73,695

Services and other
9,350

 
9,276

Total revenue
88,717

 
82,971

COSTS AND EXPENSES:
 
 
 
Cost of product sales
27,583

 
29,512

Cost of services and other
6,296

 
6,904

Research and development
12,120

 
11,635

Selling, general and administrative
35,433

 
38,562

Litigation settlement

 
5,100

Total costs and expenses
81,432

 
91,713

Income (loss) from operations
7,285

 
(8,742
)
Other (expense) income, net
(673
)
 
293

Interest expense
1,483

 
1,753

Income (loss) before income taxes
5,129

 
(10,202
)
Income tax provision
743

 
272

Net income (loss)
$
4,386

 
$
(10,474
)
 
 
 
 
Basic net income (loss) per common share
$
0.06

 
$
(0.14
)
Diluted net income (loss) per common share
$
0.06

 
$
(0.14
)
 
 
 
 
Shares used in computing basic net income (loss) per common share
75,408

 
72,498

Shares used in computing diluted net income (loss) per common share
78,754

 
72,498

See accompanying Notes to the Condensed Consolidated Financial Statements

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

 
Three Months Ended 
 March 31,
 
2015
 
2014
Net income (loss)
$
4,386

 
$
(10,474
)
Other comprehensive loss, net of tax:
 
 
 
Foreign currency translation adjustment
(8,122
)
 
151

Unrealized change in available-for-sale and non-marketable securities (net of $0 tax for the three months ended March 31, 2015 and 2014)
224

 
1,319

Unrealized change in cash flow hedges (net of $0 tax for the three months ended March 31, 2015 and 2014)
1,788

 
297

Net change in other comprehensive (loss) income, net of tax
(6,110
)
 
1,767

Comprehensive loss
$
(1,724
)
 
$
(8,707
)
See accompanying Notes to the Condensed Consolidated Financial Statements

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AFFYMETRIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
4,386

 
$
(10,474
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
5,515

 
8,712

Amortization of inventory step-up in fair value

 
2,896

Share-based compensation
4,063

 
3,145

Deferred tax, net
(977
)
 
(284
)
(Gain) loss on sales of securities
(59
)
 
15

Other non-cash transactions
291

 
134

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(2,035
)
 
130

Inventories
145

 
(2,456
)
Prepaid expenses and other assets
(916
)
 
2,191

Accounts payable and accrued liabilities
(9,533
)
 
3,205

Deferred revenue
(309
)
 
(2,527
)
Other long-term liabilities
771

 
(82
)
Net cash provided by operating activities
1,342

 
4,605

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Proceeds on sale of fixed assets

 
106

Capital expenditures
(2,297
)
 
(1,111
)
Purchase of technology rights
(41
)
 

Net cash used in investing activities
(2,338
)
 
(1,005
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Issuance of common stock, net of issuance costs
26,658

 
184

Repayments of long-term debt
(1,000
)
 
(3,250
)
Net cash provided by (used in) financing activities
25,658

 
(3,066
)
Effect of exchange rate changes on cash and cash equivalents
(576
)
 
44

Net increase in cash and cash equivalents
24,086

 
578

Cash and cash equivalents at beginning of period
79,923

 
57,128

Cash and cash equivalents at end of period
$
104,009

 
$
57,706

See accompanying Notes to the Condensed Consolidated Financial Statements

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AFFYMETRIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2015
(UNAUDITED)
NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") 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 GAAP for complete financial statements. The unaudited 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.

Interim financial results are not necessarily indicative of results anticipated for the full year. These unaudited financial statements should be read in conjunction with the Company's audited financial statements and footnotes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014, from which the balance sheet information as of that date and as included herein was derived.

The preparation of 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. Actual results could differ from those estimates.

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, 2014.

Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive loss (“OCI”). OCI includes foreign currency translation adjustments, unrealized gains and losses on the Company's non-marketable securities and unrealized gains and losses on cash flow hedges that are excluded from net loss. Total comprehensive loss has been disclosed in the Company's Condensed Consolidated Statements of Comprehensive Loss.

The following table summarizes the amounts reclassified out of accumulated other comprehensive income, net of tax, for the three months ended March 31, 2015 (in thousands):
 
December 31,
2014
 
(Decrease)/ Increase
 
Reclassification
Adjustments
 
March 31,
2015
Foreign currency translation adjustment
$
(2,933
)
 
$
(8,122
)
 
$

 
$
(11,055
)
Unrealized change in non-marketable securities
1,219

 
224

 

 
1,443

Unrealized change in cash flow hedges
1,102

 
3,573

 
(1,785
)
 
2,890

Total accumulated other comprehensive loss, net of tax
$
(612
)
 
$
(4,325
)
 
$
(1,785
)
 
$
(6,722
)

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09) to provide guidance on revenue recognition. ASU 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects

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the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In April 2015, the FASB proposed a one-year deferral of the effective date for ASU 2014-09. Under the proposal, ASU 2014-09 is effective for the Company in the first quarter of 2018. Early adoption up to the first quarter of 2017 is permitted. Upon adoption, ASU 2014-09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retained earnings in the most current period presented. The Company is currently evaluating the method of adoption and the impact of adopting ASU 2014-09 on its consolidated financial statements.

NOTE 2—FAIR VALUE MEASUREMENTS

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

As of March 31, 2015 and December 31, 2014, the assets and liabilities measured at fair value consisted of the following (in thousands):

 
March 31, 2015
 
December 31, 2014
 
Fair Value Measurements Using Input Types
 
 
 
Fair Value Measurements Using Input Types
 
 
 
Level 2
 
Level 3
 
Total
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
3,063

 
$

 
$
3,063

 
$
1,258

 
$

 
$
1,258

Non-marketable securities

 
3,667

 
3,667

 

 
3,384

 
3,384

     Total assets
$
3,063

 
$
3,667

 
$
6,730

 
$
1,258

 
$
3,384

 
$
4,642

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Derivatives liabilities
$
12

 
$

 
$
12

 
$

 
$

 
$


Derivative financial instruments

The Company's derivative financial instruments are measured at fair value on a recurring basis utilizing Level 2 inputs as determined based on review of third-party sources. The fair value of the Company's derivative assets and liabilities is determined based on the estimated consideration the Company would pay or receive to terminate these agreements on the reporting date. The derivative assets and liabilities are located in Prepaid expenses and other current assets and Accounts payable and accrued expenses, respectively, in the accompanying Condensed Consolidated Balance Sheets.

Non-Marketable Securities

The Company believes the carrying amounts of its non-marketable securities approximated their fair values at the dates presented above. These non-marketable securities consist of an investment in a limited partnership investment fund that invests in companies in the life science industry and are located in the United States. The investments were initially valued at purchase price and subsequently on the basis of inputs that market participants would use in pricing such investments. The portfolio of investments includes Level 1 publicly-traded equity securities and Level 3 equity securities and notes.

During the year ended December 31, 2014, other-than-temporary impairment charges of $0.1 million were recognized on the Company's non-marketable securities. There were no other-than-temporary impairment charges during the three months ended March 31, 2015. Net investment losses are included in Other (expense) income, net in the accompanying Consolidated Statements of Operations. Depending on market conditions, the Company may incur additional charges on this investment in the future.

The following table summarizes the change in the fair value of the Company's non-marketable securities during the three months ended March 31, 2015 (in thousands).


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Balance as of December 31, 2014
$
3,384

Sales

Realized gains
59

Unrealized gains
224

Balance as of March 31, 2015
$
3,667

 
Fair Value of Long-Term Debt Obligations

As further discussed in Note 7, "Long-Term Debt Obligations", the Company's long-term debt obligations are not measured at fair value on a recurring basis and are carried at amortized cost. The Company believes the fair value of the Term Loan approximates its carrying value, or amortized cost, due to the short-term nature of these obligations and the market rates of interest rates they bear, and therefore is classified as Level 3 of the fair value hierarchy. The fair value of the Company’s 4.00% Notes is based on quoted market prices as of the respective balance sheet date, and therefore is classified as Level 1 of the fair value hierarchy. As of March 31, 2015, the fair value of the Company’s 4.00% Notes was approximately $241.2 million.

NOTE 3—DERIVATIVE FINANCIAL INSTRUMENTS

The Company derives a portion of its revenues in foreign currencies, predominantly in Europe and Japan, as part of its ongoing business operations. In addition, a portion of its assets are held in the foreign 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 is exposed to the risk that the counterparties to its hedges may be unable to meet the terms of these agreements. To mitigate the risk, only contracts with carefully selected highly-rated major financial institutions are entered into. In the event of non-performance by these counterparties, the asset position carrying values of the financial instruments represent the maximum amount of loss that can be incurred; however, no losses as a result of counterparty defaults are expected. The Company does not require and is not required to pledge collateral for these financial instruments. The Company does not enter into foreign currency forward contracts for trading or speculative purposes and is not party to any leveraged derivative instruments.

As of March 31, 2015 and December 31, 2014, the total notional values of the Company’s derivative assets and liabilities were as follows (in thousands):

 
March 31,
2015
 
December 31,
2014
Euro
$
27,384

 
$
15,982

Japanese Yen
2,656

 
3,391

British Pound
6,941

 
1,784

Total
$
36,981

 
$
21,157


The Company records all derivative assets and liabilities on the accompanying Condensed Consolidated Balance sheets at fair value. The following table shows the Company’s derivatives as of March 31, 2015 and December 31, 2014 (in thousands):


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March 31,
2015
 
December 31,
2014
 
Balance Sheet
Classification
Derivative assets:
 
 
 
 
 
Foreign exchange contracts
$
3,063

 
$
1,258

 
Prepaid expenses and other current assets
Derivative liabilities:
 
 
 
 
 
Foreign exchange contracts
12

 

 
Accounts payable and accrued liabilities

The effective portions of designated cash flow hedges are recorded in OCI until the hedged item is recognized in operations. Derivatives that are not designated as hedging instruments and the ineffective portions of cash flow hedges are adjusted to fair value through operations.

Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur in the initially identified time period or within a subsequent two-month time period. Deferred gains and losses associated with such derivative instruments are reclassified immediately into operations through Other (expense) income, net on the Condensed Consolidated Statements of Operations. Any subsequent changes in fair value of such derivative instruments are reflected in Other (expense) income, net unless they are re-designated as hedges of other transactions.

All derivative assets and liabilities were designated as hedging relationships as of March 31, 2015 and December 31, 2014.

The following table shows the effect, net of tax, of the Company’s derivative instruments on the accompanying Condensed Consolidated Statements of Operations and OCI for the three months ended March 31, 2015 and 2014 (in thousands):

 
Three Months Ended 
 March 31,
 
2015
 
2014
Derivatives in cash flow hedging relationships:
 
 
 
Net gain (loss) recognized in OCI
$
1,788

 
$
(297
)
Net gain (loss) reclassified from accumulated OCI into Revenue
1,785

 
(444
)
Net loss reclassified from accumulated OCI into Other (expense) income, net

 
(10
)
Net gain (loss) recognized in Other (expense) income, net
14

 
(18
)
Derivatives not designated as hedging relationships:
 
 
 
Net gain recognized in Other (expense) income, net

 
1


As of March 31, 2015, the deferred amount recorded in OCI related to the Company's derivatives recorded is a net gain of $2.9 million and is expected to be recognized into earnings over the next 12 months.

NOTE 4—STOCKHOLDERS’ EQUITY AND SHARE-BASED COMPENSATION EXPENSE

At the Market Offering

On November 18, 2014, the Company entered into a sales agreement with Cantor Fitzgerald & Co. (“Cantor Fitzgerald”) to offer shares of its common stock, $0.01 par value per share, from time to time through Cantor Fitzgerald, as the Company’s sales agent for the offer and sale of the shares. The Company may offer and sell shares for an aggregate offering price of up to $50.0 million. The Company pays a commission equal to 3% of the gross proceeds from the sale of shares of its common stock under the sales agreement. The Company intends to use the net proceeds from this offering for general corporate purposes, including capital expenditures, debt repayments and working capital. The Company may also use a portion of the net proceeds from this offering to acquire or invest in complementary businesses, technologies, product candidates or other intellectual property, although there are no present commitments or agreements to do so. The Company is

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not obligated to make any sales of shares of common stock under the sales agreement. As of March 31, 2015, the Company has sold a total of 2.2 million shares of common stock at an average price of $11.80 through its “at-the-market” offering, for total net proceeds of $25.3 million.

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 March 31, 2015, the Company had approximately 4.6 million shares of common stock reserved for future issuance under its share-based compensation plans. 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 in the accompanying Condensed Consolidated Statements of Operations for the three months ended March 31, 2015 and 2014 as follows (in thousands):

 
Three Months Ended March 31,
 
2015
 
2014
Costs of product sales
$
695

 
$
537

Research and development
514

 
507

Selling, general and administrative
2,854

 
2,101

Total share-based compensation expense
$
4,063

 
$
3,145


As of March 31, 2015, $16.4 million of total unrecognized share-based compensation expense related to non-vested awards is expected to be recognized over the respective vesting terms of each award through 2018. The weighted‑average terms of the unrecognized share-based compensation expense are 2.3 years for stock options and 2.0 years for restricted stock.

Performance-Based Awards

The Company's share-based awards program includes performance-based restricted stock awards ("PRSUs") that vest based upon the achievement of certain performance criteria and a service vesting criteria following the achievement of performance criteria. Performance criteria include various operational criteria of the Company such as revenues, earnings before interest, taxes, depreciation and amortization, earnings per share, and similar criteria, either on a Company-wide or business unit specific basis. The service vesting criteria ranges from two to four years. The Company recognizes the fair value of these awards to the extent the achievement of the related performance criteria is estimated to be probable. If a performance criteria is subsequently determined to not be probable of achievement, any related expense is reversed in the period such determination is made. Conversely, if a performance criteria is not currently expected to be achieved but is later determined to be probable of achievement, a “catch-up” entry is recorded in the period such determination is made for the expense that would have been recognized had the performance criteria been probable of achievement since the grant of the award.
During the first quarter of 2015, the Compensation Committee granted certain PRSUs associated with performance criteria referred to as the 2015 Program. The purpose of the 2015 Program is to retain key employees. The measurement period for the 2015 Program is the twelve month period ended December 31, 2015 and the awards granted under the 2015 Program were granted in the form of performance shares pursuant to the terms of our 2000 Plan. Based on the achievement of the performance conditions, shares of stock would vest in equal installments over three years. The level of achievement of 2015 financial performance will be assessed during the first quarter of 2016 after which the shares of stock will be issued to the participants, contingent upon the recipient’s continued service to the Company. In 2015, the Company awarded 243,000 PRSUs under the 2015 Program at a grant date fair value of $11.88 per PRSU.
As of March 31, 2015, there were 931,600 PRSUs outstanding with an average grant date fair value of $8.24 per PRSU. The Company expects that it is probable that 823,600 of these PRSUs will vest and that the related unrecognized stock compensation expense of $2.7 million will be recognized over the next three years. Changes in the Company’s assessment of the probability of achievement of performance criteria could have a material effect on the results of operations

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in future periods. There were no material changes in estimate related to the probability of vesting or recognition of expense related to PRSUs during either of the periods ended March 31, 2015 or 2014.

For additional information concerning the Company's share-based compensation plans, including performance-based awards programs, see Note 13, "Stockholders' Equity and Share-Based Compensation Expense", to the consolidated financial statements in Part II, Item 8 of the Company's 2014 Annual Report on Form 10-K.

NOTE 5—INVENTORIES

At March 31, 2015 and December 31, 2014, inventories, net consisted of the following (in thousands):

 
March 31,
2015
 
December 31,
2014
Raw materials
$
10,839

 
$
11,461

Work-in-process
19,382

 
18,147

Finished goods
25,289

 
27,024

Total
$
55,510

 
$
56,632

 
 
 
 
Short-term portion
$
50,701

 
$
50,676

Long-term portion
$
4,809

 
$
5,956


Amortization expense related to the fair value step-up during the three months ended March 31, 2014 was approximately $2.9 million. The inventory fair value step-up was fully amortized as of June 30, 2014.

NOTE 6—WARRANTIES

The Company provides for anticipated warranty costs at the time the associated product revenue is recognized. Accrued warranties are included in Accounts payable and accrued liabilities in the accompanying Condensed Consolidated Balance Sheets. 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. Changes to the Company’s product warranty liability for the three months ended March 31, 2015 are as follows (in thousands):

Balance at December 31, 2014
$
912

Additions charged to cost of product sales
281

Repairs and replacements
(335
)
Balance at March 31, 2015
$
858


NOTE 7—LONG-TERM DEBT OBLIGATIONS

The following table summarizes the carrying amount of the Company's borrowings (in thousands):

 
March 31, 2015
 
December 31, 2014
Term loan
$
21,950

 
$
22,950

Convertible notes
105,000

 
105,000

Total debt
126,950

 
127,950

Less: current portion of long-term debt
4,000

 
4,000

Total long-term debt
$
122,950

 
$
123,950



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Term Loan and Revolving Credit Facility

On June 25, 2012, in conjunction with the acquisition of eBioscience, Inc., the Company entered into a five year $100.0 million Senior Secured Credit Facility credit agreement (the “Credit Agreement”). The Credit Agreement provided for a Term Loan in an aggregate principal amount of $85.0 million and a revolving credit facility in an aggregate principal amount of $15.0 million.

On October 17, 2013, the Company refinanced its Senior Secured Credit Facility and entered into the Fourth Amendment to Credit Agreement (the "Fourth Amendment"). The Fourth Amendment provided, among other things, for a term loan in the aggregate principal amount of $38.0 million and revolving loan commitments in the aggregate principal amount of $10.0 million, each with a term of five years. The Company borrowed a total of $38.0 million under the Term Loan and $10.0 million under the revolving loan upon refinancing.

On July 28, 2014, the Company entered into the Fifth Amendment to Credit Agreement (the "Fifth Amendment" and the Credit Agreement as so amended, the "Amended Credit Agreement"). The Fifth Amendment provides, among other things, for (1) an uncommitted incremental term loan facility in an aggregate amount not to exceed $50.0 million and (2) the reduction of interest rate margins. As of March 31, 2015, the applicable interest rate was approximately 3.04%.

At the option of the Company (subject to certain limitations), borrowings under the Amended 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 1.5% to 1.75% dependent on the senior leverage ratio then in effect calculated on the basis of the actual number of days elapsed in a year of 365 or 366 days (as applicable) and payable quarterly in arrears. The base rate will be equal to the greatest of (a) the rate last quoted by The Wall Street Journal (or another national publication described in the Amended Credit Agreement) as the U.S. “Prime Rate,” (b) the federal funds rate, plus 0.50% per annum or (c) LIBOR for an interest period of one month, plus 1.00% per annum. Under the LIBOR Option, interest will be determined based on interest periods to be selected by Affymetrix of one, two, three or six months (and, to the extent available to all relevant lenders, nine or 12 years) and will be equal to LIBOR plus 2.50% and 2.75% dependent on the senior leverage ratio then in effect, calculated based on the actual number of days elapsed in a 360-day year. Interest will be paid at the end of each interest period or in the case of interest periods longer than three months, quarterly.

The loans and other obligations under the Senior Secured Credit Facility are (i) guaranteed by substantially all of the Company’s domestic subsidiaries (subject to certain exceptions and limitations) and (ii) secured by substantially all of the assets of Affymetrix and each guarantor (subject to certain exceptions and limitations).

The Amended Credit Agreement requires the Company to maintain an interest coverage ratio of at least 3.5 to 1.0 and a senior leverage ratio not exceeding initially 1.75 to 1.00 and stepping down to 1.20 to 1.00. The Amended Credit Agreement also includes other covenants, including negative covenants that, subject to certain exceptions, limit Affymetrix’, and that of certain of its subsidiaries’, ability to, among other things: (i) incur additional debt, including guarantees by the Company or its subsidiaries, (ii) make investments, pay dividends on capital stock, redeem or repurchase capital stock, redeem or repurchase the Company’s senior convertible notes or any subordinated obligations, (iii) create liens and negative pledges, (iv) make capital expenditures, (v) dispose of assets, (vi) make acquisitions, (vii) create or permit restrictions on the ability of Affymetrix’ subsidiaries to pay dividends or make distributions to Affymetrix, (viii) engage in transactions with affiliates, (ix) engage in sale and leaseback transactions, (x) consolidate or merge with or into other companies or sell all or substantially all the Company’s assets and (xi) change their nature of business, their organizational documents or their accounting policies.

The Company is required to make the following mandatory prepayments: (a) annual prepayments in an amount equal to 50% of excess cash flow (as defined in the Amended Credit Agreement), subject to leverage-based step-downs, (b) prepayments in an amount equal to 100% of the net cash proceeds of issuances or incurrences of debt obligations of Affymetrix and its subsidiaries (other than debt incurrences expressly permitted by the Credit Agreement), (c) prepayments in an amount equal to 100% of the net proceeds of asset sales in excess of $2.5 million annually (subject to certain reinvestment rights) and (d) prepayments in an amount equal to any indemnification payments or similar payments received under the Acquisition Agreement, subject to certain exclusions.

The Amended Credit Agreement also contains events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-default and cross-acceleration to other indebtedness in excess of specified amounts, monetary judgment defaults in excess of specified amounts, bankruptcy or insolvency, actual or asserted

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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% Convertible Notes would be an event of default under the Amended Credit Agreement. As of March 31, 2015, the Company was in compliance with the covenants.

The proceeds received on June 25, 2012 from the original Term Loan were net of debt issuance costs of approximately $4.5 million being amortized over the 5-year term of the Senior Secured Credit Facility. Following the refinancing under the Fourth Amendment, the Company wrote off unamortized debt issuance costs of $2.5 million associated with the original Term Loan, and received proceeds on October 17, 2013 from the new Term Loan and Revolver, net of debt issuance costs of approximately $0.8 million that amortize on the effective interest rate method beginning October 17, 2013.

As of March 31, 2015, the Company had an outstanding principal balance of approximately $22.0 million under the Term Loan and incurred $0.3 million in interest expense under the Senior Secured Credit Facility for the three months ended March 31, 2015. There were no amounts outstanding under the Revolving Credit Facility as of March 31, 2015.

Quarterly, principal payments are due under the Term Loan, which amortizes such that 10% of the outstanding principal is due during the first four years and the remaining 60% is due in the fifth year, including any remaining principal balance and any outstanding revolver balance at such time. The principal amount of unpaid maturities per the Amended Credit Agreement is as follows (in thousands):

2015, remainder thereof
$

2016

2017

2018
21,950

Total
$
21,950


The Company intends to continue making quarterly payments during 2015 and reclassified $4.0 million as current on the accompanying Condensed Consolidated Balance Sheet as of March 31, 2015.

4.00% Convertible Senior Notes

On June 25, 2012, the Company issued $105.0 million principal amount of 4.00% Convertible Senior Notes ("4.00% Convertible Notes") due July 1, 2019. The net proceeds, after debt issuance costs totaling $3.9 million from the 4.00% Convertible Notes offering, were $101.1 million. The 4.00% Convertible 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% Convertible Notes, which is seven years.

Holders of the 4.00% Convertible Notes may convert their 4.00% Convertible 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% Convertible 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% Convertible 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% Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. If the Company calls the 4.00% Notes for redemption, a holder of notes may convert its notes only until the close of business on the scheduled trading day immediately preceding the redemption date unless the Company fails to pay the redemption price (in which case a holder of notes may convert such notes until the redemption price has been paid or duly provided for).

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As of March 31, 2015, the outstanding balance on the 4.00% Convertible Notes was $105.0 million and interest incurred for the three months ended March 31, 2015 was $1.2 million.

NOTE 8—NET INCOME (LOSS) PER COMMON SHARE

Basic earnings 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 earnings per common share, if any, gives effect to dilutive common stock subject to repurchase, stock options (calculated based on the treasury stock method), shares purchased under the employee stock purchase plan and convertible debt (calculated using an as-if-converted method).

The following table sets forth a reconciliation of basic and diluted net income (loss) per common share (in thousands except per common share amounts):

 
Three Months Ended 
 March 31,
 
2015
 
2014
Net income (loss)
$
4,386

 
$
(10,474
)
 


 


Shares used in computing basic net income (loss) per common share
75,408

 
72,498

     Add effect of dilutive securities:
 
 
 
          Employee stock options
1,639

 

          Employee stock purchase plan
71

 

          Restricted stock and restricted stock units
1,636

 

Shares used in computing diluted net income (loss) per common share
78,754

 
72,498

 
 
 
 
Basic net income (loss) per common share
$
0.06

 
$
(0.14
)
Diluted net income (loss) per common share
$
0.06

 
$
(0.14
)

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

 
Three Months Ended March 31,
 
2015
 
2014
Employee stock options
2,309

 
5,068

Employee stock purchase plan

 
173

Restricted stock and restricted stock units
1,359

 
4,419

Convertible notes
17,857

 
17,857

Total
21,525

 
27,517


NOTE 9—LEGAL PROCEEDINGS

The Company has been in the past, and continues to be, a party to litigation, which has consumed, and may continue to consume, substantial financial and managerial resources. The Company could incur substantial costs and divert the attention of management and technical personnel in defending against litigation, and any adverse ruling or perception of an adverse ruling could have a material adverse impact on the Company’s stock price. In addition, any adverse ruling could have a material adverse impact on the Company’s cash flows and financial condition. The results of any litigation or any other legal proceedings are uncertain and, as of the date of this report, the Company has not accrued any liability with respect to any of the litigation matters listed below:

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Enzo Litigation

Southern District of New York Case: On October 28, 2003, Enzo Life Sciences, Inc., a wholly-owned subsidiary of Enzo Biochem, Inc. (collectively "Enzo"), filed a complaint against the Company that is pending in the United States District Court for the Southern District of New York for breach of contract, injunctive relief and declaratory judgment. The Enzo complaint relates to a 1998 distributorship agreement with Enzo under which the Company served as a non-exclusive distributor of certain reagent labeling kits supplied by Enzo. On November 10, 2003, the Company filed a complaint against Enzo in the United States District Court for the Southern District of New York for declaratory judgment, breach of contract and injunctive relief relating to the 1998 agreement. On April 22, 2014, the Company entered into a settlement agreement with Enzo with respect to these two lawsuits. Pursuant to the agreement the Company agreed to pay Enzo $5.1 million and recorded the litigation settlement charge within the results of operations in the first three months of 2014. The settlement agreement does not include the Delaware Case described below.
 
Delaware Case: On April 6, 2012, Enzo filed a complaint against the Company in the United States District Court for the District of Delaware. In the complaint, plaintiff alleges that Affymetrix is infringing U.S. Patent No. 7,064,197 by making and selling certain GeneChip® products. The plaintiff seeks a preliminary and permanent injunction enjoining the Company from further infringement and unspecified monetary damages. The Company will vigorously defend against the plaintiff’s case. No trial date is set for this action.

Administrative Proceedings

The Company’s intellectual property is subject to a number of significant administrative actions. These proceedings could result in the Company’s patent protection being significantly modified or reduced, and the incurrence of significant costs and the consumption of substantial managerial resources. For the three months ended March 31, 2015 and 2014, the Company did not incur significant costs in connection with administrative proceedings.

NOTE 10—INCOME TAXES

During the three months ended March 31, 2015, the Company recognized an income tax expense of $0.7 million. The provision for income taxes during the three months ended March 31, 2015 primarily consists 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 Company's U.S. deferred tax assets continue to be subject to a valuation allowance as of March 31, 2015.

As of March 31, 2015, the total amount of unrecognized tax benefits increased minimally compared to December 31, 2014. As a result of settlements of ongoing tax examinations and/or expiration of statues of limitations without the assessment of additional income taxes, the amount of unrecognized tax benefits that could be recognized in earnings in the next 12 months could range from zero to approximately $1.7 million.

NOTE 11—SEGMENT 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 the combined presence of its Chief Executive Officer and Chief Operating Officer is the Company's chief operating decision maker ("CODM") as they are responsible for reviewing and approving investments in the Company's technology platforms and manufacturing infrastructure. The Company is organized into two reportable segments: Affymetrix Core and eBioscience.

Affymetrix Core is divided into four business units, with each business unit having its own strategic marketing and research and development groups to better serve customers and respond quickly to market needs. Affymetrix Core manufacturing operations are based on platforms that are used to produce various Affymetrix Core products that serve multiple applications and markets and similar customer and economic characteristics. Additionally, the business units share certain research, development and common corporate services that provide capital, infrastructure and functional support. As

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such, the Company concluded that the four business units represent one reportable operating segment. The following describes the four business units that form Affymetrix Core:

Expression: This business unit markets the Company's GeneChip® gene expression products and services;

Genetic Analysis and Clinical Applications: This business unit markets the Company's Axiom® genotyping product line, as well as products with clinical diagnostic and research applications including CytoScan® HD, OncoScan products, and the ViewRNA insitu hybridization platform for clinical translational research. In addition, the business unit is responsible for managing the PbA clinical partnering and licensing program which enables third-party diagnostic companies to access and develop DNA and RNA-based diagnostic tests based on Affymetrix technology platforms. This business unit also markets the CytoScan Dx product, the recently FDA approved microarray system for post natal diagnostics of children with developmental delays and intellectual disabilities;

Life Science Reagents: This business unit sells reagents, enzymes, purification kits and biochemicals used by life science researchers and other biological and health care manufacturers, including those developing and marketing Next Generation Sequencing (“NGS”) products and molecular diagnostics; and

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

The eBioscience business unit operates with its own manufacturing, research and development, and marketing groups. The business unit does utilize certain Corporate functions such as finance, legal and human resources. This reportable segment specializes in the areas of flow cytometry reagents, immunoassays, microscopic imaging, other protein-based analyses, QuantiGene single and multiplex RNA solution assays (not including the View RNA insitu hybridization platform) and the Procarta multiplex immunoassay product lines.

All business units sell their products through the Global Commercial Organization comprised of sales, field application and engineering support personnel. The Company markets and distributes its products directly to customers in North America, Japan and major European markets. In these markets, the Company has its own sales, service and application support personnel responsible for expanding and managing their respective customer bases. In other markets, such as Mexico, India, Brazil, the Middle East and Asia Pacific, including China, the Company sells its products principally through third-party distributors that specialize in life science supply. The Company is selectively expanding its presence in the larger and more attractive markets, such as China. For certain molecular diagnostic and industrial opportunities, the Company supplies its partners with arrays and instruments, which they incorporate into diagnostic products or other routine applications and assume the primary commercialization responsibilities.

During 2015, the commercial organization and general and administrative functions are fully integrated. The Company no longer reports these operating expenses at a segment level and began evaluating the performance of its reportable segments based on revenue and gross profit. Revenue is allocated to each business unit based on product codes. The 2014 amounts have been recast to conform to the current presentation.

The following table shows revenue and gross profit by reportable operating segment for the three months ended March 31, 2015 and 2014 (in thousands):


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Three Months Ended March 31,
 
2015
 
2014
Revenue:
 
 
 
Affymetrix Core
$
64,445

 
$
59,447

eBioscience
24,272

 
23,524

Total revenue
$
88,717

 
$
82,971

Gross Profit:
 
 
 
Affymetrix Core
$
40,627

 
$
35,004

eBioscience
14,211

 
11,551

Total gross profit
$
54,838

 
$
46,555


NOTE 12—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 former 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 2016, 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 March 31, 2015, no significant royalties have been earned from this agreement.

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 March 31, 2015 and for the three months ended March 31, 2015 and 2014 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, 2014.

All statements in this quarterly report that are not historical in nature, are predicative in nature or that depend upon or refer to future events or conditions are "forward-looking statements" within the meaning of Section 21 of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These include statements regarding our strategic initiatives, market expectations, integration of and synergies related to eBioscience, anticipated product and revenue growth, financial strength and regulatory environment, as well as all other "expectations," "beliefs," "hopes," "intentions," "strategies" and words of similar import and the negatives thereof. Such statements are based on our current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. We cannot assure you that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, those discussed in “Risk Factors” contained in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014. These forward-looking statements speak only as of the date of the Quarterly Report. Unless required by law, we do not undertake 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.

OVERVIEW

We are a provider of life science and molecular diagnostic products that enable parallel analysis of biological systems at the gene, protein and cell level. We sell our products to life science research centers, academic institutions, government and private laboratories, as well as pharmaceutical, diagnostic and biotechnology companies. Over 94,500 peer-reviewed papers have been published based on work using our products. We have approximately 1,100 employees worldwide and maintain sales and distribution operations across the United States, Europe, Latin America and Asia.


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Reportable Segments

See Note 11, "Segment Information", of the accompanying Condensed Consolidated Financial Statements for information on our reportable operating segments.

Our Strategy

Our strategy has been to transform the company from one that is highly dependent on its GeneChip® Expression product line that faces intense competition in certain applications, to one with diversified revenue streams and a broad reach into the growing markets for translational medicine, molecular diagnostics and applied sciences, such as agricultural biotechnology ("AgBio").

Since Dr. Frank Witney became our President and Chief Executive Officer in July 2011, we have begun shifting our resources and focus from a dependency on our Expression business unit products to a more diversified portfolio with broader and growing revenue streams that reach into the growing markets for translational medicine, molecular diagnostics and applied sciences. Revenue from the Expression business unit was reduced to approximately 17% of total revenue in the first quarter of 2015 as compared to 22% in the same period of 2014 while revenue from our Genetic Analysis and Clinical Applications business unit increased to 42% of total revenue in the first quarter of 2015 as compared to 36% in the same period of 2014. Our eBioscience business was approximately 27% and 28% of our consolidated revenue for the first quarter of 2015 and 2014, respectively.

Since 2011, under the leadership of Dr. Witney, we have executed on a strategy to realign our product portfolio, stabilize our business and return our company to growth and profitability. We expect this transformation to take place over three phases, two of which are now completed:

Phase 1 (2011-2012) –Portfolio Realignment. During this phase, we reorganized ourselves into business units to sharpen our focus based on target markets. We also launched CytoScan®, our cytogenetic microarray product line, enhanced our Axiom Genotyping Solution and acquired eBioscience. Through eBioscience, we offer flow cytometry reagents and immunoassay products which, aligned with our new product introductions, have enabled us to broaden our reach into the translational medicine, applied, and molecular diagnostics markets. We believe these actions contributed to the stabilization of our business and the realignment of our product portfolio positioned us for growth.

Phase II (2013-2014) – Profitability, Strengthen Balance Sheet, Development of Newer Product Lines. In the beginning of 2013, we implemented a corporate restructuring which resulted in significant cost savings and accelerated our path to profitability. In addition, we reduced our senior secured debt to $23.0 million as of December 31, 2014. We grew total revenue by 9% in 2014 compared to 2013, after adjustment for the divestiture of our Anatrace product line (which was sold in 2013) and a one-time license payment in 2013. This growth was driven by strong sales of CytoScan and Axiom Genotyping products and services, along with eBioscience products. We trained and refocused our internal research and development, marketing, operations and regulatory teams along with our global commercial organization to expand our reach to customers in the translational medicine, molecular diagnostics and applied markets.

Phase III (2015 -2017) – Strategic Flexibility, Expansion of Product Lines, Growth. We entered Phase III of our transformation in 2015. In this phase, our goal is to leverage the work we have done in Phase I and II in order to have well established and growing franchises in: (1) translational medicine and molecular diagnostics (with a focus on reproductive health and oncology); (2) genotyping (both human and AgBio); and (3) single cell biology (the analysis of individual cells that comprise the population of cells typically studied by researchers, a market expected to grow rapidly over the next several years). We intend to continue the growth that we demonstrated in Phase II, as well as continue to improve our profitability. We strengthened our balance sheet in Phase II and are now in position to evaluate complimentary technology acquisitions that may enhance our positions in our target markets.


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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Condensed Consolidated Financial Statements, which we have prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, refer to Note 1, "Summary of Significant Accounting Policies", in the Notes to the Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q. During the three months ended March 31, 2015, 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, 2014.


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RESULTS OF OPERATIONS

The following discussion compares the historical results of operations for the three months ended March 31, 2015 and 2014.

REVENUE
 
Three Months Ended March 31,
 
$ Change
 
% Change
 
2015
 
2014
 
 
Total revenue ($ in thousands):
 
 
 
 
 
 
 
Consumables
$
76,454

 
$
69,886

 
$
6,568

 
9%
Instruments
2,913

 
3,809

 
(896
)
 
(24)%
Product sales
79,367

 
73,695

 
5,672

 
8%
Services and other revenue
9,350

 
9,276

 
74

 
1%
Total revenue
$
88,717

 
$
82,971

 
$
5,746

 
7%
 
 
 
 
 
 
 
 
Segment revenue ($ in thousands):
 
 
 
 
 
 
 
Affymetrix Core:
 
 
 
 
 
 
 
Expression
$
14,886

 
$
18,549

 
$
(3,663
)
 
(20)%
Genetic analysis and clinical applications
36,955

 
30,221

 
6,734

 
22%
Life science reagents
6,683

 
6,943

 
(260
)
 
(4)%
Corporate
5,921

 
3,734

 
2,187

 
59%
Total Affymetrix Core
64,445

 
59,447

 
4,998

 
8%
eBioscience
24,272

 
23,524

 
748

 
3%
Total revenue
$
88,717

 
$
82,971

 
$
5,746

 
7%
 
 
 
 
 
 
 
 
Segment revenue (% of revenue):
 
 
 
 
 
 
 
Affymetrix Core:
2015
 
2014
 
 
 
 
Expression
17%
 
22%
 


 

Genetic analysis and clinical applications
42%
 
36%
 


 

Life science reagents
8%
 
9%
 


 

Corporate
6%
 
5%
 


 

Total Affymetrix Core
73%

72%
 


 

eBioscience
27%
 
28%
 


 

Total revenue
100%
 
100%
 


 


Product sales

For the three months ended March 31, 2015, total product sales increased $5.7 million as compared to the same period in 2014. The increase was primarily due to a higher volume of sales of our Axiom Genotyping Solution, PbA partners, Cytogenetics and ProCarta Plex products. These increases were partially offset by a decline in our legacy in vitro transcription (IVT) expression product sales and Gene arrays sales and decreased instrument revenue due to a lower volume of sales.

Services and other revenue

For the three months ended March 31, 2015, services and other revenue increased $0.1 million as compared to the same period in 2014, primarily due to increased royalty and license revenue of $0.3 million and genotyping services revenue of $0.1 million. This increase was offset by lower field services revenue of $0.4 million.

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Expression

For the three months ended March 31, 2015, Expression revenue decreased $3.7 million as compared to the same period in 2014, primarily due to lower IVT sales of $1.8 million, lower Gene and Exon array sales of $1.3 million, and lower instruments sales of $0.6 million.

Genetic Analysis and Clinical Applications

For the three months ended March 31, 2015, Genetic Analysis and Clinical Applications revenue increased $6.7 million as compared to the same period in 2014, primarily due to increased Axiom® Genotyping Solution product sales and services of $5.0 million, increased PbA partners sales of $2.1 million, and Cytogenetics product sales of $1.2 million, partially offset by a decline in sales of our legacy genotyping product SNP 6.0 of $0.9 million, and DMET sales of $0.4 million.

Life Science Reagents

For the three months ended March 31, 2015, Life Science Reagents revenue decreased $0.3 million as compared to the same period in 2014, primarily due to lower volume of biochemical products.

Corporate

For the three months ended March 31, 2015, Corporate revenue increased $2.2 million as compared to the same period in 2014, primarily due to a net realized gain from designated cash flow hedges of $2.2 million and increased royalties of $0.3 million, offset by decreased field services of $0.4 million.

eBioscience

For the three months ended March 31, 2015, eBioscience revenue increased $0.7 million as compared to the same period in 2014, primarily due to increase in our ProCarta Plex sales of $0.6 million and QuantiGene ViewCell sales of $0.5 million, offset by a decrease in Elisa product sales of $0.4 million.

GROSS MARGIN

Management evaluates business segment performance based on revenue and gross margin. The following table presents gross margin for each reportable segment:
Dollars in thousands
Three Months Ended March 31,
 
$ % Change
 
2015
 
2014
 
Total gross profit:
 
 
 
 
 
Product
$
51,784

 
$
44,183

 
$
7,601

Services and other
3,054

 
2,372

 
682

Total gross profit
$
54,838

 
$
46,555

 
$
8,283

 
 
 
 
 
 
Product gross margin
65
%
 
60
%
 
5

Service and other gross margin
33
%
 
26
%
 
7

 
 
 
 
 
 
Segment gross profit:
 
 
 
 
 
Affymetrix Core
$
40,627

 
$
35,004

 
$
5,623

eBioscience
14,211

 
11,551

 
2,660

Total gross profit
$
54,838

 
$
46,555

 
$
8,283

 
 
 
 
 
 
Affymetrix Core gross margin
63
%
 
59
%
 
4

eBioscience gross margin
59
%
 
49
%
 
10


    

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Product gross profit

For the three months ended March 31, 2015, product gross profit increased $7.6 million as compared to the same period in 2014, consisting of $4.6 million improvement due to higher sales and $2.9 million due to the completion of amortization for the step-up in inventory fair value that was recognized when we acquired eBioscience in 2012. In addition, inventory reserves were lower by $0.3 million driven primarily by the sell through of previously reserved inventory, offset by increased royalties of $0.2 million in line with additional revenues.

Service and other gross profit

For the three months ended March 31, 2015, service gross profit increased $0.7 million as compared to the same period in 2014, primarily due to lower supplies expenses for the service lab related to a large biobank project of $0.6 million and increased royalties revenue of $0.3 million, offset by reduced field services gross profit of $0.3 million.

Affymetrix Core

For the three months ended March 31, 2015, Affymetrix Core gross profit increased $5.6 million as compared to the same period in 2014, consisting of $3.4 million increase due to higher product sales, $1.3 million increase due to higher utilization of our Singapore and Ohio factories and lower costs due to a certain license payment in the prior years which was not recurring, and $0.9 million increase in service gross profit, primarily due to lower supplies expenses for the service lab related to a large biobank project of $0.6 million and increased royalties revenue of $0.3 million, offset by reduced field services gross profit of $0.3 million.

eBioscience

For the three months ended March 31, 2015, eBioscience gross profit increased $2.7 million as compared to the same period in 2014, primarily due to the completion of amortization for the step-up in inventory fair value that was recognized when we acquired eBioscience in 2012.

OPERATING EXPENSES
Dollars in thousands
Three Months Ended March 31,
 
$ Change
 
% Change
 
2015
 
2014
 
 
Research and development
$
12,120

 
$
11,635

 
$
485

 
4%
Selling, general and administrative expenses
35,433

 
38,562

 
(3,129
)
 
(8)%
Litigation settlement

 
5,100

 
(5,100
)
 
100%

Research and development Research and development expense increased $0.5 million for the three months ended March 31, 2015 as compared to the same periods in 2014. The increases are primarily due to higher spending on supplies and increased consulting and external services.

Selling, general and administrative Selling, general and administrative expenses decreased $3.1 million for the three months ended March 31, 2015 as compared to the same period in 2014. The decrease is primarily related to decreases in compensation and benefits, lower legal fees incurred during the current period, and lower depreciation expense as certain fixed assets have been fully depreciated, partially offset by higher stock-based compensation expense related to new grants.

Litigation settlement On April 22, 2014, the Company entered into a settlement agreement with Enzo with respect to our dispute with Enzo Life Sciences, Inc. brought in the Southern District Court of New York. Pursuant to the agreement the Company agreed to pay Enzo $5.1 million as consideration for both parties agreeing to release each other from all liabilities and claims arising under both lawsuits. As the settlement related to past claims with no ongoing benefit, these costs were recognized during the first three months of 2014 when the amount was determined to be probable and estimable.


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OTHER (EXPENSE) INCOME, NET
    
Dollars in thousands
Three Months Ended March 31,
 
$ Change
 
% Change
 
2015
 
2014
 
 
Other (expense) income, net
$
(673
)
 
$
293

 
$
(966
)
 
(330)%
Interest expense
1,483

 
1,753

 
(270
)
 
15%

Other (expense) income, net Other (expense) income, net, decreased $1.0 million for the three months ended March 31, 2015 as compared to the same period in 2014. The decrease is primarily due to currency losses, partially offset by a gain related to the recovery of certain investments in the quarter.

Interest expense Interest expense decreased $0.3 million for the three months ended March 31, 2015 as compared to the same period in 2014. The decreases are due to a combination of lower outstanding borrowings in the first three months of 2015 as well as lower interest rates following the modification of our Senior Secured Credit Facility in July 2014.

INCOME TAX PROVISION
Dollars in thousands
Three Months Ended March 31,
 
$ Change
 
% Change
 
2015
 
2014
 
 
Income tax provision
$
743

 
$
272

 
$
471

 
(173
)%

During the three months ended March 31, 2015, the Company recognized an income tax expense of $0.7 million. The provision for income taxes during the three months ended March 31, 2015 primarily consists 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 Company's U.S. deferred tax assets continue to be subject to a valuation allowance as of March 31, 2015.

As of March 31, 2015, the total amount of unrecognized tax benefits increased minimally compared to December 31, 2014. As a result of settlements of ongoing tax examinations and/or expiration of statues of limitations without the assessment of additional income taxes, the amount of unrecognized tax benefits that could be recognized in earnings in the next 12 months could range from zero to approximately $1.7 million.

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% Convertible Notes and at-the-market offering; collaborative agreements; 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 activities, 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 March 31, 2015, we had cash and cash equivalents of approximately $104.0 million. We anticipate that our existing capital resources along with the cash to be generated from operations and at-the-market offering will enable us to maintain currently planned operations, debt repayments, 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; an 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 dispositions; the progress of our research and development programs; initiation or expansion of research programs and

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collaborations; the costs involved in preparing, filing, prosecuting and enforcing intellectual property rights; the purchase of patent licenses; and other factors.

During the three months ended March 31, 2015, we prepaid $1.0 million of our senior secured debt with cash provided by operations. As of March 31, 2015, the carrying amount of the senior secured debt was $22.0 million.

As part of the terms of the senior secured debt agreement, we are required to meet certain financial and other negative covenants. As of March 31, 2015, we were in compliance with the amended covenants. Refer to Note 7, “Long-Term Debt Obligations”, for further details regarding our Senior Secured Credit Facility and 4.00% Convertible Notes.

From time to time, we may seek to retire, repurchase or exchange common stock or convertible notes in open market purchases, privately negotiated transactions dependent on market conditions, liquidity, and contractual obligations and other factors. We did not retire, repurchase or exchange any of our common stock or convertible notes during the three months ended March 31, 2015.

On November 18, 2014, we entered into a sales agreement with Cantor Fitzgerald & Co. (“Cantor Fitzgerald”) to offer shares of our common stock, $0.01 par value per share, from time to time through Cantor Fitzgerald, as our sales agent for the offer and sale of the shares. We may offer and sell shares for an aggregate offering price of up to $50.0 million. We pay a commission equal to 3% of the gross proceeds from the sale of shares of our common stock under the sales agreement. We intend to use the net proceeds from this offering for general corporate purposes, including capital expenditures, debt repayments and working capital. We may also use a portion of the net proceeds from this offering to acquire or invest in complementary businesses, technologies, product candidates or other intellectual property, although there are no present commitments or agreements to do so. We are not obligated to make any sales of shares of our common stock under the sales agreement. As of March 31, 2015, we have sold a total of 2.2 million shares of our common stock at an average price of $11.80 through our “at-the-market” offering, for total net proceeds of $25.3 million.

Cashflow (in thousands)
 
Three Months Ended March 31,
 
2015
 
2014
Net cash provided by operating activities
$
1,342

 
$
4,605

Net cash used in investing activities
(2,338
)
 
(1,005
)
Net cash provided by (used in) financing activities
25,658

 
(3,066
)

Operating Activities

Net cash provided by operating activities for the three months ended March 31, 2015 was comprised of net income of $4.4 million, non-cash charges of $8.8 million and a decrease of $11.9 million related to changes in operating assets and liabilities. Adjustments for non-cash expenses include depreciation and amortization expense of $5.5 million, and share-based compensation expense of $4.1 million.

Net cash provided by operating activities for the three months end March 31, 2014 was comprised of net loss of $10.5 million, non-cash charges of $14.6 million and a decrease of $0.5 million related to changes in operating assets and liabilities. Adjustments for non-cash expenses include depreciation and amortization expense of $8.7 million, amortization expense related to inventory step-up in fair value of $2.9 million, and share-based compensation expense of $3.1 million.

Investing Activities

Net cash used in investing activities for the three months ended March 31, 2015 included capital expenditures of $2.3 million.

Net cash used in investing activities for the three months ended March 31, 2014 included capital expenditures of $1.1 million.


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Financing Activities

Net cash provided by financing activities for the three months ended March 31, 2015 included net proceeds of $25.3 million from our at-the-market offering, and the use of $1.0 million of early payments on the outstanding principal amount of borrowings under our Term Loan agreement. Other financing activities also consisted of stock option exercise activity of $3.3 million under our employee stock plan. Cash used in paying withholding taxes in connection with issuance of stock under our employee stock plan, net of treasury shares withheld for taxes, was $2.0 million for the three months ended March 31, 2015.

Net cash used in financing activities for the three months ended March 31, 2014 included $3.3 million of pre-payment on our Senior Credit Facility. 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.

OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS

As of March 31, 2015, we had no off-balance sheet arrangements. 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, 2014, except with respect to the prepayment of amounts owned under our Term Loan as discussed above.

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 1, "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, 2014 for further information.

Interest Rate Risk

We are exposed to market risk from changes in interest rates on long-term obligations. We have a combination of fixed and variable rate debt. Refer to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2014. In October 2013, we refinanced $48.0 million under our Senior Secured Credit Facility. In July 2014, we entered into the Fifth Amendment, which provides, among other things, for (1) an uncommitted incremental term loan facility in an aggregate amount not to exceed $50.0 million and (2) the reduction of interest rate margins. Our interest rate risk relates primarily to U.S. dollar LIBOR-indexed borrowings.

A 100 basis point increase in interest rates on the current borrowings is not expected to have a material impact on our financial position, results of operations or cash flows since interest on our borrowings is not material to our overall financial position.

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.


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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 the fiscal quarter covered by this report on Form 10-Q 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 9, "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

Our business is subject to various risks, including those described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, which we strongly encourage you to review. There have been no material changes from the risk factors disclosed in Item 1A of our Form 10-K.
 
ITEM 2. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 3. OTHER INFORMATION

None.

ITEM 4. EXHIBITS
Exhibit
Number
 
Description of Document
 
 
 
31.1(1)
 
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
31.2(1)
 
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32(1)
 
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(2)
EX-101.SCH
 
XBRL Taxonomy Extension Schema Document(2)
EX-101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document(2)
EX-101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document(2)
EX-101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document(2)
EX-101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document(2)

(1)
Filed herewith.
(2)
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.


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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
 
 
 
April 30, 2015
 
 
 
 
 
 
 
Duly Authorized Officer and Principal Financial
And Accounting Officer

 
 
 
 
 


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