UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007
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 incorporation or organization)		(I.R.S. Employer Identification Number)
3420 CENTRAL EXPRESSWAY SANTA CLARA, CALIFORNIA		95051
(Address of principal executive offices)		(Zip Code)

 

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

 

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

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b(2) of the Exchange Act. (Check one).

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

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 AUGUST 3, 2007: 68,925,818

AFFYMETRIX, INC.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	Item 1.		Financial Statements (Unaudited)
			Condensed Consolidated Balance Sheets at June 30, 2007 and December 31, 2006
			Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2007 and 2006
			Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006
			Notes to Condensed Consolidated Financial Statements
	Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.		Quantitative and Qualitative Disclosures About Market Risk
	Item 4.		Controls and Procedures
PART II. OTHER INFORMATION
	Item 1.	Legal Proceedings
	Item 1A.	Risk Factors
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information
	Item 6.	Exhibits
SIGNATURES

 

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 

		June 30, 2007			December 31, 2006
					Note 1
ASSETS
Current assets:
Cash and cash equivalents		$	91,140		$	119,063
Restricted cash		6,087			—
Available-for-sale securities — short-term		140,893			118,088
Accounts receivable, net		68,234			75,553
Accounts receivable from Perlegen Sciences		3,826			2,290
Inventories		56,334			46,506
Deferred tax assets—current portion		14,490			13,534
Notes receivable from employees – short-term portion		1,705			—
Prepaid expenses and other current assets		12,017			8,858
Total current assets		394,726			383,892
Available-for-sale securities – long-term		6,088			10,601
Property and equipment, net		146,438			141,322
Acquired technology rights, net		50,960			55,125
Goodwill		125,050			124,916
Deferred tax assets—long-term portion		32,472			29,170
Notes receivable from employees – long-term portion		523			2,186
Other assets		32,334			34,003
Total assets		$	788,591		$	781,215
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		$	49,105		$	62,893
Deferred revenue — current portion		36,544			30,697
Total current liabilities		85,649			93,590
Deferred revenue — long-term portion		4,798			9,562
Other long-term liabilities		10,108			5,100
Convertible notes		120,000			120,000
Stockholders’ equity:
Common stock		686			679
Additional paid-in capital		690,351			674,428
Accumulated other comprehensive income (loss)		827			(1,717		)
Accumulated deficit		(123,828		)	(120,427		)
Total stockholders’ equity		568,036			552,963
Total liabilities and stockholders’ equity		$	788,591		$	781,215

 

Note 1:          The condensed consolidated balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date included in the Company’s Form 10-K for the fiscal year ended December 31, 2006.

See accompanying notes.

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AFFYMETRIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Revenue
Product sales		$	63,986		$	61,043		$	121,793		$	127,015
Product related revenue		17,167			14,407			30,695			27,650
Total product and product related revenue		81,153			75,450			152,488			154,665
Royalties and other revenue		2,731			2,419			5,153			4,294
Revenue from Perlegen Sciences		4,423			2,197			11,101			7,498
Total revenue		88,307			80,066			168,742			166,457
Costs and expenses:
Cost of product sales		23,833			19,646			43,554			38,720
Cost of product related revenue		10,826			7,412			17,301			13,853
Cost of revenue from Perlegen Sciences		1,907			1,074			4,328			2,658
Research and development		19,427			21,597			38,654			45,098
Selling, general and administrative		33,643			39,476			69,501			78,242
Restructuring charges		1,771			—			7,142			—
Total costs and expenses		91,407			89,205			180,480			178,571
Loss from operations		(3,100		)	(9,139		)	(11,738		)	(12,114		)
Interest income and other, net		5,340			3,720			8,091			8,007
Interest expense		(414		)	(400		)	(829		)	(824		)
Income (loss) before income taxes		1,826			(5,819		)	(4,476		)	(4,931		)
Income tax (provision) benefit		(584		)	(4,235		)	1,712			(3,298		)
Net income (loss)		$	1,242		$	(10,054	)	$	(2,764	)	$	(8,229	)
Basic net income (loss) per common share		$	0.02		$	(0.15	)	$	(0.04	)	$	(0.12	)
Diluted net income (loss) per common share		$	0.02		$	(0.15	)	$	(0.04	)	$	(0.12	)
Shares used in computing basic net income (loss) per share		68,244			67,313			68,075			67,275
Shares used in computing diluted net income (loss) per share		68,758			67,313			68,075			67,275

 

See accompanying notes.

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AFFYMETRIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

		Six Months Ended June 30,
		2007			2006
Cash flows from operating activities:
Net loss		$	(2,764	)	$	(8,229	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		11,608			11,028
Amortization of intangible assets		4,165			4,154
Amortization of investment discounts, net		(23		)	(298		)
Stock-based compensation		4,609			8,882
Restructuring charges		(1,375		)	—
Realized (gain) loss on sales of available for sale securities		(86		)	68
Deferred tax assets		(213		)	(160		)
Write-down of equity investment		199			108
Amortization of debt offering costs		380			379
Accretion of interest on notes receivable		(41		)	(29		)
Loss on disposal of equipment		144			—
Change in operating assets and liabilities:
Restricted cash		(6,087		)	—
Accounts receivable, net		5,783			29,373
Inventories		(9,828		)	(9,111		)
Prepaid expenses and other current assets		(24		)	3,474
Accounts payable and accrued and other current liabilities		(12,413		)	(10,044		)
Deferred revenue		1,083			(3,765		)
Other long-term liabilities		326			579
Net cash (used in) provided by operating activities		(4,557		)	26,409
Cash flows from investing activities:
Capital expenditures		(16,868		)	(47,576		)
Purchases of available-for-sale securities		(76,025		)	(67,986		)
Proceeds from the sales or maturities of available-for-sale securities		58,044			59,961
Purchase of non-marketable equity investment		(800		)	(250		)
Capital distribution of non-marketable securities		902			—
Purchase of technology rights		—			(250		)
Net cash used in investing activities		(34,747		)	(56,101		)
Cash flows from financing activities:
Issuance of common stock through the Company’s stock option plans		11,321			5,378
Net cash provided by financing activities		11,321			5,378
Effect of exchange rate changes on cash and cash equivalents		60			109
Net decrease in cash and cash equivalents		(27,923		)	(24,205		)
Cash and cash equivalents at beginning of period		119,063			100,236
Cash and cash equivalents at end of period		$	91,140		$	76,031

 

See accompanying notes.

5

AFFYMETRIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2007
(Unaudited)

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The condensed consolidated financial statements include the accounts of Affymetrix, Inc. (“Affymetrix” or the “Company”) and its wholly owned subsidiaries. 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 Company’s Annual Report on Form 10-K for the year ended December 31, 2006, as filed with the Securities and Exchange Commission on March 1, 2007.

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.

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 product or product related revenue items 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.

Product Sales

Product sales, as well as revenues from Perlegen Sciences (a related party, see Note 8), 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.

Product Related Revenue

Product related revenue includes subscription fees earned under GeneChip® array access programs; license fees; milestones and royalties earned from collaborative product development and supply agreements; equipment service revenue; product related scientific services revenue; and revenue from custom probe array design fees.

Revenue from subscription fees earned under GeneChip® array access programs is recorded ratably over the related supply term.

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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 related to extended warranty arrangements is deferred and recognized ratably over the applicable periods. Revenue from custom probe array design fees associated with the Company’s GeneChip® CustomExpressÔ and CustomSeqÔ 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 royalties earned from third party license agreements and research revenue which mainly consists of amounts earned under government grants. Additionally, other revenue includes fees earned through the license of the Company’s intellectual property.

Royalty revenues are earned from the sale of products by third parties who have been licensed under the Company’s 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.

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 Company’s technical staff and include the costs for material and subcontract efforts. The Company’s 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.

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.

Transactions with Distributors

The Company recognizes revenue on sales to distributors in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition.”  The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price is fixed or determinable, and collectibility is reasonably assured. The Company’s agreements with distributors do not include rights of return.

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).

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

 

The following securities were excluded from the computation of diluted net (loss) income per common share, on an actual outstanding basis, as they were anti-dilutive (in thousands):

 

Restructuring

Commencing in the third quarter of fiscal 2006, the Company 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 Company’s estimates, the amount of the restructuring charges could be materially impacted. For a full description of the Company’s restructuring actions, see Note 3.

Recent Accounting Pronouncements

In February 2007, FASB issued Statement of Financial of Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB No. 115 (“SFAS 159”). The Statement permits entities to choose, at specified election dates, to measure many financial instruments and certain other items at fair value that are not currently measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected would be reported in earnings at each subsequent reporting date. SFAS 159 also establishes presentation and disclosure requirements in order to facilitate comparisons between entities choosing different measurement attributes for similar types of assets and liabilities. SFAS 159 does not affect existing accounting requirements for certain assets and liabilities to be carried at fair value and the Company is currently evaluating the impact, if any, of SFAS 159 on its financial position, results of operation and cash flows. This statement is effective for fiscal years beginning after November 15, 2007 and is required to be adopted by the Company for the fiscal year ending December 31, 2008.

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In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”) defines fair value. Establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 does not require any new fair value measurement and the Company is currently evaluating the impact, if any, of SFAS 157 on its financial position, results of operations and cash flows. SFAS 157 requires prospective application for fiscal year ending December 31, 2008.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”). Under FIN 48 a company recognizes the benefit from a tax position only if it is more-likely-than-not that the position would be sustained upon audit based solely on the technical merits of the tax position. FIN 48 clarifies how a company would measure the income tax benefits from the tax positions that are recognized, provides guidance as to the timing of the derecognition of previously recognized tax benefits and describes the methods for classifying and disclosing the liabilities within the financial statements for any unrecognized tax benefits. FIN 48 also addresses when a company should record interest and penalties related to tax positions and how the interest and penalties may be classified within the income statement and presented in the balance sheet. The Company adopted FIN 48 effective January 1, 2007 as described in Note 10.

NOTE 2—STOCK-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, non-vested stock awards (also known as restricted stock), and restricted stock units 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. As of June 30, 2007, the Company had approximately 1.1 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 total stock-based compensation expense, before taxes, associated with the Company’s stock-based employee compensation plans was $1.9 million and $5.1 million for the three months ended June 30, 2007 and 2006, respectively, and $4.6 million and $8.9 million for the six months ended June 30, 2007 and 2006, respectively.

The Company allocated stock-based compensation expense under SFAS No. 123R, Share-Based Payment, (“SFAS 123R”) as follows (in thousands):

 

 

As of June 30, 2007, $28.8 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 June 2011. The weighted average term of the unrecognized stock-based compensation expense is 2.3 years.

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Stock Options

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:

 

The risk free interest rate for periods within the contractual life of the Company’s stock options is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term is derived from an analysis of the Company’s historical exercise trends over ten years. The expected volatility for the three and six months ended June 30, 2007 is based on a blend of historical and market-based implied volatility. The expected volatility for the three and six months ended June 30, 2006, is based solely on historical volatility. The Company’s management changed its expected volatility estimation approach based upon the availability of actively traded options on the Company’s common stock and because management believes this blended method is more representative of future stock price trends than historical volatility alone. Using the assumptions above, the weighted average grant date fair value per share of options granted during the three months ended June 30, 2007 and 2006 was $10.77 and $11.27, respectively, and for the six months ended June 30, 2007 and 2006 was $10.78 and $12.15, respectively.

Activity under the Company’s stock plans for the six months ended June 30, 2007 is as follows (in thousands, except per share amounts):

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on the last trading day of its second quarter of 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2007. This amount changes based on the fair market value of the Company’s stock. Total intrinsic value of options exercised is $0.9 million and $0.7 million for the three months ended June 30, 2007 and 2006, respectively, and $5.0 million and $4.2 million for the six months ended June 30, 2007 and 2006, respectively.

10

Restricted Stock

The following table summarizes the Company’s non-vested restricted stock activity for the six months ended June 30, 2007 (in thousands, except per share amounts):

		Number of Shares		Weighted-Average Grant Date Fair Value
Non-vested stock at December 31, 2006		247		$	30.81
Granted		452		$	26.23
Vested		(35	)	$	27.82
Forfeited		(77	)	$	36.62
Non-vested stock at June 30, 2007		587		$	26.66

 

Total fair value of shares vested is approximately $0.9 million and $0.3 million for the six months ended June 30, 2007 and 2006, respectively.

NOTE 3—RESTRUCTURING

In the third quarter of 2006, the Company initiated a restructuring plan (“the Plan”) to better align certain of its expenses with the Company’s current business outlook. The Company’s primary focus of the Plan was in the general and administrative functions and included rationalizing its facilities. In August 2006, the Company terminated certain employees in the general and administrative functions. Additionally, in September 2006, the Company announced its plan to close its Bedford, Massachusetts based instrumentation manufacturing and developing facility. In the second quarter of 2007, the Company began to consolidate the Bedford facility’s instrument manufacturing operations with its probe array manufacturing facility located in West Sacramento, California. The Company’s instrumentation development capabilities are being consolidated with its principal research and development facilities located in Santa Clara, California. The Company expects implementation of the workforce severance and relocation elements of the Bedford facility closure began in the Massachusetts facility to be materially completed by the third quarter of fiscal 2007. As a final element of the Company’s restructuring plan, the Company terminated certain employees in the sales, marketing and research and development functions in Santa Clara, California during January 2007.

The Company estimates that the total restructuring expenses to be incurred in connection with the Plan will be approximately $25 to $28 million. Of this total, the Company estimates that approximately $19 million relates to employee severance and relocation benefits, approximately $4 to $7 million relates to contract termination costs associated with vacating the leased Bedford facility, which will be recognized when the facility is vacated, likely in the third quarter of 2007, and approximately $2 million relates to other restructuring costs such as fixed asset write down and equipment and inventory relocation costs. The Company has begun to incur non-employee related restructuring expenses beginning in 2007 and expect to continue incurring these expenses into the second half of 2007. Total cash outlays incurred in connection with these restructuring activities are estimated to be approximately $20 million. In accordance with Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the costs relating to employee severance and relocation are being accrued over the remaining service periods of the employees.

During the second quarter of 2007, the Company recognized approximately $1.8 million of expense related to the Plan which was presented in a single line item labeled “Restructuring charges” in the Company’s Statement of Operations, of which approximately $1.5 million related to employee termination benefit costs and approximately $0.3 million related to facility exit costs. The Company has incurred restructuring charges of approximately $13.5 million in fiscal 2006 and $7.1 million in the first six months of 2007.

In July 2007, the Company announced that it will be consolidating an administrative facility located in Sunnyvale, California into its main campus in Santa Clara, California during the second half of 2007.  The Company has not completed its analysis of the additional costs associated with vacating the leased Sunnyvale facility.

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The following table summarizes the accrual balances and utilization by cost type for the Plan (in thousands):

		Employee severance and relocation benefits			Facility exit, lease termination costs and other			Total
Balance as of June 30, 2006		$	—		$	—		$	—
Restructuring charges accrued		10,008			—			10,008
Cash payments		(1,541		)	—			(1,541		)
Non-cash settlement		(7,544		)	—			(7,544		)
Balance as of September 30, 2006		923			—			923
Restructuring charges accrued		3,489			—			3,489
Cash payments		(282		)	—			(282		)
Balance as of December 31, 2006		4,130			—			4,130
Restructuring charges accrued		4,804			567			5,371
Cash payments		(4,153		)	(480		)	(4,633		)
Balance as of March 31, 2007		4,781			87			4,868
Restructuring charges accrued		1,502			269			1,771
Cash payments		(3,527		)	(272		)	(3,799		)
Non-cash settlement		—			(84		)	(84		)
Balance as of June 30, 2007		$	2,756		$	—		$	2,756

 

NOTE 4—INVENTORIES

Inventories consist of the following (in thousands):

		June 30, 2007			December 31, 2006
Raw materials		$	22,036		$	21,612
Work-in-process		13,859			13,127
Finished goods		20,439			11,767
Total		$	56,334		$	45,506

 

NOTE 5—ACQUIRED TECHNOLOGY RIGHTS

Acquired technology rights are comprised of licenses to technology covered by patents acquired from 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 $34.8 million and $30.2 million at June 30, 2007 and December 31, 2006, respectively.

The expected future annual amortization expense of the Company’s acquired technology rights and other intangible assets is as follows (in thousands):

For the Year Ending December 31,		Amortization Expense
2007, remainder thereof		$	4,163
2008		8,314
2009		7,446
2010		6,676
2011		6,280
Thereafter		18,081
Total expected future annual amortization		$	50,960

 

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NOTE 6—ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consist of the following (in thousands):

		June 30, 2007			December 31, 2006
Accounts payable		$	14,810		$	23,248
Accrued compensation and related liabilities		22,961			19,050
Accrued taxes		1,764			6,362
Accrued legal		1,750			2,426
Accrued warranties		3,678			6,801
Other		4,142			5,006
Total		$	49,105		$	62,893

 

NOTE 7—COMPREHENSIVE INCOME (LOSS)

The components of comprehensive income (loss) are as follows (in thousands):

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
Net income (loss)		$	1,242		$	(10,054	)	$	(2,764	)	$	(8,229	)
Foreign currency translation adjustment		(1		)	113			60			109
Unrealized gain on debt securities		1,680			344			2,484			325
Unrealized (loss) gain on hedging contracts		—			(336		)	—			(604		)
Comprehensive income (loss)		$	2,921		$	(9,933	)	$	(220	)	$	(8,399	)

 

NOTE 8—RELATED PARTY TRANSACTIONS

Perlegen Sciences, Inc.

As of June 30, 2007, the Company, and certain of its affiliates, including the Company’s 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 Perlegen’s board of directors are also members of the Company’s 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 Company’s 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 Perlegen’s 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 Company’s investment in Perlegen had no cost basis; accordingly, the Company has not recorded its proportionate share of Perlegen’s operating losses in its financial statements since the completion of Perlegen’s initial financing. In February 2005, the Company participated in Perlegen’s Series D preferred stock financing and recorded a $2.0 million investment related to this transaction, which was included in the Company’s 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 Perlegen’s 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.

In June 2005, the Company executed an agreement with a customer pursuant to which the Company agreed to provide genotypic data in the context of whole genome association studies. The Company had subcontracted certain elements of this agreement to Perlegen which used Affymetrix GeneChip® technology to provide the genotypic data. The agreement ended in the third quarter of 2006 and no expenses were incurred.

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In October 2006, the Company entered into four new supply and license agreements with Perlegen. These four agreements, consisting of a commercial products supply agreement, non-commercial products supply agreement and two intellectual property license agreements, replace the prior supply and intellectual property license agreements entered into by the Company and Perlegen in 2003. Under the new supply agreements, which include terms that are generally consistent with the Company’s standard supply terms, the Company shall supply commercial GeneChip products and certain non-commercial custom GeneChip products for Perlegen’s use in defined fields.

NOTE 9—COMMITMENTS AND CONTINGENCIES

Product Warranty Commitment

The Company provides for anticipated warranty costs at the time the associated revenue is recognized. Product warranty costs are estimated based upon the Company’s historical experience and the warranty period. The Company periodically reviews the adequacy of its warranty reserve, and adjusts, if necessary, the warranty percentage and accrual based on actual experience and estimated costs to be incurred.  Since the beginning of 2007, the Company has noted that improvement in its internal quality control programs have resulted in an overall decline in product replacement claims.  As a result, an adjustment decreasing the warranty reserve balance was made. Information regarding the changes in the Company’s product warranty liability for the six months ended June 30, 2007, was as follows (in thousands):

Beginning balance at December 31, 2006		$	6,801
New warranties issued		1,191
Repairs and replacements		(2,315		)
Adjustments		(1,567		)
Ending balance at March 31, 2007		4,110
New warranties issued		642
Repairs and replacements		(1,074		)
Adjustments		—
Ending balance at June 30, 2007		$	3,678

 

Legal Proceedings — General

The Company has been in the past and continues to be a party to litigation which has consumed and may in the future continue to consume substantial financial and managerial resources and which could adversely affect its business, financial condition and results of operations. If in any pending or future intellectual property litigation involving the Company or its collaborative partners, the Company is found to have infringed the valid intellectual property rights of third parties, the Company, or its collaborative partners, could be subject to significant liability for damages, could be required to obtain a license from a third party, which may not be available on reasonable terms or at all, or could be prevented from manufacturing and selling its products. In addition, if the Company is unable to enforce its patents and other intellectual property rights against others, or if its patents are found to be invalid or unenforceable, third parties may more easily be able to introduce and sell DNA array technologies that compete with the Company’s GeneChip® brand technology, and the Company’s competitive position could suffer. The Company expects to devote substantial financial and managerial resources to protect its intellectual property rights and to defend against the claims described below as well as any future claims asserted against it. Further, because of the substantial amount of discovery required in connection with any litigation, there is a risk that confidential information could be compromised by disclosure.

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 Company’s 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 Company’s corporate governance and internal control procedures, and an award of attorneys’ fees and costs.  As

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previously disclosed in the Company’s Form 10-K/A for the year ended December 31, 2005, the Company’s 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.  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 is conducting an informal inquiry into the Company’s stock option practices.  The Company has responded to the request for information and is cooperating fully in the informal inquiry.  The Company was advised in the SEC’s notice that the SEC’s 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.

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 with others in order to corner the market for non-radioactive labeling reagents, and improperly using the 1998 agreement to claim ownership rights to the Company’s proprietary technology. The Company seeks declarations that it has not breached the 1998 agreement and that nine Enzo patents that are identified in the 1998 agreement are invalid and/or not infringed by it. The Company also seeks damages and injunctive relief to redress Enzo’s alleged breaches of the 1998 agreement, its alleged tortious interference with the Company’s business relationships and prospective economic advantage, and Enzo’s 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 Company’s case. There is no trial date in the actions between Enzo and the Company.

The Company believes that the claims set forth in Enzo’s complaint are without merit and have 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 Company’s 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 Company’s 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 Company’s competitors, have filed oppositions against several of the Company’s European patents in the European Patent Office. These opposition 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 European 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 result in the Company’s patent protection being significantly modified or reduced, in the incurrence of significant costs and the consumption of substantial managerial resources.

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NOTE 10—INCOME TAXES

Effective January 1, 2007, the Company adopted FIN 48 as a change in accounting principle. As a result prior periods are not restated for the effect of FIN 48, and the cumulative effect of applying FIN 48 was recorded as an adjustment to accumulated deficit as of the beginning of the period of adoption.  The cumulative effect of adoption was a $0.6 million increase in the opening balance of retained deficit as a change in accounting principle.

The total amount of unrecognized tax benefits as of January 1, 2007 is approximately $16 million.  If recognized, the amount of unrecognized tax benefits that would impact income from continuing operations and the effective tax rate is $13 million.  Any changes to acquisition related unrecognized tax benefits of approximately $1 million will impact goodwill.

As of January 1, 2007, the amount of unrecognized tax benefit where it is reasonably possible that a significant change may occur in the next 12 months is approximately $0.2 million.  The change would result from a possible expiration of a statute of limitations in foreign jurisdictions.

The Company classifies interest and penalties related to tax positions as components of income tax expense.  As of January 1, 2007, the amount of accrued interest and penalties related to tax uncertainties is approximately $0.1 million.

The tax years 1992-2006 remain open to examination by various major tax jurisdictions to which the Company is subject.

NOTE 11—RESTRICTED CASH

The Company entered into a sales contract with a European customer wherein an upfront deposit of approximately $8.1 million was received during the quarter ended March 31, 2007, to be applied against the future delivery of product and services expected to be completed within the next 12 months.  Per terms of the contract, the cash was deposited into a restricted interest bearing bank account to be applied upon the Company’s delivery of product and services.  During the quarter ended June 30, 2007, approximately $2.0 million was released from restricted cash into cash and cash equivalents.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations as of June 30, 2007 and for the three and six month periods ended June 30, 2007 and 2006 should be read in conjunction 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, 2006.

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. We caution investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, risks related to our ability to achieve and sustain higher levels of revenue and operating income (including risks related to the outcome of our previously announced efforts to reduce expenses in the general and administrative functions including the rationalization of our facilities); uncertainties concerning our product mix and its effect on gross margins; uncertainties relating to our restructuring charges; uncertainties relating to technological approaches, manufacturing (including risks related to resolving any manufacturing problems) and product development; uncertainties relating to changes in senior management personnel and structure; uncertainties related to cost and pricing of our products; risks relating to dependence on collaborative partners; uncertainties relating to sole source suppliers; uncertainties relating to FDA and other regulatory approvals; competition; risks relating to intellectual property of others and the uncertainties of patent protection; and risks relating to intellectual property and other litigation.

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.

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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 breakthrough 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. Although we have achieved profitability in the past, we incurred a net loss for fiscal 2006 and in the first quarter of 2007. The following overview describes a few of the key elements of our business strategy and our goals:

Increase top-line revenue growth.   We intend to increase our top-line revenue through the successful commercialization of our technologies and expansion of our customer base, including leveraging our technologies into new markets. We intend to expand the overall genotyping market opportunity by giving customers the highest possible genetic power for the dollar. We believe that this is a key competitive advantage and will drive commercial momentum by continuing to enable affordable, high-volume genotyping studies. We believe that this continued path toward higher information content and ever more cost-effective products will fuel market growth for years to come. In gene expression, we anticipate expanding the overall market by ensuring that customers have a clear path to clinical studies and the products to get them there. As we continue to enhance the functionality and ease of use of our GeneChip® products, we aim to encourage our customers to expand their uses for our GeneChip® system, which we believe will create new market opportunities for us.

Improve operating efficiencies.   We intend to monitor our expenses closely to ensure our research and development and selling, general and administrative cost structures remain in line with our revenue growth. Associated with this goal, we announced in July 2006 our intent to restructure our general and administrative cost structure, including rationalizing our facilities requirements in order to bring our operating expenses in line with our current business requirements. We began those efforts and have incurred restructuring charges of approximately $13.5 million in fiscal 2006 and $7.1 million in the first six months of fiscal 2007.  We expect to incur total charges in 2007 of approximately $15 million related to this restructuring.  In July 2007, we announced an additional administrative facility consolidation. As a result of these restructuring efforts and through active cost management, we have decreased expenses in our general and administrative and research and development areas in 2007.   Also, as a result of our increased manufacturing capacity and changes in product mix, we may make additional changes to our cost structure in the future.

Critical Accounting Policies & Estimates

General

The following section of Management’s 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

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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.

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 customer’s inability to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration in the customer’s 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 investee’s (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.

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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, 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 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 pretax earnings, and ultimate outcomes of income tax audits.

Beginning January 1, 2007, we apply FIN 48 in accounting for income taxes in accordance with SFAS 109.  Under FIN 48 a company recognizes the benefit from a tax position only if it is more-likely-than-not that the position would be sustained upon audit based solely on the technical merits of the tax position.  FIN 48 clarifies how a company would measure the income tax benefits from the tax positions that are recognized, provides guidance as to the timing of the derecognition of previously recognized tax benefits, and describes the methods for classifying and disclosing the liabilities within the financial statement for any unrecognized tax benefits.  FIN 48 also addresses when a company should record interest and penalties related to tax positions and how the interest and penalties may be classified within the income statement and presented in the balance sheet.

We evaluate the likelihood of sustaining tax positions and assess the benefit to be recognized from these positions using certain subjective assumptions.  The estimate of these key assumptions is based on historical information and judgment regarding audit experience, similar positions, as well as expert advice. As required we review our assumptions at each balance sheet date and, as a result, we may change our valuation assumptions as our experience changes.

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 5, Accounting for Contingencies. Any reserves recorded may change in the future due to new developments in each matter.

Accounting for Stock-Based Compensation

Beginning January 1, 2006, 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 first six months of 2007, we recognized employee stock-based compensation of approximately $0.5 million in cost of product sales, approximately $1.2 million in research and development expense and approximately $2.9 million in selling, general and administrative expenses.  We adopted SFAS 123R on a modified prospective basis. As of June 30, 2007, approximately $28.8 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 June 2011. The weighted average term of the unrecognized

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stock-based compensation expense is 2.3 years.

During the six months ended June 30, 2006 under SFAS 123R we recognized employee stock-based compensation of $0.7 million in cost of product sales, $2.1 million in research and development expense and $6.1 million in sales, general and administrative expenses, which includes approximately $1.1 million related to the modification of an executive officer’s stock option grant to increase the associated exercise period.

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 cancellation, 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 3 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 six months ended June 30, 2007 and 2006, respectively.

Product Sales

The components of product sales are as follows (in thousands, except percentage amounts):

		Three Months Ended June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007			2006			$ Change		% Change
Probe arrays		$	41,018		$	40,177		$	841		2	%	$	76,739		$	83,379		(6,640	)	(8	)%
Reagents		14,172			9,641			4,531			47	%	27,778			20,081			7,697		38	%
Instruments		8,796			11,225			(2,429		)	(22	)%	17,276			23,555			(6,279	)	(27	)%
Total product sales		$	63,986		$	61,043		$	2,943		5	%	$	121,793		$	127,015		(5,222	)	(4	)%

Probe array sales increased in the second quarter of 2007 due to an increase of $7.4 million primarily due to growth in genotyping unit sales.  This growth was partially offset by a decrease of $6.6 million in revenue related to a reduction in the average selling price of our probe arrays.  Reagent sales grew due to an increase of $2.5 million related to growth in unit sales and an additional $2.0 million because of an increase in the average selling price.  Instrument sales decreased primarily due to a decline of $1.6 million in revenue because of a drop in the average selling price of our GeneChip® Scanner 3000.

Probe array sales decreased in the first six months of 2007 due to a decline of $11.9 million related to a reduction in the average selling price of our probe arrays.  This decrease was partially offset by an increase of $5.3 million primarily due to growth in genotyping unit sales.  Reagent sales grew primarily due to an increase of $6.6 million related to an increase in unit sales and an additional $1.1 million because of an increase in average selling price.  Instrument sales decreased primarily due to a decline of $3.8 million because of a drop in the average selling price of our GeneChip® Scanner 3000.

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Product Related Revenue

The components of product related revenue are as follows (in thousands, except percentage amounts):

		Three Months Ended June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007			2006			$ Change			% Change
Subscription fees		$	990		$	1,716		$	(726	)	(42	)%	$	2,006		$	3,709		$	(1,703	)	(46	)%
Service and other		12,481			9,112			3,369			37	%	21,389			16,824			4,565			27	%
License fees and milestone revenue		3,696			3,579			117			3	%	7,300			7,117			183			3	%
Total product related revenue		$	17,167		$	14,407		$	2,760		19	%	$	30,695		$	27,650		$	3,045		11	%

 

Service and other revenue increased for the second quarter of 2007 and in the first six months of 2007 primarily due to growth of $2.9 million and $3.2 million, respectively, in revenue related to our genotyping services business. These increases were partially offset by declines in subscription fees earned under our GeneChip® array access programs as we continue to transition customers to volume-based pricing on array sales.

In January 2003, under the terms of an expanded collaborative agreement, Roche paid us an access fee of $70 million, which we are recognizing as a component of product related revenue in license fees over the estimated research and development period of approximately five years. The amortization of the remaining $7.2 million of deferred revenue related to this access fee is expected to be completed in fiscal 2007.

Royalties and Other Revenue (in thousands, except percentage amounts)

		Three Months Ended June 30,										Six Months Ended June 30,
		2007		2006			$ Change			% Change		2007			2006			$ Change			% Change
Royalties and other revenue		2,731		$	2,419		$	312		13	%	$	5,153		$	4,294		$	859		20	%

Royalties and other revenue increased for the second quarter of 2007 and in the first six months of 2007 primarily due to additional license and grant revenue.  Certain of our license agreements contain provisions which require our licensees to pay us additional fees in the event of a change of control.  In the event a change of control is completed, our license revenue could materially increase from prior periods.

In August 2007, we received a $7.5 million license fee related to a change of control provision that will be recorded in royalties and other revenue in the third quarter of 2007.

Revenue from Perlegen Sciences (in thousands, except percentage amounts)

		Three Months Ended June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007		2006			$ Change			% Change
Revenue from Perlegen Sciences		$	4,423		$	2,197		$	2,226		101	%	11,101		$	7,498		$	3,603		48	%

 

Perlegen revenue increased for the second quarter of 2007 and in the first six months of 2007 primarily due to increases of approximately $3.3 million and $5.6 million, respectively, related to increased demand by Perlegen for our commercial probe arrays.  These increases were partially offset by a decrease in demand for wafers used by Perlegen for internal research and development of $0.7 million and $1.2 million and a decrease in royalties of $0.3 million and $0.9 million for the second quarter of 2007 and in the first six months of 2007, respectively. Probe arrays and wafers used by Perlegen for use in their research and development activities are sold at our fully burdened cost of manufacturing.  We expect revenue from Perlegen to decrease in the second half of fiscal 2007 as they complete a large genotyping study.

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Product and Product Related Gross Margins (in thousands, except percentage/point amounts)

		Three Months Ended June 30,						Dollar / Point change from			Six Months Ended June 30,						Dollar / Point change from
		2007			2006			2006			2007			2006			2006
Total gross margin on product sales		$	40,153		$	41,397		$	(1,244	)	$	78,239		$	88,295		$	(10,056	)
Total gross margin on product related revenue		6,341			6,995			(654		)	13,394			13,797			(403		)
Total gross margin on product and product related revenue		$	46,494		$	48,392		$	(1,898	)	$	91,633		$	102,092		$	(10,459	)
Product gross margin as a percentage of product sales		62.8		%	67.8		%	(5.0		)	64.2		%	69.5		%	(5.3		)
Product related gross margin as a percentage of product related revenue		36.9		%	48.6		%	(11.7		)	43.6		%	49.9		%	(6.3		)

The 5.0 point decrease in product gross margin in the second quarter of 2007 is primarily due to the following factors: 10.8 points of the decrease is attributable to a decline in the average selling price of our probe arrays; 4.1 points of the decrease is attributable to a decline in the average selling price of our instrumentation products; and 1.3 points of the decrease is due to an increase in our inventory reserves related to expired arrays.   These decreases were partially offset by a 4.6 point increase in product gross margins due to higher factory utilization as we produced and sold more probe arrays and a 5.9 point impact for increased volume primarily associated with DNA chips and reagents.

The 5.3 point decrease in product gross margin in the first six months of 2007 is primarily due to the following factors:  9.3 points of the decrease is attributable to a decline in the average selling price of our probe arrays; 4.5 points of the decrease is attributable to a decline in the average selling price of our instrumentation products; 2.1 points of the decrease is attributable to higher costs of production for reagents and 1.9 points of the decrease is attributable to an increase in our inventory reserves related to expired arrays.   These decreases were partially offset by a 3.3 point increase in product gross margins due to higher factory utilization as we produced and sold more probe arrays and a 7.1 point impact for increased volume primarily associated with DNA chips and reagents.

Our margins in the second half of fiscal 2007 could be adversely affected if we cannot absorb the costs of our new manufacturing capacity through increased unit production and sales or if we have a shift in our product mix to our lower margin product lines.

The 11.7 point and 6.3 point decreases in product related gross margins for the second quarter of 2007 and in the first six months of 2007, respectively, were primarily due to a shift in our product mix as our genotyping services business grew as a percentage of total product related sales.  In addition, sales of our GeneChip® array access agreements declined as we continue to transition customers to volume-based discounting on product sales.

Cost of Perlegen Revenues (in thousands, except percentage amounts)

		Three Months Ended June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007			2006			$ Change			$ Change
Cost of revenue from Perlegen Sciences		$	1,907		$	1,074		$	833		78	%	$	4,328		$	2,658		$	1,670		63	%

Cost of Perlegen revenue increased for the second quarter of 2007 and in the first six months of 2007 primarily due to increased demand by Perlegen for our commercial products.  The increase was partially offset by lower demand of wafers used by Perlegen for their internal use.

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Research and Development Expenses (in thousands, except percentage amounts)

		Three Months Ended June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007			2006			$ Change			% Change
Research and development		$	19,427		$	21,597		$	(2,170	)	(10	)%	$	38,654		$	45,098		$	(6,444	)	(14	)%

The decrease in research and development expenses in the second quarter of 2007 was primarily due to a $0.6 million reduction of spending on supplies through cost cutting measures, $0.4 million reduction in employee related expenses following a corporate restructuring plan implemented in the third quarter of 2006 and a decrease in stock-based compensation expense of $0.4 million.

The decrease in research and development expenses in the first six months of 2007 was primarily due to a $2.9 million reduction of spending on supplies and co-development expenses as we concluded certain co-development activities and began to focus our research and development efforts on fewer more strategic programs that will enable the development of next generation products in our key genetic analysis markets as well as overall cost cutting measures.  Additionally, employee related expenses decreased $1.7 million following a corporate restructuring plan implemented in the third quarter of 2006.  Lastly, stock-based compensation expense decreased $0.9 million.

While our research and development costs have declined in the near term, 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 June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007		2006			$ Change			% Change
Selling, general and administrative		$	33,643		$	39,476		$	(5,833	)	(15	)%	69,501		$	78,242		$	(8,741	)	(11	)%

 

The decrease in selling, general and administrative expenses in the second quarter of 2007 was primarily due to $2.7 million of lower stock-based compensation expenses and $1.8 million of lower legal expenses. The decrease for the first six months of 2007 was primarily due to $3.2 million of lower stock-based compensation expense, $2.6 million of lower legal expenses and lower employee related costs of $2.1 million following a corporate restructuring plan implemented in the third quarter of 2006. We expect legal costs to vary substantially depending on the intensity of legal activity, such as patent litigation.

Restructuring charges (in thousands, except percentage amounts)

		Three Months Ended June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007			2006			$ Change			% Change
Restructuring charges		$	1,771		$	—		$	1,771		100	%	$	7,142		$	—		$	7,142		100	%

In the third quarter of 2006, we initiated a restructuring plan (“the Plan”) to better align certain of our expenses with our current business outlook.  Our primary focus of the Plan was in the general and administrative functions and included rationalizing our facilities.  In August 2006, we terminated certain employees in the general and administrative functions.  Additionally, in September 2006, we announced our plan to close our Bedford, Massachusetts based instrumentation manufacturing and development facility. In the second quarter of 2007, we began to consolidate the Bedford facility’s instrument manufacturing operations with our probe array manufacturing facility located in West Sacramento, California. Our instrumentation development capabilities are being consolidated with our principal research and development facilities located in Santa Clara, California. Implementation of the workforce severance and relocation elements of the Bedford facility closure began in the fourth quarter of 2006 and we expect it will continue into the third quarter of 2007. We expect the closure of our Bedford, Massachusetts facility to be materially completed by the third quarter of fiscal 2007. As a final element of our restructuring plan, we terminated certain employees in the sales, marketing and research and development functions in Santa Clara, California during January 2007.

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We estimate that the total restructuring expenses to be incurred in connection with the Plan will be approximately $25 to $28 million. Of this total, we estimate that approximately $19 million relates to employee severance and relocation benefits,  approximately $4 to $7 million relates to contract termination costs associated with vacating the leased Bedford facility, which will be recognized when the facility is vacated, likely in the third quarter of 2007, and approximately $2 million relates to other restructuring costs such as fixed asset write downs and equipment and inventory relocation costs.  We have begun to incur non-employee related restructuring expenses beginning in 2007 and expect to continue incurring these expenses into the second half of 2007. Total cash outlays incurred in connection with these restructuring activities are estimated to be approximately $20 million.  In accordance with Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the costs relating to employee severance and relocation are being accrued over the remaining service periods of the employees.

During the second quarter and in the the first six months of 2007, we recognized approximately $1.8 million and $7.1 million, respectively, of expense related to the plan which was presented in a single line item labeled “Restructuring charges” in our Statement of Operations, of which approximately $1.5 million and $6.3 million, respectively, related to employee termination benefit costs and approximately $0.3 million and $0.8 million, respectively, related to facility exit costs.

In July 2007, we announced that it will be consolidating an administrative facility located in Sunnyvale, California into our main campus in Santa Clara, California during the second half of 2007.  We have not completed our analysis of the additional costs associated with vacating the leased Sunnyvale facility.

Interest Income and Other, Net (in thousands, except percentage amounts)

The components of interest income and other, net, are as follows:

		Three Months Ended June 30,											Six Months Ended June 30,
		2007			2006			$ Change			% Change		2007			2006			$ Change			% Change
Interest income		$	3,088		$	2,988		$	100		3	%	$	5,842		$	5,835		$	7		0	%
Write down of equity investment		(68		)	(62		)	(6		)	(10	)%	(199		)	(108		)	(91		)	(84	)%
Currency gains, net		240			776			(536		)	(69	)%	179			2,342			(2,163		)	(92	)%
Other		2,080			18			2,062			11,456	%	2,269			(62		)	2,331			3,760	%
Interest income and other, net		$	5,340		$	3,720		$	1,620		44	%	$	8,091		$	8,007		$	84		1	%

Interest income and other, net increased for the second quarter of 2007 primarily due to the sale of two of our non-marketable securities for a gain of $2.1 million offset by $0.5 million decrease in currency gains.   Interest income and other, net remained flat for the first six months of 2007 primarily due to the $2.1 million gain from the sale of two of our non-marketable securities, which was primarily offset by a decrease in currency gains.  In the first quarter of 2006, we realized a $1.6 million currency gain on assets held in various foreign currencies.

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Income Tax (Provision) Benefit (in thousands, except percentage amounts)

		Three Months Ended June 30,											Three Months Ended June 30,
		2007			2006			$ Change			% Change		2007			2006			$ Change			% Change
Income tax (provision) benefit		$	(584	)	$	(4,235	)	$	(3,651	)	(86	)%	$	1,712		$	(3,298	)	$	(5,010	)	(152	)%

 

The provision for income tax decreased approximately $3.7 million in the second quarter of 2007 and decreased approximately $5.0 million in the first six months of 2007.  These decreases were due to changes in the geographic mix of our levels of profitability.  The provision for income tax for fiscal 2007 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 stock option compensation expense recorded under SFAS 123R, state taxes and research and development credits.  We believe realization of our deferred tax assets as of June 30, 2007 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.

Liquidity and Capital Resources

Cashflow (in thousands)

Net Cash (Used in) Provided by Operating Activities

Cash (used in) provided by operating activities is net (loss) income adjusted for certain non-cash items and changes in operating assets and liabilities. Cash used in operating activities in the first six months of 2007 was comprised of a net loss of $2.8 million and restricted cash of $6.1 million.  These cash usages were primarily offset by non-cash charges of depreciation and amortization of $15.8 million, stock-based compensation expense of $4.6 million and significant changes in assets and liabilities as follows:

Our total accounts receivable, including Perlegen, was $72.1 million at June 30, 2007, a decrease of $5.8 million from December 31, 2006. The decrease is primarily due to lower sales of consumables and instruments in the six months ended June 30, 2007.

Our inventory balance was $56.3 million at June 30, 2007, an increase of $9.8 million from December 31, 2006. The increase is primarily due to the buildup of consumables in advance of anticipated demand as well as a buildup of instruments inventory as we transitioned instrument production from our Bedford, Massachusetts facility to our Sacramento, California facility.

Our accounts payable and accrued liabilities balance was $49.1 million at June 30, 2007, a decrease of $13.8 million from December 31, 2006. The decrease was primarily due to the payment of accounts payable related to our manufacturing expansion in Sacramento, California and capital costs on our new manufacturing facility in Singapore.

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 and strategic investments. Cash used for capital expenditures was $16.9 million in the six months

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ended June 30 2007 compared to $47.6 million in the same period in 2006. Our capital expenditures in the current period are primarily related to the final phase of our manufacturing expansion in Sacramento, California, as well as costs incurred to upgrade our enterprise resource planning system.

Net Cash Provided by Financing Activities

Our financing activities consist of stock option exercise activity under our employee stock plan. Cash provided by the issuance of stock under our employee stock plan was $11.3 million and $5.4 million in the six month periods ended June 30, 2007 and 2006, 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, 2006.

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. In early 2003, we began hedging activities by using 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.  Prior to 2007, we hedged a percentage of forecasted international revenue with forward contracts and the gains and losses on these contracts largely offset gains and losses on the transactions being hedged. Our revenue hedging policy is designed to reduce the negative impact on our forecasted revenue due to foreign currency exchange rate movements. For 2007 we will no longer carry or initiate new currency forward contracts on a percentage of forecasted international revenue, based on management’s internal assessment of the risk posed by extrapolating historical and potential future currency rate changes.  Management will continue to reevaluate this risk on an ongoing basis.

At June 30, 2007, we had no open hedging contracts.

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, 2006.

ITEM 4. CONTROLS AND PROCEDURES

(a) Disclosure controls and procedures.

Affymetrix’s management carried out an evaluation, as required by Rule 13a-15(b) of the Securities Exchange Act of 1934  (the “Exchange Act”), with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as 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 Affymetrix’s management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in internal control over financial reporting.

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

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

Information pertaining to legal proceedings can be found in “Item 1. Condensed Consolidated Financial Statements – Note 9. 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.

We incurred losses each year from our inception through the year ended December 31, 2003 and have incurred a loss for the year ended December 31, 2006 and for the six months ended June 30, 2007. As a result, we had an accumulated deficit of approximately $123.8 million at June 30, 2007. We expect to continue experiencing fluctuations in our operating results and cannot assure sustained profitability. Our losses have resulted principally from costs incurred in research and development, manufacturing and from selling, general and administrative costs associated with our operations.

Our ability to generate significant revenues and maintain profitability is dependent in large part on our ability to expand our customer base, increase sales of our current products to existing customers, manage our expense growth, and enter into additional supply, license and collaborative arrangements as well as on our ability and that of our collaborative partners to successfully manufacture and commercialize products incorporating our technologies in new applications and in new markets. 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 quarterly results have historically fluctuated significantly and may continue to fluctuate unpredictably and any 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. However, we have historically 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 management’s 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. In particular, our revenue growth and profitability depend on sales of our GeneChip® products. Factors that could cause sales for these products to fluctuate include:

·       competition

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

·       the loss of or reduction in orders from key customers;

·       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.

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Some additional factors that could cause our operating results to fluctuate include:

·       weakness in the global economy and changing market conditions;

·       general economic conditions affecting our target customers;

·       changes in the amounts or timing of government funding to companies and research institutions; and

·       changes in the attitude of the pharmaceutical industry towards the use of genetic information and genetic testing as a methodology for drug discovery and development.

We cannot forecast with any certainty the impact of these and other factors on our sales and operating results in any future period. Results of operations in any period, therefore, should not be considered indicative of the results to be expected for any future period. Because of this difficulty in predicting future performance, our operating results may fall below 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.

We may experience fluctuations in demand for our products that may impact our manufacturing capacity requirements.

If demand for our products is reduced, 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 may lose customers or experience lost sales if we are unable to manufacture our products and 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 not fully understand all of the factors that affect our manufacturing processes or product performance.

Although we have taken steps to increase our manufacturing capacity, including the expansion of our existing West Sacramento, California probe array manufacturing facility and the development of a new probe array manufacturing facility in Singapore, there are uncertainties inherent in the expansion of our manufacturing capabilities. For example, manufacturing and product quality issues may arise at the new Singapore facility or as we increase production rates at our West Sacramento facility and launch new products. In addition, 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 manufacture our GeneChip® instrumentation products at our manufacturing facility in Bedford, Massachusetts. In the third quarter of 2006, we announced that we will be consolidating our Bedford instrumentation manufacturing facility with our probe array manufacturing facility in West Sacramento, California as part of our previously announced efforts to reduce expenses in the general and administrative functions including the rationalization of our facilities. This transition is subject to risks and uncertainties that may cause interruptions in our ability to supply GeneChip® instrumentation products to our customers, which could result in lost revenue and seriously harm our business, financial condition and results of operations.

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

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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 GeneChip® instruments. 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 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. There can be no guarantee that we will be able to maintain our technological advantages over emerging technologies in the future. Over time, we will need to respond to technological innovation in a rapidly changing industry. 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.

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, and 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. 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. 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 uncompetitive, our pricing and margins will decline and our business will suffer.

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.

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If we do not execute our planned facilities rationalization and employee downsizing cost reductions successfully then we could incur total costs and expenses in excess of what is expected.

In the third quarter of 2006, we initiated a restructuring plan (“the plan”) to better align certain of our expenses with our current business outlook.  Our primary focus of the plan was in the general and administrative functions and included rationalizing our facilities.  In August 2006, we terminated certain employees in the general and administrative functions.  Additionally, in September 2006, we announced our plan to close our Bedford, Massachusetts based instrumentation manufacturing and development facility. We plan to consolidate the Bedford facility’s instrument manufacturing operations with our probe array manufacturing facility located in West Sacramento, California. Our instrumentation development capabilities will be consolidated with our principal research and development facilities located in Santa Clara, California. Implementation of the workforce severance and relocation elements of the Bedford facility closure began in the fourth quarter of 2006 and will continue into the third quarter of 2007. We expect the closure of our Bedford, Massachusetts facility to be materially completed by the third quarter of fiscal 2007. As a final element of our restructuring plan, we terminated certain employees in the sales, marketing and research and development functions in Santa Clara, California during January 2007. Failure to successfully execute any part of the plan could result in unexpected manufacturing delays and additional unforecasted plan costs, and could adversely impact production and inventory level and results of operations and our financial condition.

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. We will not be able to expand our business if we are unable to hire, train and retain a sufficient number of qualified employees. There can be no assurance that we will be successful in hiring or retaining qualified personnel and our failure to do so could have a material adverse impact on our business, financial condition and results of operations.

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. A scientific advisor’s other obligations may prevent him or her from assisting us in developing our technical and business strategies.

We expect to face increasing competition.

Future competition will likely come from existing competitors as well as other companies seeking to develop new technologies for analyzing genetic information. 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. 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 Abbott Laboratories, Bayer AG, 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.

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Recent accounting pronouncements may impact our future financial position and results of operations.

There have been new accounting pronouncements that may have an impact on our future financial position and results of operations. For instance, in July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). Under FIN 48 a company recognizes the benefit from a tax position only if it is more-likely-than-not that the position would be sustained upon audit based solely on the technical merits of the tax position. FIN 48 clarifies how a company measures the income tax benefits from the tax positions that are recognized, provides guidance as to the timing of the derecognition of previously recognized tax benefits and describes the methods for classifying and disclosing the liabilities within the financial statements for any unrecognized tax benefits. FIN 48 also addresses when a company should record interest and penalties related to tax positions and how the interest and penalties may be classified within the income statement and presented in the balance sheet. We adopted FIN 48 effective January 1, 2007.  See Note 10 to the Condensed Consolidated Financial Statements in Item 1 for further details.

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.

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 success will depend upon their demand for and use of our products and services. Our operating results may fluctuate substantially due to reductions and delays in research and development expenditures by these customers. For example, reductions in capital expenditures by these customers may result in lower than expected instrumentation sales and similarly, reductions in operating expenditures by these customers could result in lower than expected GeneChip® array and reagent sales. These reductions and delays may result from factors that are not within our control, such as:

·       changes in economic conditions;

·       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;

·       market-driven pressures on companies to consolidate and reduce costs; and

·       other factors affecting research and development spending.

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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.

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 needed approvals.

We may not successfully obtain 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

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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 payor 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.

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 vendors 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 are currently available only from a single source or limited sources. In addition, components of our manufacturing equipment and certain raw materials used in the synthesis of probe arrays are available from limited sources. 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.

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 there can be no assurance 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 investors 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 chose 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. In addition, we have incurred and may in future periods incur substantial costs in litigation to defend against patent suits brought by third parties or initiated by us. For example, we currently are engaged in litigation regarding intellectual property rights with Enzo Life Sciences, Inc. For additional information concerning intellectual property litigation and administrative proceedings, see “Part II, Item 1, Legal Proceedings” of this Form 10-Q. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could harm our results of operations.

In addition to patent protection, we also rely upon copyright and trade secret protection for our confidential and proprietary information. There can be no assurance, however, that such measures will provide adequate protection for our copyrights, trade secrets or other proprietary information. In addition, there can be no assurance 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, including reagents used in probe array synthesis and in probe array assays, probe array scanners, synthesis techniques, polynucleotide amplification techniques, assays, and probe arrays. 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.

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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. Currently, our significant collaborative partners include Qiagen GmBH for sample preparation and purification systems, Invitrogen Corporation for reagents, and Ingenuity Systems, Inc. for analytical software. We collaborate with both Beckman Coulter Inc. and Caliper Life Sciences in the development of automation for GeneChip® technology applications for use in drug discovery, drug development and clinical research. Roche, bioMérieux and Veridex are collaborative partners in the development of chip products for medical diagnostic and applied testing markets. Relying on these or other 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

·       we may not be able to negotiate future collaborative arrangements on acceptable terms.

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 other 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.

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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.

Future acquisitions may disrupt our business and distract our management.

We have previously engaged in acquisitions and may do so in the future in order to exploit technology or market opportunities. If we acquire another company, we may not be able to successfully integrate the acquired business into our existing business in a timely and non-disruptive manner, or at all. Furthermore, an acquisition may not produce the revenues, earnings or business synergies that we anticipate. If we fail to integrate the acquired business effectively, commercialize the acquired technology, or if key employees of that business leave, the anticipated benefits of an acquisition would be jeopardized. The time, capital management and other resources spent on an acquisition that fails to meet our expectations could cause our business and financial condition to be materially and adversely affected. For example, on October 21, 2005, we completed the acquisition of ParAllele BioScience, Inc. We may not realize the anticipated benefits of the acquisition because of integration and other challenges which include, among others, unanticipated incompatibility of corporate and administrative infrastructures, the ability to retain key employees, including key scientists, the diversion of management’s attention from ongoing business concerns, and the potential adverse reaction of customers to an acquisition or resulting changes to the combined company’s product and services offerings. In addition, acquisitions can involve substantial charges of stock based compensation that could adversely affect our results of operations.

The market price of our common stock has been volatile.

The market price of our common stock is volatile. To demonstrate this volatility, during the twelve-month period ending on June 30, 2007, the volume of our common stock traded on any given day ranged from 179,200 to 9,561,600 shares. Moreover, during that period, our common stock traded as low as $17.50 per share and as high as $31.95 per share.

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 management’s 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

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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. 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. Also, as a result of our delayed filing of our Form 10-Q for the quarter ended June 30, 2006, we will be ineligible to register our securities on Form S-3 for sale by us or resale by others until we have timely filed all periodic reports under the Securities Exchange Act of 1934 for one year. We may use Form S-1 to raise capital or complete acquisitions, which could increase transaction costs and adversely affect our ability to raise capital or complete acquisitions of other companies during this period.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a)          Date of Meeting

The annual meeting of the stockholders of Affymetrix, Inc. was held on June 13, 2007. 59,557,878 shares of Affymetrix common stock were present at the meeting, representing 86.9% of a total of 68,540,845 shares of common stock outstanding and eligible to vote at such time.

(b) and (c) Name of Each Director Elected at the Meeting and Description of Each Matter Voted on and Number of Votes Cast

				For		Against		Withheld
1.		To elect directors to serve until the next meeting of stockholders or until their successors are elected.
		Stephen P.A. Fodor, Ph.D.		58,398,014		—		1,159,863
		Paul Berg, Ph.D.		57,923,538		—		1,634,339
		Susan D. Desmond-Hellmann, M.D.		58,834,650		—		723,227
		John D. Diekman, Ph.D.		37,809,206		—		21,748,671
		Vernon R. Loucks, Jr.		58,401,405		—		1,156,472
		David B. Singer		37,808,618		—		21,749,259
		Robert H. Trice, Ph.D.		58,848,175		—		709,702
		Robert P. Wayman		58,832,138				725,739
		John A. Young		57,894,304		—		1,663,573

 

Consequently all nominees were elected by the stockholders of Affymetrix.

				For		Against		Abstain
2.		To ratify the appointment of Ernst & Young LLP as independent registered public accounting firm of the Company for the fiscal year ending December 31, 2007.		56,384,319		3,139,978		33,581

 

Consequently the proposal was approved by the stockholders of Affymetrix

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS

Exhibit Number		Description of Document
10.1 (1)		Offer letter from the Company to John Batty dated May 16, 2007
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 Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002

 

(1)           Incorporated by reference to Registrant’s Form 8-K as filed on June 6, 2007 (File No. 666-28218).

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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, Chief Financial Officer, Treasurer and Principal Financial Officer
Date: August 9, 2007

 

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AFFYMETRIX, INC.

EXHIBIT INDEX

JUNE 30, 2007

Exhibit Number		Description of Document
10.1 (1)		Offer letter from the Company to John Batty dated May 16, 2007
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 Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002

 

(1)           Incorporated by reference to Registrant’s Form 8-K as filed on June 6, 2007 (File No. 666-28218).

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