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AFFYMETRIX INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of Operations as of September 30, 2014 and for the three and nine months ended September 30, 2014 and 2013 should be read in conjunction with our financial statements and accompanying notes thereto included in this Quarterly Report on Form 10-Q and with the Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013. All statements in this quarterly report that are not historical are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act as amended, including statements regarding our strategic initiatives, anticipated cost savings, return to profitability and integration of and synergies related to eBioscience, as well as all other statements regarding our "goals," "expectations," "beliefs," "intentions," "strategies" or the like. Such statements are based on our current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Actual results or business conditions may differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, our capacity to identify and capitalize upon emerging market opportunities; risks relating to our ability to acquire new businesses and technologies and successfully integrate and realize the anticipated strategic benefits and cost savings or other synergies thereof, including our acquisition of eBioscience, in a cost-effective manner while minimizing the disruption to our business; risks that eBioscience's future performance may not be consistent with its historical performance; risks relating to our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness; risks relating to our ability to develop and successfully commercialize new products and services; uncertainties related to cost and pricing of Affymetrix products; fluctuations in overall capital spending in the academic and biotechnology sectors; changes in government funding policies; our dependence on collaborative partners; the size and structure of our current sales, technology and technical support organizations; uncertainties relating to our suppliers and manufacturing processes; risks relating to our ability to achieve and sustain higher levels of revenue, higher gross margins and reduced operating expenses; uncertainties relating to technological approaches; global credit and financial market conditions; personnel retention; uncertainties relating to the Food & Drug Administration (FDA) and other regulatory approvals; competition; risks relating to intellectual property of others and the uncertainties of patent protection and litigation; volatility of the market price of our common stock; unpredictable fluctuations in quarterly revenues; and the risk factors disclosed under Part I, Item 1A of this Annual Report on Form 10-K for the year ended December 31, 2013. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based, except as required by law. OVERVIEW We are a provider of life science and molecular diagnostic products that enable parallel analysis of biological systems at the gene, protein and cell level. We sell our products to life science research centers, academic institutions, government and private laboratories, as well as pharmaceutical, diagnostic and biotechnology companies. Over 65,000 peer-reviewed papers have been published based on work using our products. We have approximately 1,100 employees worldwide and maintain sales and distribution operations across the United States, Europe, Latin America and Asia. Reportable Segments The Company reports segment information on the "management" approach which designates the internal reporting used by management for making decisions and assessing performance as the source of the Company's reportable segments. The Company has determined that its Chief Executive Officer is the Company's chief operating decision maker ("CODM") as he is responsible for reviewing and approving investments in the Company's technology platforms and manufacturing infrastructure. The Company is organized in two reportable segments: Affymetrix Core and eBioscience. Affymetrix Core is divided into four business units, with each business unit having its own strategic Marketing and Research and Development groups to better serve customers and respond quickly to the market needs. Affymetrix Core manufacturing operations are based on platforms that are used to produce various Affymetrix products that serve multiple applications and markets. Additionally, the business units share certain research, development and common corporate services that provide capital, infrastructure and functional support, and have similar customers and economic 19-------------------------------------------------------------------------------- Table of Contents characteristics. As such, the Company has concluded that the four business units represent one reportable operating segment. The following describes the four business units that form Affymetrix Core: • Expression: This business unit markets the Company's GeneChip® gene expression products and services; • Genetic Analysis and Clinical Applications: This business unit markets the Company's rapidly growing Axiom® genotyping product line, as well as products with clinical diagnostic and research applications including the CytoScan® Dx and OncoScan products, as well as the ViewRNA in-situ hybridization platform for clinical translational research. In addition, the business unit is responsible for development and marketing of the PbA clinical partnering and licensing program which enables third-party diagnostic companies to access and develop DNA and RNA-based diagnostic tests on Affymetrix technology platforms. This business unit also markets the CytoScan Dx product, the recently FDA approved microarray system for post natal diagnostics of children with developmental delays and intellectual disabilities; • Life Science Reagents: This business unit sells reagents, enzymes, purification kits and biochemicals used by life science researchers and other tool provider businesses, including those developing and marketing Next Generation Sequencing products and molecular diagnostics; and • Corporate: This business unit is comprised primarily of incidental revenue from royalty arrangements and field revenue from field-services provided to customers of the Company. The eBioscience business unit operates with its own manufacturing, research and marketing groups. The eBioscience business unit does utilize certain Corporate functions such as finance, legal and human resources. This reportable segment specializes in the areas of flow cytometry reagents, immunoassays, microscopic imaging, other protein-based analyses, QuantiGene single and multiplex RNA solution assays (not including the QuantiGeneRNA View in-situ hybridization platform) and Procarta multiplex immunoassay product lines. Effective 2014, the Genetic Analysis and Clinical Applications Business Unit market the ViewRNA in-situ hybridization platform for clinical translational research of RNA in tissue sections that was previously part of the Expression Business Unit. In addition, eBioscience began integrating the development and marketing of the remaining QuantiGene (excluding the ViewRNA in-situ hybridization platform) and Procarta product lines during 2013 with full integration in 2014. These products were also previously reported by the Expression Business Unit. Accordingly, segment information for prior periods has been restated to reflect these changes for purposes of comparability. All of our business units sell their products through our Global Commercial Organization comprised of sales, field application and service support, and marketing personnel. We market and distribute our products directly to customers in North America, Japan and major European markets. In these markets, we have our own sales, service and application support personnel responsible for expanding and managing their respective customer bases. In other markets, such as Mexico, India, Brazil, the Middle East and Asia Pacific, including China, we sell our products principally, through third party distributors that specialize in life science supply. In China and Brazil, we are investing in local management, sales, service and application support. In certain of these markets we also have focused and dedicated sales, service and application support as well to increase the reach and effectiveness of our distributors. For certain molecular diagnostic and industrial applications market opportunities, we supply our PbA partners with arrays, assays, reagents and instruments, which they incorporate into diagnostic products and assume the primary commercialization responsibilities. See Note 11, "Segment Information", of the accompanying condensed consolidated financial statements for more information on our reportable operating segments. Overview of the third quarter of 2014 and strategic initiatives Traditionally, a significant portion of our revenue came from the well-established gene expression business, specifically our GeneChip® Expression product line and our legacy genotyping products, and we concentrated on selling these products in the basic research market focused on discovery activities. Declining sales and intense competition from newer technologies such as next generation sequencing in the gene expression business led to decreasing gene expression revenue and our legacy genotyping products also experienced declines due to competition and shifting customer priorities. 20-------------------------------------------------------------------------------- Table of Contents Since Frank Witney became our President and Chief Executive Officer in July 2011, we have begun shifting our resources and focus from a dependency on our Expression business unit products to a more diversified portfolio with broader and growing revenue streams that reach into the growing markets for translational medicine, molecular diagnostics and applied sciences. Revenue from the Expression business unit was reduced to approximately 21% of total revenue in the third quarter of 2014 as compared to 27% in the same period of 2013 while revenue from our Genetic Analysis and Clinical Applications business unit increased to 40% of total revenue in the third quarter of 2014 as compared to 30% in the same period of 2013. Our eBioscience business was approximately 26% and 28% of our consolidated revenue for the third quarter of 2014 and 2013, respectively. As we progress through 2014, we continue to focus on the strategy developed by Dr. Witney and the management team where we continue to stabilize our core business and position our company for growth and increasing profitability. We expect this transformation to take several years, and have categorized this plan into three phases. • Phase 1 (2011-2012) -Portfolio Realignment. During this phase, we reorganized ourselves into business units to sharpen our business focus based on target markets. We also launched CytoScan®, our growing cytogenetic microarray product line and acquired eBioscience. Through eBioscience, we now offer flow cytometry reagents and immunoassay products which, aligned with our new product introductions, enable us to broaden our reach into the translational medicine, applied, and molecular diagnostics markets. We believe these actions have and will promote stabilization of our core business and the realignment of our product portfolio has positioned us for growth. • Phase II (2013-2014) - Profitability, Strengthen Balance Sheet, Development of Newer Product Lines. In the beginning of 2013, we implemented a corporate restructuring with a goal of accelerating our path to profitability. Our priorities for this phase are to achieve profitability, pay down a significant portion of our senior secured debt, successfully commercialize our newer product lines (for example, CytoScan®, Axiom®, OncoScanTM, Human Transcriptome Array and QuantiGene® View RNA lines, as well as our eBioscience products) and invest in new product offerings. In addition, we are training and refocusing our global commercial organization to expand our reach to customers in the translational medicine, molecular diagnostics and applied markets. • Phase III (2015 -2016) - Strategic Flexibility, Expansion of Product Lines; Growth. In this phase, our goal is to have well established growing product lines in translational medicine, clinical diagnostics and applied science such as Ag Bio. We also intend to have a strong balance sheet that will provide us with strategic flexibility. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Condensed Consolidated Financial Statements, which we have prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, refer to Note 1, "Summary of Significant Accounting Policies", in the Notes to the Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q. During the three and nine months ended September 30, 2014, there have been no significant changes in our critical accounting policies and estimates compared to the disclosures in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013 except for the following. 21 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS The following discussion compares the historical results of operations for the three and nine months ended September 30, 2014 and 2013. REVENUE Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change Total revenue ($ in thousands): Consumables $ 73,709 $ 72,005 $ 1,704 2% $ 216,196 $ 210,105 $ 6,091 3% Instruments 4,360 2,771 1,589 57% 11,448 10,400 1,048 10% Product sales 78,069 74,776 3,293 4% 227,644 220,505 7,139 3% Services and other revenue 9,017 5,578 3,439 62% 27,845 17,258 10,587 61% Total revenue $ 87,086 $ 80,354 $ 6,732 8% $ 255,489 $ 237,763 $ 17,726 7% Segment revenue ($ in thousands): Affymetrix Core: Expression $ 18,236 $ 21,340 $ (3,104 ) (15)% $ 53,888 $ 61,214 $ (7,326 ) (12)% Genetic analysis and clinical applications 34,838 24,337 10,501 43% 99,292 70,194 29,098 41% Life science reagents 6,440 7,756 (1,316 ) (17)% 20,234 24,356 (4,122 ) (17)% Corporate 5,131 4,745 386 8% 12,763 15,571 (2,808 ) (18)% Total Affymetrix Core 64,645 58,178 6,467 11% 186,177 171,335 14,842 9% eBioscience 22,441 22,176 265 1% 69,312 66,428 2,884 4% Total revenue $ 87,086 $ 80,354 $ 6,732 8% $ 255,489 $ 237,763 $ 17,726 7% Segment revenue (% of revenue): 2014 2013 2014 2013 Expression 21% 27% 21% 26% Genetic analysis and clinical applications 40% 30% 39% 30% Life science reagents 7% 9% 8% 10% Corporate 6% 6% 5% 6% Total Affymetrix Core 74% 72% 73% 72% eBioscience 26% 28% 27% 28% Total revenue 100% 100% 100% 100% Product sales For the three months ended September 30, 2014, total product sales increased $3.3 million as compared to the same period in 2013. The increase was primarily due to higher volume of Cytogenetics, Axiom, and ProCarta Plex products. These increases were partially offset by a decline in our legacy in vitro transcription (IVT) expression product sales and a decrease 22-------------------------------------------------------------------------------- Table of Contents in revenue of $1.3 million due to the divestiture of our Anatrace-branded reagents in October of 2013. Instrument revenue increased due to a higher volume of genotyping instrument sales. For the nine months ended September 30, 2014, total product sales increased $7.1 million as compared to the same period in 2013. The increase was primarily due to higher revenues from our Cytogenetics, Axiom® and ProCarta Plex product lines. These increases were partially offset by a decline in our legacy in vitro transcription (IVT) expression product sales and a decrease in revenue of $4.3 million due to the divestiture of our Anatrace-branded reagents in October of 2013. Services and other revenue For the three months ended September 30, 2014, services and other revenue increased $3.4 million as compared to the same period in 2013, primarily due to increased Axiom genotyping services of $3.4 million. For the nine months ended September 30, 2014, services and other revenue increased $10.6 million as compared to the same period in 2013, primarily due to increased Axiom genotyping services of $10.2 million and OncoScan services of $0.6 million. These increases were partially offset by lower royalties and licensing revenue of $0.6 million. Expression For the three months ended September 30, 2014, Expression revenue decreased $3.1 million as compared to the same period in 2013, primarily due to lower IVT sales of $1.9 million, lower Gene array sales of $0.5 million, and lower Whole Transcriptome (WT) product sales of $0.4 million. For the nine months ended September 30, 2014, Expression revenue decreased $7.3 million as compared to the same period in 2013, primarily due to lower IVT sales of $7.0 million, lower Gene Array product sales of $1.2 million, and lower Expression instrument sales of $0.6 million, partially offset by higher sales of Exon and HTA products of $0.8 million. Genetic Analysis and Clinical Applications For the three months ended September 30, 2014, Genetic Analysis and Clinical Applications revenue increased $10.5 million as compared to the same period in 2013, primarily due to increased Axiom® product sales and services of $6.1 million, increased Cytogenetics product sales of $1.6 million, increased instrument sales of $1.4 million, increased sales to PbA partners of $1.1 million, and increased OncoScanTM product sales and services of $0.7 million, partially offset by a decline in sales of our legacy genotyping product SNP 6.0 of $0.6 million. For the nine months ended September 30, 2014, Genetic Analysis and Clinical Applications revenue increased $29.1 million as compared to the same period in 2013, primarily due to increased Axiom® product sales and services of $17.4 million, increased CytoScan® sales of $5.1 million, increased OncoScanTM product sales and services of $3.1 million, and increased instrument sales of $1.6 million, partially offset by a decline in sales of our legacy genotyping product SNP 6.0 of $1.0 million. Life Science Reagents For the three and nine months ended September 30, 2014, Life Science Reagents revenue decreased $1.3 million and $4.1 million, respectively, as compared to the same periods in 2013, primarily due to the divestiture of our Anatrace-branded reagents in October of 2013. Corporate For the three months ended September 30, 2014, Corporate revenue increased $0.4 million, as compared to the same period in 2013, primarily due to a net realized gain from designated cash flow hedges. For the nine months ended September 30, 2014, Corporate revenue decreased $2.8 million, as compared to the same period in 2013, primarily due to a decrease in royalty and license revenue and a decrease in net realized gain from designated cash flow hedges. 23 -------------------------------------------------------------------------------- Table of Contents eBioscience For the three and nine months ended September 30, 2014, eBioscience revenue increased $0.3 million and $2.9 million, respectively, as compared to the same periods in 2013, primarily due to higher volume of ProCarta Plex product sales. GROSS MARGIN Three Months Ended Dollars in thousands September 30, Nine Months Ended September 30, 2014 2013 $/Point Change 2014 2013 $/Point Change Total gross profit on product sales $ 48,929 $ 42,176 $ 6,753 $ 138,433 $ 119,884 $ 18,549 Total gross profit on services and other revenue 2,591 1,663 928 8,487 6,130 2,357 Product gross margin 63 % 56 % 7 61 % 54 % 7 Service and other revenue gross margin 29 % 30 % (1 ) 30 % 36 % (6 ) Product gross profit For the three months ended September 30, 2014, product gross profit increased $6.8 million as compared to the same period in 2013. Product gross profit increased $2.9 million due to the completion of amortization for the step-up in inventory fair value that was recognized when we acquired eBioscience in 2012. The increase is also due to higher sales of $2.1 million as compared to the same period in 2013, and lower inventory reserve of $0.6 million and impact of an inventory write-off for a quality issue in the same period in 2013 of $0.5 million. For the nine months ended September 30, 2014, product gross profit increased $18.5 million as compared to the same period in 2013. Product gross profit increased $9.1 million due to increased sales, favorable factory absorption on higher manufacturing volume to support increased sales, and cost savings impact of material in-sourcing projects. Product gross profit increased due to the decline in amortization of step-up in inventory fair value that was recognized when we acquired eBioscience in 2012 and was fully amortized as of June 30, 2014. Product gross profit for the first nine month of 2014 included $4.7 million of amortization of step-up in inventory fair value compared to $12.0 million in the same period of 2013. The increase is also due to lower Instrument and Array replacements and higher returned material authorization (RMA) recoveries of $1.3 million and the impact of an inventory write-off for a quality issue in the same period in 2013 of $0.5 million. Service and other gross profit For the three months ended September 30, 2014, service gross profit increased $0.9 million as compared to the same period in 2013, due to the favorable impact of revenue recognized from a large biobank project in the third quarter of 2014. For the nine months ended September 30, 2014, service gross profit increased $2.4 million as compared to the same period in 2013, due to the favorable impact of revenue recognized from a large biobank project in the first nine months of 2014, partially offset by a decrease in royalty and license revenue. OPERATING EXPENSES Dollars in Three Months Ended Nine Months Ended thousands September 30, September 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change Research and development $ 12,926 $ 11,478 $ 1,448 13% $ 37,443 $ 35,686 $ 1,757 5% Selling, general and administrative expenses 33,718 33,646 72 0% 108,546 102,286 6,260 6% Litigation settlement - - - 0% 5,100 - 5,100 100% Restructuring charges - (2 ) 2 (100)% - 4,484 (4,484 ) (100)% 24 -------------------------------------------------------------------------------- Table of Contents Research and development Research and development expense increased $1.4 million and $1.8 million for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in 2013. The increases are primarily due to increased variable compensation and consulting services related to the development of our new instrument, partially offset by lower spending of supplies. Selling, general and administrative Selling, general and administrative expenses increased $0.1 million for the three months ended September 30, 2014 as compared to the same period in 2013. The increase is primarily related to increases in compensation and benefits due to headcount increases and additional legal fees incurred during the current period primarily related to litigation, offset by lower depreciation expense as certain fixed assets have been fully depreciated. Selling, general and administrative expenses increased $6.3 million for the nine months ended September 30, 2014 as compared to the same period in 2013. The increases are primarily due to increases in compensation and benefits due to increased headcount, increased variable compensation, and additional legal fees incurred during the current periods primarily related to on-going Enzo litigation activities. Litigation settlement On April 22, 2014, the Company entered into a settlement agreement with Enzo with respect to our dispute with Enzo Life Sciences, Inc. brought in the Southern District Court of New York. Pursuant to the agreement the Company agreed to pay Enzo $5.1 million as consideration for both parties agreeing to release each other from all liabilities and claims arising under both lawsuits. As the settlement related to past claims with no ongoing benefit, these costs were recognized during the first three months of 2014 when the amount was determined to be probable and estimable. Restructuring charges During the fourth quarter of 2012, the Company initiated a cost reduction action that included workforce reductions to realign the Company's organization to support its strategy to stabilize its core business and position the Company for growth. Restructuring charges of $4.5 million were recognized during the first half of 2013. The restructuring activities were completed in the second quarter of 2013. OPERATING INCOME (LOSS) Management evaluates business segment performance based on revenue and income (loss) from operations. The following table presents operating income (loss) for each reportable segment and a reconciliation of our segment operating income (loss) to income (loss) before income taxes: Dollars in thousands Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change Operating loss: Affymetrix Core $ 3,139 $ 686 $ 2,453 (358)% $ (3,595 ) $ (7,103 ) $ 3,508 49% eBioscience 1,737 (1,969 ) 3,706 188% (574 ) (9,339 ) 8,765 94% Total operating income (loss) $ 4,876 $ (1,283 ) $ 6,159 480% $ (4,169 ) $ (16,442 ) $ 12,273 75% Reconciliation to loss before income taxes : Other (expense) income, net (1,008 ) $ 68 $ (1,076 ) (1,582)% $ 703 $ 501 $ 202 40% Interest expense 1,595 2,652 (1,057 ) 40% 4,972 8,274 (3,302 ) 40% Income (loss) before income taxes $ 2,273 $ (3,867 ) $ 6,140 159% $ (8,438 ) $ (24,215 ) $ 15,777 65% Other (expense) income, net Other (expense) income, net, decreased $1.1 million for the three months ended September 30, 2014 as compared to the same period in 2013. The decrease is primarily due to currency losses, partially offset by an additional gain related to the liquidation of certain investments recorded in the third quarter of 2014. Other (expense) income, net, increased $0.2 million for the nine months ended September 30, 2014 as compared to the same period in 2013. The increase is primarily due to the gains recorded in the first nine months of 2014 related to the liquidation of non-marketable securities, partially offset by currency losses. 25-------------------------------------------------------------------------------- Table of Contents Interest expense Interest expense decreased $1.1 million and $3.3 million for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in 2013. The decreases are due to a combination of lower outstanding borrowings in the third quarter and the first nine months of 2014 as well as lower interest rates following the refinance of our Senior Secured Credit Facility in October 2013 and the modification in July 2014. INCOME TAX PROVISION Dollars in Nine Months Ended September thousands Three Months Ended September 30, 30, 2014 2013 $ Change % Change 2014 2013 $ Change % Change Income tax (benefit) provision $ (111 ) $ 289 $ (400 ) 138% $ 563 $ 1,485 $ (922 ) 62 % During the three and nine months ended September 30, 2014, the Company recognized an income tax benefit of $0.1 million and a provision of $0.6 million, respectively. The benefit for income taxes during the three months ended September 30, 2014 primarily consists of an income tax benefit of $0.2 million resulting from a reduction in valuation allowance for net deferred tax assets arising from other comprehensive income recorded in accordance with intraperiod tax allocation guidance, and an income tax benefit of $0.2 million related to the effective settlements of unrecognized tax benefits, offset by foreign taxes. The provision for income taxes during the nine months ended September 30, 2014 primarily consists of foreign taxes, offset by an income tax benefit of $0.3 million resulting from a reduction in valuation allowance for net deferred tax assets arising from other comprehensive income recorded in accordance with intraperiod tax allocation guidance, and an income tax benefit of $0.6 million related to the lapses of statutes of limitations as well as effective settlements of unrecognized tax benefits. Due to the Company's history of cumulative operating losses, management concluded that, after considering all the available objective evidence, it is not more likely than not that all the Company's net deferred tax assets will be realized. Accordingly, all of the Company's U.S. deferred tax assets continue to be subject to a valuation allowance as of September 30, 2014. As of September 30, 2014, the total amount of our unrecognized tax benefits has decreased by approximately $0.3 million as compared to December 31, 2013, primarily due to the lapses of statutes of limitations. As a result of settlements of ongoing tax examinations and/or expiration of statues of limitations without the assessment of additional income taxes, the amount of unrecognized tax benefits that could be recognized in earnings in the next 12 months could range from zero to approximately $1.3 million. LIQUIDITY AND CAPITAL RESOURCES Historically, we have financed our operations primarily through product sales; borrowings under credit arrangements; sales of equity and debt securities such as our 4.00% Convertible Notes; collaborative agreements; and licensing of our technology. Our cash outflows have generally been as follows: cash used in operating activities such as research and development programs, sales and marketing activities, compensation and benefits of our employees and other working capital needs; cash paid for acquisitions; cash paid for litigation activity and settlements; and cash used for the payment of principal on debt obligations and repurchases of our convertible notes as well as interest payments on our long-term debt obligations. As of September 30, 2014, we had cash and cash equivalents of approximately $68.3 million. We anticipate that our existing capital resources along with the cash to be generated from operations will enable us to maintain currently planned operations, debt repayments, and capital expenditures for the foreseeable future. These expectations are based on our current operating and financing plans, which are subject to change, and therefore we could require further funding. Factors that may cause us to require additional funding may include, but are not limited to: costs associated with defending third party claims; an adverse ruling in any of our current litigation proceedings; investments required to commercialize our products; investments required to upgrade our older product lines; a decline in cash generated by sales of our products and services; our ability to maintain existing collaborative and customer arrangements and establish and maintain new collaboration and customer arrangements; arrangements that we may enter into in connection with future acquisitions or dispositions; the progress of our research and development programs; initiation or expansion of research programs and collaborations; the 26-------------------------------------------------------------------------------- Table of Contents costs involved in preparing, filing, prosecuting and enforcing intellectual property rights; the purchase of patent licenses; and other factors. During the nine months ended September 30, 2014, we prepaid $15.5 million of our senior secured debt with cash provided by operations. In July 2014, we entered into the Fifth Amendment, which provides, among other things, for (1) an uncommitted incremental term loan facility in an aggregate amount not to exceed $50.0 million and (2) the reduction of interest rate margins. As of September 30, 2014, the carrying amount of the senior secured debt was $24.0 million. As part of the terms of the senior secured debt agreement, we are required to meet certain financial and other negative covenants. As of September 30, 2014, we were in compliance with the amended covenants. Refer to Note 7, "Long-Term Debt Obligations", for further details regarding our Senior Secured Credit Facility and 4.00% Convertible Notes. From time to time, we may seek to retire, repurchase or exchange common stock or convertible notes in open market purchases, privately negotiated transactions dependent on market conditions, liquidity, and contractual obligations and other factors. We did not retire, repurchase or exchange any of our common stock during the three and nine months ended September 30, 2014. Cashflow (in thousands) Nine Months Ended September 30, 2014 2013 Net cash provided by operating activities $ 28,332 $ 32,185 Net cash (used in) provided by investing activities (2,039 ) 5,540 Net cash used in financing activities (14,679 ) (13,328 ) Operating Activities Net cash provided by operating activities for the nine months ended September 30, 2014 was comprised of net loss of $9.0 million, non-cash charges of $35.3 million and an increase of $2.1 million related to changes in operating assets and liabilities. Adjustments for non-cash expenses include depreciation and amortization expense of $23.7 million, amortization expense related to inventory step-up in fair value of $4.7 million (which was fully amortized as of June 30, 2014), and share-based compensation expense of $9.4 million. Net cash provided by operating activities for the nine months end September 30, 2013 was comprised of net loss of $25.7 million, non-cash charges of $50.1 million and a decrease of $7.8 million related to changes in operating assets and liabilities. Adjustments for non-cash expenses include depreciation and amortization expense of $30.0 million, amortization expense related to inventory step-up in fair value of $12.0 million, share-based compensation expense of $5.1 million. Investing Activities Net cash used in investing activities for the nine months ended September 30, 2014 included proceeds from sale of non-marketable securities of $2.2 million and capital expenditures of $4.3 million. Net cash provided by investing activities for the nine months ended September 30, 2013 included $9.4 million in cash proceeds resulting from the sale of our remaining available-for-sale securities, offset by $3.0 million spent on capital expenditures, $0.2 million of non-marketable investments purchase, and $0.6 million of technology rights purchase. Financing Activities Net cash used in financing activities for the nine months ended September 30, 2014 included $15.5 million of early payments on the outstanding principal amount of borrowings under our Term Loan agreement. Net cash used in financing activities for the nine months ended September 30, 2013 included $3.9 million in payments to repurchase our 3.50% Notes and $9.6 million in payments on the outstanding principal amount of our Term Loan. 27-------------------------------------------------------------------------------- Table of Contents In addition to certain mandatory payments, from time to time, we also may make early payments on the outstanding principal amount of our Term Loan. OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS As of September 30, 2014, we had no off-balance sheet arrangements. There have been no significant changes to our aggregate contractual obligations as compared to the disclosures in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013, except with respects to the prepayment of amounts owned under our Term Loan as discussed above and leases described below. In June 2014, the Company entered into two leases for premises located in San Diego, California (the "Leases"). The Leases cover premises totaling approximately 82,759 rentable square feet. Subject to the completion of tenant improvements, both Leases are expected to commence in August 2015 and expire in March 2023. On August 26, 2014, the Company extended its two leases for 26111 and 26101 Miles Road, Warrensville Heights, Ohio 44128 for three years commencing on April 1, 2015 and terminating on March 31, 2018. In addition, the Company has two options to extend these leases for an additional three year period with respect to each option. Future minimum lease obligations, net of sublease income, as of September 30, 2014 under the two leases mentioned above are as follows (in thousands): For the Year Ending December 31, Amount 2014, remainder thereof $ - 2015 376 2016 2,008 2017 2,639 2018 2,524 Thereafter 11,242 Total $ 18,789 |