Table
of Contents
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 SEPTEMBER 30,
2008
|
|
|
|
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)
|
|
(Zip
Code)
|
Registrants 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
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
x
|
|
Accelerated filer
o
|
|
|
|
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
OCTOBER 31, 2008: 70,202,630
Table
of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AFFYMETRIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In
thousands)
(Unaudited)
|
|
September 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
ASSETS:
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
315,151
|
|
$
|
288,644
|
|
Restricted cash
|
|
7,844
|
|
|
|
Available-for-sale securitiesshort-term
portion
|
|
256,410
|
|
205,718
|
|
Accounts receivable, net
($67 in 2008 and $389 in 2007 from
Perlegen Sciences)
|
|
63,464
|
|
81,941
|
|
Inventories
|
|
46,373
|
|
42,912
|
|
Deferred tax assetscurrent portion
|
|
7,825
|
|
28,584
|
|
Notes receivable from employeescurrent
portion
|
|
|
|
1,376
|
|
Prepaid expenses and other current assets
|
|
15,732
|
|
17,933
|
|
Total current assets
|
|
712,799
|
|
667,108
|
|
Available-for-sale securitieslong-term
portion
|
|
10,938
|
|
89,912
|
|
Property and equipment, net
|
|
107,087
|
|
143,884
|
|
Acquired technology rights, net
|
|
54,859
|
|
46,797
|
|
Goodwill
|
|
193,000
|
|
125,050
|
|
Deferred tax assetslong-term portion
|
|
45,886
|
|
18,426
|
|
Notes receivable from employeeslong-term
portion
|
|
|
|
487
|
|
Other assets
|
|
33,522
|
|
41,927
|
|
Total assets
|
|
$
|
1,158,091
|
|
$
|
1,133,591
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY:
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
$
|
54,290
|
|
$
|
61,543
|
|
Deferred revenuecurrent portion
|
|
18,276
|
|
22,498
|
|
Total current liabilities
|
|
72,566
|
|
84,041
|
|
Deferred revenuelong-term portion
|
|
3,668
|
|
3,922
|
|
Other long-term liabilities
|
|
10,451
|
|
10,971
|
|
Convertible notes
|
|
436,250
|
|
436,250
|
|
Stockholders equity:
|
|
|
|
|
|
Common stock
|
|
702
|
|
692
|
|
Additional paid-in capital
|
|
734,390
|
|
704,189
|
|
Accumulated other comprehensive income
|
|
(2,261
|
)
|
1,998
|
|
Accumulated deficit
|
|
(97,675
|
)
|
(108,472
|
)
|
Total stockholders equity
|
|
635,156
|
|
598,407
|
|
Total liabilities and stockholders equity
|
|
$
|
1,158,091
|
|
$
|
1,133,591
|
|
Note 1:
The
condensed consolidated balance sheet at December 31, 2007 has been derived
from the audited consolidated financial statements at that date included in the
Companys Form 10-K for the fiscal year ended December 31, 2007.
See accompanying notes.
3
Table of Contents
AFFYMETRIX, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In
thousands, except per share amounts)
(Unaudited)
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
REVENUE:
|
|
|
|
|
|
|
|
|
|
Product sales
($46 and $843 in 2008 and $355 and $11,456 in
2007 from Perlegen Sciences)
|
|
$
|
65,952
|
|
$
|
69,727
|
|
$
|
203,780
|
|
$
|
202,621
|
|
Services
|
|
6,132
|
|
10,829
|
|
23,557
|
|
31,617
|
|
Royalties and other revenue
|
|
3,105
|
|
14,430
|
|
104,338
|
|
29,490
|
|
Total revenue
|
|
75,189
|
|
94,986
|
|
331,675
|
|
263,728
|
|
COSTS AND EXPENSES:
|
|
|
|
|
|
|
|
|
|
Cost of product sales
($4 and $446 in 2008 and $166 and $4,494
in 2007
from Perlegen
Sciences)
|
|
32,347
|
|
28,246
|
|
90,581
|
|
76,117
|
|
Cost of services
|
|
5,791
|
|
7,307
|
|
18,160
|
|
24,473
|
|
Cost of royalties and other revenue
|
|
29
|
|
39
|
|
81
|
|
185
|
|
Research and development
|
|
20,739
|
|
16,489
|
|
59,098
|
|
55,143
|
|
Selling, general and administrative
|
|
28,409
|
|
33,300
|
|
92,782
|
|
102,800
|
|
Acquired in-process technology
|
|
5,100
|
|
|
|
5,900
|
|
|
|
Restructuring charges
|
|
14,571
|
|
5,737
|
|
29,379
|
|
12,879
|
|
Total costs and expenses
|
|
106,986
|
|
91,118
|
|
295,981
|
|
271,597
|
|
(Loss) income from operations
|
|
(31,797
|
)
|
3,868
|
|
35,694
|
|
(7,869
|
)
|
Interest income and other, net
|
|
1,672
|
|
291
|
|
10,830
|
|
8,382
|
|
Interest expense
|
|
(3,497
|
)
|
(417
|
)
|
(10,634
|
)
|
(1,246
|
)
|
(Loss) income before income taxes
|
|
(33,622
|
)
|
3,742
|
|
35,890
|
|
(733
|
)
|
Income tax benefit (provision)
|
|
1,802
|
|
(1,162
|
)
|
(25,093
|
)
|
550
|
|
Net (loss) income
|
|
$
|
(31,820
|
)
|
$
|
2,580
|
|
$
|
10,797
|
|
$
|
(183
|
)
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net (loss) income per
common share
|
|
$
|
(0.46
|
)
|
$
|
0.04
|
|
$
|
0.16
|
|
$
|
(0.00
|
)
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing basic net (loss)
income per common share
|
|
68,582
|
|
68,356
|
|
68,542
|
|
68,170
|
|
Shares used in computing diluted net (loss)
income per common share
|
|
68,582
|
|
68,725
|
|
68,650
|
|
68,170
|
|
See accompanying notes.
4
Table
of Contents
AFFYMETRIX, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In
thousands)
(Unaudited)
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
Net income (loss)
|
|
$
|
10,797
|
|
$
|
(183
|
)
|
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
|
|
|
|
|
|
Depreciation and amortization
|
|
24,424
|
|
17,495
|
|
Amortization of intangible assets
|
|
8,313
|
|
6,244
|
|
Charge for acquired in-process technology
|
|
5,900
|
|
|
|
Amortization of investment premiums, net
|
|
116
|
|
109
|
|
Stock-based compensation
|
|
6,618
|
|
7,901
|
|
Restructuring charges
|
|
(1,703
|
)
|
50
|
|
Realized (gain) loss on equity investments
|
|
(47
|
)
|
3,249
|
|
Realized loss (gain) on the sales of
investments
|
|
450
|
|
(99
|
)
|
Deferred tax assets
|
|
18,445
|
|
(327
|
)
|
Amortization of debt offering costs
|
|
1,583
|
|
570
|
|
Accretion of interest on notes receivable
|
|
(7
|
)
|
(48
|
)
|
Loss on disposal of property and equipment
|
|
25,858
|
|
1,088
|
|
Changes in operating assets and
liabilities:
|
|
|
|
|
|
Restricted cash
|
|
(7,844
|
)
|
|
|
Accounts receivable, net
|
|
21,509
|
|
9,315
|
|
Inventories
|
|
3,732
|
|
(2,102
|
)
|
Prepaid expenses and other assets
|
|
4,222
|
|
(5,604
|
)
|
Accounts payable and accrued liabilities
|
|
(19,176
|
)
|
(10,878
|
)
|
Deferred revenue
|
|
(4,476
|
)
|
(8,851
|
)
|
Other long-term liabilities
|
|
(520
|
)
|
1,427
|
|
Net cash provided by operating activities
|
|
98,194
|
|
19,356
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
Capital expenditures
|
|
(10,809
|
)
|
(22,954
|
)
|
Purchases of available-for-sale securities
|
|
(336,258
|
)
|
(82,074
|
)
|
Proceeds from sales and maturities of
available-for-sale securities
|
|
363,985
|
|
77,712
|
|
Acquisition of businesses, net of cash
acquired
|
|
(88,213
|
)
|
|
|
Purchase of non-marketable equity
investments
|
|
(311
|
)
|
(800
|
)
|
Capital distribution of non-marketable
equity investments
|
|
|
|
902
|
|
Net cash used in investing activities
|
|
(71,606
|
)
|
(27,214
|
)
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
Issuance of common stock, net
|
|
(35
|
)
|
12,227
|
|
Net cash (used in) provided by financing
activities
|
|
(35
|
)
|
12,227
|
|
Effect of exchange rate changes on cash and
cash equivalents
|
|
(46
|
)
|
304
|
|
Net increase in cash and cash equivalents
|
|
26,507
|
|
4,673
|
|
Cash and cash equivalents at beginning of
period
|
|
288,644
|
|
119,063
|
|
Cash and cash equivalents at end of period
|
|
$
|
315,151
|
|
$
|
123,736
|
|
See accompanying notes.
5
Table of Contents
AFFYMETRIX, INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER
30, 2008
(UNAUDITED)
NOTE 1SUMMARY 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 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 financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended December 31,
2007, as filed with the Securities and Exchange Commission on February 29,
2008.
Use of Estimates
The preparation of the condensed consolidated
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
amounts reported in the financial statements and accompanying notes. Actual
results could differ materially from those estimates.
Reclassification
Certain
prior year revenue and cost of sales amounts in the Companys Condensed Consolidated
Statements of Operations have been reclassified to conform to the current
period presentation.
Revenue Recognition
Overview
The Company recognizes revenue when
persuasive evidence of an arrangement exists, delivery has occurred, the fee is
fixed or determinable, and collectibility is reasonably assured. In instances
where final acceptance of the product or system is required, revenue is deferred
until all the acceptance criteria have been met.
The Company derives the majority of its
revenue from product sales of GeneChip
®
probe arrays, reagents, and
related instrumentation that may be sold individually or combined with any of
the products, services or other sources of revenue listed below. When a sale
combines multiple elements, the Company accounts for multiple element
arrangements under Emerging Issues Task Force Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables
,
(EITF 00-21)
EITF 00-21 provides guidance on accounting
for arrangements that involve the delivery or performance of multiple products,
services and/or rights to use assets. In accordance with EITF 00-21, the
Company allocates revenue for transactions or collaborations that include
multiple elements to each unit of accounting based on its relative fair value,
and recognizes revenue for each unit of accounting when the revenue recognition
criteria have been met. The price charged when the element is sold separately
generally determines fair value. In the absence of fair value of a delivered
element, the Company allocates revenue first to the fair value of the
undelivered elements and the residual revenue to the delivered elements. The
Company recognizes revenue for delivered elements when the delivered elements
have standalone value and the Company has objective and reliable evidence of
fair value for each undelivered element. If the fair value of any undelivered
element included in a multiple element arrangement cannot be objectively
determined, revenue is deferred until all elements are delivered and services
have been performed, or until fair value can objectively be determined for any
remaining undelivered elements.
6
Table of Contents
Product Sales
Product sales, as well as revenues from
Perlegen Sciences (a related party, see Note 10), include sales of GeneChip®
probe arrays, reagents and related instrumentation. Probe array, reagent and
instrumentation revenues are recognized when earned, which is generally upon
shipment and transfer of title to the customer and fulfillment of any
significant post-delivery obligations. Accruals are provided for anticipated
warranty expenses at the time the associated revenue is recognized.
Services
Services revenue includes equipment service
revenue; scientific services revenue, which includes associated consumables;
and revenue from custom probe array design fees.
Revenue related to extended warranty
arrangements is deferred and recognized ratably over the applicable periods.
Revenue from custom probe array design fees associated with the Companys
GeneChip
®
CustomExpress
Ô
and CustomSeq
Ô
products are recognized when the associated
products are shipped.
Revenue from scientific and DNA analysis
services are recognized upon shipment of the required data to the customer.
Royalties and Other
Revenue
Royalties and other revenue include license
revenue; royalties earned from third party license agreements; milestones and
royalties earned from collaborative product development and supply agreements;
subscription fees earned under GeneChip® array access programs; and research
revenue which mainly consists of amounts earned under government grants; and
non-recurring intellectual property payments.
License revenues are generally recognized
upon execution of the agreement unless the Company has continuing performance
obligations, in which case the license revenue is recognized ratably over the
period of expected performance.
Royalty revenues are earned from the sale of
products by third parties who have been licensed under the Companys
intellectual property portfolio. Revenue from minimum royalties is amortized
over the term of the creditable royalty period. Any royalties received in
excess of minimum royalty payments are recognized under the terms of the
related agreement, generally upon notification of manufacture or shipment of a
product by a licensee.
The Company enters into collaborative
arrangements which generally include a research and product development phase
and a manufacturing and product supply phase. These arrangements may include
up-front nonrefundable license fees, milestones, the rights to royalties based
on the sale of final product by the partner, product supply agreements and
distribution arrangements.
Any up-front, nonrefundable payments from
collaborative product development agreements are recognized ratably over the
research and product development period, and at-risk substantive based
milestones are recognized when earned. Any payments received which are not yet
earned are included in deferred revenue.
Revenue from subscription fees earned under
GeneChip
®
array access programs is recorded ratably over the related
supply term.
Research revenues result primarily from
research grants received from U.S. Government entities or from subcontracts
with other life science research-based companies which receive their research
grant funding from the U.S. Government. Revenues from research contracts are
generated from the efforts of the Companys technical staff and include the
costs for material and subcontract efforts. The Companys research grant
contracts generally provide for the payment of negotiated fixed hourly rates
for labor hours incurred plus reimbursement of other allowable costs. Research
revenue is recorded in the period in which the associated costs are incurred,
up to the limit of the prior approval funding amounts contained in each
agreement. The costs associated with these grants are reported as research and
development expense.
Transactions with
Distributors
The Company recognizes revenue when
persuasive evidence of an arrangement exists, delivery has occurred or services
have been rendered, the sellers price is fixed or determinable, and
collectability is reasonably assured. The Companys agreements with
distributors do not include rights of return.
7
Table of Contents
Net Income (Loss) Per Share
Basic net income (loss) per share is
calculated using the weighted-average number of common shares outstanding
during the period less the weighted-average shares subject to repurchase.
Diluted income (loss) per share gives effect to the dilutive common stock
subject to repurchase, stock options and warrants (calculated based on the
treasury stock method), and convertible debt (calculated using an
as-if-converted method). There are no dilutive warrants and convertible debt in
any of the periods presented in the table below.
The following table sets forth a
reconciliation of basic and diluted net income (loss) per share (in thousands,
except per share amounts):
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
Net (loss) income - basic
|
|
$
|
(31,820
|
)
|
$
|
2,580
|
|
$
|
10,797
|
|
$
|
(183
|
)
|
Add effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
Interest on convertible notes (inclusive of
amortization of debt issuance costs)
|
|
|
|
|
|
|
|
|
|
Net (loss) income - diluted
|
|
$
|
(31,820
|
)
|
$
|
2,580
|
|
$
|
10,797
|
|
$
|
(183
|
)
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding
|
|
70,249
|
|
68,935
|
|
69,682
|
|
68,607
|
|
Less: weighted-average shares of common
stock subject to repurchase
|
|
(1,667
|
)
|
(579
|
)
|
(1,140
|
)
|
(437
|
)
|
Shares used in computing basic net (loss)
income per common share
|
|
68,582
|
|
68,356
|
|
68,542
|
|
68,170
|
|
Add effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
Employee stock options
|
|
|
|
327
|
|
35
|
|
|
|
Common stock subject to repurchase
|
|
|
|
42
|
|
73
|
|
|
|
Shares used in computing diluted net (loss)
income per common share
|
|
68,582
|
|
68,725
|
|
68,650
|
|
68,170
|
|
Basic and diluted net (loss) income per
common share
|
|
$
|
(0.46
|
)
|
$
|
0.04
|
|
$
|
0.16
|
|
$
|
(0.00
|
)
|
|
|
|
|
|
|
|
|
|
|
Diluted net (loss) income per common share
|
|
$
|
(0.46
|
)
|
$
|
0.04
|
|
$
|
0.16
|
|
$
|
(0.00
|
)
|
The following
securities were excluded from the computation of diluted earnings per common
share, on an actual outstanding basis, as they were anti-dilutive (in
thousands):
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Employee stock options
|
|
6,302
|
|
3,876
|
|
6,156
|
|
5,479
|
|
Restricted stock subject to repurchase
|
|
1,624
|
|
96
|
|
589
|
|
577
|
|
Convertible notes
|
|
14,369
|
|
3,870
|
|
14,369
|
|
3,870
|
|
Total
|
|
22,295
|
|
7,842
|
|
21,114
|
|
9,926
|
|
Restructuring
The Company has in recent
years engaged in, and may continue to engage in, restructuring actions, which
require management to utilize significant estimates related to expenses for
severance and other employee separation costs, lease cancellation, realizable
values of assets that may become duplicative or obsolete, and other exit costs.
If the actual amounts differ from the Companys estimates, the amount of the
restructuring charges could be materially impacted. For a full description of
the Companys restructuring actions, see Note 4.
8
Table
of Contents
Recent Accounting Pronouncements
In May 2008, the FASB
issued
Statement of Financial Accounting Standards (SFAS)
No. 162,
The
Hierarchy of Generally Accepted Accounting Principles
(SFAS 162).
SFAS 162 identifies the sources of accounting principles and the framework for
selecting the principles used in the preparation of financial statements. SFAS
162 is effective 60 days following the SECs approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, The Meaning of
Present Fairly in Conformity with Generally Accepted Accounting Principles.
The implementation of this standard will not have a material impact on our
consolidated financial position and results of operations.
In March 2008, the FASB issued SFAS No. 161,
Disclosures About Derivative Instruments and
Hedging Activities an amendment of FASB Statement No. 133
(SFAS 161). SFAS 161 expands quarterly disclosure requirements in SFAS No. 133
about an entitys derivative instruments and hedging activities. SFAS 161 is
effective for fiscal years
beginning after November 15, 2008. The Company is currently assessing the impact of SFAS 161 on its consolidated
results of operations and financial condition.
Effective January 1, 2008, the Company
adopted SFAS No. 157,
Fair Value Measurements
(SFAS 157). In February 2008, the FASB issued FASB Staff Position No. FAS
157-2,
Effective Date of FASB Statement No. 157
,
which provides a one year deferral of the effective date of SFAS 157 for
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value at least
annually. Therefore, the Company has adopted the provisions of SFAS 157 with
respect to its financial assets and liabilities only. SFAS 157 defines fair
value, establishes a framework for measuring fair value under generally
accepted accounting principles and enhances disclosures about fair value
measurements. Fair value is defined under SFAS 157 as the exchange price that
would be received for an asset or paid to transfer a liability (an exit price)
in the principal or most advantageous market for the asset or liability in an
orderly transaction between market participants on the measurement date. Valuation
techniques used to measure fair value under SFAS 157 must maximize the use of
observable inputs and minimize the use of unobservable inputs. The standard
describes a fair value hierarchy based on three levels of inputs, of which the
first two are considered observable and the last unobservable, that may be used
to measure fair value which are the following:
·
|
|
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 for
similar assets or liabilities; quoted prices 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.
|
|
|
|
·
|
|
Level 3 - Unobservable inputs that are
supported by little or no market activity and that are significant to the
fair value of the assets or liabilities.
|
The adoption
of SFAS 157 did not have a material effect on the Companys financial position,
results of operations, or cash flows.
In December 2007, the FASB issued SFAS No. 141R,
Business Combinations
(SFAS 141R).
SFAS 141R amends SFAS 141 and provides revised guidance for recognizing
and measuring identifiable assets and goodwill acquired, liabilities assumed,
and any non-controlling interest in the acquiree. It also provides disclosure
requirements to enable users of the financial statements to evaluate the nature
and financial effects of the business combination. It is effective for fiscal
years beginning on or after December 15, 2008 and will be applied
prospectively. The Company is currently assessing the impact of SFAS 141R on
its consolidated results of operations and financial condition.
In
October 2008, the FASB issued FSP 157-3
Determining
Fair Value of a Financial Asset in a Market That Is Not Active
(FSP
157-3). FSP 157-3 clarified the application of SFAS No. 157 in an inactive
market. It demonstrated how the fair value of a financial asset is determined
when the market for that financial asset is inactive. FSP 157-3 was effective
upon issuance, including prior periods for which financial statements had not
been issued. The implementation of this standard did not have a material impact
on the Companys consolidated results of operations and financial condition.
9
Table of Contents
NOTE 2FAIR VALUE
In accordance
with SFAS 157, the following table
represents the Companys fair value hierarchy for its financial assets (cash
equivalents and investments) measured at fair value on a recurring basis as of September 30,
2008 (in thousands):
|
|
Level 1
|
|
Level 2
|
|
Total
|
|
Non-U.S. equity securities
|
|
$
|
894
|
|
$
|
|
|
$
|
894
|
|
U.S. government obligations and agencies
|
|
|
|
308,024
|
|
308,024
|
|
U.S. corporate debt
|
|
|
|
120,774
|
|
120,774
|
|
Total
|
|
$
|
894
|
|
$
|
428,798
|
|
$
|
429,692
|
|
As of September 30, 2008, the Company
had no financial assets or liabilities requiring Level 3 classification.
NOTE 3STOCK-BASED COMPENSATION
Stock-Based
Compensation Plans
The Company has a stock-based compensation program that provides the
Board of Directors broad discretion in creating equity incentives for
employees, officers, directors and consultants. This program includes incentive
and non-qualified stock options and non-vested stock awards (also known as
restricted stock) granted under various stock plans. Stock options are
generally time-based, vesting 25% on each annual anniversary of the grant date
over four years and expire 7 to 10 years from the grant date. Non-vested stock
awards are generally time-based, vesting 25% on each annual anniversary of the
grant date over four years. On June 11, 2008, at the annual shareholders
meeting, the shareholders approved the amendment to increase the maximum
number of shares of the Companys common stock authorized for issuance under
the Companys Amended and Restated 2000 Equity Incentive Plan by 4.2 million
shares.
As of September 30, 2008, the Company had
approximately 3.3 million shares of common stock reserved for future issuance
under its stock-based compensation plans. New shares are issued as a result of
stock option exercises and non-vested restricted stock awards.
The Company allocated stock-based
compensation expense under SFAS No. 123R,
Share-Based
Payment
, as follows (in thousands):
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Costs of product sales
|
|
$
|
498
|
|
$
|
229
|
|
$
|
1,086
|
|
$
|
775
|
|
Research and development
|
|
625
|
|
417
|
|
1,489
|
|
1,578
|
|
Selling, general and administrative
|
|
2,229
|
|
2,306
|
|
4,044
|
|
5,208
|
|
Restructuring
|
|
|
|
340
|
|
|
|
340
|
|
Total stock-based compensation expense
|
|
3,352
|
|
3,292
|
|
6,619
|
|
7,901
|
|
Income tax benefit
|
|
|
|
(635
|
)
|
(871
|
)
|
(2,095
|
)
|
Total stock-based compensation expense, net
of tax
|
|
$
|
3,352
|
|
$
|
2,657
|
|
$
|
5,748
|
|
$
|
5,806
|
|
As of September 30, 2008,
$38.1 million of total unrecognized stock-based compensation expense related to
non-vested awards is expected to be recognized over the respective vesting
terms of each award through 2012. The weighted average term of the unrecognized
stock-based compensation expense is 3.1 years.
10
Table
of Contents
Stock Option Assumptions
The fair value of
options was estimated at the date of grant using a Black-Scholes option pricing
model with the following weighted average assumptions:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Risk free interest rate
|
|
3.0
|
%
|
4.2
|
%
|
3.2
|
%
|
4.2
|
%
|
Expected dividend yield
|
|
0.0
|
%
|
0.0
|
%
|
0.0
|
%
|
0.0
|
%
|
Expected volatility
|
|
42
|
%
|
42
|
%
|
42
|
%
|
42
|
%
|
Expected option term (in years)
|
|
4.5
|
|
4.5
|
|
4.5
|
|
4.5
|
|
The risk free interest rate for periods
within the contractual life of the Companys 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 Companys historical exercise trends over ten
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 September 30,
2008 and 2007 was $3.51 and $9.90, respectively, and for the nine months ended September 30,
2008 and 2007 was $4.55 and $9.90, respectively.
NOTE 4RESTRUCTURING
Fiscal
2008 Restructuring Plan
In February 2008, the Company committed
to a restructuring plan (the 2008 Plan) designed primarily to optimize its
production capacity and cost structure and improve its future gross
margins. The restructuring plan was approved as part of the Companys
ongoing efforts to reduce costs.
This phase of the
restructuring plan involves moving the majority of the Companys probe array
manufacturing from its West Sacramento, California facility to its Singapore
facility by the end of 2008. The Company estimates the total
restructuring expenses to be incurred in connection with this phase of the 2008
Plan will be approximately $14.0 million. Of this total, approximately $1.5
million relates to employee severance and $12.5 million relates to non-cash
charges associated with the abandonment of certain long-lived manufacturing
assets.
In July 2008,
the Company decided to expand the 2008 Plan to include the closing of its West
Sacramento manufacturing facility. Following the closure of its West
Sacramento manufacturing facility, all of its products will be manufactured at
its Singapore and Ohio facilities, as well as by third parties. The Company
expects the closure of the West Sacramento facility to be substantially
complete by the end of the second quarter of 2009. In this phase of the
2008 Plan, the Company currently expects to incur a total of approximately $36
million in charges related to this expansion of its restructuring plan.
Of this total, the Company expects that approximately $18 million will be included
as a component of total cost of product sales, $12 million of which relates to
accelerated depreciation charges associated with the continued use of certain
long-lived manufacturing assets and $6 million of which relates to
manufacturing transition and other costs. Additionally, the Company
expects to recognize approximately $18 million in the line item labeled as Restructuring
charges in its Condensed Consolidated Statements of Operations, $14 million of
which relates to asset impairment charges associated with the facility itself
and to certain long-lived manufacturing assets and $4 million related to
employee severance costs. In accordance with SFAS No. 146
, Accounting for Costs Associated with Exit or Disposal Activities
(SFAS 146),
the costs relating to employee
severance and relocation are being recognized as expense over the remaining
service periods of the employees.
The estimated cash outlays to be incurred in connection with the 2008
Plan are estimated to be approximately $12.5 million. Depending on the
rate at which the Company transfers its production capacity out of its West
Sacramento facility, the Company may incur additional expenses. During the
first nine months of 2008, the Company recognized approximately $2.9 million of
expense for employee termination benefits associated with the 2008 Plan and
$25.8 million of non-cash charges related to the abandonment and impairment of
certain manufacturing assets. These expenses are presented as a component of Restructuring
charges in the Companys Condensed Consolidated Statements of Operations.
11
Table of Contents
Fiscal
2007 Restructuring Plan
In July 2007,
the Company announced that it was consolidating an administrative facility
located in Sunnyvale, California into its main campus in Santa Clara,
California during the fourth quarter of 2007 (the 2007 Plan). Additionally,
in August and December 2007, the Company terminated certain employees
in the research and development and selling, general and administrative
functions. The Sunnyvale, California facility was vacated during the fourth
quarter of 2007. The estimated cash outlays to be incurred in connection with
these restructuring activities are estimated to be approximately $5 million.
During the nine months ended September 30, 2008, the Company recognized
approximately $0.4 million related to contract termination costs associated with
the 2007 Plan.
Fiscal 2006
Restructuring Plan
In 2006, the Company
initiated a restructuring plan (the 2006 Plan) to better align certain of its
expenses with the Companys current business outlook. The Companys primary
focus of the 2006 Plan was in the general and administrative functions and
included rationalizing its facilities. Cash outlays incurred in connection with
these restructuring activities are estimated to be approximately
$16 million. During the nine months ended September 30, 2008, the
amount of expense recognized associated with the 2006 Plan was not material.
The activity for the
restructuring plans above for the nine months ended September 30, 2008 and
estimated costs for the amounts expected to be
recognized as Restructuring charges in
the Companys Condensed Consolidated Statements of Operations is as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008
|
|
|
|
Balance as of
|
|
|
|
|
|
|
|
|
|
Total
|
|
Total
|
|
|
|
December 31,
|
|
2008
|
|
Cash
|
|
Non-Cash
|
|
Balance as of
|
|
costs
|
|
expected
|
|
|
|
2007
|
|
Charges
|
|
Payments
|
|
Settlements
|
|
2008
|
|
to date
|
|
costs
|
|
Fiscal 2008 Restructuring Plan:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee severance and relocation benefits
|
|
$
|
|
|
$
|
2,857
|
|
$
|
(1,450
|
)
|
$
|
(179
|
)
|
$
|
1,228
|
|
$
|
2,857
|
|
$
|
5,800
|
|
Abandonment and impairment of certain
long-lived manufacturing assets
|
|
|
|
25,797
|
|
|
|
(25,797
|
)
|
|
|
25,797
|
|
26,000
|
|
Fiscal 2007 Restructuring Plan:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee severance and relocation benefits
|
|
1,295
|
|
|
|
(1,295
|
)
|
|
|
|
|
2,887
|
|
3,000
|
|
Contract termination costs
|
|
1,122
|
|
380
|
|
(870
|
)
|
(7
|
)
|
625
|
|
1,596
|
|
1,700
|
|
Other restructuring costs
|
|
|
|
|
|
|
|
|
|
|
|
114
|
|
200
|
|
Fiscal 2006 Restructuring Plan:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee severance and relocation benefits
|
|
140
|
|
(46
|
)
|
(94
|
)
|
|
|
|
|
20,196
|
|
20,200
|
|
Contract termination costs
|
|
1,761
|
|
184
|
|
(762
|
)
|
111
|
|
1,294
|
|
2,575
|
|
2,900
|
|
Other restructuring costs
|
|
|
|
207
|
|
(207
|
)
|
|
|
|
|
2,195
|
|
2,200
|
|
Total
|
|
$
|
4,318
|
|
$
|
29,379
|
|
$
|
(4,678
|
)
|
$
|
(25,872
|
)
|
$
|
3,147
|
|
$
|
58,217
|
|
$
|
62,000
|
|
NOTE 5ACQUISITIONS
USB Corporation
On January 30, 2008, the
Company acquired 100% of the outstanding shares of USB Corporation (USB), a
privately held Cleveland, Ohio-based company that develops, manufactures and
markets an extensive line of molecular biology and biochemical reagent
products. The acquisition will enable the Company to accelerate the development
and commercialization of new genetic analysis solutions and increase the value
of its current product portfolio.
12
Table of Contents
Affymetrix accounted for the
merger under the purchase method of accounting in accordance with the
provisions of SFAS No. 141,
Business
Combinations
(SFAS 141)
.
In accordance with SFAS 141, the Company recorded the assets acquired and
liabilities assumed at their estimated fair value, with the excess purchase
price reflected as goodwill. Additionally, certain costs directly related to
the merger were reflected as additional purchase price in excess of net assets
acquired. The results of operations of USB have been included in Affymetrix
consolidated financial statements since January 31, 2008.
Purchase Price
The total purchase price
of the USB acquisition was $72.9 million and includes the following
components (in thousands):
Merger consideration paid in cash
|
|
$
|
70,895
|
|
Direct acquisition costs
|
|
1,958
|
|
Total purchase price
|
|
$
|
72,853
|
|
Purchase Price
Allocation
During
the third quarter of 2008, the Company reduced the estimated fair value of the
tangible assets, net acquired by $3.1 million due to increasing USBs inventory
reserves to conform to the Companys inventory reserve methodology, resulting
in a corresponding increase of $3.1 million to goodwill. The following table
allocates the purchase price based on the estimated fair values of the assets
acquired and liabilities assumed as of the acquisition date
(in thousands):
Tangible assets, net
|
|
$
|
4,003
|
|
Amortizable intangible assets
|
|
16,300
|
|
Goodwill
|
|
51,750
|
|
In-process technology
|
|
800
|
|
Total
|
|
$
|
72,853
|
|
Intangible Assets
and Goodwill
A
valuation of the purchased intangible assets was undertaken by Affymetrix
management in its determination of the estimated fair value of such assets. The
$6.1 million value assigned to developed technology and patents and core
technology is included in acquired technology rights on the Companys Condensed
Consolidated Balance Sheet and will be amortized to cost of product sales over
the estimated useful lives of these assets, generally four to five years.
Affymetrix recorded amortization expense of approximately $0.3 million and
$0.9 million for the three and nine months ended September 30, 2008,
respectively, related to these acquired patents and technology. The
$10.2 million value assigned to customer contracts and trade names and
trademarks will be amortized to selling, general and administrative
expenses over the estimated useful lives of these assets, generally four to eight
years. Affymetrix recorded amortization expense of approximately $0.4 and
$1.2 million for the three and nine months ended September 30, 2008,
respectively, related to customer contracts and trade names and trademarks.
Goodwill of $51.8 million was recorded as the excess of the purchase price
over the net assets acquired. Goodwill will not be amortized, but will be
assessed for impairment on an annual basis or when an indication of potential
impairment exists.
In-process
Technology
Management
determined the estimated fair value of certain research and development
programs in-process at the acquisition date that had not yet reached
technological feasibility and had no alternative future use. These projects
primarily included certain molecular biology projects. The fair values of these
projects were determined using the Income Approach whereby management estimated
each projects related future net cash flows between 2008 and 2014 and
discounted them to their present value using a risk adjusted discount rate of
21%. This discount rate is based on the Companys estimated weighted average
cost of capital adjusted upward for the risks associated with the projects
acquired. The projected cash flows from the acquired projects were based on
estimates of revenues and operating profits related to the projects considering
the stage of development of each potential product acquired, the time and
resources needed to complete the development and approval of each product, the
life of each potential commercialized product and the inherent difficulties and
uncertainties in developing products and services based on complex genetic
technologies and biochemical processes. The Company expects cash flows from
these projects to begin in 2009 and is not anticipating any material changes to
its historical pricing, expense levels or gross margins related to these
products
.
13
Table of Contents
Escrow Agreement
Pursuant
to the terms of the USB merger agreement, the Company withheld from the merger
consideration $4.0 million and delivered those funds to an escrow account which
shall be released to the USB shareholders upon achievement of certain revenue
targets in fiscal 2008. Quarterly, the Company must review the revenue targets
and to the extent they are achieved, all or a portion of the escrow funds shall
be disbursed to the
USB
shareholders consistent with the terms of the merger agreement. If the
prescribed revenue targets are not achieved, some or all of the escrow funds
shall be released from restriction. As funds are disbursed to the USB
shareholders, the Company will reflect these payments as additional goodwill
and will reduce restricted cash. Any funds remaining in escrow at the end of
the fiscal year 2008 which are not payable to the USB shareholders and are
released from restriction will be reclassified to cash and cash equivalents. As
of September 30, 2008, $0.4 million had been disbursed from the escrow
account as a result of the achievement of certain revenue targets. Accordingly,
$3.6 million is presented as a component of restricted cash in the Companys
Condensed Consolidated Balance Sheet at September 30, 2008.
True Materials, Inc.
On
July 17, 2008, Affymetrix
acquired 100% of the outstanding shares
of True Materials, Inc. (TMI),
a privately held San Francisco-based company that develops digitally
encoded microparticle technology. This technology is applicable to the
research, applied and diagnostic markets and will enable the Company to enter
low to mid-multiplex markets.
Affymetrix accounted for the merger under the purchase method of
accounting in accordance with the provisions of SFAS No. 141
.
In accordance with SFAS 141, the Company recorded the
assets acquired and liabilities assumed at their estimated fair value, with the
excess purchase price reflected as goodwill. Additionally, certain costs
directly related to the merger were reflected as additional purchase price in
excess of net liabilities assumed. The results of operations have been included
in Affymetrix consolidated financial statements since July 18, 2008.
Purchase Price
The total purchase price of the acquisition was $20.4 million and
includes the following components (in thousands):
Merger consideration paid in cash
|
|
$
|
20,160
|
|
Direct acquisition costs
|
|
268
|
|
Total purchase price
|
|
$
|
20,428
|
|
Purchase Price
Allocation
The
following table allocates the purchase price based on the estimated fair values
of the assets acquired and liabilities assumed as of the acquisition date
(in thousands):
Goodwill
|
|
$
|
16,200
|
|
In-process technology
|
|
5,100
|
|
Net liabilities assumed
|
|
(872
|
)
|
|
|
$
|
20,428
|
|
In-process
Technology
Management
determined the estimated fair value of certain research and development
programs in-process at the acquisition date that had not yet reached
technological feasibility and had no alternative future use. These projects
primarily included materials research projects. The fair values of these
projects were determined using the Income Approach whereby management estimated
each projects related future net cash flows between 2009 and 2015 and
discounted them to their present value using a risk adjusted discount rate of
30%. This discount rate is based on the Companys estimated weighted average
cost of capital adjusted upward for the risks associated with the projects
acquired. The projected cash flows from the acquired projects were based on
estimates of revenues and operating profits related to the projects considering
the stage of development of each potential product acquired, the time and
resources needed to complete the development and approval of each product, the
life of each potential commercialized product and the inherent difficulties and
uncertainties in developing products and services based on complex genetic
technologies and biochemical processes. The Company expects cash flows from
these projects to begin in 2009 and is not anticipating any material changes to
its historical pricing, expense levels or gross margins related to these
products
.
14
Table of Contents
Escrow Agreement
Pursuant
to the terms of the merger agreement, the Company withheld from the merger
consideration $5.1 million and delivered those funds to an escrow account,
which shall be released to the founder and certain key employees of TMI upon
achievement of certain employment milestones. As the continuous employment
milestones are achieved, a portion of the escrow funds shall be disbursed to
the founder and certain key employees consistent with the terms of the merger
agreement.
The Company will record these payments
as additional goodwill. As of September 30, 2008, $0.3 million had been
disbursed from the escrow account.
NOTE 6
GOODWILL
AND OTHER INTANGIBLE ASSETS
Goodwill
balance is presented below (in thousands):
Balance at December 31, 2007
|
|
$
|
125,050
|
|
Goodwill additions
|
|
67,950
|
|
Balance at September 30, 2008
|
|
$
|
193,000
|
|
During
2008, the Company recorded additional goodwill totaling approximately $68.0
million, of which approximately $51.7 million pertained to the acquisition of
USB in the first quarter of fiscal 2008 and approximately $16.2 million
pertained to the acquisition of True Materials, Inc. during the third
quarter of fiscal year 2008.
As of September 30, 2008, the
Companys goodwill totaled approximately $193.0 million, or 16% of total
assets, and its other intangible assets, consisting of net acquired technology rights totaled
approximately $54.9 million, or 5% of its total assets (see Note 8).
SFAS
No. 142,
Goodwill and Other Intangible
Assets (SFAS 142)
requires that goodwill be assessed for
impairment at least annually or whenever changes in circumstances indicate that
the carrying amount may not be recoverable from estimated future cash
flows. Factors that may be considered a
change in circumstance indicating the carrying value of our intangible assets,
including goodwill, may not be recoverable include, but are not limited to,
significant underperformance relative to historical or projected future
operating results, a significant decline in our stock price and market
capitalization, and negative industry or economic trends. Additionally, the Company periodically
evaluates the recoverability and the amortization period of its acquired technology rights.
The Company performed its required annual impairment test in June 2008
and determined that goodwill was not impaired.
During the third quarter of 2008, the Companys stock price fell below
the Companys net book value per share.
The stock price decline, along with other conditions in the Companys
business, are defined as indicators of impairment of goodwill and other
intangibles under SFAS 142
.
Accordingly,
the Company was required to assess whether or not an impairment of its
intangible assets, including goodwill, had occurred. The Company performed an impairment test using
a market based approach as of September 30, 2008 and determined that there
was no impairment.
The continued decline of the Companys stock price subsequent to
September 30, 2008 and the resulting book value per share being in excess of
market value per share, along with other conditions in its business, are
indicators that it is more likely than not that the fair value of the Company
is less than the carrying value. Therefore, in the fourth quarter of 2008, the
Company will assess whether or not an impairment of its goodwill and other
intangible assets has occurred and will be conducting an evaluation of the fair
market value of these assets. If the implied fair values of goodwill and other
intangible assets are less than the carrying amounts, impairment losses will be
recognized for the differences.
NOTE
7INVENTORIES
Inventories consist of the following (in
thousands):
|
|
September 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
Raw materials
|
|
$
|
20,116
|
|
$
|
20,507
|
|
Work-in-process
|
|
11,577
|
|
11,297
|
|
Finished goods
|
|
14,680
|
|
11,108
|
|
Total
|
|
$
|
46,373
|
|
$
|
42,912
|
|
NOTE 8ACQUIRED TECHNOLOGY RIGHTS
Acquired technology rights are comprised of
licenses to technology covered by patents to third parties and are amortized
over the expected useful life of the underlying patents, which range from one
to fifteen years. Accumulated amortization of these rights amounted to
approximately $47.3 million and $39.0 million at September 30, 2008 and December 31,
2007, respectively.
15
Table of Contents
The expected future annual amortization
expense of the Companys acquired technology rights and other intangible assets
is as follows (in thousands):
|
|
Amortization
|
|
For the Year Ending December 31,
|
|
Expense
|
|
2008, remainder thereof
|
|
$
|
2,920
|
|
2009
|
|
10,550
|
|
2010
|
|
9,780
|
|
2011
|
|
9,385
|
|
2012
|
|
7,631
|
|
Thereafter
|
|
14,593
|
|
Total
|
|
$
|
54,859
|
|
NOTE 9COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss)
are as follows (in thousands):
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Net (loss) income
|
|
$
|
(31,820
|
)
|
$
|
2,580
|
|
$
|
10,797
|
|
$
|
(183
|
)
|
Foreign currency translation adjustment
|
|
(342
|
)
|
243
|
|
(46
|
)
|
303
|
|
Unrealized (loss) gain on debt securities
|
|
(2,034
|
)
|
(996
|
)
|
(4,228
|
)
|
1,488
|
|
Unrealized hedging contracts gain
|
|
15
|
|
|
|
15
|
|
|
|
Comprehensive (loss) income
|
|
$
|
(34,181
|
)
|
$
|
1,827
|
|
$
|
6,538
|
|
$
|
1,608
|
|
NOTE 10RELATED PARTY TRANSACTIONS
Perlegen Sciences, Inc.
As of September 30, 2008, the Company,
and certain of its affiliates, including the Companys chief executive officer
and members of the board of directors, held approximately 22% ownership
interest in Perlegen Sciences, Inc. (Perlegen), a privately-held
biotechnology company. In addition, two members of Perlegens board of
directors are also members of the Companys board of directors.
The Company formed Perlegen in October 2000
as a wholly-owned subsidiary and spun it off in March 2001 in a
$100 million private equity financing. The Company acquired its initial
ownership interest in Perlegen in an arrangement which provides Perlegen rights
to use certain of the Companys intellectual property in its development
efforts, and also provides the Company rights to use and commercialize certain
data generated by Perlegen in the array field.
The
Company accounts for its ownership interest in Perlegen using the equity method
as the Company and its affiliates do not control the strategic, operating,
investing and financing activities of Perlegen; however, the Company does have
significant influence over Perlegens operating activities. Further, the
Company has no obligations to provide funding to Perlegen nor does it guarantee
or otherwise have any obligations related to the liabilities or results of
operations of Perlegen or its investors. Through January 2005, the Companys
investment in Perlegen had no cost basis; accordingly, the Company has not
recorded its proportionate share of Perlegens operating losses in its
financial statements since the completion of Perlegens initial financing. In February 2005,
the Company participated in Perlegens Series D preferred stock financing
and recorded a $2.0 million investment related to this transaction, which
was included in the Companys balance sheet as a component of other assets. As
of June 30, 2005, the Company had reduced the carrying value of its
investment to zero through the recording of its proportionate share of Perlegens
operating losses.
In accordance with Financial Accounting
Standards Board Interpretation No. 46,
Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51 as amended
(FIN 46),
the Company has concluded that Perlegen is a variable interest entity in which
the Company holds a variable interest, and that the Company is not the primary
beneficiary.
16
Table of Contents
NOTE 11COMMITMENTS AND CONTINGENCIES
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. This could adversely
affect our business, financial condition and results of operations. If the
Company is found to have infringed the valid intellectual property rights of
third parties in any litigation involving the Company or its collaborative
partners, the Company or its collaborative partners could be subject to
significant liability for damages, prevented from manufacturing and selling its
products, or required to obtain a license from a third party, which may not be
available on reasonable terms or at all.
The Company expects to devote substantial
financial and managerial resources to protect its intellectual property rights
and to defend itself against the claims described below.
E8 Pharmaceuticals LLC Litigation
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 upon one patent owned by MIT and licensed to E8
Pharmaceuticals by making and selling the Companys 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, and unspecified monetary damages, including lost profits, enhanced
damages pursuant to 35 U.S.C. § 284, costs, attorneys fees and other relief as
the court deems just and proper. The Company believes that the plaintiffs
claims are without merit and will vigorously defend against the claims advanced
in the complaint.
Shareholder
Derivative Lawsuits
In 2006, three
shareholders of the Company filed purported derivative lawsuits on behalf of
the Company, which lawsuits name the Company (as nominal defendant) and several
of the Companys current and former officers and directors, and allege that
these officers and directors breached their fiduciary duties and breached other
laws by participating in backdating stock options grants. Two of these lawsuits
were filed in the United States District Court for the Northern District of
California, one on August 30, 2006 and the other on September 13,
2006, and were subsequently consolidated. The third lawsuit was filed in the
Superior Court of the State of California on October 20, 2006. The
substance of the allegations in these cases is similar, and includes claims
against the individual defendants for breach of fiduciary duties, unjust
enrichment, and violations of federal securities laws, Generally Accepted
Accounting Principles, Section 162(m) of the Internal Revenue Code,
and certain state laws in each case in connection with the allegedly backdated
options. The plaintiffs seek monetary and equitable relief on behalf of the
Company, including damages and disgorgement from the individual defendants,
changes in the Companys corporate governance and internal control procedures,
and an award of attorneys fees and costs. As previously disclosed in the
Companys Forms 10-K/A for the year ended December 31, 2005, the
Companys decision to restate its consolidated financial statements was based
on the results of an internal review of its historical stock option granting
practices from January 1, 1997 through May 31, 2006 performed under
the direction of the Audit Committee of the Board of Directors. The review did
not find any pattern or practice of inappropriately identifying grant dates
with hindsight in order to provide discounted or in-the-money grants. On March 31,
2008, the federal district court presiding over the two consolidated cases
issued an order granting in part and denying in part the motion of the Company
and the individual defendants to dismiss the amended consolidated shareholder
derivative complaint. The court allowed the plaintiffs leave to amend, and the
plaintiffs filed a second amended consolidated shareholder derivative complaint
on April 18, 2008. The individual defendants filed motions to dismiss the
second amended consolidated derivative complaint on May 15, 2008. On October 24,
2008, the Court issued a decision granting in part and denying in part the motions
to dismiss, and scheduled a case management conference for December 15,
2008. The case in California Superior Court is currently stayed pending
resolution of the consolidated federal cases. The Company does not believe that
the claims in these derivative lawsuits have merit and the Company intends to
vigorously defend the cases.
SEC Informal Inquiry
On September 12,
2006, the Company received written notice from the Securities and Exchange
Commission that it was conducting an informal inquiry into the Companys stock
option practices. The Company responded to the request for information and
cooperated fully in the informal inquiry. The Company was advised in the SECs
notice that the SECs request should not be construed as an indication by the
SEC or its staff that any violations of law have occurred; and nor should the
request be considered an adverse reflection upon any person, entity or
security.
17
Table of Contents
Enzo
Litigation
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 now 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. In connection with its complaint, Enzo provided the
Company with a notice of termination of the 1998 agreement effective on November 12,
2003.
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 in order to corner the
market for non-radioactive labeling reagents, and improperly using the 1998
agreement to claim ownership rights to the Companys proprietary technology.
The Company seeks declarations that it has not breached the 1998 agreement and
that nine Enzo patents identified in the 1998 agreement are invalid and/or not
infringed by it. The Company also seeks damages and injunctive relief to
redress Enzos alleged breaches of the 1998 agreement, its alleged tortuous
interference with the Companys business relationships and prospective economic
advantage, and its alleged unfair competition. The Company filed a notice of
related case stating that its complaint against Enzo is related to the
complaints already pending in the Southern District of New York against eight
other former Enzo distributors. The U.S. District Court for the Southern
District of New York has related the Companys case. There is no trial date in
the actions between Enzo and the Company.
The Company believes that
the claims set forth in Enzos complaint are without merit and has filed the
action in the Southern District of New York to protect its interests. However,
the Company cannot be sure that it will prevail in these matters. The Companys
failure to successfully defend against these allegations could result in a
material adverse effect on its business, financial condition and results of
operation.
Administrative Litigation and Proceedings
The Companys intellectual property is
subject to a number of significant administrative and litigation actions. For
example, in Europe and Japan, we expect third parties to oppose significant
patents that the Company owns or controls. Currently, third parties, including
several of the Companys competitors, have filed oppositions against several of
the Companys European patents in the European Patent Office and requested
reexamination of several of the Companys patents by the United States Patent &
Trademark Office. These proceedings are at various procedural stages and will
result in the respective patents being either upheld in their entirety, allowed
to issue in amended form in designated countries, or revoked. Further, in the
United States, the Company expects that third parties will continue to copy
the claims of its patents in order to provoke interferences in the United
States Patent & Trademark Office. These proceedings could modify or
reduce the Companys patent protection and may cause the Company to incur
significant costs and consume substantial managerial resources.
NOTE 12INCOME TAXES
The income tax provision for the nine months
ended September 30, 2008 differs from the amount computed by applying the
35% U.S. federal statutory rate to the consolidated income before income taxes
due to various factors, including the tax impact of non-U.S. operations,
non-deductible in-process research and development, and the establishment of a
partial valuation allowance against the Companys U.S. deferred tax assets.
For the
quarter ended September 30, 2008, the Company recorded a non-cash income
tax provision of approximately $6.3 million to establish a valuation allowance
to partially reserve the Companys U.S. gross deferred tax assets as of September 30,
2008. The Company evaluated both positive and negative evidence and determined
that there is a need for the valuation allowance during the quarter ended September 30,
2008 due to a revised forecast that lowered projected future taxable income.
The Company intends to maintain the valuation allowance until sufficient positive
evidence exists to support reversal of the valuation allowance. Management
periodically evaluates the realizability of the Companys net deferred tax
assets based upon all available evidence. The realization of net deferred tax
assets is dependent on the Companys ability to generate sufficient future
taxable income. The forecasted future taxable income is highly influenced by
assumptions regarding the Companys ability to achieve its forecasted revenue
and its ability to effectively manage its
18
Table of Contents
expenses in line with its forecasted revenue. The Company believes
realization of the deferred tax assets as of September 30, 2008 is more
likely than not based upon future taxable earnings. An additional valuation
allowance against deferred tax assets may be necessary if it is more likely
than not that all or a portion of the deferred tax assets will not be realized,
for example as a result of a change in the Companys ability to reliably
project future taxable income or a reduction in the amount of future taxable
income.
The Company does not expect any material
changes to the estimated amount of liability associated with its uncertain tax
positions within the next twelve months. As of September 30, 2008, there
have been no material changes to the total amount of unrecognized tax benefits.
ITEM 2. MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Managements Discussion and Analysis of
Financial Condition and Results of Operations as of September 30, 2008 and
for the three and nine month periods ended September 30, 2008 and 2007
should be read in conjunction with the Managements 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, 2007.
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 expectations,
beliefs, hopes, 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, risks
of our ability to achieve and sustain higher levels of revenue, improved gross
margins, reduced operating expenses, market acceptance, personnel retention,
global economic conditions, fluctuations in overall capital spending in the
academic and biotechnology sectors, changes in government funding policies,
unpredictable fluctuations in quarterly revenues, uncertainties related to cost
and pricing of Affymetrix products, dependence on collaborative partners,
uncertainties relating to sole source suppliers, uncertainties relating to FDA,
and other regulatory approvals, risks relating to intellectual property of
others and the uncertainties of patent protection and litigation.
Overview
We are engaged in the development,
manufacture, sale and service of consumables and systems for genetic analysis
in the life sciences and clinical healthcare markets and are recognized as a
market leader in creating tools that are advancing our understanding of the
molecular basis of life. There are a number of factors that influence the size
and development of our industry, including: the availability of genomic
sequence data for human and other organisms, technological innovation that increases
throughput and lowers the cost of genomic and genetic analysis, the development
of new computational techniques to handle and analyze large amounts of genomic
data, the availability of government and private funding for basic and
disease-related research, the amount of capital and ongoing expenditures
allocated to research and development spending by biotechnology, pharmaceutical
and diagnostic companies, the application of genomics to new areas including
molecular diagnostics, agriculture, human identity and consumer goods, and the
availability of genetic markers and signatures of diagnostic value.
We have established our GeneChip
®
system as the platform of choice for
acquiring, analyzing and managing complex genetic information. Our integrated
GeneChip
®
platform includes disposable DNA probe arrays
(chips) consisting of gene sequences set out in an ordered, high density
pattern; certain reagents for use with the probe arrays; a scanner and other
instruments used to process the probe arrays; and software to analyze and
manage genomic information obtained from the probe arrays. We currently sell
our products directly to pharmaceutical, biotechnology, agrichemical,
diagnostics and consumer products companies as well as academic research
centers, government research laboratories, private foundation laboratories and
clinical reference laboratories in North America and Europe. We also sell our
products through life science supply specialists acting as authorized
distributors in Latin America, India, the Middle East and Asia Pacific regions,
including China. The following overview describes a few of the key elements of
our strategy to improve our overall business:
Develop new products and technology.
We
believe that the genotyping market will continue to be one of the most
attractive growth opportunities in life sciences and that new content and new
clinical applications will continue to drive growth. These opportunities
include our new cytogenetic applications and our new Drug Metabolizing Enzymes
and Transporters (DMET) product which we believe addresses a significant unmet
need. We anticipate that these products and technologies will contribute to the
growth of our business in 2008 and beyond. Additionally, we have been working
on a technology revision cycle that we expect will lead to a new product
platform. This new product platform is expected to have a lower cost basis and
smaller, higher density and more flexible chip formats that will enable us to
reach new customers and generate future growth.
19
Table of Contents
Targeted acquisitions to
expand our market opportunities.
In addition to continued innovation, we are also pursuing acquisitions
to expand our market opportunities. In 2008, we completed two acquisitions. The
first was USB, a privately held Cleveland, Ohio-based company that develops,
manufactures and markets an extensive line of molecular biology and biochemical
reagent products for approximately $73 million in cash. This acquisition
is expected to accelerate next-generation reagents that will be used with new
products that we have in development. In July 2008, we completed an
acquisition of a privately held San Francisco-based company that develops
digitally encoded microparticle technology for approximately $25 million in
cash. This technology is applicable to the research, applied, and
diagnostic markets and will enable us to enter low to mid-multiplex markets and
compete with bead-based platforms.
Reducing our overall cost
structure.
Earlier
this year, we committed to a restructuring plan designed to optimize our
production capacity and cost structure and improve our future gross
margins. The first phase of this restructuring plan involved moving the
majority of our probe array manufacturing from our West Sacramento, California
facility to our Singapore facility. In July 2008, we decided to
expand our restructuring plan to include the closure of our West Sacramento
manufacturing facility. Following the closure of our West Sacramento
manufacturing facility, all of our products will be manufactured at our
Singapore and Ohio facilities, as well as by third parties.
We expect to incur
additional restructuring charges of approximately $50 million relating to our
2008 restructuring plan to the close our West Sacramento facility. The
estimated cash outlays to be incurred in connection with the 2008 Plan are
estimated to be approximately $12 million. In connection with these and
our other restructuring activities, we incurred a total restructuring charge of
$29 million for the nine months ended September 30, 2008. Depending
on the rate at which we transfer our production capacity out of our West
Sacramento facility, we may incur additional expenses.
Critical Accounting Policies & Estimates
General
The following section of Managements
Discussion and Analysis of Financial Condition and Results of Operations is
based upon our unaudited condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. 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 certain assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Certain accounting policies are particularly
important to the reporting of our financial position and results of operations
and require the application of significant judgment by our management. An
accounting policy is deemed to be critical if it requires an accounting
estimate to be made based on assumptions about matters that are highly
uncertain at the time the estimate is made, and if different estimates that
reasonably could have been used, or changes in the accounting estimates that
are reasonably likely to occur periodically, could materially impact the
financial statements.
Revenue
Recognition
We enter into
contracts to sell our products and, while the majority of our sales agreements
contain standard terms and conditions, there are agreements that contain
multiple elements or non-standard terms and conditions. As a result,
significant contract interpretation is sometimes required to determine the
appropriate accounting, including whether the deliverables specified in a
multiple element arrangement should be treated as separate units of accounting
for revenue recognition purposes, and if so, how the value of the arrangement
should be allocated among the deliverable elements, when and how to recognize
revenue for each element, and the period over which revenue should be
recognized. We recognize revenue for delivered elements only when the fair
values of undelivered elements are known and customer acceptance has occurred.
Changes in the allocation of the sales price between delivered to undelivered
elements might impact the timing of revenue recognition, but would not change
the total revenue recognized on any arrangement.
20
Table
of Contents
Accounts Receivable
We evaluate the
collectibility of our trade receivables based on a combination of factors. We
regularly analyze our significant customer accounts, and, when we become aware
of a specific customers inability to meet its financial obligations to us,
such as in the case of bankruptcy filings or deterioration in the customers
operating results or financial position, we record specific bad debt allowances
to reduce the related receivable to the amount we reasonably believe is
collectible. We also record allowances for bad debt on a small portion of all
other customer balances based on a variety of factors including the length of
time the receivables are past due, the financial health of the customer,
macroeconomic considerations and historical experience. If circumstances
related to specific customers change, our estimates of the recoverability of
receivables could be further adjusted.
Inventories
We enter into
inventory purchases and commitments so that we can meet future shipment
schedules based on forecasted demand for our products. The business environment
in which we operate is subject to rapid changes in technology and customer
demand. We perform a detailed assessment of inventory each period, which
includes a review of, among other factors, demand requirements, product life
cycle and development plans, component cost trends, product pricing, product
expiration and quality issues. Based on this analysis, we record adjustments to
inventory for potentially excess, obsolete or impaired goods, when appropriate,
in order to report inventory at net realizable value. Revisions to our
inventory adjustments may be required if actual demand, component costs,
supplier arrangements, or product life cycles differ from our estimates.
Non-marketable
Securities
As part of our
strategic efforts to gain access to potential new products and technologies, we
invest in equity securities of certain private biotechnology companies. Our
non-marketable equity securities are carried at cost unless we determine that
an impairment that is other than temporary has occurred, in which case we write
the investment down to its impaired value. We periodically review our investments
for impairment; however, the impairment analysis requires significant judgment
in identifying events or circumstances that would likely have significant
adverse effect on the fair value of the investment. The analysis may include
assessment of the investees (i) revenue and earnings trend, (ii) business
outlook for its products and technologies, (iii) liquidity position and
the rate at which it is using its cash, and (iv) likelihood of obtaining
subsequent rounds of financing. If an investee obtains additional funding at a
valuation lower than our carrying value, we presume that the investment is
other than temporarily impaired. We have experienced impairments in our
portfolio due to the decline in equity markets over the past few years.
However, we are not able to determine at the present time which specific
investments are likely to be impaired in the future, or the extent or timing of
the individual impairments.
Valuation of Goodwill and
Intangible Assets
We review goodwill and intangible assets with
indefinite lives for impairment annually and whenever events or changes in
circumstances indicate the carrying value of goodwill may not be recoverable in
accordance with SFAS No. 142,
Goodwill and Other
Intangible Assets
(SFAS 142). Purchased intangible assets with
finite useful lives are amortized using the straight-line method over their
estimated useful lives and are reviewed for impairment under SFAS No. 144,
Accounting for the Impairment of Disposal of
Long-Lived Assets
(SFAS 144). Determining the fair value of a
reporting unit is judgmental in nature and involves the use of significant
estimates and assumptions. These estimates and assumptions include revenue
growth rates and forecasted operating margins used to calculate projected
future cash flows, risk-adjusted discount rates, future economic and market
conditions and determination of appropriate market comparables. We base our
fair value estimates on assumptions we believe to be reasonable. Actual future
results may differ from those estimates.
We performed our required annual impairment
test in June 2008 and determined that goodwill was not impaired. During the third quarter of 2008, our stock
price fell below our net book value per share.
The stock price decline, along with other conditions in our business,
are defined as indicators of impairment of goodwill and other intangibles under
SFAS 142. Accordingly, we were required
to assess whether or not an impairment of our intangible assets, including
goodwill, had occurred. We performed an
impairment test using a market-based approach as of September 30, 2008 and
determined that there was no impairment.
The continued decline of our stock price
subsequent to September 30, 2008 and the resulting book value per share being
in excess of market value per share, along with other conditions in our
business, are indicators that it is more likely than not that the fair value of
the Company is less than the carrying value. Therefore, in the fourth quarter
of 2008,we will assess whether or not an impairment of its goodwill and other
intangible assets has occurred and will be conducting an evaluation of the fair
market value of these assets. If the implied fair values of goodwill and other
intangible assets are less than the carrying amounts, impairment losses will be
recognized for the differences.
Income
Taxes
Income tax expense is based on pretax
financial accounting income. Under the liability method, deferred tax
assets and liabilities are determined based on the difference between the
financial statement and tax basis of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to
reverse. We must then assess the likelihood that the resulting deferred
tax assets will be realized. To the extent we believe that realization is
not more likely than not, we establish a valuation allowance. Significant
estimates are required in determining our provision for income taxes, our
deferred tax assets and liabilities, unrecognized tax benefits, and any valuation
allowance to be recorded against our net deferred tax asset. Some of
these estimates are based on interpretations of existing tax laws or
regulations. We believe that our estimates are reasonable and that our
reserves for income tax related uncertainties are adequate. Various
21
Table of Contents
internal and external factors may have favorable or unfavorable effects
on our future effective tax rate. These factors include, but are not
limited to, changes in tax laws, regulations and/or rates, changing
interpretations of existing tax laws or regulations, changes in the valuation
of deferred tax assets or liabilities, future level of research and development
spending, nondeductible expenses, changes in overall levels and geographical
mix of actual and forecast pretax earnings, and ultimate outcomes of income tax
audits.
Contingencies
We are subject to
legal proceedings principally related to intellectual property matters. Based
on the information available at the balance sheet dates, we assess the
likelihood of any adverse judgments or outcomes to these matters, as well as
potential ranges of probable losses. If losses are probable and reasonably
estimable, we will record a reserve in accordance with SFAS No. 5,
Accounting for Contingencies
. Any reserves recorded may
change in the future due to new developments in each matter.
Accounting for Stock-Based Compensation
We account for employee stock-based
compensation in accordance with SFAS 123R. Under the provisions of SFAS
123R, we estimate the fair value of our employee stock awards at the date of
grant using the Black-Scholes option-pricing model, which requires the use of
certain subjective assumptions. The most significant of these assumptions are
our estimates of the expected term, volatility and forfeiture rates of the
awards. The expected stock price volatility assumption was determined using a
combination of historical and implied volatility of our common stock. We
determined that blended volatility is more reflective of market conditions and
a better indicator of expected volatility than historical volatility. The
estimate of these key assumptions is based on historical information and
judgment regarding market factors and trends. As required under the
accounting rules, we review our valuation assumptions at each grant date and,
as a result, we are likely to change our valuation assumptions used to value
employee stock-based awards granted in future periods.
SFAS 123R requires that employee stock-based
compensation costs be recognized over the requisite service period, or the
vesting period, in a manner similar to all other forms of compensation paid to
employees. Accordingly, in the nine months ended September 30, 2008, we
recognized employee stock-based compensation of approximately $1.1 million in
cost of product sales, approximately $1.5 million in research and development
expense and approximately $4.0 million in selling, general and administrative
expenses. During the nine months ended September 30, 2007, we recognized
employee stock-based compensation of $0.8 million in cost of product sales,
$1.6 million in research and development expense, $5.2 million in selling,
general and administrative expenses and $0.3 million in restructuring charges
recognized under SFAS 123R.
As of September 30, 2008, approximately
$38.1 million of total unrecognized stock-based compensation expense related to
non-vested awards is expected to be to be recognized over the respective
vesting terms of each award through 2012. The weighted-average term of the
unrecognized stock-based compensation expense is 3.1 years.
Restructuring
We have recently engaged in, and may
continue to engage in, restructuring actions, which require management to
utilize significant estimates related to expenses for severance and other
employee separation costs, lease cancellations, realizable values of assets
that may become duplicative or obsolete, and other exit costs. If the actual
amounts differ from our estimates, the amount of the restructuring charges
could be materially impacted. For a full description of our restructuring
actions, see Note 4 to the Condensed Consolidated Financial Statements in Item 1.
Results of Operations
The following discussion compares the historical
results of operations for the three and nine months ended September 30,
2008 and 2007, respectively.
Product Sales
The components of product sales are as
follows (in thousands, except percentage amounts):
|
|
|
|
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Consumables
|
|
$
|
59,804
|
|
$
|
59,064
|
|
$
|
740
|
|
1
|
%
|
$
|
187,420
|
|
$
|
174,681
|
|
$
|
12,739
|
|
7
|
%
|
Instruments
|
|
6,148
|
|
10,663
|
|
(4,515
|
)
|
(42
|
)
|
16,360
|
|
27,940
|
|
(11,580
|
)
|
(41
|
)
|
Total product sales
|
|
$
|
65,952
|
|
$
|
69,727
|
|
$
|
(3,775
|
)
|
(5
|
)
|
$
|
203,780
|
|
$
|
202,621
|
|
$
|
1,159
|
|
1
|
|
22
Table of Contents
Total product sales decreased in the third
quarter of 2008 as compared to the same period in 2007. Consumables, which
include
probe
arrays and reagents, increased primarily due to an increase in unit sales of
reagents associated with our acquisition of USB Corporation, which was
partially offset by a decrease in unit sales of probe arrays. Instrument sales declined primarily
due to a decrease in unit sales of our Probe Array systems and GeneChip
®
Scanners.
Total
product sales increased in the first nine months of 2008 compared to the same
period in 2007. Consumables
increased primarily due to an increase in unit sales of reagents associated
with our acquisition of USB Corporation. The increase in unit sales of reagents
was partially offset by decreases in the average selling price of certain of
our consumables. In addition, instrument sales declined primarily due to a
decrease in unit sales of our Probe Array systems and GeneChip
®
Scanners. Sales to our pharmaceutical
customers have declined in the first nine months of 2008 as compared to 2007,
particularly in instrument sales.
Consumable sales for the three months ended September 30,
2008 and 2007 include $46,000 and $355,000, respectively, of revenue from
Perlegen Sciences Inc. (Perlegen), a related party. Consumable sales for the
nine months ended September 30, 2008 and 2007 include $0.8 million and
$11.5 million, respectively, of revenue from Perlegen.
Services (in thousands, except percentage
amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Services
|
|
$
|
6,132
|
|
$
|
10,829
|
|
$
|
(4,697
|
)
|
(43
|
)%
|
$
|
23,557
|
|
$
|
31,617
|
|
$
|
(8,060
|
)
|
(25
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total services revenue
decreased in the third quarter of 2008 as compared to 2007 primarily due to a
decrease of $5.0 million in our genotyping services business because of the
variable timing of projects, partially offset by an increase of $0.3 million in
instrument service revenue. The decrease in total services revenue for the
first nine months of 2008 as compared to 2007 is primarily due to a decrease of
$9.5 million in our genotyping services business because of the variable timing
of projects, partially offset by an increase of $1.4 million in instrument
service revenue.
Royalties and Other Revenue (in thousands
,
except percentage amounts
):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Royalties and other revenue
|
|
$
|
3,105
|
|
$
|
14,430
|
|
$
|
(11,325
|
)
|
(78
|
)%
|
$
|
104,338
|
|
$
|
29,490
|
|
$
|
74,848
|
|
254
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties and other revenue decreased in the
third quarter of 2008 as compared to 2007 primarily due to higher license and
grant revenue recognized in 2007. Royalties and other revenue increased in the
nine months ended September 30, 2008 as compared to 2007 primarily due to
the recognition of a non-recurring $90 million intellectual property
payment received in January 2008, partially offset by higher license and
grant revenue recognized in 2007.
Product and Services Gross
Margins (in thousands, except percentage/point amounts):
|
|
Three Months Ended
|
|
Dollar/Point
|
|
Nine Months Ended
|
|
Dollar/Point
|
|
|
|
September 30,
|
|
change from
|
|
September 30,
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
Total gross margin on product sales
|
|
$
|
33,605
|
|
$
|
41,481
|
|
$
|
(7,876
|
)
|
$
|
113,199
|
|
$
|
126,504
|
|
$
|
(13,305
|
)
|
Total gross margin on services
|
|
341
|
|
3,521
|
|
(3,180
|
)
|
5,397
|
|
7,143
|
|
(1,746
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product gross margin as a
percentage of products sales
|
|
51
|
%
|
59
|
%
|
(9
|
)
|
56
|
%
|
62
|
%
|
(7
|
)
|
Service gross margin as a
percentage of services
|
|
6
|
%
|
33
|
%
|
(27
|
)
|
23
|
%
|
23
|
%
|
0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in product
gross margin in the third quarter and first nine months of 2008, as compared to
2007, is primarily due to a charge for accelerated depreciation expense related
to the closing of our West Sacramento manufacturing facility and lower average
selling prices for certain of our consumable products. These decreases were
partially offset by favorable consumable product costs.
23
Table of Contents
Gross margin on product
sales for the third quarter of 2008 and 2007 includes $42,000 and $188,000,
respectively, of gross margin from Perlegen and $0.4 million and $7.0 million,
respectively, for the first nine months of 2008 and 2007.
The decrease in services
gross margin in the third quarter and first nine months of 2008 as compared to
the same period in 2007 was primarily due to lower volumes principally
associated with sample acquisition delays and a proportionately higher mix of
lower priced control samples.
Research and Development Expenses (in
thousands, except percentage amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Research and development
|
|
$
|
20,739
|
|
$
|
16,489
|
|
$
|
4,250
|
|
26
|
%
|
$
|
59,098
|
|
$
|
55,143
|
|
$
|
3,955
|
|
7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The increase in research and development
expenses in the third quarter and first nine months of 2008, as compared to the
same periods in 2007 was primarily due to higher headcount related expenses and
increased spending for supplies and outside services.
Our research and
development costs have increased in the near term and we believe a substantial
investment in research and development is essential to a long-term sustainable
competitive advantage and critical to expansion into additional markets.
Selling, General and Administrative Expenses
(in thousands, except percentage amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Selling, general and administrative
|
|
$
|
28,409
|
|
$
|
33,300
|
|
$
|
(4,891
|
)
|
(15
|
)%
|
$
|
92,782
|
|
$
|
102,800
|
|
$
|
(10,018
|
)
|
(10
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in selling, general and
administrative expenses for the third quarter of 2008, as compared to the same
period in 2007 was primarily due to lower headcount related expenses and lower
spending for consulting and other outside services.
The decrease in selling, general and
administrative expenses for the first nine months of 2008, as compared to the
same period in 2007 was primarily due to a decrease in legal expenses,
principally as a result of the settlement of the Illumina litigation in January 2008,
lower headcount related expenses and lower spending for consulting and other
outside services.
Acquired-in-process technology (in thousands,
except percentage amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Acquired in-process technology
|
|
$
|
5,100
|
|
$
|
|
|
$
|
5,100
|
|
100
|
%
|
$
|
5,900
|
|
$
|
|
|
$
|
5,900
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the third quarter of 2008, we
completed the acquisition of True Materials, Inc. which we recorded a
charge of approximately $5.1 million to acquired in-process technology. We
believe the acquisition will enable us to enter low to mid-multiplex markets.
We determined the estimated fair value of certain research and development
programs in-process at the acquisition date that had not yet reached
technological feasibility and had no alternative future use. The fair values of
these projects were determined using the Income Approach whereby we estimated
each projects related future net cash flows between 2009 and 2015 and
discounted them to their present value using a risk adjusted discount rate of
30%. This discount rate is based on our estimated weighted average cost of
capital adjusted upward for the risks associated with the projects acquired.
During the first quarter of 2008, we recorded
a charge of approximately $0.8 million to acquired in-process technology
upon the January 30, 2008 completion of our acquisition of USB. We believe
the acquisition will enable us to accelerate the development and
commercialization of new genetic analysis solutions and increase the value of
our current product portfolio. We determined the estimated fair value of certain
research and development programs in-process at the acquisition date that had
not yet reached technological feasibility and had no alternative future use.
These projects primarily included certain molecular biology projects. The fair
values of these projects were determined using the Income Approach whereby we
estimated each projects related future net cash flows between 2008 and 2014
and discounted them to their present value using a risk adjusted discount rate
of 21%. This discount rate is based on our estimated weighted average cost of
capital adjusted upward for the risks associated with the projects acquired.
24
Table of Contents
The projected cash flows from the acquired
projects were based on estimates of revenues and operating profits related to
the projects considering the stage of development of each potential product
acquired, the time and resources needed to complete the development and
approval of each product, the life of each potential commercialized product and
the inherent difficulties and uncertainties in developing products and services
based on complex genetic technologies and biochemical processes. We expect cash
flows from these projects to begin in 2009 and are not anticipating any
material changes to our historical pricing, expense levels or gross margins
related to these products.
Restructuring charges (in thousands, except
percentage amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Restructuring
|
|
$
|
14,571
|
|
$
|
5,737
|
|
$
|
8,834
|
|
154
|
%
|
$
|
29,379
|
|
$
|
12,879
|
|
$
|
16,500
|
|
128
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2008 Restructuring Plan
In February 2008, we committed to a
restructuring plan (the 2008 Plan) designed primarily to optimize our
production capacity and cost structure and improve its future gross margins.
The restructuring plan was approved as part of our ongoing efforts to reduce
costs.
This phase of the
restructuring plan involves moving the majority of our probe array
manufacturing from our West Sacramento, California facility to our Singapore
facility by the end of 2008. We estimate the total restructuring expenses
to be incurred in connection with this phase of the 2008 Plan will be
approximately $14.0 million. Of this total, approximately $1.5 million relates
to employee severance and $12.5 million relates to non-cash charges associated
with the abandonment of certain long-lived manufacturing assets.
In
July 2008, we decided to expand the 2008 Plan by closing our West
Sacramento manufacturing facility. Following the closure of our West
Sacramento manufacturing facility, all of our products will be manufactured at
our Singapore and Ohio facilities, as well as by third parties. We expect
to incur a total of approximately $36 million in charges related to this
expansion of its restructuring plan. Of this total, we expect that
approximately $18 million will be included as a component of total cost of
product sales, $12 million of which relates to accelerated depreciation charges
associated with the continued use of certain long-lived manufacturing assets
and $6 million of which relates to manufacturing transition and other
costs. Additionally, we expect to include approximately $18 million in
the line item labeled Restructuring charges in our Condensed Consolidated Statements
of Operations, $14 million of which relates to asset impairment charges
primarily related to the facility itself and to certain long-lived
manufacturing assets and $4 million related to employee severance costs.
In
accordance with SFAS No. 146
, Accounting for Costs
Associated with Exit or Disposal Activities
(SFAS 146),
the costs relating to employee severance and relocation are
being accrued over the remaining service periods of the employees.
We
expect the closure of the West Sacramento facility to be substantially complete
by the end of the second quarter of 2009. The estimated cash outlays to
be incurred in connection with these restructuring activities are estimated to
be approximately $10 million. Depending on the rate at which we transfer
our production capacity out of our West Sacramento facility, we may incur
additional expenses.
Fiscal 2007 Restructuring Plan
In July 2007,
we announced that it was consolidating an administrative facility located in
Sunnyvale, California into our main campus in Santa Clara, California during
the fourth quarter of 2007 (the 2007 Plan). Additionally, in August and December 2007,
we terminated certain employees in the research and development and selling,
general and administrative functions. The Sunnyvale, California facility was
vacated during the fourth quarter of 2007. The estimated cash outlays to be
incurred in connection with these restructuring activities are estimated to be
approximately $5 million.
Fiscal 2006 Restructuring Plan
In 2006, we initiated a
restructuring plan (the 2006 Plan) to better align certain of its expenses
with our current business outlook. Our primary focus of the 2006 Plan was in
the general and administrative functions and included rationalizing our
facilities. Cash outlays to be incurred in connection with these restructuring
activities are estimated to be approximately $25 million.
25
Table of Contents
During the three months ended September 30,
2008 and 2007, the amount of expense recognized associated with our
restructuring plans was approximately $14.6 million and $5.7 million,
respectively. The third quarter 2008 restructuring expenses primarily related
to our 2008 Plan and were associated with the abandonment and impairment of
certain manufacturing assets. The third quarter 2007 restructuring expenses
primarily related to our 2007 Plan and were associated with employee related
post-termination benefits and contract termination costs.
During the nine months ended September 30,
2008 and 2007, the amount of expense recognized associated with our
restructuring plans was approximately $29.4 million and $12.9 million,
respectively. For the nine months ended September 30, 2008, the
restructuring expenses primarily related to our 2008 Plan and were associated
with the abandonment and impairment of certain manufacturing assets. For the
nine months ended September 30, 2007, the restructuring expenses primarily
related to our 2006 Plan as well as employee related post-termination benefits
and contract termination costs associated with our 2007 Plan.
Interest Income and Other, Net
The components of interest income and other,
net, are as follows (in thousands,
except percentage amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Interest income
|
|
$
|
3,442
|
|
$
|
3,146
|
|
$
|
296
|
|
9
|
%
|
$
|
11,739
|
|
$
|
8,988
|
|
$
|
2,751
|
|
31
|
%
|
Realized (loss) gain on equity investments,
net
|
|
(491
|
)
|
(3,050
|
)
|
2,559
|
|
84
|
|
1,219
|
|
(3,249
|
)
|
4,468
|
|
138
|
|
Currency (losses) gains, net
|
|
(1,268
|
)
|
348
|
|
(1,616
|
)
|
464
|
|
(2,154
|
)
|
527
|
|
(2,681
|
)
|
509
|
|
Other
|
|
(11
|
)
|
(153
|
)
|
142
|
|
(93
|
)
|
26
|
|
2,116
|
|
(2,090
|
)
|
(99
|
)
|
Total interest income and other, net
|
|
$
|
1,672
|
|
$
|
291
|
|
$
|
1,381
|
|
475
|
|
$
|
10,830
|
|
$
|
8,382
|
|
$
|
2,448
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income and
other, net increased for the third quarter of 2008 by $1.4 million, as compared
to the same period in 2007, primarily due to a loss of $3.0 million on the
write-down of a non-marketable investment in 2007, partially offset by currency
losses in the third quarter of 2008.
Interest income and
other, net increased for the first nine months of 2008 as compared to the same
period in 2007 primarily due to an increase in interest earned of $2.8 million
on our higher average total cash balances and a loss of $3.0 million on the
write-down of a non-marketable investment in 2007. This was partially offset by
higher currency losses of $2.7 million incurred during the first nine months of
2008.
Interest Expense (in thousands, except
percentage amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Interest expense
|
|
$
|
(3,497
|
)
|
$
|
(417
|
)
|
$
|
(3,080
|
)
|
739
|
%
|
$
|
(10,634
|
)
|
$
|
(1,246
|
)
|
$
|
(9,388
|
)
|
753
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense increased in the third
quarter and first nine months of 2008 as compared to 2007 as we recognized
interest expense on our $316.3 million 3.50% senior convertible notes issued in
November 2007.
Income Tax Provision (Benefit) (in thousands,
except percentage amounts):
|
|
Three Months Ended
|
|
Dollar
|
|
Percentage
|
|
Nine Months Ended
|
|
Dollar
|
|
Percentage
|
|
|
|
September 30,
|
|
change from
|
|
change from
|
|
September 30,
|
|
change from
|
|
change from
|
|
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
2008
|
|
2007
|
|
2007
|
|
2007
|
|
Income tax benefit (provision)
|
|
$
|
1,802
|
|
$
|
(1,162
|
)
|
$
|
2,964
|
|
255
|
%
|
$
|
(25,093
|
)
|
$
|
550
|
|
$
|
(25,643
|
)
|
(4,662
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The income tax benefit increased
approximately $3.0 million in the third quarter of 2008 and the income tax
provision increased approximately $25.6 million in the first nine months of
2008. In the third quarter of 2008, the income tax provision differs from the
amount computed by applying the federal statutory rate of 35% due
to various factors including the tax impact of non-U.S. operations,
non-deductible in-process research and development, and the establishment of a
partial valuation allowance against our U.S. deferred tax assets.
26
Table of Contents
For the quarter ended September 30,
2008, we recorded a non-cash income tax provision of approximately $6.3 million
to establish a valuation allowance to partially reserve our U.S. gross deferred
tax assets as of September 30, 2008. We evaluated both positive and
negative evidence and determined that there is a need for the valuation
allowance during the quarter ended September 30, 2008 due to a revised
forecast that lowered projected future taxable income. We intend to maintain
the valuation allowance until sufficient positive evidence exists to support
reversal of the valuation allowance. Management periodically evaluates the
realizability of our net deferred tax assets based upon all available evidence.
The realization of net deferred tax assets is dependent on our ability to
generate sufficient future taxable income. The forecasted future taxable income
is highly influenced by assumptions regarding our ability to achieve the
forecasted revenue and our ability to effectively manage the expenses in line with
the forecasted revenue. We believe realization of the deferred tax assets as of
September 30, 2008 is more likely than not based upon future taxable
earnings. An additional valuation allowance against deferred tax assets may be
necessary if it is more likely than not that all or a portion of the deferred
tax assets will not be realized, for example as a result of a change in our
ability to reliably project future taxable income or a reduction in the amount
of future taxable income.
We do not expect any material changes to the
estimated amount of liability associated with our uncertain tax positions
within the next twelve months. As of September 30, 2008, there have been
no material changes to our total amount of unrecognized tax benefits.
Liquidity and Capital Resources
Cashflow (in thousands):
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
Net cash provided by operating activities
|
|
$
|
98,194
|
|
$
|
19,356
|
|
Net cash used in investing activities
|
|
(71,606
|
)
|
(27,214
|
)
|
Net cash (used in) provided by financing
activities
|
|
(35
|
)
|
12,227
|
|
Effect of foreign currency translation on
cash and cash equivalents
|
|
(46
|
)
|
304
|
|
Net increase in cash and cash equivalents
|
|
$
|
26,507
|
|
$
|
4,673
|
|
Net Cash Provided by Operating Activities
Cash provided by
operating activities is net (loss) income
adjusted for certain non-cash items and changes in operating assets and
liabilities. Cash provided by operating activities in the first nine months of
2008 was primarily comprised of net income of $10.8 million, which included
a non-recurring $90.0 million intellectual property payment, depreciation and
amortization of $32.7 million and a loss on disposal of property and equipment
of $25.9 million. Significant changes in assets and liabilities are as follows:
Our total accounts
receivable, including Perlegen, was $63.5 million at September 30,
2008, a decrease of $18.5 million from December 31, 2007. The
decrease is primarily due to lower sales of consumables and instruments in the
third quarter of 2008 as compared to the fourth quarter of 2007.
Our inventory balance was
$46.4 million at September 30, 2008, an increase of $3.5 million from December 31,
2007. The increase is primarily due to the acquisition of USBs inventory on January 30,
2008, partially offset by an increase in our inventory reserves of $3.1
million.
Our prepaid expenses and other assets balance
was $15.7 million at September 30, 2008, a decrease of $2.2 million from December 31,
2007. The decrease is primarily related to the receipt of a non-recurring license
fee in our other non-trade receivables.
Our deferred tax assets balance was $53.7
million at September 30, 2008 an increase of $6.7 million from December 31,
2007. The increase is primarily due to a temporary timing difference associated
with the abandonment of certain long-lived manufacturing assets.
Our deferred revenue balance was $21.9
million at September 30, 2008, a decrease of $4.5 million from December 31,
2007. The decrease is primarily due to the payment, and recognition as revenue,
of a non-recurring license fee.
27
Table of Contents
Net
Cash Used in
Investing Activities
Our investing activities, other than purchases,
sales and maturities of available-for-sale securities, primarily consist of
capital expenditures, strategic investments and purchased technology rights.
Cash used for capital expenditures was $10.9
million and $23.0 million in the first nine months of 2008 and 2007,
respectively. Our capital expenditures in 2008 primarily related to our
manufacturing facility in Singapore and network upgrades, including the
capitalization of cost related to our new enterprise resource planning system.
In 2008, we paid approximately
$88.2 million, net of cash acquired, for acquisitions of businesses.
Net Cash (Used in)
Provided by Financing Activities
Our financing activities consist of stock
option exercise activity under our employee stock plan. Cash (used in) provided
by the issuance of stock under our employee stock plan was ($35,000) and $12.2
million in the first nine months of 2008 and 2007, respectively.
Off-Balance Sheet Arrangements and Aggregate
Contractual Obligations
There have been no other significant changes
in our off-balance sheet arrangements and 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, 2007.
On December 15, 2008, 2013, 2018, 2023
and 2028 the security holders have the option to require us to repurchase our
$120.0 million 0.75% Notes at a price equal to 100% of the principal amount of
the 0.75% Notes plus accrued and unpaid interest. Additionally, on or after December 15,
2008, we have the option of redeeming for cash at 100% of the principal amount
all or part of the then outstanding 0.75% Notes plus accrued but unpaid
interest.
We anticipate that our existing capital
resources along with the cash to be generated from operations will enable us to
maintain currently planned operations and planned capital expenditures for the
foreseeable future, including the potential repayment of our 0.75% Notes.
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.
There have been no other significant changes
in our market risk compared to the disclosures in Item 7A of our Annual Report
on Form 10-K for the year ended December 31, 2007.
ITEM 4. CONTROLS AND
PROCEDURES
(a) Disclosure
controls and procedures.
Affymetrixs 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 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 (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) 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 Affymetrixs management, including our Chief Executive
Officer and our Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.
28
Table of Contents
(b) Changes
in internal control over financial reporting.
Affymetrixs 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 Affymetrixs 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.
PART II. OTHER
INFORMATION
ITEM 1. LEGAL
PROCEEDINGS
Information pertaining to legal proceedings can be found in Item 1.
Condensed Consolidated Financial Statements Note 11. Commitments and Contingencies
to the interim condensed consolidated financial statements, and is incorporated
by reference herein.
ITEM 1A. RISK FACTORS
In evaluating our business, you should carefully consider the following
risks, as well as the other information contained in this quarterly report on Form 10-Q.
If any of the following risks actually occurs, our business could be harmed.
We
may not maintain profitability.
Although we were profitable for the year ended December 31, 2007,
we incurred losses each year from our inception through the year ended December 31,
2002 and also for the year ended December 31, 2006. As a result, we had an
accumulated deficit of approximately $97.7 million at September 30, 2008.
We expect to continue experiencing fluctuations in our operating results and
cannot assure sustained profitability.
If our revenues grow more slowly than we anticipate, or if our
operating expenses increase more than we expect or cannot be reduced in the
event of lower revenues, our business will be materially and adversely
affected.
Our
business depends on research and development spending levels for pharmaceutical
and biotechnology companies and academic and governmental research
institutions.
We expect that our revenues in the foreseeable future will be derived
primarily from products and services provided to a relatively small number of
pharmaceutical and biotechnology companies and 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. For example, recent delays and reductions in expenditures by our
pharmaceutical customers, as well as governmental and research institutions,
had adversely affected our results of operations.
Factors that could affect the spending levels of our customers include:
·
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
government programs that provide funding to companies and research
institutions;
·
changes in the
regulatory environment affecting life sciences companies and life sciences
research; and
·
market-driven
pressures on companies to consolidate and reduce costs.
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 revenues 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 GeneChip®
instrumentation and GeneChip® arrays where the majority of the shipments occur
in the last month of the quarter. These ordering patterns may limit managements
ability to accurately forecast our future revenues or product mix.
Additionally, license revenue may also be unpredictable and may fluctuate 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
revenues will materially reduce our profitability and may cause us to
experience losses.
29
Table of Contents
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 GeneChip® 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.
We may be required to
record a significant charge to earnings if our goodwill or other identified
intangible assets become impaired.
Current accounting rules require that goodwill
be assessed for impairment at least annually or whenever changes in
circumstances indicate that the carrying amount may not be recoverable from
estimated future cash flows. Factors that may be considered a change in
circumstance indicating the carrying value of our intangible assets, including
goodwill, may not be recoverable include, but are not limited to, significant
underperformance relative to historical or projected future operating results,
a significant decline in our stock price and market capitalization, and
negative industry or economic trends. Additionally, we periodically evaluate
the recoverability and the amortization period of our acquired technology rights.
As of September 30,
2008, our goodwill and net acquired technology
rights comprised approximately 21% of our total assets. Subsequent to September 30,
2008, the decline in our stock price led to the market
value falling below our net equity value. The decline, along with
other conditions in our business, are defined as indicators of
impairment of goodwill and other intangibles under Statement of Financial
Accounting Standards No. 142,
Goodwill
and Other Intangibles.
Therefore, we are required to assess
whether or not an impairment of our intangible assets has occurred and we will
be conducting an evaluation of the fair market value of these and other assets,
including our deferred tax assets. We expect to complete our impairment
analysis during the fourth quarter.
Although
we have not recorded any impairment charges to date as a result of our annual
and other periodic evaluations, we cannot assure you that future impairment
charges may not occur. If we determine that we need to write-down our
intangible assets, including goodwill, to their fair value, we may incur
material charges that could harm our results of operations and financial
condition.
The recent financial crisis could negatively affect our business,
results of operations, and financial condition.
The
recent financial crisis affecting the banking system and financial markets and
the going concern threats to investment banks and other financial institutions
have resulted in a tightening in the credit markets, a low level of liquidity
in many financial markets, and extreme volatility in fixed income, credit and
equity markets. There could be a number of follow-on effects from the credit
crisis on our business, including insolvency of key suppliers resulting in
product delays; inability of customers to obtain credit to finance purchases of
our products and/or customer insolvencies; counterparty failures negatively
impacting our treasury operations; increased expense or inability to obtain
short-term financing of our operations from the issuance of commercial paper;
and increased impairments from the inability of investee companies to obtain
financing.
30
Table
of Contents
We
may need to adjust our manufacturing capacity based on business requirements or
improvements made to our technological capabilities. There are risks associated
with the consolidation of our manufacturing facilities.
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 we may be required to record an impairment on our
long-lived assets including facilities and equipment, 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, which would have a negative impact on our
gross margin.
We have in the past, and may in the future, adjust our 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. In February 2008,
we implemented a restructuring plan in order to optimize our production
capacity and cost structure to enable us to increase our gross margins. In
July 2008, we expanded our restructuring plan to include the closure of
our West Sacramento, California facility.
Under our restructuring plan, we will close our West Sacramento
manufacturing facility and consolidate our manufacturing to three locations. In
addition, we will outsource the manufacturing of our instruments to one or more
third parties. Manufacturing and product quality issues may arise as we
implement this transition process and increase our production rates and launch
new products in our Singapore and Cleveland, Ohio facilities. 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 lose customers or experience lost sales if we are unable to manufacture or
experience delays in the manufacture of our products, or if we are unable to
ensure their proper performance and quality.
We produce our GeneChip® 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.
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 probe arrays that do not
meet all of our performance specifications may not be identified before they
are shipped. If our products do not consistently meet our customers
performance expectations, demand for our products will decline. In addition, we
do not maintain any backup manufacturing capabilities for the production of our
products. Any interruption in our ability to continue operations at our
existing manufacturing facilities could delay our ability to develop or sell
our products, which could result in lost revenue and seriously harm our business,
financial condition and results of operations.
We
may not realize the expected benefits of our initiatives to reduce costs across
our operations.
We are pursuing and may continue to pursue a number of initiatives to
reduce costs across our operations. These initiatives include workforce
reductions in certain areas and the rationalization of our facilities. In 2007,
we implemented workforce reductions in certain areas in Santa Clara,
California. In February 2008, we implemented a restructuring plan in order
to optimize our production capacity and cost structure to enable us to increase
our gross margins. In July 2008, we expanded our restructuring plan to
include the closure of our West Sacramento, California facility. We expect the
closure of our West Sacramento facility to be substantially complete by the end
of the second quarter of 2009. We anticipate that we will incur some level of
restructuring charges through the end of 2008 and in 2009 as we continue to
implement these initiatives.
We may not realize the expected benefits of our current and future
initiatives to reduce costs. As a result of these initiatives, we expect to
incur restructuring or other charges and we may experience disruptions in our
operations, a loss of key personnel and difficulties in delivering products in
a timely manner.
31
Table
of Contents
We
depend on a limited number of suppliers and we will be unable to manufacture
our products if shipments from these suppliers are delayed or interrupted.
We depend on our suppliers to provide components of our products in
required volumes, at appropriate quality and reliability levels, and in
compliance with regulatory requirements. Key parts of the GeneChip® product
line, including components of our manufacturing equipment and certain raw
materials used in the synthesis of probe arrays, are currently available only
from a single source or limited sources. This risk is increased by the recent
consolidation among our suppliers, including the acquisition of Applied
Biosystem by Invitrogen.
If supplies from these vendors were delayed or interrupted for any
reason, we would not be able to get manufacturing equipment, produce probe
arrays, or sell scanners or other components for our GeneChip® products in a
timely fashion or in sufficient quantities or under acceptable terms.
Furthermore, our business is dependent on our ability to forecast the needs for
components and products in the GeneChip® product line 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.
Future
acquisitions may disrupt our business and distract our management.
We have engaged in acquisitions, including our acquisition of two
companies in 2008. We will continue to evaluate future acquisitions that we
believe to be of strategic importance. Future acquisitions could involve the
use of a material portion of our existing cash balance and could limit other
potential uses of our cash. If we incur indebtedness in connection with our
acquisitions, we may significantly increase our interest expense. To the extent
we issue a significant amount of equity securities in connection with future
acquisitions, existing stockholders would be diluted.
We may not be able to successfully integrate an acquired business into
our existing business or an acquired product into our existing product
offerings in a timely and non-disruptive manner, or at all, and we could fail
to commercialize an acquired technology. Furthermore, an acquisition may not
produce the revenues, cost savings, earnings or business synergies that we
anticipate. Other challenges could include unanticipated incompatibility of
corporate cultures, an inability to retain key employees, including key
scientists, the diversion of managements attention from ongoing business concerns,
and the potential adverse reaction of customers or other business partners to
an acquisition or resulting changes to the combined companys product and
services offerings.
Our due diligence process could fail to identify problems, liabilities
or other shortcomings or challenges of an acquired business, product or
technology, including issues with the associated intellectual property, product
quality or accounting practices. Pre-existing liabilities that we assume in
connection with an acquisition could be materially larger than we anticipate.
We may face litigation or other claims in connection with an acquisition, or we
may inherit claims or litigation risk as a result of an acquisition. If a past
or future acquisition fails to meet our expectations, we may need to recognize
a goodwill impairment charge. The final valuation of purchased assets and
liabilities could impact our future operating results, including our gross
margins.
Our
success depends on the continual development of new products and our ability to
manage the transition from our older products to new products.
We compete in markets that are new, intensely competitive, highly
fragmented and rapidly changing. We may not be able to develop new products
that serve these rapidly changing markets. In addition, the successful
development, manufacture and introduction of our new products is a complicated
process and depends on our ability to manufacture enough products in sufficient
quantity and at acceptable cost in order to meet customer demand. If we fail to
keep pace with emerging technologies or are unable to develop, manufacture and
introduce new products, including the development of new assay protocols and
training our customers, we will become less competitive, our pricing and margins
will decline and our business will suffer.
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The continued success of our GeneChip® products will depend on our ability
to produce products with smaller feature sizes, our ability to dice the wafer,
and create greater information capacity at our current or lower costs. Our
failure to successfully manage the transition between our older products and
our new products may adversely affect our financial results. As we introduce
new or enhanced products, we must successfully manage the transition from older
products to minimize disruption in customers ordering patterns, avoid
excessive levels of older product inventories and provide sufficient supplies
of new products to meet customer demands. When we introduce new or enhanced
products, we face numerous risks relating to product transitions, including 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.
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 public databases
throughout the world. These databases are rapidly expanding and evolving. In
addition, the accuracy of such 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
depends on 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.
We
face risks associated with technological obsolescence and emergence of
standardized systems for genetic analysis.
The RNA/DNA probe array field is undergoing rapid technological changes.
New technologies, techniques or products could emerge which might allow the
packaging and analysis of genomic information at densities similar to or higher
than our microarray technology. Other companies may begin to offer products
that are directly competitive with, or are technologically superior, to our
products. We cannot assure you that we will be able to maintain our
technological advantages over emerging technologies in the future. In addition,
although we believe that we are recognized as a market leader in creating
systems for genetic analysis in the life sciences, standardization of tools and
systems for genetic research is still ongoing and there can be no assurance
that our products will emerge as the standard for genetic research. The emergence
of competing technologies and systems as market standards for genetic research
may result in our products becoming uncompetitive and could cause our business
to suffer.
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, 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. 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.
We
expect to face increasing competition.
The markets for our products are characterized by rapidly changing
technology, evolving industry standards, changes in customer needs, emerging
competition, new product introductions and strong price competition. We expect
to face increased competition in the future as existing companies develop new
or improved products and as new companies enter the market with new technologies.
For example, companies such as Agilent Technologies, Applied Biosystems
and Illumina have products for genetic analysis which are directly competitive
with our GeneChip® products. In addition, pharmaceutical and biotechnology
companies have significant needs for genomic information and may choose to
develop or acquire competing technologies to meet these needs.
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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.
In the molecular diagnostics field, competition will likely come from
established diagnostic companies, companies developing and marketing DNA probe
tests for genetic and other diseases and other companies conducting research on
new technologies to ascertain and analyze genetic information. Further, in the
event that we develop new technology and products that compete with existing
technology and products of well established companies, there can be no guarantee
that the marketplace will readily adopt any such new technology and products
that we may introduce in the future.
The market for molecular diagnostics products is currently limited and
highly competitive, with several large companies already having significant
market share. Companies such as Beckman Coulter, Becton Dickinson, bioMérieux,
Celera Diagnostics, Johnson & Johnson and Roche Diagnostics 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, regulatory
expertise, manufacturing capabilities and the distribution channels to deliver
products to customers. Established diagnostic companies also have an installed
base of instruments in several markets, including clinical and reference
laboratories, which are not compatible with the GeneChip® system and could
deter acceptance of our products. In addition, these companies have formed
alliances with genomics companies which provide them access to genetic
information that may be incorporated into their diagnostic tests.
Our
effective tax rate may vary significantly.
Our operations are subject to income and
transaction taxes in the United States and in multiple foreign jurisdictions.
Significant 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.
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 tax rate could be
adversely impacted. Changes in tax laws and regulatory requirements in the
countries in which we operate could have a material impact on our tax
provision. To the extent that we are unable to continue to reinvest a
substantial portion of our profits in our foreign operations, we may be subject
to additional effective income tax rate increases in the future. Tax
authorities may challenge the allocation of profits between our subsidiaries
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.
We rely on our ability to project future
taxable income to assess the likelihood that our net deferred tax
asset will be realized. To the extent we believe that realization is not
more likely than not, we establish a valuation allowance. Significant estimates
are required in determining any valuation allowance to be recorded against our
net deferred tax assets. Changes in the amount of valuation allowance required
may adversely impact our financial results of operations.
Other factors that could affect our effective
tax rate include levels of research and development spending and
nondeductible expenses such as stock based compensation or merger related
expenditures, and ultimate outcomes of income tax audits.
Our
success in penetrating emerging market opportunities in molecular diagnostics
depends on the efforts of our partners and the ability of our GeneChip®
technologies to be used in clinical applications for diagnosing and enabling
informed disease management options in the treatment of disease.
The clinical applications of GeneChip® technologies for diagnosing and
enabling informed disease management options in the treatment of disease is an
emerging market opportunity in molecular diagnostics that seeks to improve the
effectiveness of health care by collecting information about DNA variation and
RNA expression in patients at various times from diagnosis through prognosis
and on to the end of therapy. However, there can be no assurances that
molecular diagnostic markets will develop as quickly as we expect or reach what
we believe is their full potential. Although we believe that there will be
clinical applications of our GeneChip® 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.
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The molecular diagnostics market is relatively new for us and presents
us with new risks and uncertainties. Our success in this area depends to a
large extent on our collaborative relationships and the ability of our
collaborative partners to successfully market and sell products using our
GeneChip® technologies. As a result, we are also dependent on the ability of
our collaborative partners to achieve regulatory approval for such products in
the United States and in overseas markets. Although Roche received FDA approval
of the first diagnostic genotyping test for use with our GeneChip® System
3000Dx in late 2004, there can be no assurance that other products using our
GeneChip® technologies will achieve required approvals.
We
may not successfully obtain or retain regulatory approval of any diagnostic or
other product or service that we or our collaborative partners develop.
The FDA must approve certain in-vitro diagnostic products before they
can be marketed in the U.S. Certain in-vitro diagnostic products must also be
approved by the regulatory agencies of foreign governments or jurisdictions
before the product can be sold outside the U.S. Commercialization of our and
our collaborative partners in-vitro diagnostic products outside of the
research environment that 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 for product
approval 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.
Even where 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.
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.
Our diagnostic clinical laboratory is subject to extensive federal and
state regulation including the requirements of the Clinical Laboratory
Improvement Act of 1988 (CLIA). CLIA is intended to ensure the quality and
reliability of clinical laboratories in the United States by requiring all
laboratories to meet specified standards in the areas of personnel
qualification, administration, participation in proficiency testing, patient
test management, quality control, quality assurance and inspections. There can
be no assurance that regulations under and future administrative
interpretations of CLIA will not have an adverse impact on the potential market
for our diagnostic clinical laboratory.
Healthcare
reform and restrictions on reimbursements may limit our returns on molecular
diagnostic products that we may develop with our collaborators.
We are currently developing diagnostic and therapeutic products with
our collaborators. The ability of our collaborators to commercialize such
products may depend, in part, on the extent to which reimbursement for the cost
of 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 U.S., third-party payer
price resistance, the trend towards managed health care and legislative
proposals to reform health care or reduce government insurance programs could
reduce prices for health care products and services, adversely affect the
profits of our customers and collaborative partners and reduce our future
royalties.
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.
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Our
success will require that we establish a strong intellectual property position
and that we can defend ourselves against intellectual property claims from
others.
Maintaining a strong patent position is critical to our business.
Litigation on these matters has been prevalent in our industry and we expect
that this will continue. Patent law relating to the scope of claims in the
technology fields in which we operate is still evolving and the extent of
future protection is highly uncertain, so we cannot assure you that the patent
rights that 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
will 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 assure you that any such patent applications will not have priority
over our patent applications. Also, our intellectual property may be subject to
significant administrative and litigation proceedings such as opposition
proceedings against our patents in Europe, Japan and other jurisdictions.
Because of the size and breadth of our patent portfolio 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. 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. For
example, we currently are engaged in litigation regarding intellectual property
rights with third parties. For additional information concerning intellectual
property litigation and administrative proceedings, see Note 11 to the
Condensed Consolidated Financial Statements in Item 1, Commitments and
Contingencies of this Form 10-Q.
In addition to patent protection, we also rely upon copyright and trade
secret protection for our confidential and proprietary information. Such
measures may not provide adequate protection for our copyrights, trade secrets
or other proprietary information. In addition, we cannot assure you that trade
secrets and other proprietary information will not be disclosed, or that others
will not independently develop substantially equivalent proprietary information
and techniques or otherwise gain access to or disclose our trade secrets and
other proprietary information. There can also be no assurance that we will be able
to effectively protect our copyrights, trade secrets or other proprietary
information. If we cannot obtain, maintain or enforce intellectual property
rights, our competitors may be able to offer probe array systems similar to our
GeneChip® technology.
Our success also depends in part on us neither infringing patents or
other proprietary rights of third parties nor breaching any licenses that may
relate to our technologies and products. 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.
There can be no assurance that we will not infringe on these patents or
other patents or proprietary rights or that we would be able to obtain a
license to such patents or proprietary rights on commercially acceptable terms,
if at all.
If
we are unable to maintain our relationships with collaborative partners, we may
have difficulty developing and selling our products and services.
We believe that our success in penetrating our target markets depends
in part on our ability to develop and maintain collaborative relationships with
key companies as well as with key academic researchers. Relying on our
collaborative relationships is risky to our future success because:
our partners may develop technologies or
components competitive with our GeneChip® products;
our existing collaborations may preclude us
from entering into additional future arrangements;
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;
our partners may not devote sufficient
resources to the development and sale of our products;
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 on acceptable terms.
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The
size and structure of our current sales, marketing and technical support
organizations may limit our ability to sell our products.
Although we have invested significant resources to expand our direct
sales force and our technical and support staff, we may not be able to establish
a sufficiently sized global sales, marketing or technical support organization
to sell, market or support our products 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. These and other third parties on whom we rely for sales, marketing and
technical support in these geographic areas may decide to develop and sell
competitive products or otherwise become our competitors, which could harm our
business.
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. Though 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 are also subject to general geopolitical risks in connection with
international operations, such as political, social and economic instability,
potential hostilities 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.
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.
We may seek to acquire additional insurance for clinical 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.
Our
strategic equity investments may result in losses.
We periodically make strategic equity investments in various publicly
traded and non-publicly traded 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 will require us to
record losses relative to our ownership interest. This could result in future
charges on our earnings and as a result, it is uncertain whether or not we will
realize any long term benefits associated with these strategic investments.
The
market price of our common stock has been volatile.
The market price of our common stock is volatile. From October 1,
2007 through September 30, 2008, the volume of our common stock traded
from 313,600 to 25,474,600 shares. Moreover, during that period, our common
stock traded as low as $7.24 per share and as high as $28.12 per share.
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Furthermore, volatility in the stock price of other companies has often
led to securities class action litigation against those companies. Any future
securities litigation against us could result in substantial costs and divert
managements attention and resources, which could seriously harm our business,
financial condition and results of operations.
The
matters relating to our internal review of our historical stock option granting
practices and the restatement of our consolidated financial statements may have
a material adverse effect on us.
During 2006, we conducted an internal review, performed under the
direction of our Audit Committee of the Board of Directors, of our historical
stock option granting practices from January 1, 1997 through May 31,
2006. As a result of this review, we restated our consolidated financial
statements for the years ended December 31, 2005, 2004 and 2003 to record
additional non-cash stock-based compensation expense and the related tax impact
resulting from stock options granted during fiscal years 1997 to 1999. We have
been, and may in the future be, subject to litigation or other proceedings or
actions arising in relation to our historical stock option granting practices
and the restatement of our prior period financial statements. For example,
three purported derivative lawsuits have been filed against us and several of
our current and former officers and directors alleging that the defendants
breached their fiduciary duty by backdating stock option grants, as well as
violations of federal securities laws in connection with the dissemination of
our financial and proxy statements, violations of Generally Accepted Accounting
Principles, violations of Section 162(m) of the Internal Revenue Code
and violations of state law including violation of the California Corporations
Code. In addition, we have received notice from the Securities and Exchange
Commission that it is conducting an informal inquiry into our stock option
practices and we have received notice from the IRS that it is conducting an
employment tax audit for the 2005 and 2006 tax years. Litigation and any
potential regulatory proceeding or action may be time consuming, expensive and
distracting from the conduct of our business. The adverse resolution of any
specific lawsuit or any potential regulatory proceeding or action could have a
material adverse effect on our business, financial condition and results of operations.
Global
credit and financial market conditions could negatively impact the value of our
current portfolio of cash equivalents or short-term investments and our ability
to meet our financing objectives.
Our cash and cash equivalents are maintained in highly liquid
investments with remaining maturities of 90 days or less at the time of
purchase. Our short-term investments consist primarily of readily marketable
debt securities with remaining maturities of more than 90 days at the time
of purchase. While as of the date of this filing, we are not aware of any
downgrades, material losses, or other significant deterioration in the fair
value of our cash equivalents or short-term investments since
September 30, 2008, no assurance can be given that further deterioration
in conditions of the global credit and financial markets would not negatively
impact our current portfolio of cash equivalents or short-term investments or
our ability to meet our financing objectives.
ITEM 5. OTHER
INFORMATION
On
November 5, 2008, our Board of Directors adopted the Amended and Restated
Bylaws of the Company (the Restated Bylaws), effective immediately upon
adoption. The principal changes effected by the Restated Bylaws include:
(a) expanding
the required disclosure for stockholders making proposals or nominations to
include, among other things, all ownership interests, hedges, economic
incentives and rights to vote any shares of any security of the Company;
(b) providing
that electronic transmissions of notices of stockholder meetings and Board
meetings and waivers of such notices, and participation by stockholders in
stockholders meetings and directors in Board meetings via remote
communications are permitted;
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(c) providing
that the notice period for special meetings of the stockholders is the same as
the notice period for all meetings of the stockholders, which is at least 10 but
not more than 60 days before the meeting;
(d) providing
that the officers shall have some powers and perform such duties as are
conferred upon them by the Board from time to time and eliminating prescribed
duties set forth in the bylaws;
(e) adding
a provision to permit the use of uncertificated shares;
(f) making
certain other technical and clarifying amendments to matters of administration
and process; and
(g) incorporating
prior amendments.
The
foregoing description of the Restated Bylaws is qualified in its entirety by
the copy of the Amended and Restated Bylaws that is filed as Exhibit 3.2 hereto
and is incorporated herein by reference.
ITEM 6. EXHIBITS
Exhibit
Number
|
|
Description of Document
|
|
|
|
3.2
|
|
Amended and
Restated By-laws
|
10.20
|
(a)
|
Non
Qualified Supplemental Deferred Compensation Plan of Affymetrix, Inc.
|
10.20
|
(b)
|
Non
Qualified Supplemental Deferred Compensation Plan Adoption Agreement
|
10.32
|
|
Affymetrix, Inc.
Change of Control Plan
|
10.33
|
|
Offer Letter
from the Company to John F. (Rick) Runkel dated October 6, 2008
|
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
|
32.1
|
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002
|
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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/ JOHN C. BATTY
|
|
Name:
|
John C. Batty
|
|
Title:
|
Executive Vice
President and Chief Financial Officer
|
|
|
|
November 7, 2008
|
|
|
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AFFYMETRIX, INC.
EXHIBIT INDEX
SEPTEMBER 30, 2008
Exhibit
Number
|
|
Description of Document
|
|
|
|
3.2
|
|
Amended and
Restated By-laws
|
10.20
|
(a)
|
Non
Qualified Supplemental Deferred Compensation Plan of Affymetrix, Inc.
|
10.20
|
(b)
|
Non
Qualified Supplemental Deferred Compensation Plan Adoption Agreement
|
10.32
|
|
Affymetrix, Inc.
Change of Control Plan
|
10.33
|
|
Offer Letter
from the Company to John F. (Rick) Runkel dated October 6, 2008
|
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
|
32.1
|
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant to
Section 906 of Sarbanes-Oxley Act of 2002
|
41
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