10-K 1 form10-k.htm 10-K form10-k.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

 
FORM 10-K
 
(Mark One)
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011
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 NUMBER 0-28218
 

 
AFFYMETRIX, INC.
(Exact name of registrant as specified in its charter)
 
DELAWARE
(State or other jurisdiction of
incorporation or organization)
77-0319159
(IRS Employer Identification Number)
   
3420 CENTRAL EXPRESSWAY
SANTA CLARA, CALIFORNIA
(Address of principal executive offices)
 
95051
(Zip Code)
(408) 731-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
 
Common Stock, $0.01 par value
Preferred Stock Purchase Rights
 
Name of Each Exchange on Which Registered
 
The Nasdaq Global Select Market
The Nasdaq Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act:
None
 

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company 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
 
The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant at June 30, 2011, based on the closing price of such stock on The Nasdaq Global Select Market on such date, was approximately $553 million. The number of shares of the registrant’s Common Stock outstanding on February 22, 2012 was 70,447,986.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Certain sections of the Proxy Statement to be filed in connection with the 2012 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K where indicated.
 

 
 

 

AFFYMETRIX, INC.
 
FORM 10-K
DECEMBER 31, 2011
 
 
Item No.
 
Page
 
     
 
     
 
     
 
 
 
 

PART I
 
ITEM 1.  BUSINESS
 
Forward-Looking Statements
 
All statements in this Annual Report on Form 10-K that are not historical are "forward-looking statements" within the meaning of the federal securities laws. These include 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 cannot assure you that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, those discussed in "Risk Factors" contained in Item 1A of this Annual Report on Form 10-K. Unless required by law, we do not undertake to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions, or circumstances on which any such statements are based.
 
Overview
 
We develop, manufacture and sell products and services for genetic analysis to the life science research and clinical healthcare markets. Researchers around the world use our technology to better understand the role that genes play in disease, the effectiveness and safety of therapies and many other biological factors that affect human well-being. We sell our products to some of the world’s largest pharmaceutical, diagnostic and biotechnology companies, as well as leading academic, government and not-for profit research institutions. Approximately 24,000 peer-reviewed papers have been published based on work using our products. We have almost 900 employees worldwide and maintain sales and distribution operations across the United States, Europe, Latin America and Asia.
 
We were incorporated in California in 1992 and reincorporated in Delaware in 1998. Our principal executive offices are located at 3420 Central Expressway, Santa Clara, CA 95051. Our telephone number is (408) 731-5000.
 
Pending Acquisition of eBioscience
 
On November 29, 2011, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) to acquire eBioscience Holding Company, Inc. (“eBioscience”) for approximately $330 million in cash, subject to certain adjustments as provided in the Merger Agreement. eBioscience is a privately-held San Diego, California-based company engaged in the development, manufacture and sale of flow cytometry and immunoassay reagents for immunology and oncology research and diagnostics. The merger is subject to customary closing conditions, including our receipt of financing for the merger.
 
In connection with the Merger Agreement, we entered into a commitment letter with financing sources providing for $190 million of senior secured credit. The conditions to funding these facilities have not yet been satisfied and as a result, we will not be able to complete the eBioscience acquisition unless the terms of the acquisition and the financing are restructured. We are in discussions with financing sources and with eBioscience regarding the possibility of restructuring the committed financing, but no agreements or understandings have been reached.
 
We have waived eBioscience’s obligations under the non-solicitation provisions set forth in the Merger Agreement and we understand that eBioscience is considering alternatives to the merger. The Merger Agreement may be terminated by either party if the closing of the merger has not occurred by March 31, 2012, so long as a breach of the Merger Agreement by the party seeking to terminate has not been the proximate cause of or resulted in the failure of the merger to occur on or before such date.
 
 
 
Our Strategy
 
Our objective is to be the leading provider of genetic analysis tools that service the needs of a growing base of research and clinical markets. The key elements of our strategy are:
 
·  
Entering new markets and expanding our product lines. Our goal continues to be to expand our revenue base by entering new markets, growing our customer base and successfully commercializing our established and acquired technologies. In the future, we intend to continue to expand our focus to include the validation and routine testing markets which we believe offer attractive compound annual growth rates and opportunities for recurring revenue growth in the future. We seek to expand our product line with new products that combine automated instrumentation, powerful new biological assays, and new array designs and content.
 
·  
Improving operating leverage. We remain focused on improving our operating leverage and were successful in lowering our operating expenses in 2011 as compared to 2010. Profitability in the future will depend on a number of factors, including but not limited to, increasing top-line revenue and sustained operating leverage.
 
Our Markets
 
The market for genetic analysis tools is large, growing and consists of several important end user segments. Traditionally, end users of our technologies and products have been scientific researchers located in major academic university research laboratories and within major pharmaceutical and biotechnology companies. Our products enable a research workflow that consists of several phases:
 
·  
discovery – describing the differences between individuals,
 
·  
exploration – seeking to further understand the biological relevance of a disease or process, and
 
·  
validation and testing – identifying disease mechanisms and pathways.
 
Discovery and Exploration Markets
 
The main source of discovery funding comes from a variety of public and private sources, with the National Institute of Health being the largest. A primary end-point of these end users is peer-reviewed scientific publication and our technologies have been referenced in approximately 24,000 scientific publications. The required technologies generally must enable large-scale and highly complex analysis of genetic variation (genotyping) and biological function (gene expression). Our products for large scale genotyping and gene expression applications serve customers in the exploration markets which include academic research centers, government agencies, private research foundations, clinical and commercial reference laboratories and the research departments of pharmaceutical companies.
 
Validation and Testing Markets
 
As the adoption of genetic analysis has increased, new end users entered the markets that are downstream of the basic research markets described above. In particular, clinical researchers, molecular pathologists, oncologists and cytogeneticists have become increasingly engaged in applying genetic analysis technologies for the development of new clinical methods to be used in the diagnosis, monitoring and treatment of a wide variety of molecular based diseases. These end users are often located in diagnostic companies, commercial reference laboratories, clinical research departments within academic medical centers, major pharmaceutical, biotechnology companies and agricultural based companies focused on plant and animal breed testing. The required technology is used in a repetitive testing environment and must enable cost effective, flexible analysis of significantly fewer genetic and biological markers. We believe these new users are more likely to generate recurring revenue and the downstream markets are growing at a higher compound annual growth rate than the scientific research markets.
 
 
 
Our genotyping products with diagnostic or copy number applications, our targeted genotyping products and our low- to mid-plex gene expression products target the needs of the new users.
 
We expect that the following factors, among others, will influence the size and development of the markets served by our technologies:
 
·  
the availability of genomic sequence and sequence variation data for the human population and for 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 funding for basic and disease-related research;
 
·  
the amount of capital and ongoing expenditures allocated to research and development and outsourced spending by biotechnology, pharmaceutical and diagnostic companies for products and services;
 
·  
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.
 
Scientific Background
 
Introduction to the Genome and its Opportunity
 
In the years following the completion of the Human Genome Project in 2003, an explosion of research in genome structure, function and variation has led to an understanding that human genetic variation is common and takes on many structural forms. Among individual humans, genetic variation ranges from single nucleotide changes to gross alterations of entire chromosomes. Subsequent efforts to identify and catalog human genetic variation, including the HapMap Project and the 1000 Genomes Project, continue to generate tremendous amounts of information that is made freely and quickly available to the public. Genetic variation accounts for many of the differences between individuals, such as eye color and blood group, and also affects a person’s susceptibility to certain diseases including cancer, diabetes, stroke and Alzheimer’s disease. Genetic variation can also determine a person’s response to drug therapies. Further, many cancers are caused by genetic variations in individual cells. Understanding the genome helps us understand the inheritance of biological characteristics. We believe that this will lead to a new healthcare paradigm where disease is understood at the molecular level, allowing patients to be diagnosed according to genetic information and then treated with drugs designed to work on specific molecular targets.
 
All known genomes, including the human genome, are composed of either deoxyribonucleic acid (“DNA”) or ribonucleic acid (“RNA”). The instructions required for every living cell to develop its characteristic form and function are believed to be represented within discrete regions of the genome known as genes. DNA molecules consist of two long complementary strands held together by base pairs. Four nucleotide bases—adenine-A, cytosine-C, guanine-G and thymine-T form the chemical building blocks of DNA. The two DNA strands are held together by hydrogen bonds between nucleotide bases on one strand to complementary nucleotide bases on the other strand. Only certain pairs of the bases can form these complementary bonds: C pairs with G, and A pairs with T. Therefore, a single DNA strand containing bases in the sequence CGTACGGAT can form a bond with a DNA strand containing bases in the sequence GCATGCCTA. Such paired DNA strands are said to be "complementary" and can form a double helix structure in a process called "hybridization." Our technology uses the principle of hybridization to recognize the presence of specific gene sequences and to analyze genetic information.
 
Through the process of transcription RNA, copies of the DNA are made from the regions containing genes. Many copies of RNA can be made from each DNA region. The amount of RNA made from any given gene is a measure of the expression level of that gene. In the cell, RNA is typically single-stranded, while DNA is double-stranded. One type of RNA, the messenger RNA (mRNA) is central to protein synthesis. There are RNAs with other roles, such as regulating which genes are expressed and carrying genetic information of viruses.
 
 
 
Genotyping
 
Genotyping is the process of determining the genetic constitution of a cell, organism or individual in order to determine how it is specialized or differs from a group. Typically, each cell in an individual contains a complete copy of its genome. In a population, individuals vary from one another because of differences in gene sequences which are inherited from each parent and sometimes through the introduction of sequence changes due to environmental damage or biological errors in processes like gene replication. Common forms of genetic variation include single-nucleotide polymorphisms, or SNPs, and copy number variations, or CNVs. A SNP is a variation in a single position in a DNA sequence and a CNV is a variation in the number of copies of a segment of the DNA.
 
Genotyping is a valuable tool for studying genetic contributions to diseases and the efficacy of drug therapies in specified patient populations. While, in some cases, genetic variations, or polymorphisms, have little detectable effect on the biology of the organism, in other cases they may result in a predisposition to disease or an altered biological response to the environment. By screening for these polymorphisms, researchers seek to identify those that might be implicated in specific diseases. Sometimes it is not a single SNP or CNV, but the combination of certain variations that lead to a diseased state. For this reason, researchers look at the patterns of these polymorphisms in a large number of healthy and diseased individuals in order to correlate specific variants with specific diseases or phenotypes. Large scale genotyping can be used, for example, in studies designed to elucidate the genetic contributions to disease and, in the case of clinical trials, to drug response.
 
Gene Expression Monitoring
 
Gene expression monitoring is the process of determining which genes are active in a specific cell or group of cells. Timing and level of gene expression is an important mechanism by which the fate and function of cells are regulated. Although most cells contain an organism's full set of genes, each cell expresses only a subset of genes at any given time and the level of expression also varies with the state of that cell. The expression pattern or profile of genes can be correlated with many human diseases such as cancer, as well as with the effectiveness of treatment in specific patient populations. By identifying genes that are differentially expressed in particular diseases or patient populations, novel molecular targets and treatments may be identified and validated. In addition, gene expression signatures may be identified that provide early identification of a predisposition to disease or allow the selection of treatments optimized for an individual.
 
Gene expression monitoring is a valuable tool for identifying correlations between genes, determining their biological functions and identifying patterns that might be useful in classifying diseases. To monitor gene expression, we design and manufacture arrays with single-stranded DNA molecules that are complementary to sequences within genes or exons of interest. By synthesizing specific probes for multiple genes or exons on a single probe array, we enable researchers to quickly, quantitatively and simultaneously monitor the expression of a large number of genes or exons of interest. By monitoring the expression of such genes under different conditions and at different times, researchers can use the arrays to understand the dynamic relationship between gene expression and biological activity. We believe such information will be an important tool in understanding gene function and for the development of new drugs and diagnostic tools. Increasingly, clinical research is showing that gene expression patterns in tissue samples, particularly those from cancerous tissues, can be used to characterize disease sub-types and hopefully to predict therapeutic responses and likely outcomes.
 
In order to understand the impact of genomics on health, disease and other aspects of the human condition, scientists must compare both the sequence variation and the gene expression patterns of healthy and diseased individuals, tissues and cells. The use of arrays to identify correlations of gene expression patterns and sequence variation with specific diseases is expected to become increasingly important for gene marker validation, exploration and routine testing for diagnosis of disease.
 
Our Technologies
 
Array Technology
 
Our array technology leverages semiconductor-based photolithographic fabrication techniques, which enables us to synthesize a large variety of predetermined DNA sequences simultaneously in predetermined locations on a small glass chip called an "array."
 
 
 
Photolithography is a technique which uses light to create exposure patterns on the glass chip and to direct chemical reactions. The process begins by coating the chip with light-sensitive chemical compounds that prevent chemical coupling. These light-sensitive compounds are called "protecting groups." Lithographic masks, which consist of predetermined transparent patterns etched into a glass plate that block or transmit light, are used to selectively illuminate the glass surface of the chip. Only those areas exposed to light are deprotected, and thus activated for chemical coupling through removal of the light-sensitive protecting groups. The entire surface is then flooded with a solution containing the first in a series of DNA building blocks (A, C, G or T). Coupling only occurs in those regions that have been deprotected through illumination. The new DNA building block also bears a light-sensitive protecting group so that the cycle can be repeated.
 
This process of exposure to light and subsequent chemical coupling can be repeated many times on the same chip in order to generate a complex array of DNA sequences of defined length. The intricate illumination patterns allow us to build high-density arrays of many diverse DNA sequences in a small area. Unlike conventional synthesis techniques, which generally use a linear process to create compounds, our synthesis technique is combinatorial, in that the number of different compounds synthesized grows exponentially with the number of cycles in the synthesis. Currently, our commercial arrays contain over six million unique sequences. Each unique sequence is 25 to 50 nucleotides in length and is represented millions of times within a specified area of the array. Just as in the semiconductor industry, we manufacture arrays in a wafer format. Each wafer is approximately five inches square and can contain over 300 million unique probe sequences based on current technology. For our commercial array products, we can manufacture a large number of identical or different DNA probe arrays on a glass wafer, which is then diced into individual chips. The number of chips manufactured per wafer can be varied depending on the desired amount of information on each chip. The chips can be packaged individually, in our cartridge format, in our strip format or in our peg format. A strip format can have four arrays packaged together on a strip and a peg format can have up to 96 arrays packaged together for automated and parallel processing. Given the large amount of unique sequences represented in our arrays, our technology enables the efficient analysis of a multitude of DNA probes to analyze DNA or RNA sequences in a test sample.
 
The function of each single-stranded sequence on our array is to bind to its complementary single strand of DNA or RNA from a biological sample. Each unique feature on the array contains multiple copies of the same single strand of DNA. The nucleic acid (DNA or RNA) to be tested is isolated from a sample, such as blood, saliva or biopsy tissue, amplified and prepared for hybridization to the array. The test sample is then washed over the array, where the individual nucleic acid sequences that represent the genetic content or expressed genes of the sample hybridize to their complementary sequences bound on the array. The molecules in the test sample may be labeled with fluorescent dye either before or after hybridization. When scanned by a laser in the scanner instrument, the test sample generates a fluorescent signal. The locations where a fluorescent signal is detected by an optical detection system on the scanner instrument correspond to sequences complementary to the test sample. Sequence variation, or the quantification of specific sequences of nucleic acids in the sample, can be determined by detecting the relative strength of these signals since the sequence and position of each complementary DNA probe on the probe array is known. The combination of a particular array, together with an optimized set of reagents and a user protocol describing how to carry out the procedure, is referred to as an "assay."
 
bDNA Technology
 
We offer customers a suite of assay products for a wide variety of low- to mid-plex genetic, protein and cellular analysis applications using branched DNA, or bDNA, technology. These assays measure RNA levels directly from samples using a novel signal amplification method without the need for RNA purification, providing customers with improved accuracy, scale and workflow relative to traditional methods based on polymerase chain reaction, or PCR.
 
Our Products
 
Overview
 
We offer a comprehensive line of products for two principal applications: genotyping and gene expression. The majority of our product sales consist of sales of instruments and related consumables. We have three families of instrument systems, GeneChip®, GeneTitan® and GeneAtlasTM that include instruments, consumables and software. Our GeneChip® instruments run arrays packaged in cartridges and our GeneTitan® and GeneAtlasTM instruments run arrays packaged in a peg format for automated high throughput processing.
 
We also offer a variety of assays for gene expression targeting low- to mid-plex markets that are downstream of our whole genome arrays and a range of reagent kits that are compatible with our platforms as well as the products of other vendors.
 


GeneChip® Family of Products
 
Our GeneChip® system provides an integrated solution for gene expression and genotyping analysis. It consists of instruments and consumables that provide for the robust preparation and analysis of samples using our GeneChip® cartridge arrays. The components of the GeneChip® system include (1) disposable probe arrays containing genetic information on a chip, (2) reagents for extracting, amplifying and labeling target nucleic acids, (3) a fluidics station for introducing the test sample to the probe arrays, (4) a hybridization oven for optimizing the binding of samples to the probe arrays, (5) a scanner to read the fluorescent image from the probe arrays, and (6) software to analyze and manage the resulting genetic information.
 
Our major GeneChip® instrument products include:
 
Product
Product Description
GeneChip® Scanner 3000
Instrument for scanning higher-density arrays, including SNP arrays with up to 900,000 SNPs, tiling arrays for transcription and all-exon arrays for whole-genome analysis.
GeneChip® Scanner 3000Dx
This instrument is a version of the GeneChip® Scanner 3000 that is cleared by the United States Food and Drug Administration as an in vitro diagnostic device (“IVD”).
GeneChip® Fluidics Station
Instrument for the wash and stain of GeneChip® arrays.
GeneChip® Hybridization Oven
This instrument provides temperature and rotation control to ensure the successful hybridization of cartridge arrays before scanning.
 
Our major GeneChip® array and reagent products include:
 
Genotyping Catalog Cartridge Arrays
· CytoScan™ HD Array This array includes more than 2.6 million copy number markers and provides broad coverage for the detection of human chromosomal aberrations associated with genes related to constitutional and cancer cytogenetics.
 
· SNP 6.0 Array – This single chip array is a robust tool for studying variation. It enables genotyping of approximately 906,600 SNPs and assaying of approximately 946,000 non-polymorphic probes for detection of copy number.
 
· DMETPlus – This array features drug markers in FDA-validated genes and enables discovery and measurement of genetic variation associated with drug response.
 
Gene Expression Catalog Cartridge Arrays
· U133 – This array analyzes the expression level of over 47,000 transcripts and variants of the human genome.
 
· Other Arrays – We also offer a range of catalog expression arrays for the study of rat, mouse and other mammalian and model organisms.
 
Custom Arrays
· MyGeneChip™ and CustomSeq™ products are custom expression and sequence arrays designed by our customers to study organisms of interests to them.
 
 
GeneTitan® Family of Products
 
Our GeneTitan® family of products consists of the GeneTitan® instrument system that runs genotyping and gene expression array plates. The GeneTitan® family of products provides a hands-free, automated solution for monitoring gene expression and genome-wide SNP genotyping.
 


Our GeneTitan® products include:
 
Product
Product Description
GeneTitan®
The GeneTitan® instrument automates array processing from target hybridization to data generation by combining a hybridization oven, fluidics processing and imaging device into a single bench-top instrument. It runs array plates and supports both gene expression and genotyping studies.
Axiom™ Genotyping Solution
The Axiom™ Genotyping Solution includes array plates with validated genomic content, complete reagent kits, data analysis tools and a fully automated workflow utilizing the GeneTitan®.
 
· AxiomHuman Array Plates – these arrays are designed to maximize genomic coverage of common and novel SNPs and insertions and deletions in Caucasian, Asian and African populations.
 
· AxiomCustom Arrays – Customers can make custom arrays utilizing a proprietary database of validated genomic markers.
 
Gene Expression Array Plates
We offer a catalog of gene expression array plates similar to our catalog gene expression cartridge arrays to be used on the GeneTitan® instrument. These arrays are available for the study of human, rat, mouse and a broad range of other mammalian and model organisms.
 
Our GeneAtlasTM products include:
 
Product
Product Description
GeneAtlasTM Personal Microarray System
The GeneAtlasTM is a lower-priced instrument for low-to-medium throughput.  The GeneAtlasTM utilizes the array strip format, with four arrays per strip, and provides simplified hybridization and simple array processing with common microwell-based labware.
Gene Expression Array Plates
We offer a catalog of gene expression array plates for the study of human, rat and mouse to be used on our GeneAtlasTM system.
 
Low- to Mid-plex Products
 
We also offer an extensive line of multiplex assays to serve both the discovery and the validation markets. Multiplex assays measure many different targets from the same sample. These products enable drug target identification through analysis of gene silencing, cell signaling and biomarker validation. Our QuantiGene line of products is based on bDNA technology and delivers quantitative gene expression analysis. These products are compatible with a wide variety of samples and tissues.
 


Reagents
 
We offer researchers an extensive line of reagent kits, enzymes and biochemicals. Our reagents are complementary to our array portfolio, thus enabling us to provide our customers with whole product solutions. In addition, they can be applied to a broad variety of emerging technologies. Our reagents include:
 
·  
ExoSAP-IT® For PCR Product Clean-Up, a reagent for the rapid clean-up of PCR products used in downstream applications, such as DNA sequencing or SNP analysis.
 
·  
HotStart-IT® line of PCR reagents, reagents that utilize a novel primer binding protein to inhibit primer dimer formation, with results in sensitive and consistent amplification for real-time PCR.
 
Our Services
 
We offer high-throughput genotyping services for customers using our genotyping products. Our projects range in size from a few hundred samples to over 10,000 samples. We serve customers requiring quick turnaround times and suitably priced solutions to their large-scale academic and consortia genotyping studies.
 
Our Collaborative Partners
 
We collaborate with our partners to expand the applications of our technology and to acquire access to complementary technologies and resources. We collaborate with a number of instrumentation and reagent companies to develop and supply certain components of the user work flow. These companies include Beckman Coulter, Inc., CapitalBio Corporation, Life Technologies Corporation, Genisphere LLC, Takara Bio Inc., New England Biolabs, Inc., Luminex Corporation and Qiagen GmbH.
 
Through our Powered by Affymetrix™, or PbA Program, we permit commercial entities to license our technologies to develop custom product solutions based upon our arrays, instrumentation and software. Our PbA partners include F. Hoffman-La Roche Ltd., bioMerieux, Inc., Veridex, LLC, a Johnson & Johnson company, Signature Diagnostics and TessArae. We provide our PbA partners custom arrays. Our partners subsequently package these arrays into kits, seek regulatory approval and reimbursement for their diagnostic use, and sell them into the diagnostic markets using their sales channels. An example is the PathChip, a gene expression array used by our PbA partner Pathwork Diagnostics, Inc., in its Pathwork Tissue of Origin test. In July 2008, and again in January 2010, the U.S. Food and Drug Administration (“FDA”) cleared the version of the Pathwork Tissue of Origin test for marketing.
 
We also collaborate with certain academic, government, and commercial research groups to develop and validate new applications of our technologies. These include the Broad Institute of Harvard, the Massachusetts Institute of Technology and the National Genome Research Institute.
 
Sales and Distribution
 
We market and distribute our products directly to customers in North America, Japan and major European markets. In these markets, we have our own sales, service and application support personnel responsible for expanding and managing their respective customer bases. In other markets, such as Mexico, India, the Middle East and Asia Pacific, including the People’s Republic of China, we sell our products principally through third party distributors that specialize in life science supply. For molecular diagnostic and industrial applications market opportunities, we supply our partners with arrays and instruments, which they incorporate into diagnostic products and assume the primary commercialization responsibilities.
 
Manufacturing and Raw Materials
 
We manufacture our consumables, including our arrays and the majority of our reagents, and contract with third parties to manufacture our instruments. We manufacture our reagents in our Cleveland, Ohio facility and our arrays in our Singapore facility.
 


Our array manufacturing process involves wafer preparation, probe synthesis, dicing of synthesized wafers into chips, assembly of chips and quality control. We have developed software programs that extensively automate the design of photolithographic masks used in array manufacturing and that control the array manufacturing lines. Glass wafers are prepared for synthesis through the application of chemical coatings. Arrays are synthesized on the wafers using our proprietary, combinatorial photolithographic process. The completed wafers can then be diced into chips. The chips can be packaged individually, in our cartridge format, in our strip format or in our peg format.
 
We offer a variety of reagents to our customers, including those that are manufactured in-house, those that are supplied by qualified third-party suppliers and a combination of the two.
 
Our Singapore and Ohio facilities are fully operational and have been certified to ISO 13485 standards. The Singapore and Ohio facilities operate under the strict standards of our corporate quality plan. Third parties who manufacture our instruments will have to meet our quality standards as part of the qualification process.
 
Key parts of our product lines, such as our GeneTitan® instrument and hybridization ovens, are available from single sources. Likewise, certain raw materials or components used in the synthesis of arrays or the assembly of instrumentation are currently available only from a single source or limited sources. Alternative sources of supply may be time consuming and expensive to qualify. In addition, we are dependent on our vendors to provide components of appropriate quality and reliability, and to meet applicable regulatory requirements. We take what we believe are appropriate measures to prevent the delay or interruption of supplies from these vendors and to ensure the appropriate quality for our customers, since any delay or interruption could delay our ability to deliver our products to our customers.
 
Research and Development
 
Our research and development effort is divided into the major areas of basic research, product research and development, and manufacturing technology development. Our product development efforts are focused primarily on the development of new array, assay and reagent products, improving the overall performance of our assays and simplifying highly complex assays. We are also actively engaged in research aimed at enhancing the manufacturing process currently employed in the production of our arrays.
 
Our research and development expenses for the years ended December 31, 2011, 2010 and 2009 were $63.6 million, $67.9 million and $77.4 million, respectively.
 
Intellectual Property
 
We rely on a combination of patent, copyright, and trade secret laws, know-how and licensing opportunities to establish and protect our proprietary technologies and products. Our success depends in part on our ability to obtain patent protection for our products and processes, to preserve our copyrights and trade secrets, to operate without infringing the proprietary rights of third parties and to acquire licenses related to enabling technology or products used with our technology.
 
We are pursuing a patent strategy designed to facilitate our research and development program and the commercialization of our current and future products. While no one patent is considered essential to our success, we aggressively seek to protect our patent rights as our patent portfolio as a whole is material to the success of the business.
 
There are a significant number of United States and foreign patents and patent applications in our areas of interest, and we believe that there will continue to be significant litigation in the industry regarding patent and other intellectual property rights. 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. It may be necessary for us to enter into litigation to defend against or assert claims of infringement, to enforce patents issued to us, to protect trade secrets or know-how owned by us or to determine the scope and validity of the proprietary rights of others. From time to time, to determine the priority of inventions, it may be necessary for us to participate in interference proceedings declared by the United States Patent and Trademark Office. Litigation or patent administrative proceedings could result in substantial costs to and distraction from our core business and our efforts in respect to such proceedings may not be successful. For further information regarding intellectual property litigation involving us, see “Item 8. Financial Statements and Supplementary Data—Note 12. Legal Proceedings” in this Annual Report on Form 10-K.
 


We also rely upon copyright and trade secrets to protect our confidential and proprietary information. We seek to protect our proprietary technology and processes by confidentiality agreements with our employees and certain consultants and contractors. These agreements may be breached, we may not have adequate remedies for any breach and our trade secrets may otherwise become known or be independently discovered by competitors. To the extent that our employees or our consultants or contractors use intellectual property owned by others in their work for us, disputes may also arise as to the rights in related or resulting know-how and inventions.
 
We are party to various option, supply and license agreements with third parties which grant us rights to use certain aspects of our technologies. We take such measures as we believe are appropriate to maintain rights to such technology under these agreements. In addition, our academic collaborators have certain rights to publish data and information in which we have rights. There is considerable pressure on academic institutions to publish discoveries in the genetics and genomics fields. We take such steps as we believe are appropriate to ensure that such publication will not adversely affect our ability to obtain patent protection for information in which we may have a commercial interest.
 
Competition
 
The markets for our products are characterized by rapidly changing technology, evolving industry standards, changes in customer needs, emerging competition, new product introductions and strong price competition. We face significant competition as existing companies develop new or improved products, and as companies enter the market with new technologies, such as next-generation sequencing.
 
In the highly multiplexed genotyping and gene expression markets, existing competitive technologies include DNA sequencing, which we do not offer and is offered by companies such as Illumina, Inc., Life Technologies Corporation and Pacific Biosciences of California, Inc. Other companies developing or marketing competitive DNA array technology include Illumina, Inc., Agilent Technologies, Inc., BD Biosciences, CombiMatrix Corporation, MDS Analytic Technologies/Danaher, Nimblegen/Roche Diagnostics and NuGEN Technologies, Inc, some of which offer products directly competitive with our microarrays or reagents. In the low to midplex genotyping and gene expression markets, much of the existing low-plex competition comes from the supplier of realtime PCR products, including Life Technologies Corporation, who has a dominant position, Roche Diagnostics, Agilent Technologies, Inc. and BioRad Laboratories, Inc. In addition, there are new midplex technologies being offered by Fluidigm Corporation, Sequenom, Inc., High Throughput Genomics, Inc., Beckman Coulter, NanoString Technologies and Life Technologies Corporation (BioTrove). In order to compete against existing and emerging technologies, we will need to demonstrate that our products have superior throughput, cost and accuracy advantages over competing products.
 
In the molecular diagnostic field, competition is likely to 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. The market for molecular diagnostic products derived from gene discovery is highly competitive and has high barriers of entry, with several large corporations already having significant market share. Established diagnostic companies such as Beckman Coulter, Becton, Dickinson and Company, bioMérieux, Johnson & Johnson, Gen-Probe Incorporated and Roche Diagnostics have the strategic commitment to diagnostics, the financial and other resources to invest in new technologies, 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 our system and could slow 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.
 
We will face increased competition in existing and potential markets as the cost of new technologies such as sequencing and other technologies improves. We expect new competitors and technologies to emerge. 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 themselves. We have significantly expanded our network of approved service providers in America, Japan, Europe, and China. While these companies expand the reach of Affymetrix technology and make its analytical power available to a wider base of users they may act as a substitute for outright purchase of instruments and arrays by those end users. In addition, we have several other third-party licensees that could offer products that compete with our product offerings.
 


Government Regulation
 
Many of our products are labeled for research use only. Products intended for research use only are not subject to clearance or approval by the FDA. However, research use only products may fall under the FDA’s jurisdiction if these are used for clinical rather than research purposes. Even where a product is not otherwise subject to clearance or approval by the FDA, the FDA may impose restrictions as to the manner in which we can market and sell our products and/or the types of customers to which we can market and sell our products in order to limit sales to those who use the products for research only.
 
Our GeneChip® Scanner 3000Dx is cleared by the FDA to be used in conjunction with cleared medical devices such as the Roche Diagnostics AmpliChip CYP450 Test. We will continue to develop diagnostic products ourselves or with our collaborative partners that may require regulatory clearance or approval by governmental agencies. Commercially available in-vitro diagnostic test kits and the reagents and instrumentation used with in-vitro diagnostic tests are regulated as medical devices and are generally subject to rigorous testing and other pre-market review procedures by the FDA in the U.S. and by other regulatory agencies in other countries. The FDA's Quality System Regulations also apply in connection with our manufacture of arrays and systems as components for use in diagnostic products distributed outside of the research environment. Obtaining these clearances or approvals and the compliance with these regulations require the expenditure of substantial resources over a significant period of time, and we cannot assure you that any clearances or approvals will be granted on a timely basis, if at all. Once granted, a clearance or approval may place substantial restrictions on how the device is marketed or labeled or to whom it may be sold. In addition, various federal and state statutes and regulations govern or influence the manufacturing, safety, and storage of our products and components of our products as well as our record keeping.
 
The FDA, the U.S. Department of Health and Human Services, state authorities, and foreign government regulators are increasingly focused on genetic analysis tools, including the use of microarrays, which are labeled for research use only, by clinical laboratories in laboratory-developed tests offered by these laboratories, including labs certified under the Clinical Laboratory Improvement Amendments, or CLIA, or licensed under state laboratory regulations. We cannot predict the nature of future regulatory or policy initiatives with respect to the sale and use of arrays for the development of assays by CLIA-certified, state licensed laboratories, or the extent to which such initiatives will impact our business. If new regulations restrict our customers’ development of laboratory-developed tests using products labeled for research use only, or if we otherwise are required to obtain FDA premarket clearance or approval prior to commercializing products labeled as research use only, our ability to generate revenue from the sale of our products may be delayed or otherwise adversely affected. Moreover, our failure to comply with governmental rules and regulations related to our products could cause us to incur significant adverse publicity, or subject us to investigations and notices of non-compliance or lead to fines or restrictions upon our ability to sell our products. We also may be at risk for liability related to government reimbursement of tests involving the use of our products if it were determined that these tests require FDA-clearance or approval and no such clearance or approval has been obtained.
 
Medical device laws and regulations are also in effect in many countries, including countries in the European Union, ranging from comprehensive device approval requirements to requests for product data or certifications. The number and scope of these requirements are increasing. We may not be able to obtain regulatory approvals in such countries or may incur significant costs in obtaining or maintaining our foreign regulatory approvals. In addition, the export by us of certain of our products which have not yet been cleared for domestic commercial distribution may be subject to FDA or other export restrictions.
 
We have agreements relating to the sale of our products to government entities and, as a result, we are subject to various statutes and regulations that apply to companies doing business with the government. A failure to comply with these regulations might result in suspension of these contracts or administrative or other penalties, and could have a material adverse effect on our ability to compete for future government grants, contracts and programs.
 
Reimbursement
 
The design of our products and the potential market for their use may be directly or indirectly affected by U.S. and other government regulations governing reimbursement for clinical testing services. The availability of third-party reimbursement for our products and services may be limited or uncertain, particularly with respect to genetic tests and other clinical applications products.
 


Third-party payers may deny reimbursement if they determine that an ordered health care product or service has not received appropriate FDA or other governmental regulatory clearances, is not used in accordance with cost-effective treatment methods as determined by the payer, or is deemed by the third-party payer to be experimental, unnecessary or inappropriate. Under Medicare rules, diagnostic tests must be ordered by a physician who is treating the beneficiary and who uses the test results in patient management. Under this rule, some Medicare contractors may deny coverage for a test, even if the test has been cleared or approved by the FDA, without proof, as determined sufficient by the contractor, that the test is useful in patient management. Furthermore, third-party payers are increasingly challenging the prices charged for health care products and services.
 
We are currently developing diagnostic and therapeutic products, including those with our collaborative partners which may be subject to reimbursement issues. The commercialization of such products may depend, in part, on the extent to which reimbursement for these products will be available under U.S. and foreign regulations governing reimbursement for clinical testing services by government authorities, private health insurers and other organizations.
 
In the United States, third-party payer price resistance, the trend towards managed health care, implementation of the Patient Protection and Affordable Care Act of 2010 and other legislative proposals to reform health care or reduce government insurance programs could reduce payment rates for health care products and services, adversely affect the profits of our customers and collaborative partners and thus reduce our future royalties and product sales.
 
Environmental Matters
 
We are dedicated to compliance and protection of the environment and individuals. Our operations require the use of hazardous materials (including biological materials) which subject us to a variety of federal, state and local environmental and safety laws and regulations. Some of the regulations under the current regulatory structure allow for "strict liability," holding a party potentially liable without regard to fault or negligence. We could be held liable for damages and fines as a result of our, or others', business operations should contamination of the environment or individual exposure to hazardous substances occur. We cannot predict how changes in these laws or development of new regulations will affect our business operations or the cost of compliance.
 
Employees
 
As of February 22, 2012, we had 875 full-time employees. The employee group includes chemists, engineers, computer scientists, mathematicians and molecular biologists with experience in the diagnostic products, medical products, semiconductor, computer software and electronics industries. None of our employees is represented by a collective bargaining agreement, nor have we experienced work stoppages. Our success depends in large part on our ability to attract and retain skilled and experienced employees.
 
Seasonality
 
Customer demand for probe arrays and instrumentation systems is typically highest in the fourth quarter of the calendar year as customers spend unused budget allocations before the end of the year.
 
Backlog
 
Because most customer orders are shipped in the quarter in which they are received, we believe that backlog at quarter end is typically not a material indicator of future sales. In addition, backlog may not result in sales because of cancellation of orders or other factors. On a few occasions we have experienced, and made public announcements about, short-term increases in backlog as a result of factors such as new product introductions or supply constraints.
 
Financial Information About Industry Segments
 
We operate in one business segment, for the development, manufacture, and commercialization of systems for genetic analysis in the life sciences and diagnostic industry. Our operations are treated as one segment as we only report operating information on a total enterprise level to our chief operating decision-maker. Further, resource allocations are also made at the enterprise level by our chief operating decision-maker.
 


Financial Information About Geographic Areas
 
Our total revenue from customers outside of the United States for the years ended December 31, 2011, 2010 and 2009 was $125.0 million, $132.7 million and $136.8 million, or approximately 47%, 43% and 42%, respectively, of our total revenue. A summary of revenues from external customers attributed to each of our geographic areas for the years ended December 31, 2011, 2010 and 2009 is included in “Item 8. Financial Statements and Supplementary Data—Note 16. Segment and Geographic Information”.
 
Available Information
 
Our internet address is www.affymetrix.com. Information included on our website is not part of this Form 10-K. We make available free of charge on our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition, copies of our annual reports are available free of charge upon written request. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is www.sec.gov.
 


ITEM 1A. RISK FACTORS
 
Risks Related to the Growth of Our Business
 
If we do not continually develop and commercialize new or enhanced products and services, our business may not grow.
 
Our success depends in large part on our continual, timely development and commercialization of new or enhanced products and services that address evolving market requirements and are attractive to customers. The genetic analysis tools market, including the RNA/DNA probe array field, is characterized by rapid and significant technological changes, frequent new product introductions and enhancements, evolving industry standards and changing customer needs. Standardization of tools and systems for genetic research is still ongoing and we cannot assure you that our products will emerge as the standard for genetic research. Other companies may introduce new technologies, techniques, products or services that render our products or services obsolete or uneconomical. If we do not appropriately innovate and invest in new technologies, then our technologies will become dated and our customers could move to new technologies offered by our competitors.
 
As a result, we are continually looking to develop, license or acquire new or enhanced technologies, products and services to further broaden and deepen our offerings. Some of the factors affecting market acceptance of our products and services include:
 
 
·
availability, quality and price as compared to competitive technologies, products and services;
 
 
·
the functionality of new and existing products and services, and whether they address market requirements;
 
 
·
the timing of introduction of our technologies, products and services as compared to competitive technologies, products and services;
 
 
·
the existence of product defects;
 
 
·
scientists’ and customers’ opinions of the utility of our products and services and our ability to incorporate their feedback into future products and services;
 
 
·
citation of our products in published research; and
 
 
·
general trends in life science research and life science informatics software development.
 
Our new or enhanced technologies, products or services may not be accepted by customers in our target markets. For example, once we have developed or obtained a new technology, we may fail to successfully commercialize new products and services based on that technology, particularly to the extent that our new products and services compete with established technologies or the products and services of more established competitors. Risks relating to product adoptions include the inability to accurately forecast demand and difficulties in managing different sales and support requirements due to the type or complexity of the new products.
 
Further, many of our current and potential customers have limited budgets. Accordingly, we cannot assure you that the successful introduction of new or enhanced products or services will not adversely affect sales of our current products and services or that customers that currently purchase our products or services will increase their aggregate spending as a result of the introduction of new products and services.
 
The Merger Agreement pursuant to which we have agreed to acquire eBioscience may be terminated in accordance with its terms and the merger may not be completed.
 
On November 29, 2011, we entered into a Merger Agreement to acquire eBioscience for approximately $330 million in cash, subject to certain adjustments as provided in the Merger Agreement. The merger is subject to a number of conditions which must be fulfilled in order to complete the merger, including our receipt of financing for the merger.
 
 
 
In connection with the Merger Agreement, we entered into a commitment letter with financing sources providing for $190 million of senior secured credit. The conditions to funding these facilities have not been satisfied, and as a result we will not be able to complete the eBioscience acquisition unless the terms of the acquisition and the financing are restructured. We are in discussions with financing sources and with eBioscience but no agreements or understandings have been reached. We have waived eBioscience’s obligations under the non-solicitation provisions set forth in the Merger Agreement and we understand that eBioscience is considering alternatives to the merger. The Merger Agreement may be terminated by either party if the closing of the merger has not occurred by March 31, 2012, so long as a breach of the Merger Agreement by the party seeking to terminate has not been the proximate cause of or resulted in the failure of the merger to occur on or before such date.
 
If we cannot successfully reach agreement with the financing sources and eBioscience on a restructured merger, the Merger Agreement may be terminated under its terms. The failure of the merger to be completed may result in negative publicity and/or a negative impression of us in the investment community, may cause our stock price to decline and may adversely affect our relationship with employees, customers and other partners in the business community.
 
Uncertainty associated with the completion of the merger may cause substantial disruptions in our business and eBioscience’s business.
 
Uncertainty associated with the completion of the merger may cause substantial disruptions in our business and eBioscience’s business, which could have an adverse effect on our financial results. Among other things, such uncertainty may affect our relationships with customers, potential customers and suppliers and our ability to recruit prospective employees or to retain and motivate existing employees. eBioscience may face similar disruptions to its business, which could have an adverse effect on the combined business if the merger is completed. The adverse effect of such disruptions could be exacerbated by further delay in the completion of the merger or termination of the Merger Agreement.
 
Uncertainty about the completion of the merger also may impair our and eBioscience’s ability to attract, retain and motivate key personnel. Employee retention may be particularly challenging during the pendency of the merger as our employees and those of eBioscience may experience uncertainty about the completion of the merger or their future roles with the combined business if the merger is completed. If our key employees or those of eBioscience depart, we may have to incur significant costs in identifying, hiring and retaining replacements for departing employees, which could reduce our ability to realize the anticipated benefits of the merger.
 
We are not able to complete the merger unless the terms of the acquisition and the related financing are restructured. If the merger is completed, we may incur a substantial amount of indebtedness, which could adversely affect our business, or issue a significant amount of common stock or other equity securities, which would dilute our existing stockholders.
 
In connection with the Merger Agreement, we entered into a commitment letter with financing sources providing for $190 million of senior secured credit. The conditions to funding these facilities have not been satisfied, and as a result we will not be able to complete the merger unless the terms of the acquisition and the financing are restructured. Although we are in discussions with financing sources and with eBioscience regarding the possibility of restructuring the committed financing, no agreements or understandings have been reached.
 
If the merger is completed, we may incur a substantial amount of indebtedness, which could adversely affect us, including by decreasing our business flexibility and increasing our borrowing costs. If we incur indebtedness in connection with the merger, we may significantly increase our interest expense, leverage and debt service requirements. Increased levels of indebtedness may reduce funds available for our investment in product development as well as capital expenditures and other activities, increase our borrowing costs and create competitive disadvantages for us relative to other companies with lower debt levels. In addition, we expect the financing agreements governing any debt financing to contain customary restrictive covenants imposing operating and financial restrictions on us, including restrictions that may limit our ability to finance future operations or capital needs or to engage in other business activities. If an event of default occurs under any debt financing agreement, we may be required to immediately repay all outstanding borrowings, together with accrued interest and other fees. We may not be able to repay all amounts due in the event these amounts are declared due upon an event of default.
 
 
 
If we issue a significant amount of common stock or other equity securities in connection with the merger, our existing stockholders will be diluted, and the market price of our common stock may decline. In addition, such an issuance may require the approval of our stockholders, which would further delay the completion of the merger. There can be no assurance that stockholder approval, if required, would be obtained on a timely basis, or at all.
 
If the merger is completed, we will incur significant transaction and merger-related costs.
 
If the merger is completed, we expect to incur a number of non-recurring costs associated with combining the operations of the two companies. The substantial majority of non-recurring expenses resulting from the merger will be comprised of transaction costs related to the merger and financing arrangements and employment-related costs. We also will incur transaction fees and costs related to formulating and implementing integration plans. We continue to assess the magnitude of these costs and additional unanticipated costs may be incurred in the integration of the two companies’ businesses. Although we expect that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, should allow us to offset incremental transaction and merger-related costs over time, this net benefit may not be achieved in the near term, or at all.
 
Our growth depends in part on our ability to acquire new businesses and technologies and successfully integrate acquisitions, which may absorb significant resources and may not be successful.
 
As part of our strategy to develop and identify new technologies, products and services, we have made and may continue to acquire new businesses and technologies. Our integration of the operations of acquired businesses requires significant efforts, including the coordination of information technologies, research and development, sales and marketing, operations, manufacturing and finance. In particular, if our proposed acquisition of eBioscience is completed, its success will depend, in part, on our ability to successfully integrate eBioscience’s business and operations and fully realize the anticipated benefits and synergies from combining our businesses and eBioscience. If we are not able to achieve these objectives following the merger, the anticipated benefits and synergies of the merger may not be realized fully or at all or may take longer to realize than expected. Our efforts to successfully integrate acquisitions may result in additional expenses and divert significant amounts of management’s time from other projects.
 
Our failure to manage successfully and coordinate the growth of the combined company could also have an adverse impact on our business. In addition, there is no guarantee that some of the businesses we acquire will become profitable or remain so. If our acquisitions do not meet our initial expectations, we may record impairment charges.
 
Factors that will affect the success of our acquisitions include:
 
 
·
our ability to retain key employees of the acquired company;
 
 
·
the performance of the acquired business, technology, product or service;
 
 
·
our ability to integrate operations, financial and other systems;
 
 
·
the ability of the combined company to achieve synergies among its constituent companies, such as increasing sales of the combined company’s products and services, achieving expected cost savings and effectively combining technologies to develop new products and services;
 
 
·
any disruption in order fulfillment or loss of sales due to integration processes;
 
 
·
the presence or absence of adequate internal controls and/or significant fraud in the financial systems of acquired companies;
 
 
·
any decrease in customer and distributor loyalty and product orders caused by dissatisfaction with the combined companies’ product lines and sales and marketing practices, including price increases; and
 
 
·
our assumption of known contingent liabilities that are realized, known liabilities that prove greater than anticipated, or unknown liabilities that come to light, to the extent that the realization of any of these liabilities increases our expenses or adversely affects our business or financial position.
 


Emerging market opportunities in molecular diagnostics may not develop as quickly as we expect and we depend on the efforts of our partners to be successful.
 
The clinical applications of our technologies for diagnosing and enabling informed disease management options in the treatment of disease is an emerging market opportunity in molecular diagnostics. At this time, we cannot be certain that molecular diagnostic markets will develop as quickly as we expect. Although we believe that there will be clinical applications of our technologies that will be utilized for diagnosing and enabling informed disease management options in the treatment of disease, there can be no certainty of the technical or commercial success our technologies will achieve in such markets.
 
Our success in the molecular diagnostics market depends in part on our collaborative relationships and the ability of our collaborative partners to achieve regulatory approval for such products in the United States and in overseas markets, and successfully market and sell products using our technologies.
 
Risks Related to Our Sales
 
We face significant competition, and our failure to compete effectively could adversely affect our sales and results of operations.
 
We compete with companies that develop, manufacture and market genetic analysis tools for the life science and clinical healthcare markets. We face significant competition as our competitors and new companies develop new, improved or more economical products, services and technologies.
 
The market for our products and services is highly competitive, has high barriers to entry and has several other large companies with significant market share. For example, companies such as Illumina, Inc., Agilent Technologies and Life Technologies Corporation have products for genetic analysis that are directly competitive with certain of our products. In addition, Illumina, Inc., Life Technologies Corporation and Complete Genomics, Inc. also offer DNA sequencing technology which we do not offer. As the costs of DNA sequencing fall, we will face increased competition in certain of our existing and potential markets. We also face competition from established diagnostic companies such as Beckman Coulter, Becton, Dickinson and Company, bioMérieux, Celera Diagnostics, Johnson & Johnson, Gen-Probe Incorporated and Roche Diagnostics, which have made strategic commitments to diagnostics, have financial and other resources to invest in new technologies, and have substantial intellectual property portfolios, substantial experience in new product development and regulatory expertise. In addition, our collaborative partners may compete with us.
 
Many of our current and potential competitors have significantly greater financial, technical, marketing and other resources than we do. In addition, many current and potential competitors have greater name recognition, more extensive customer bases and access to proprietary genetic content.
 
Reduction or delay in research and development budgets and government funding may adversely impact our sales.
 
We expect that our revenue in the foreseeable future will be derived primarily from products and services provided to pharmaceutical and biotechnology companies, as well as a relatively small number of academic, governmental and other research institutions. Our operating results may fluctuate substantially due to reductions and delays in research and development expenditures by these customers.
 
Factors that could affect the spending levels of our customers include:
 
 
·
changes in government programs that provide funding to companies and research institutions;
 
 
·
weakness in the global economy and changing market conditions that affect our customers;
 
 
·
changes in the extent to which the pharmaceutical industry may use genetic information and genetic testing as a methodology for drug discovery and development;
 
 
·
changes in the regulatory environment affecting life science companies and life science research;
 
 
·
impact of consolidation within the pharmaceutical industry; and
 
 
 
 
·
cost reduction initiatives of customers.
 
As we implement our strategy to expand into new markets, the size and structure of our current sales, marketing and technical support organizations may limit our ability to sell our products and services.
 
As we implement our strategy to expand into new markets, we may not be able to establish a sales, marketing and technical support organization sufficient to sell, market and support all of our new products, or to cover all of the regions that we target globally. To assist our sales and support activities, we have entered into distribution agreements through certain distributors, principally in markets outside of North America and Europe. In addition, we may enter into distribution arrangements with respect to some of our products that we believe will be better served in such arrangements than our current sales and marketing organizations. We have less control over other third parties on whom we rely for sales, marketing and technical support. In addition, these third parties may decide to develop and sell competitive products or otherwise become our competitors, which could harm our business.
 
Consolidation trends in both our market and many of our customers’ markets have increased competition.
 
There has been a trend toward industry consolidation in our markets for the past several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in operating results and could harm our business.
 
Additionally, there has been a trend toward consolidation in many of the customer markets we sell to, in particular the pharmaceutical industry. Consolidation in our customer markets results in increased competition for important market segments and fewer available accounts, and larger consolidated customers may be able to exert increased pricing pressure on companies in our market.
 
If we are unable to maintain our relationships with collaborative partners, we may have difficulty developing and selling our products and services.
 
Our commercial success depends in part on our ability to develop and maintain collaborative relationships with key companies as well as with key academic researchers. In particular, we depend on our collaborators for in-licensed technology and components for a variety of our product lines. We collaborate with a number of instrumentation and reagent companies, including Beckman Coulter, CapitalBio Corporation, Genisphere LLC, Life Technologies Corporation, Luminex Corporation, Siemens Medical Solutions Diagnostics, Takara Bio Inc., New England Biolabs, Inc. and Qiagen GmbH. Some of these collaborators, like Life Technologies Corporation, Takara Bio Inc., New England Biolabs, Inc. and Luminex Corporation, are currently sole suppliers of components of some of our reagent kits but they are also our competitors. Relying on our collaborative relationships is risky to our future success because:
 
 
·
our partners may develop technologies or components competitive with our products and services;
 
 
·
our existing collaborations may preclude us from entering into additional future arrangements;
 
 
·
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 and services;
 
 
·
our partners may be unable to provide the resources required for us to progress in the collaboration on a timely basis;
 
 
·
our collaborations may be unsuccessful; or
 
 
·
some of our agreements have expired and we may not be able to negotiate future collaborative arrangements on acceptable terms.
 
 
 
Risks Related to the Manufacturing of Our Products
 
We depend on a limited number of suppliers. We will be unable to launch or commercialize our products in a timely manner if our suppliers are unable to meet our requirements or if shipments from these suppliers are delayed or interrupted.
 
We outsource the manufacturing of our instruments to a limited number of suppliers. Some of our instruments and other key parts of our product lines, including components of our manufacturing equipment and certain raw materials used in the manufacture of our products are currently only available from a single supplier. Therefore, we depend on our suppliers to supply our instruments, or components of our products, in required volumes, at appropriate quality and reliability levels, and in compliance with regulatory requirements on a timely basis. If supplies from these vendors do not meet our requirements, or were delayed or interrupted for any reason, we would not be able to commercialize our products successfully or in a timely fashion, and our business could be adversely impacted.
 
Our business is dependent on our ability to forecast our needs for components and products in our product lines and our suppliers’ ability to deliver such components and products in time to meet critical manufacturing and product release schedules. Our business could be adversely affected, for example, if suppliers fail to meet product release schedules, if we experience supply constraints, if we fail to negotiate favorable pricing or if we experience any other interruption or delay in the supply chain which interferes with our ability to manufacture our products or manage our inventory levels.
 
We may lose customers or sales if we are unable to meet customer demand for our products on a timely and cost-effective basis, or if we are unable to ensure the proper performance and quality of our products.
 
We produce our products in an innovative and complicated manufacturing process which has the potential for significant variability in manufacturing yields. We have encountered, and may in the future encounter, difficulties in manufacturing our products and, due to the complexity of our products and our manufacturing process, we may experience delays in the manufacture of our products or fail to ensure their proper performance or quality. As we develop new and enhanced products, we must be able to resolve in a timely, cost-effective manner manufacturing issues that may arise from time to time.
 
We base our manufacturing capabilities on our forecasted product mix for the quarter. If the actual product mix varies significantly from our forecast, we may not be able to fill some orders during that quarter, which could adversely impact our financial results. Difficulties in meeting customer, collaborator and internal demand could also cause us to lose customers or require us to delay new product introductions, which could in turn result in reduced demand for our products.
 
We rely on internal quality control procedures to verify our manufacturing processes. Due to the complexity of our products and manufacturing process, however, it is possible that products that do not meet all of our performance specifications may not be identified before they are shipped. If our products do not consistently meet our customers’ performance expectations, demand for our products will decline. In addition, we do not maintain any backup manufacturing capabilities for the production of our products. Any interruption in our ability to continue operations at our existing manufacturing facilities could delay our ability to develop or sell our products, which could result in lost revenue and seriously harm our business, financial condition and results of operations.
 
We may need to adjust our manufacturing capacity based on business requirements or improvements made to our technological capabilities and there are risks associated with such adjustment.
 
If demand for our products is reduced or if we implement technologies that increase the density or yields of our wafers, our manufacturing capacity could be under-utilized and some of our long-lived assets, including facilities and equipment, may be impaired, which would increase our expenses. In addition, factory planning decisions may shorten the useful lives of long-lived assets including facilities and equipment, and cause us to accelerate depreciation. These changes in demand for our products, and changes in our customers’ product needs, could have a variety of negative effects on our competitive position and our financial results, and, in certain cases, may reduce our revenue, increase our costs, lower our gross margin percentage or require us to recognize impairments of our assets. In addition, if demand for our products is reduced or we fail to accurately forecast demand, we could be required to write down inventory since certain of our products have a limited shelf life, which would have a negative impact on our gross margin.
 
 
 
We have in the past, and may in the future, adjust our manufacturing capacity based on business requirements, which may include the rationalization of our facilities, including the abandonment of long-lived manufacturing assets and additional charges related to a reduction in capacity. Manufacturing and product quality issues may arise as we launch new products in our Singapore and Ohio facilities and rely increasingly upon manufacturing by third parties. We may lose customers if we are unable to manufacture products or if we experience delays in the manufacture of our products as a result of this transition.
 
We may not be able to deliver acceptable products to our customers due to the rapidly evolving nature of genetic sequence information upon which our products are based.
 
The genetic sequence information upon which we rely to develop and manufacture our products is contained in a variety of databases throughout the world. These databases are rapidly expanding and evolving. In addition, the accuracy of these databases and resulting genetic research is dependent on various scientific interpretations and it is not expected that global genetic research efforts will result in standardized genetic sequence databases for particular genomes in the near future.
 
Although we have implemented ongoing internal quality control efforts to help ensure the quality and accuracy of our products, the fundamental nature of our products requires us to rely on genetic sequence databases and scientific interpretations which are continuously evolving. As a result, these variables may cause us to develop and manufacture products that incorporate sequence errors or ambiguities. The magnitude and importance of these errors will depend upon multiple and complex factors that would be considered in determining the appropriate actions required to remedy any inaccuracies. Our inability to timely deliver acceptable products as a result of these factors would likely adversely affect our relationship with customers, and could have a material adverse effect on our business, financial condition and results of operations.
 
Risks Related to Our Operations
 
We may not achieve sustained profitability.
 
Prior to 2002, we incurred losses each year since our inception, and we reported losses in 2006, and from 2008 through 2011. As a result, we had an accumulated deficit of approximately $478.7 million as of December 31, 2011. Our ability to achieve sustained profitability will depend, in part, on the rate of growth, if any, of our revenue and on the level of our expenses. In 2011, our business was affected by a significant drop in the volume of sales and consumables to our academic and pharmaceutical customers, particularly in North America, which led to a decrease in revenue as compared to 2010. There can be no assurance that our revenue will not continue to decrease in future periods. We expect to continue incurring significant expenses related to research and development, sales and marketing efforts to commercialize our products, litigation and non-cash stock based compensation, and we expect to continue to experience fluctuations in our operating results. If our revenue grows more slowly than we anticipate, or if our operating expenses are above what we expect or cannot be reduced in the event of lower revenue, we may not become profitable on a sustained basis, or at all.
 
If we do not attract and retain key employees, our business could be impaired.
 
To be successful, we must attract and retain qualified scientific, engineering, manufacturing, sales, marketing and management personnel. To expand our research, product development and sales efforts we need additional people skilled in areas such as bioinformatics, organic chemistry, information services, regulatory affairs, manufacturing, sales, marketing and technical support. Competition for these people is intense, and our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. For example, our stock price has been volatile in recent years, resulting in a significant number of stock options granted to our employees having a strike price that is higher than the current trading price of our common stock. If we are unable to hire, train and retain a sufficient number of qualified employees, we will not be able to expand our business or our business could be adversely affected.
 
We also rely on our scientific advisors and consultants to assist us in formulating our research, development and commercialization strategy. All of these individuals are engaged by other employers and have commitments to other entities that may limit their availability to us.
 
 
 
Due to the international nature of our business, political or economic changes or other factors could harm our business.
 
A significant amount of our revenue is currently generated from sales outside the United States. Although such transactions are denominated in both U.S. dollars and foreign currencies, our future revenue, gross margin, expenses and financial condition are still affected by such factors as changes in foreign currency exchange rates; unexpected changes in, or impositions of, legislative or regulatory requirements, including export and trade barriers and taxes; longer payment cycles and greater difficulty in accounts receivable collection.
 
We also are subject to general geopolitical risks in connection with international operations, such as political, social and economic instability, potential hostilities, epidemics and changes in diplomatic and trade relationships. We cannot assure investors that one or more of the foregoing factors will not have a material adverse effect on our business, financial condition and operating results or require us to modify our current business practices.
 
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. Estimates and judgments are required in determining our worldwide provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. The ultimate amount of tax liability may be uncertain as a result.
 
Changes in overall levels and the geographic mix of pretax earnings may adversely impact our effective tax rate. Certain jurisdictions have lower tax rates, and the amount of earnings in these jurisdictions may fluctuate. If we do not have profitable operations in these jurisdictions, our effective tax rate could be adversely impacted. Changes in tax laws, regulatory requirements, our treasury plans, and applicability of tax holidays and incentive programs in the countries in which we operate could have a material impact on our tax provision. Tax authorities may challenge the allocation of profits between our subsidiaries and conformance with requirements of tax holidays and incentive programs and we may not prevail in any such challenge. If we were not to prevail, we could be subject to higher tax rates or double tax.
 
Estimates are required in determining any valuation allowance to be recorded against our net deferred tax assets. Changes in the amount of valuation allowance required may significantly impact our financial results of operations.
 
In the normal course of business, we are subject to examination by taxing authorities in the U.S. and multiple foreign jurisdictions. During November 2011, the U.S. Internal Revenue Service completed its field examination of our federal income tax returns for the 2004, 2005, 2006, 2008 and 2009 tax years and issued a Revenue Agent’s Report, or RAR, with no proposed adjustments.
 
Failure in our information technology systems could disrupt our operations and cause the loss of customers or business opportunities.
 
Information technology (“IT”) systems are used extensively in virtually all aspects of our business, including sales forecast, order fulfillment and billing, customer service, logistics and management of data from running samples on our products. Our success depends, in part, on the continued and uninterrupted performance of our IT systems. IT systems may be vulnerable to damage from a variety of sources, including telecommunications or network failures, human acts and natural disasters. Moreover, despite the security measures we have implemented, our IT systems may be subject to physical or electronic break-ins, computer viruses and similar disruptive problems. We also have taken precautionary measures to prevent unanticipated problems that could affect our IT systems. Nevertheless, we may experience damages to our systems, and system failures and interruptions.
 
If we experience systems problems, they may interrupt our ability to operate and adversely affect our reputation and result in a loss of customers and revenues.
 
 
 
Risks Related to Our Investments
 
Our strategic equity investments may result in losses.
 
We periodically make strategic equity investments in various public and private companies with businesses or technologies that may complement our business. The market values of these strategic equity investments may fluctuate due to market conditions and other conditions over which we have no control. Other-than-temporary declines in the market price and valuations of the securities that we hold in other companies have required us to record losses relative to our ownership interest. This could result in future charges to our earnings. It is uncertain whether or not we will realize any long-term benefits associated with these strategic investments.
 
Global credit and financial market conditions could negatively impact the value of our current portfolio of cash equivalents or investments and our ability to meet our financing objectives.
 
Our cash and cash equivalents are maintained in highly liquid investments with remaining maturities of 90 days or less at the time of purchase. Our investments consist primarily of readily marketable debt securities with remaining maturities of more than 90 days at the time of purchase. While as of the date of this filing, we are not aware of any downgrades, material losses, or other significant deterioration in the fair value of our cash equivalents or investments since December 31, 2011, any significant deterioration in conditions of the global credit and financial markets may negatively impact our current portfolio of cash equivalents or investments or our ability to meet our financing objectives. Other-than-temporary declines in the market price and valuation of any of our investments would require us to adjust the carrying value of the investment through an impairment charge.
 
Risks Related to Government Regulation and Litigation
 
We and our customers are subject to various government regulations, and we may incur significant expenses to comply with, and experience delays in our product commercialization as a result of, these regulations.
 
The Food and Drug Administration (“FDA”) has jurisdiction over the commercialization of medical devices, including in-vitro diagnostic test kits and the reagents and instrumentation used in these tests. In-vitro diagnostic tests, reagents, and instruments may be subject to pre-market review and post-market controls by the FDA. Certain in-vitro diagnostic products must also be approved by the regulatory agencies of foreign governments or jurisdictions before the product can be sold outside the United States. Commercialization of our and our collaborative partners’ in-vitro diagnostic products outside of the research environment may depend upon successful completion of clinical trials. Clinical development is a long, expensive and uncertain process and we do not know whether we, or any of our collaborative partners, will be permitted to undertake clinical trials of any potential in-vitro diagnostic products. It may take us or our collaborative partners many years to complete any such testing, and failure can occur at any stage. Delays or rejections of potential products may be encountered based on changes in regulatory policy during the period of product development and regulatory agency review. Moreover, if and when our projects reach clinical trials, we, or our collaborative partners, may decide to discontinue development of any or all of these projects at any time for commercial, scientific or other reasons. Any of the foregoing matters could have a material adverse effect on our business, financial condition and results of operations.
 
Many of our products are labeled for “research use only”. Products intended for research use only are not subject to clearance or approval by the FDA. However, research use only products may fall under the FDA’s jurisdiction if these are used for clinical rather than research purposes. Even when a product is exempted from FDA clearance or approval, the FDA may impose restrictions as to the types of customers to which we can market and sell our products. Such restrictions may materially and adversely affect our business, financial condition and results of operations.
 
 
 
The FDA, the U.S. Department of Health and Human Services and foreign government regulators are increasingly focused on genetic analysis tools, including the use of arrays, which are labeled for research use only, by clinical laboratories in laboratory-developed tests (“LDTs”) offered by these laboratories, including labs certified under the Clinical Laboratory Improvement Amendments (“CLIA”). We cannot predict the extent of the FDA’s future efforts in regulation and enforcement policies with respect to the sale and use of arrays for the development of LDTs by CLIA-certified laboratories. If regulations or enforcement policies restrict our customers’ development of LDTs using our products labeled for research use only, or if we otherwise are required to obtain FDA premarket clearance or approval prior to commercializing these products, our ability to generate revenue from the sale of our products may be delayed or otherwise adversely affected. Moreover, our failure to comply with governmental rules and regulations related to our products could cause us to incur significant adverse publicity, subject us to investigations and notices of non-compliance or lead to fines or restrictions upon our ability to sell our products. We also may be at risk for liability related to government reimbursement of tests involving the use of our products if it is determined that these tests require FDA-clearance or approval and no such clearance or approval has been obtained.
 
Medical device laws and regulations are also in effect in many countries, ranging from comprehensive device approval requirements to requests for product data or certifications. The number and scope of these requirements are increasing. We may not be able to obtain regulatory approvals in such countries or may incur significant costs in obtaining or maintaining our foreign regulatory approvals. In addition, the export by us of certain of our products which have not yet been cleared for domestic commercial distribution may be subject to FDA or other export restrictions.
 
We have agreements relating to the sale of our products to government entities and, as a result, we are subject to various statutes and regulations that apply to companies doing business with the government. A failure to comply with these regulations might result in suspension of these contracts or administrative or other penalties, and could have a material adverse effect on our ability to compete for future government grants, contracts and programs.
 
Healthcare reform and restrictions on reimbursements may limit our returns on molecular diagnostic products that we may develop with our collaborators.
 
We are currently collaborating with our partners to develop diagnostic and therapeutic products. The ability of our collaborators to commercialize such products may depend, in part, on the extent to which reimbursement for these products will be available under U.S. and foreign regulations that govern reimbursement for clinical testing services by government authorities, private health insurers and other organizations. In the United States, third-party payer price resistance, the trend towards managed health care and the implementation of the Patient Protection and Affordable Care Act of 2010 could reduce payment rates for health care products and services, adversely affecting the profits of our customers and collaborative partners and reducing our future royalties. Under Medicare rules, diagnostic tests must be ordered by a physician who is treating the beneficiary and who uses the test results in patient management. Under this rule, some Medicare contractors may deny coverage for a test, even if the test has been cleared or approved by the FDA, without proof, as determined sufficient by the contractor, that the test is useful in patient management.
 
We face risks related to handling of hazardous materials and other regulations governing environmental safety.
 
Our operations are subject to complex and stringent environmental, health, safety and other governmental laws and regulations that both public officials and private individuals may seek to enforce. Our activities that are subject to these regulations include, among other things, our use of hazardous and radioactive materials and the generation, transportation and storage of waste. We could discover that we or an acquired business is not in material compliance. Existing laws and regulations may also be revised or reinterpreted, or new laws and regulations may become applicable to us, whether retroactively or prospectively, that may have a negative effect on our business and results of operations. It is also impossible to eliminate completely the risk of accidental environmental contamination or injury to individuals. In such an event, we could be liable for any damages that result, which could adversely affect our business.
 
We may be exposed to liability due to product defects.
 
The risk of product liability claims is inherent in the testing, manufacturing, marketing and sale of human diagnostic and therapeutic products and we may be subjected to such claims. We may seek to acquire additional insurance for clinical or product liability risks. We may not be able to obtain such insurance or general product liability insurance on acceptable terms or in sufficient amounts. A product liability claim or recall could have a serious adverse effect on our business, financial condition and results of operations.
 
 
 
Ethical, legal and social concerns surrounding the use of genetic information could reduce demand for our products.
 
Genetic testing has raised ethical issues regarding privacy and the appropriate uses of the resulting information. For these reasons, governmental authorities may call for limits on or regulation of the use of genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Similarly, such concerns may lead individuals to refuse to use genetics tests even if permissible. Any of these scenarios could reduce the potential markets for our molecular diagnostic products, which could have a material adverse effect on our business, financial condition and results of operations.
 
Risks Related to Our Intellectual Property
 
We may be unable to effectively protect or enforce our intellectual property, which could harm our competitive position.
 
Maintaining a strong patent position is critical to our business. Patent law relating to the scope of claims in the technology fields in which we operate is uncertain, so we cannot be assured the patent rights we have or may obtain will be valuable. Others have filed, and in the future are likely to file, patent applications that are similar or identical to ours or those of our licensors. To determine the priority of inventions, we may have to participate in interference proceedings declared by the United States Patent and Trademark Office that could result in substantial costs in legal fees and could substantially affect the scope of our patent protection. We cannot be assured our patent applications will have priority over those filed by others. Also, our intellectual property may be subject to significant administrative and litigation proceedings such as opposition proceedings against our patents in Europe, Japan and other jurisdictions.
 
Legal actions to enforce our patent rights can be expensive and may involve the diversion of significant management time. In addition, these legal actions could be unsuccessful and could also result in the invalidation of our patents or a finding that they are unenforceable. We may or may not choose to pursue litigation or interferences against those that have infringed on our patents, or used them without authorization, due to the associated expense and time commitment of monitoring these activities. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could harm our results of operations.
 
In addition to patent protection, we also rely upon copyright and trade secret protection, as well as non-disclosure agreements with our employees, consultants and third-parties, to protect our confidential and proprietary information. Such measures may not provide adequate protection for our proprietary information.
 
Litigation or other proceedings or third party claims of intellectual property infringement could require us to spend significant time and money and could prevent us from selling our products or services or impact our stock price.
 
Third parties have asserted and may in the future assert that we are employing their proprietary technology without authorization. As we launch new products and enter new markets, we expect that competitors will claim that our products infringe their intellectual property rights as part of business strategies designed to impede our successful commercialization and entry into new markets. We are currently engaged in litigation with third parties who allege that we have infringed their intellectual property rights. See Note 12. “Legal Proceedings” to our Consolidated Financial Statements found elsewhere in this Annual Report on Form 10-K for further information. In addition, we are aware of third-party patents that may relate to our technology. We routinely receive notices claiming infringement from third parties as well as invitations to take licenses under third party patents. Third parties may have obtained, and may in the future obtain, patents allowing them to claim that the use of our technologies infringes these patents.
 
 
 
We could incur substantial costs and divert the attention of our management and technical personnel in defending ourselves against any of these claims. Any adverse ruling or perception of an adverse ruling in defending ourselves against these claims could have a material adverse impact on our stock price, which may be disproportionate to the actual import of the ruling itself. Furthermore, parties making claims against us may be able to obtain injunctive or other relief, which could block our ability to develop, commercialize and sell products, and could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to pay damages and obtain one or more licenses from third parties, or be prohibited from selling certain products. In addition, we may be unable to obtain these licenses at a reasonable cost, if at all. We could therefore incur substantial costs related to royalty payments for licenses obtained from third parties, which could negatively affect our gross margins. Moreover, we could encounter delays in product introductions while we attempt to develop alternative methods or products. Defense of any lawsuit or failure to obtain any of these licenses on favorable terms could prevent us from commercializing products, and the prohibition of sale of any of our products could materially affect our ability to grow and maintain profitability.
 
Risks Related to Our Common Stock
 
The market price of our common stock has been volatile.
 
Our common stock traded as low as $3.68 and as high as $8.16 per share during the twelve-month period ending December 31, 2011. Our stock price may be affected by a number of factors, including those listed in these “Risk Factors” and other, unknown factors. Our stock price also may be affected by comments by securities analysts regarding our business or prospects, our issuance of common stock or other equity securities, our inability to meet analysts’ expectations, general fluctuations in the stock market or in the stock prices of our industry peers or our customers and general conditions and publicity regarding the genomics, biotechnology, pharmaceutical or life science industries.
 
Volatility in the stock price of other companies often has led to securities class action litigation against those companies. Any future securities litigation against us could result in substantial costs and divert management’s attention and resources, which could seriously harm our business, financial condition and results of operations.
 
Our quarterly results have historically fluctuated significantly and may continue to do so. Failure to meet financial expectations may disappoint securities analysts or investors and result in a decline in our stock price.
 
Our revenue and operating results may fluctuate significantly due in part to factors that are beyond our control and which we cannot predict. The timing of our customers’ orders may fluctuate from quarter to quarter. Historically, we have experienced customer ordering patterns for instrumentation and consumables in which the majority of the shipments occur in the last month of the quarter. These ordering patterns may limit management’s ability to accurately forecast our future revenue 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 revenue may cause us to experience material losses.
 
Because of this difficulty in predicting future performance, our operating results may fall below our own expectations and the expectations of securities analysts or investors in some future quarter or quarters. Our failure in the past to meet these expectations has adversely affected the market price of our common stock and may continue to do so.
 
In addition to factors that affect the spending levels of our customers described above, additional factors could cause our operating results to fluctuate, including:
 
 
·
competition;
 
 
·
our inability to produce products in sufficient quantities and with appropriate quality;
 
 
·
the frequency of experiments conducted by our customers;
 
 
·
our customers’ inventory of products;
 
 
·
the receipt of relatively large orders with short lead times; and
 
 
·
our customers’ expectations as to how long it takes us to fill future orders.
 
 

ITEM 1B.  UNRESOLVED STAFF COMMENTS

None.
 
ITEM 2.  PROPERTIES
 
Our corporate headquarters is located in Santa Clara, California, where we lease approximately 200,000 square feet and we have manufacturing facilities located in Singapore and Cleveland, Ohio, where we lease approximately 150,000 square feet and 15,000 square feet, respectively. We lease approximately 140,000 square feet of administrative and research and development space in California (Emeryville and Sunnyvale), Ohio (Cleveland and Maumee), China (Shanghai), Germany (Freiburg), Japan (Osaka and Tokyo) and the United Kingdom (Wooburn Green). We have also entered into agreements to sublease to third parties approximately 80,000 square feet of administrative and research and development space in Massachusetts (Bedford).
 
Additionally, we own a 170,000 square foot facility in West Sacramento, California that is currently vacant. In the fourth quarter of 2011, we entered into a non-binding letter of intent to sell the facility to a third-party. As of December 31, 2011, an executed purchase agreement has not been entered into and neither party has any binding obligations under the letter of intent.
 
We believe that our existing properties are in good condition and are suitable for the conduct of our business.
 
ITEM 3.  LEGAL PROCEEDINGS
 
Information pertaining to legal proceedings can be found in “Item 8. Financial Statements and Supplementary Data—Note 12. Legal Proceedings” of this Annual Report on Form 10-K, and is incorporated by reference herein.
 
ITEM 4.  MINE SAFETY DISCLOSURES
 
Not applicable.
 
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES
 
Our common stock is traded on The Nasdaq Global Select Market under the symbol of AFFX. The following table sets forth on a per share basis, for the periods indicated, the low and high closing prices of our common stock as reported by The Nasdaq Global Select Market.
 
   
Low
   
High
 
2011
           
First Quarter
  $ 4.45     $ 5.53  
Second Quarter
  $ 5.01     $ 7.93  
Third Quarter
  $ 4.14     $ 8.06  
Fourth Quarter
  $ 3.70     $ 5.83  
2010
               
First Quarter
  $ 5.28     $ 7.98  
Second Quarter
  $ 5.81     $ 8.33  
Third Quarter
  $ 3.80     $ 5.86  
Fourth Quarter
  $ 4.16     $ 5.28  
 
As of February 22, 2012, there were approximately 292 holders of record of our common stock, one of which is Cede & Co., a nominee for Depository Trust Company (“DTC”). All of the shares of common stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC and therefore are considered to be held of record by Cede & Co. as one shareholder.
 


No cash dividends have been paid on our common stock. We currently intend to retain all future earnings, if any, for use in our business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.
 
No equity securities were sold during 2011 that were not registered under the Securities Act of 1933, as amended (the “Securities Act”). We did not repurchase any shares of our common stock during the fourth quarter of 2011.
 
For information regarding compensation plans under which equity securities were authorized for issuance, see the section of the Proxy Statement to be filed in connection with our 2012 Annual Meeting of Shareholders entitled “Equity Compensation Plan Information,” incorporated by reference into Item 12 of this Annual Report on Form 10-K.
 
Performance Graph
 
The graph below compares the cumulative total return* on our common stock for the period commencing on December 31, 2006 and ending December 31, 2011 compared to the CRSP Total Return Index for the Nasdaq National Market (U.S. companies) and the CRSP Total Return Index for the Nasdaq Pharmaceutical Stocks (SIC 283). The stock price performance shown on the graph below is not necessarily indicative of future price performance.
 
*Assumes $100 invested on December 31, 2006 in our common stock and in each index listed above. The total return for our common stock and the indices used assumes the reinvestment of dividends, even though dividends have never been declared on our common stock.
 
The information under the caption “Performance Graph” is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference in any filing of Affymetrix under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (the “Exchange Act”), whether made before or after the date of this Annual Report on Form 10-K and irrespective of any general incorporation language in such filings.
 


ITEM 6.  SELECTED FINANCIAL DATA
 
The following selected historical consolidated financial information has been derived from our audited consolidated financial statements. The information below is not necessarily indicative of our future results of operations and should be read in conjunction with Item 1A, “Risk Factors,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K in order to fully understand the factors that may affect the comparability of the information presented below:
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
Consolidated Statement of Operations Data:
 
(in thousands, except per share amounts)
 
Total revenue
  $ 267,474     $ 310,746     $ 327,094     $ 410,249     $ 371,320  
(Loss) income from operations
    (16,641 )     (5,167 )     (33,158 )     (242,539 )     6,080  
Net (loss) income (1)
  $ (28,161 )   $ (10,233 )   $ (23,909 )   $ (307,919 )   $ 12,593  
Basic net (loss) income per common share
  $ (0.40 )   $ (0.15 )   $ (0.35 )   $ (4.49 )   $ 0.18  
Diluted net (loss) income per common share
  $ (0.40 )   $ (0.15 )   $ (0.35 )   $ (4.49 )   $ 0.17  
                                         
Consolidated Balance Sheet Data:
                                       
Cash, cash equivalents, and available-for-sale securities
  $ 265,067     $ 237,184     $ 346,574     $ 397,739     $ 584,274  
Working capital
    259,961       159,932       345,486       420,768       583,067  
Total assets (2)
    438,015       460,785       630,950       713,310       1,133,591  
Long-term obligations (3)(4)(5)
    108,555       111,821       261,394       330,896       451,143  
 
(1)
During 2010 and 2009, we repurchased $151.7 million and $69.1 million, respectively, of our 3.50% senior convertible notes and the resulting gain is labeled as “Gain from repurchase of convertible notes” in a single line item in our Consolidated Statements of Operations (See (4) for further details):
 
·  
In 2010, we recognized a net gain of $6.3 million on repurchases totaling $151.7 million in aggregate principal amount; and
·  
In 2009, we recognized a net gain of $17.4 million on the repurchase of $69.1 million in aggregate principal amount.
 
 
In 2008, we recognized a goodwill impairment charge of $239.1 million that is presented in a single line item labeled “Goodwill impairment charges” in our Consolidated Statements of Operations as well as an income tax provision of $65.9 million primarily resulting from a full valuation allowance recorded against all U.S. deferred tax assets.
 
 
Additionally, we recognized $2.2 million, $43.7 million and $15.3 million in 2009, 2008 and 2007, respectively, of expense related to our restructuring plans that was presented in a single line item labeled “Restructuring charges” in our Consolidated Statements of Operations.
 
(2)
In 2008, we completed the acquisitions of USB Corporation (“USB”), True Materials, Inc. (“TMI”), and Panomics, Inc. for aggregate cash consideration of $163.0 million.
 
(3)
In 2007, we issued $316.3 million aggregate principal amount of 3.50% senior convertible notes.
 
(4)
In 2010 and 2009, we partially repurchased our 3.50% convertible notes:
 
·  
In 2010, a total of $151.7 million aggregate principal amount was purchased for cash consideration of $143.6 million, including accrued interest and transaction costs; and
·  
In 2009, $69.1 million aggregate principal amount was purchased for cash consideration of $50.6 million, including accrued interest and transactions costs.
 
 
In 2008, a total of $119.9 million aggregate principal amount of our 0.75% senior convertible notes was redeemed for cash as investors exercised their put right. We repurchased an additional $0.1 million aggregate principal amount of such notes in 2009.
 
(5)
On February 3, 2012, we commenced a cash tender offer to repurchase the entire aggregate outstanding principal amount of our Notes at par plus accrued and unpaid interest from the last interest payment date applicable to the Notes to, but not including, the settlement date for the tender offer. See “Item 8. Financial Statements and Supplementary Data—Note 20. Subsequent Events” in this Annual Report on Form 10-K.

 

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with the consolidated financial statements and the related notes that appear elsewhere in this document.
 
The purpose of the following discussion and analysis is to provide an overview of the business to help facilitate an understanding of significant factors influencing our historical operating results, financial condition and cash flows and also to convey our expectations of the potential impact of known trends, events, or uncertainties that may impact our future results. The discussion and analysis in this Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, strategies, objectives, expectations, intentions and adequacy of resources. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward looking statements. Words such as “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project” or similar words or phrases, or the negatives of these words, may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward looking. Examples of forward-looking statements include, among others, statements regarding the integration of our acquired technologies with our existing technology, the commercial launch of new products and the duration which our existing cash and other resources is expected to fund our operating activities. This discussion should be read in conjunction with the other sections of this Annual Report on Form 10-K, including “Item 1: Business”; “Item 1A: Risk Factors”; “Item 6: Selected Financial Data”; and “Item 8: Financial Statements and Supplementary Data.”
 
Overview
 
We develop, manufacture and sell products and services for genetic analysis to the life science research and clinical healthcare markets. Researchers around the world use our technology to better understand the role that genes play in disease, the effectiveness and safety of therapies and many other biological factors that affect human well-being. We sell our products to some of the world’s largest pharmaceutical, diagnostic and biotechnology companies, as well as leading academic, government and not-for-profit research institutions and more than 24,000 peer-reviewed papers have been published based on work using our products. We have almost 900 employees worldwide and maintain sales and distribution operations across the United States, Europe, Asia and Latin America.
 
We offer a comprehensive line of products for two principal applications: gene expression and genotyping. Our product sales consist primarily of sales of instruments and related consumables. We have three instrument systems, GeneTitan®, GeneChip® and GeneAtlas™, that include instruments, consumables and software. Our GeneChip® instruments run arrays packaged in cartridges and our GeneTitan® and GeneAtlasTM instruments run arrays packaged in a peg format.
 
We also offer a variety of assays for gene expression targeting low- to mid-plex markets that are downstream of our whole genome arrays and a range of reagent kits that are compatible with our platforms as well as the products of other vendors.
 
Overview of Fiscal Year 2011 and Strategic Initiatives
 
In 2011, our business was affected by a significant drop in the volume of sales of consumables to our academic and pharmaceutical customers, particularly in North America, which led to a decrease in revenue as compared to the same period in 2010. Primarily due to lower revenues from product sales, we incurred a net loss of $28.2 million for the year. Despite the lower revenues, we were able to generate cash flows from operations of almost $40 million in 2011.
 
Our focus remains on carrying out the following strategic initiatives:
 
Entering new markets and expanding our product lines. Our goal continues to be to expand our revenue base by entering new markets, growing our customer base and successfully commercializing our established and acquired technologies. In the future, we intend to continue to expand our focus to include the validation and routine testing markets which we believe offer attractive compound annual growth rates and opportunities for more recurring revenue growth in the future. We seek to expand our product line with new products that combine automated instrumentation, powerful new biological assays, and new array designs and content.
 


Improving operating leverage. We remain focused on improving our operating leverage and were successful in lowering our operating expenses in 2011 as compared to 2010. Profitability in the future will depend on a number of factors, including but not limited to, increasing top-line revenue and sustained operating leverage.
 
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 consolidated financial statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“US GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
Our significant accounting policies are fully described in “Item 8. Financial Statements and Supplementary Data—Note 2. Summary of Significant Accounting Policies.” However, 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. Management believes the following critical accounting policies reflect its more significant estimates and assumptions used in the preparation of the consolidated 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.
 
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. These inventory adjustments may be required if actual demand, component costs, supplier arrangements, or product life cycles differ from our estimates. Any such adjustments would result in a charge to our results of operations.
 
NON-MARKETABLE EQUITY 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. These investments are included in other assets in our Consolidated Balance Sheets and are carried at cost. We also invest in a limited partnership investment fund that is accounted for under the equity method. 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 the value of certain of our non-marketable investments over the past few years.
 


INCOME TAXES
 
Income tax expense is based on pretax financial accounting income. Under the asset and 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 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 deferred tax assets. 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 overall levels, character, or geographical mix of pretax earnings, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, changes in the valuation of our deferred tax assets or liabilities, future levels of research and development spending, nondeductible expenses, applicability of tax holidays, and ultimate outcomes of income tax audits.
 
The total amount of unrecognized tax benefits as of December 31, 2011 was approximately $16.5 million. If recognized, the amount of unrecognized tax benefits that would impact income tax expense is $2.7 million. As of December 31, 2011, we do not anticipate any material changes to the amount of unrecognized tax benefit during the next twelve months.
 
We classify interest and penalties related to tax positions as components of income tax expense. For the year ended December 31, 2011, the amount of accrued interest and penalties related to tax uncertainties was approximately $0.2 million for a total cumulative amount of $0.7 million of non-current income taxes payable as of December 31, 2011.
 
We file U.S. federal, state, and foreign income tax returns in jurisdictions with varying statutes of limitations. During November 2011, the U.S. Internal Revenue Service completed its field examination of our federal income tax returns for the 2004, 2005, 2006, 2008 and 2009 tax years and issued a Revenue Agent’s Report, or RAR, with no proposed adjustments. We consider all tax positions taken in the 2004, 2005, 2006, 2008 and 2009 tax years to be effectively settled, because the U.S. Internal Revenue Service has completed its examination procedures and we believe that there is a remote possibility that the U.S. Internal Revenue Service will re-examine the settled positions. As a result, we have released reserves of approximately $5.8 million related to uncertain tax positions for those periods and recorded a full valuation allowance against these deferred tax assets. However, the federal and California statute of limitations on assessment still remain open for the tax years 1992 through 2011. In significant foreign jurisdictions, the 2006 through 2011 tax years generally remain subject to examination by their respective tax authorities.
 
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 which may change in the future due to new developments in each matter.
 
ACCOUNTING FOR SHARE-BASED COMPENSATION
 
We account for employee share-based compensation by estimating 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 share-based awards granted in future periods.
 


US GAAP requires that employee share-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 2011, we recognized employee share-based compensation of $8.8 million, which consisted of $1.1 million in cost of product sales, $1.9 million in research and development expense and $5.8 million in selling, general and administrative expenses. As of December 31, 2011, $16.0 million of total unrecognized compensation cost related to non-vested employee stock awards is expected to be recognized as future cost of sales and operating expenses over a weighted-average period of 2.7 years.
 
RESULTS OF OPERATIONS
 
The following discussion compares the historical results of operations for the years ended December 31, 2011, 2010 and 2009.
 
PRODUCT SALES
 
The components of product sales are as follows:
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Consumables
  $ 224,972     $ 252,165     $ 255,660     $ (27,193 )   $ (3,495 )     (11 )%     (1 )%
Instruments
    16,301       25,578       23,526       (9,277 )     2,052       (36 )     9  
Total product sales
  $ 241,273     $ 277,743     $ 279,186     $ (36,470 )   $ (1,443 )     (13 )     (1 )
 
Total product sales decreased in 2011 as compared to 2010 primarily due to volume decreases. Chip volumes shipped were lower across all products while overall average selling price remained flat. Reagent revenue decreased primarily due to lower volume Genechip® shipments combined with lower average selling price caused by a shift in product mix. Instruments were lower due to fewer GeneTitan® sales partially offset by increased sales of the lower-priced GeneAtlas™.
 
Total product sales decreased $1.4 million or 1% in 2010 as compared to 2009. Consumables sales decreased primarily due to a decrease in the sales of our RNA reagents partially offset by an increase in sales of our DNA reagents. In both areas, sales of our lower price products have increased as a percentage of the total mix. Instrument sales grew in 2010 as compared to 2009, primarily due to the increased adoption of GeneTitan® and introduction of GeneAtlasTM families of instruments, which were introduced in late 2009 and early 2010, respectively, partially offset by declines in the volume of sales of older instruments.
 
SERVICES
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Services
  $ 20,158     $ 20,565     $ 39,563     $ (407 )   $ (18,998 )     (2 )%     (48 )%
 
Total services revenue remained consistent in 2011 as compared to 2010 which was in line with our expectations.
 
Total services revenue decreased in 2010 as compared to 2009, primarily due to the completion in late 2009 of several genotyping projects that began in the fourth quarter of 2008, including the Wellcome Trust Case Consortium and the National Institutes of Health projects.
 


ROYALTY AND OTHER REVENUE
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Royalties and other revenue
  $ 6,043     $ 12,438     $ 8,345     $ (6,395 )   $ 4,093       (51 )%     49 %
 
Royalties and other revenue in 2010 was higher as compared to 2011 and 2009 primarily due to the receipt of a non-recurring $4.8 million license payment that was received in the fourth quarter of 2010. In addition to the non-recurring license payment, royalties and other revenue was lower in 2011 as compared to 2010 due to lower royalties and research activity.
 
PRODUCT AND SERVICES GROSS MARGINS
 
Dollars in thousands
             
Dollar/Point
 
   
Year ended December 31,
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
 
Total gross margin on product sales
  $ 143,458     $ 160,359     $ 152,809     $ (16,901 )   $ 7,550  
Total gross margin on services
    7,021       4,743       15,614       2,278       (10,871 )
                                         
Product gross margin as a percentage of product sales
    59 %     58 %     55 %     1       3  
Service gross margin as a percentage of services
    35 %     23 %     39 %     12       (16 )
 
Despite lower product sales in 2011, product gross margin as a percentage of product sales increased during the year as compared to 2010 primarily due to a mix shift to higher margin products along with lower material, warranty and excess and obsolescence costs in 2011 as well as plant consolidation costs that occurred in 2010. These cost improvements were partially offset by lower cost absorption due to higher production levels in 2010. We note a downward trend in product gross margin within 2011 when comparing quarterly results driven by increased absorption cost due to lower sales.
 
Product gross margin increased in 2010 as compared to 2009 primarily due to a reduction in plant consolidation costs from $9.4 million in 2009 to $1.6 million in 2010, as the majority of the West Sacramento manufacturing facility closure took place in 2009. Additionally, favorable pricing and absorption in chips contributed to the increased product margin. These increases were partially offset by higher excess and obsolescence costs for products with finite lives.
 
Service gross margin increased in 2011 as compared to 2010 primarily due to costs associated with the West Sacramento manufacturing facility closure that was completed in the second quarter of 2010. Service gross margin was lower in 2010 as compared to 2009 primarily as a result of the Wellcome Trust Case Consortium and National Institutes of Health projects which had higher margins and were completed in 2009.
 
RESEARCH AND DEVELOPMENT EXPENSES
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Research and development
  $ 63,591     $ 67,934     $ 77,358     $ (4,343 )   $ (9,424 )     (6 )%     (12 )%
 
Research and development expenses decreased in 2011 and 2010 as compared to 2009 primarily due to savings in head count-related expenses and variable compensation of $3.2 million and $5.7 million, respectively and decreased spending on supplies of $2.6 million and $2.2 million, respectively as a result of cost-control measures. This was partially offset by an increase in facilities expenses primarily due to a one-time expense of $1.2 million related to the plant consolidation activities of our Oakmead facility in Santa Clara during the third quarter of 2011.
 


SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Selling, general and administrative
  $ 109,572     $ 114,773     $ 130,838     $ (5,201 )   $ (16,065 )     (5 )%     (12 )%
 
Selling, general and administrative expenses decreased in 2011 as compared to 2010 primarily due to lower legal expenses of $4.2 million as a result of a litigation settlement at the end of 2010. Other cost savings include variable compensation adjustments of $1.6 million, lower spending on consulting and other services of $1.5 million and advertising expenses of $0.8 million. These savings were partially offset by one-time severance benefits provided to our former chief executive officer of $1.4 million, rent expense of $1.8 million primarily due to the acceleration of future lease payments as a result of the plant consolidation activities of our Oakmead facility in Santa Clara and acquisition costs of $2.9 million incurred on the anticipated eBioscience transaction.
 
In 2010, selling, general and administrative expenses decreased as compared to 2009 primarily due to lower compensation and benefits expenses of $11.0 million as a result of lower headcount and decreased variable compensation. Additionally, legal expenses decreased by $2.1 million primarily due to timing of legal proceedings with third-parties, consulting and purchased services decreased by $1.8 million as a result of various general and administrative cost reductions, and rent expense decreased by $1.4 million due primarily to the relocation of our Japan office and other site consolidation efforts.
 
INTEREST INCOME AND OTHER, NET
 
The components of interest income and other, net, are as follows:
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Interest income
  $ 2,627     $ 2,845     $ 4,455     $ (218 )   $ (1,610 )     (8 )%     (36 )%
Realized loss on equity investments, net
    (2,251 )     (4,342 )     (916 )     2,091       (3,426 )     48       (374 )
Currency loss, net
    (2,483 )     (48 )     (2,800 )     (2,435 )     2,752       (5,073 )     98  
Other
    (4,195 )     58       1,850       (4,253 )     (1,792 )     (7,333 )     (97 )
Total interest income and other, net
  $ (6,302 )   $ (1,487 )   $ 2,589     $ (4,815 )   $ (4,076 )     324       (157 )
 
Interest income and other, net decreased in 2011 as compared to 2010 due to the following:
 
·  
Realized loss on equity investments decreased in 2011 as compared to 2010 as we recognized fewer other-than-temporary impairments (“OTTI”). In 2011, we recognized $2.1 million in OTTI on our non-marketable investment in a limited partnership investment fund, a non-marketable investment in a private biotechnology company and an investment classified as available-for-sale in a publicly-traded company. In 2010, we recognized $5.6 million in OTTI on two non-marketable investments;
·  
Currency loss, net, increased primarily due to the weakening of the U.S. dollar against the Euro in 2011 as compared to 2010; and
·  
Other changed in 2011 due to a $2.2 million provision against a note receivable from a private biotechnology company and a $1.7 million impairment charge recorded against our West Sacramento facility during 2011.
 


Interest income and other, net changed by $4.1 million in 2010 as compared to 2009 due to the following:
 
·  
Interest income decreased by $1.6 million in 2010 as compared to 2009 due to lower average cash and investment balances as a result of the repurchase of a portion of our 3.50% convertible notes during 2010, partially offset by higher effective interest rates in 2010;
·  
Realized loss in equity investments increased by $3.4 million in 2010 as we recognized $5.6 million of other-than-temporary impairment expense, largely as a result of our recognition of impairment charges on two non-marketable investments. This was partially offset by a net realized gain from our investment in a limited partnership investment fund of $1.3 million. In 2009, we recognized a net realized loss of $0.9 million primarily due to OTTI on our non-marketable investment in a limited partnership investment fund;
·  
Currency loss decreased in 2010 by $2.8 million due to favorable currency movements in 2010; and
·  
Other income decreased primarily due to a nonrecurring sale of equipment in 2009 totaling $0.9 million.
 
INTEREST EXPENSE
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Interest expense
  $ 3,813     $ 7,706     $ 10,945     $ (3,893 )   $ (3,239 )     (51 )%     (30 )%
 
Interest expense decreased in 2011 as compared to 2010 and 2009 primarily due to a lower aggregate principal balance of our 3.50 % convertible notes as a result of our repurchases totaling $151.7 million in aggregate principal amount during 2010. There were no further purchases in 2011.
 
INCOME TAX PROVISION (BENEFIT)
 
Dollars in thousands
             
Dollar
   
Percentage
 
   
Year ended December 31,
   
change from
   
change from
 
   
2011
   
2010
   
2009
   
2010
   
2009
   
2010
   
2009
 
Income tax provision (benefit)
  $ 1,405     $ 2,170     $ (158 )   $ (765 )   $ 2,328       (35 )%     (1,473 )%
 
The income tax provision was approximately $1.4 million and $2.2 million in 2011 and 2010, respectively, which consisted primarily of foreign taxes. The income tax benefit in 2009 of $0.2 million consisted of foreign taxes similar to 2011 and 2010 offset by refundable U.S. credits.
 
Deferred tax assets are recognized if realization of such assets is more likely than not. As of December 31, 2011, we provided for a valuation allowance of $154.1 million against our net deferred tax assets. As a result of negative evidence based on our cumulative net loss position, we have placed a full valuation allowance on U.S. and certain foreign deferred tax assets. We intend to maintain the valuation allowance until sufficient positive evidence exists to assure realization of these tax benefits through future taxable income.
 
As of December 31, 2011, we had total net operating loss carryforwards of $288.6 million, comprised of $162.0 million for U.S. federal purposes, which expire in the years 2021 through 2031 if not utilized, and $126.6 million for state purposes, the majority of which expire in the years 2012 through 2031 if not utilized. Utilization of net operating loss carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation may result in the expiration of the net operating loss before utilization.
 
During 2011, due to potential future transactions that would require cash outflows, we changed our assertion such that foreign earnings are no longer intended to be permanently reinvested. As a result, we recorded a net deferred tax liability of approximately $0.8 million related to the foreign undistributed earnings, which was offset by a reduction in our valuation allowance against our deferred tax assets.
 


LIQUIDITY AND CAPITAL RESOURCES
 
Liquidity
 
Historically, we have financed our operations primarily through product sales; sales of equity and debt securities such as our 3.50% convertible notes in 2007, collaborative agreements; interest income; licensing of our technology; and, when necessary, financing arrangements with third party creditors.
 
Our cash outflows have generally been as follows: cash used in operating activities such as research and development programs, sales and marketing activity, compensation and benefits of our employees and other working capital needs; cash paid for acquisitions; cash paid for litigation activity and settlements; and cash used for our debt repurchases and repurchases of our convertible notes as well as interest payments on our convertible notes obligations.
 
As of December 31, 2011, we had cash, cash equivalents, and available-for-sale securities of approximately $265.1 million. We anticipate that our existing capital resources along with the cash to be generated from operations will enable us to maintain currently planned operations, debt repayments or repurchases, and capital expenditures, for the foreseeable future.
 
These expectations are based on our current operating and financing plans, which are subject to change, and therefore we could require further funding. Factors that may cause us to require additional funding may include, but are not limited to: financing arrangements that we may enter into in connection with our acquisition of eBioscience or future acquisitions; a decline in cash generated by sales of our products and services; our ability to maintain existing collaborative and customer arrangements and establish and maintain new collaboration and customer arrangements; the progress of our research and development programs; initiation or expansion of research programs and collaborations; the costs involved in preparing, filing, prosecuting, defending and enforcing intellectual property rights; the effectiveness of product commercialization activities and arrangements; the purchase of patent licenses; and other factors.
 
On November 29, 2011, we entered into a Merger Agreement to acquire eBioscience for approximately $330 million in cash, subject to certain adjustments as provided in the Merger Agreement. The merger is subject to customary closing conditions, including our receipt of financing for the merger.
 
In connection with the Merger Agreement, we entered into a commitment letter with financing sources providing for $190 million of senior secured credit. The conditions to funding these facilities have not been satisfied, and as a result, we will not be able to complete the eBioscience acquisition unless the terms of the acquisition and the financing are restructured. We are in discussions with financing sources and with eBioscience regarding the possibility of restructuring the committed financing but no agreement or understandings have been reached. We have waived eBioscience’s obligations under the non-solicitation provisions set forth in the Merger Agreement and we understand that eBioscience is considering alternatives to the merger. The Merger Agreement may be terminated by either party if the closing of the merger has not occurred by March 31, 2012, so long as a breach of the Merger Agreement by the party seeking to terminate has not been the proximate cause of or resulted in the failure of the merger to occur on or before such date.
 
On December 29, 2011, we received notice that Tang Capital Partners, LP, a holder of our 3.50% Senior Convertible Notes Due 2038 (the "Notes"), had commenced class action litigation against us in the Superior Court of California, County of Santa Clara. The complaint alleged a variety of claims relating to our proposed acquisition of eBioscience, including that the acquisition would constitute a Fundamental Change under the indenture governing the Notes. The complaint sought unspecified damages, temporary and permanent injunctive relief against completion of the eBioscience acquisition, and other remedies. On January 21, 2012, we entered into an agreement to settle the purported class action litigation. As part of the settlement, we agreed to commence a tender offer to repurchase the entire aggregate outstanding principal amount of Notes at par plus accrued interest. Tang Capital Partners, LP, which owned approximately $78.3 million principal amount of the Notes, agreed to tender all of its Notes into the offer.
 


As of December 31, 2011, we have no credit facility or other committed sources of capital. To the extent capital resources are insufficient to meet future capital requirements; we will have to raise additional funds to continue the development of our technologies. There can be no assurance that such funds will be available on favorable terms, or at all. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution to our stockholders. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds by entering into collaboration agreements on unattractive terms. Our inability to raise capital would have a material adverse effect on our business, financial condition and results of operations.
 
From time to time, we may seek to retire, repurchase or exchange convertible securities or common stock in open market purchases, privately negotiated transactions dependent on market conditions, liquidity, and contractual obligations and other factors. We did not retire, repurchase or exchange any of our common stock or remaining outstanding convertible securities during the year ended December 31, 2011. As noted above, on February 3, 2012, we commenced a cash tender offer to repurchase the entire aggregate outstanding principal amount of our Notes at par plus accrued and unpaid interest from the last interest payment date applicable to the Notes, to, but not including, the settlement date for the tender offer. See “Item 8. Financial Statements and Supplementary Data—Note 20. Subsequent Events” in this Annual Report on Form 10-K.
 
Cashflow (in thousands)
 
   
Year ended December 31,
 
   
2011
   
2010
   
2009
 
Net cash provided by operating activities
  $ 39,337     $ 47,975     $ 9,329  
Net cash provided by (used in) investing activities
    127,634       66,211       (7,190 )
Net cash used in financing activities
    (486 )     (144,759 )     (50,073 )
Effect of foreign currency translation on cash and cash equivalents
    (32 )     415       284  
Net increase (decrease) in cash and cash equivalents
  $ 166,453     $ (30,158 )   $ (47,650 )
 
Operating Activities
 
Net cash provided by operating activities for the year ended December 31, 2011 was comprised of a net loss of $28.2 million, net of non-cash charges of $49.7 million and a $17.8 million increase in working capital. Adjustments for non-cash expenses include depreciation and amortization expense of $32.3 million, a net realized loss on investments of $4.8 million, which included other-than-temporary impairment charges totaling $2.1 million, a provision against a notes receivable from a private biotechnology company of $2.2 million, an impairment charge on property and equipment of $1.7 million and share-based compensation expense of $8.8 million.
 
Investing Activities
 
We liquidated a number of investments during the fourth quarter of 2011 to fund the anticipated eBioscience acquisition that resulted in a net inflow from investing activities from the purchase, sales and maturities of available-for-sale securities totaling $136.2 million during 2011. Our investing activities further included capital expenditures of $5.8 million and purchased technology rights of $3.2 million in 2011.
 
Financing Activities
 
Our financing activities generally consist of stock option exercise activity under our employee stock plan. Cash used in the issuance of stock under our employee stock plan, net of treasury shares withheld for taxes, was $0.7 million for the year ended December 31, 2011.
 


Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
 
As of December 31, 2011, we had no off-balance sheet arrangements. The impact that our contractual obligations as of December 31, 2011 are expected to have on our liquidity and cash flow in future periods is as follows (in thousands):
 
   
Total
   
2012
     2013-2014      2015-2016    
After 2016
 
Senior convertible notes (1)
  $ 95,469     $ 95,469     $ -     $ -     $ -  
Interest payments (1)
    557       557       -       -       -  
Operating leases
    65,420       8,315       14,621       10,622       31,862  
Purchase commitments (2)
    3,153       3,153       -       -       -  
Total contractual obligations
  $ 164,599     $ 107,494     $ 14,621     $ 10,622     $ 31,862  
 
(1)  
Our 3.50% senior convertible notes are due in 2038. However, holders may require us to repurchase all or a portion of their notes on January 15, 2013, 2018 and 2028. On February 3, 2012, we commenced a cash tender offer to repurchase the entire aggregate outstanding principal amount of our Notes at par plus accrued and unpaid interest from the last interest payment date applicable to the Notes to, but not including, the settlement date for the tender offer. See “Item 8. Financial Statements and Supplementary Data—Note 20. Subsequent Events” in this Annual Report on Form 10-K.
 
(2)  
Purchase commitments include agreements to purchase goods or services that are enforceable and legally binding on Affymetrix and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.
 
The above table does not reflect unrecognized tax benefits of approximately $16.5 million, the timing of which is uncertain. Refer to “Item 8. Financial Statements and Supplementary Data—Note 15. Income Taxes” for additional discussion on unrecognized tax benefits.
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
In the normal course of business, we are exposed to foreign currency exchange rate, interest rate and equity price risks that could impact our financial position and results of operations. Our risk management strategy with respect to these three market risks may include the use of derivative financial instruments. We use derivative contracts only to manage existing underlying exposures of Affymetrix. Accordingly, we do not use derivative contracts for speculative purposes. Our risks, risk management strategy and a sensitivity analysis estimating the effects of changes in fair values for each of these exposures are outlined below.
 
Actual gains and losses in the future may differ materially from the sensitivity analyses based on changes in the timing and amount of interest rate, foreign currency exchange rate and equity price movements and our actual exposures and hedges.
 
Interest Rate Risk
 
Our exposure to interest rate risk relates primarily to our investment portfolio. Fixed rate securities may have their fair market value adversely impacted due to fluctuations in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates.
 
The primary objective of our investment activities is to preserve principal while at the same time maximize yields without significantly increasing risk. To achieve this objective, we invest our excess cash in debt instruments of the U.S. Government and its agencies and high-quality corporate issuers, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates, we maintain investments at an average maturity of less than three years.
 

 
   
Periods of Maturity
         
Fair Value at
 
   
2012
   
2013
   
2014
   
Thereafter
   
Total
   
December 31, 2011
 
ASSETS:
                                   
Available-for-sale securities
  $ 7,821     $ 25,616     $ 18,179     $ 10,248     $ 61,864     $ 62,438  
Average interest rate
    1.2 %     3.0 %     3.5 %     3.5 %                
LIABILITIES:
                                               
3.50% senior convertible notes due 2038 (1)
  $ -     $ 95,469     $ -     $ -     $ 95,469     $ 95,469  
Average interest rate
            3.50 %                                

(1) In 2013, the security holders of our 3.50% senior convertible notes have the option to require us to repurchase the notes at a price equal to 100% of the outstanding principal amount plus accrued interest. On February 3, 2012, we commenced a cash tender offer to repurchase the remaining aggregate outstanding principal amount of our Notes at par plus accrued and unpaid interest from the last interest payment date applicable to the Notes to, but not including, the settlement date for the tender offer. See “Item 8. Financial Statements and Supplementary Data—Note 20. Subsequent Events” in this Annual Report on Form 10-K.
 
   
Periods of Maturity
           
Fair Value at
 
     2011      2012      2013    
Thereafter
   
Total
    December 31, 2010  
ASSETS:
                                               
Available-for-sale securities
  $ 73,490     $ 45,556     $ 60,549     $ 28,573     $ 208,168     $ 207,517  
Average interest rate
    2.2 %     2.2 %     2.6 %     3.8 %                
LIABILITIES:
                                               
0.75% senior convertible notes due 2014
  $ -     $ -     $ 3     $ -     $ 3     $ 3  
Average interest rate
                    0.75 %                        
3.50% senior convertible notes due 2038
  $ -     $ -     $ 95,469     $ -     $ 95,469     $ 84,493  
Average interest rate
                    3.50 %                        
 
Foreign Currency Exchange Rate Risk
 
We transact business in various foreign currencies and have significant international revenues, as well as costs denominated in foreign currencies. This exposes us to the risk of fluctuations in foreign currency exchange rates. We purchase foreign exchange option contracts to reduce the volatility of cash flows related to forecasted revenues denominated in certain foreign currencies. The objective of the foreign exchange contracts is to better ensure that the U.S. dollar-equivalent cash flows are not adversely affected by changes in the U.S. dollar or foreign currency exchange rates. These contracts are designated as cash flow hedges. The gain or loss on the effective portion of a cash flow hedge is initially reported as a component of accumulated Other Comprehensive Income (“OCI”) and subsequently reclassified into revenues when the hedged revenues are recorded or as interest and other income, net, if the hedged transaction becomes probable of not occurring. Any gain or loss after a hedge is de-designated or related to an ineffective portion of a hedge is recognized as interest and other income, net, immediately.
 
The following table summarizes the notional amounts, weighted-average currency exchange rates and fair values of our unsettled foreign currency exchange forward contracts at December 31, 2011. We had no unsettled hedging contracts at December 31, 2010. All contracts have maturities of 12 months or less. Weighted-average rates are stated in terms of the amount of U.S. dollars per foreign currency. Fair values represent estimated settlement amounts at December 31, 2011 (notional amounts and fair values in U.S. dollars and in thousands):
 
         
Weighted-
       
         
Average
       
   
Notional
   
Settlement
   
Fair
 
   
Amount
   
Price
   
Value
 
Currency
                 
Euro
    11,850       1.39       816  
Japanese Yen
    7,007       79.62       (216 )
British Pound
    4,459       1.59       123  
Total
    23,316               723  
 


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AFFYMETRIX, INC.
 
 
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of Affymetrix, Inc.
 
We have audited the accompanying consolidated balance sheets of Affymetrix, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Affymetrix, Inc. at December 31, 2011 and 2010, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Affymetrix, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2012 expressed an unqualified opinion thereon.
 
/s/ Ernst & Young LLP
 
   
San Jose, California
February 28, 2012
 
 


AFFYMETRIX, INC.
 
CONSOLIDATED BALANCE SHEETS
 
(In thousands, except per share amounts)
 
   
December 31,
   
December 31,
 
   
2011
   
2010
 
ASSETS:
           
Current assets:
           
Cash and cash equivalents
  $ 201,937     $ 35,484  
Restricted cash
    692       287  
Available-for-sale securities—short-term portion
    7,937       67,223  
Accounts receivable, net
    44,021       52,281  
Inventories
    42,851       49,373  
Deferred tax assets—short-term portion
    364       1,071  
Property and equipment, net—held for sale
    9,000       -  
Prepaid expenses and other current assets
    7,785       9,422  
Total current assets
    314,587       215,141  
Available-for-sale securities—long-term portion
    54,501       134,190  
Property and equipment, net
    30,583       54,177  
Acquired technology rights, net
    29,525       38,858  
Deferred tax assets—long-term portion
    450       4,894  
Other long-term assets
    8,369       13,525  
Total assets
  $ 438,015     $ 460,785  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY:
               
Current liabilities:
               
Accounts payable and accrued liabilities
  $ 44,774     $ 44,259  
Deferred revenue—short-term portion
    9,852       10,950  
Total current liabilities
    54,626       55,209  
Deferred revenue—long-term portion
    3,959       4,601  
Other long-term liabilities
    9,127       11,748  
Convertible notes (1)
    95,469       95,472  
Stockholders’ equity:
               
Convertible redeemable preferred stock, $0.01 par value; 5,000 shares authorized; no shares issued and outstanding at December 31, 2011 and 2010
    -       -  
Common stock, $0.01 par value; 200,000 shares authorized; 70,454 and 70,578 shares issued and outstanding at December 31, 2011 and 2010, respectively
    704       706  
Additional paid-in capital
    750,332       742,206  
Accumulated other comprehensive income
    2,492       1,376  
Accumulated deficit
    (478,694 )     (450,533 )
Total stockholders’ equity
    274,834       293,755  
Total liabilities and stockholders’ equity
  $ 438,015     $ 460,785  

(1) See “Note 20. Subsequent Events” for further information.
 
See Accompanying Notes
 


AFFYMETRIX, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
(In thousands, except per share amounts)
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
REVENUE:
                 
Product sales
  $ 241,273     $ 277,743     $ 279,186  
Services
    20,158       20,565       39,563  
Royalties and other revenue
    6,043       12,438       8,345  
Total revenue
    267,474       310,746       327,094  
COSTS AND EXPENSES:
                       
Cost of product sales
    97,815       117,384       126,377  
Cost of services and other
    13,137       15,822       23,949  
Research and development
    63,591       67,934       77,358  
Selling, general and administrative
    109,572       114,773       130,838  
Restructuring charges
    -       -       2,180  
Goodwill impairment adjustment
    -       -       (450 )
Total costs and expenses
    284,115       315,913       360,252  
Loss from operations
    (16,641 )     (5,167 )     (33,158 )
Interest income and other, net
    (6,302 )     (1,487 )     2,589  
Interest expense
    3,813       7,706       10,945  
Gain from repurchase of convertible notes
    -       6,297       17,447  
Loss before income taxes
    (26,756 )     (8,063 )     (24,067 )
Income tax provision (benefit)
    1,405       2,170       (158 )
Net loss
  $ (28,161 )   $ (10,233 )   $ (23,909 )
                         
Basic and diluted net loss per common share
  $ (0.40 )   $ (0.15 )   $ (0.35 )
                         
Shares used in computing basic and diluted net loss per common share
    70,877       68,856       68,722  
 
See Accompanying Notes
 


AFFYMETRIX, INC.
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
 
(In thousands)
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Net loss
  $ (28,161 )   $ (10,233 )   $ (23,909 )
Other comprehensive income (loss), net of tax:
                       
Foreign currency translation adjustment
    79       415       284  
Unrealized gains (losses) on available-for-sale and non-marketable securities
    2,271       (4,093 )     6,979  
Reclassification adjustment for realized (losses) gains recognized in net loss
    (2,060 )     1,003       (916 )
Unrealized gains on cash flow hedges
    826       -       -  
Net change in other comprehensive income (loss), net of tax
    1,116       (2,675 )     6,347  
Comprehensive loss
  $ (27,045 )   $ (12,908 )   $ (17,562 )
 
See Accompanying Notes
 


AFFYMETRIX, INC.
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
(In thousands)
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Convertible redeemable preferred stock:
                 
Balance, beginning of year
  $ -     $ -     $ -  
Balance, end of year
    -       -       -  
Common stock:
                       
Balance, beginning of year
    706       710       703  
        Common stock issued upon exercise of stock options and restricted                        
stock, net of tax withholding related to vesting of restricted stock units
    (2 )     (4 )     7  
Balance, end of year
    704       706       710  
Additional paid-in capital:
                       
Balance, beginning of year
    742,206       733,378       721,641  
Common stock issued upon exercise of stock options and restricted
                       
stock, net of tax withholding related to vesting of restricted stock units
    (681 )     (1,178 )     (820 )
Share-based compensation expense
    8,771       9,910       11,148  
Income tax benefit from share-based compensation
    36       96       1,409  
Balance, end of year
    750,332       742,206       733,378  
Accumulated other comprehensive gain (loss):
                       
Balance, beginning of year
    1,376       4,051       (2,296 )
Unrealized gain (loss) on investments, net of tax
    211       (3,090 )     6,063  
Unrealized gain on hedging contracts, net of tax
    826       -       -  
Foreign currency translation adjustment, net of tax
    79       415       284  
Balance, end of year
    2,492       1,376       4,051  
Accumulated deficit:
                       
Balance, beginning of year
    (450,533 )     (440,300 )     (416,391 )
Net loss
    (28,161 )     (10,233 )     (23,909 )
Balance, end of year
    (478,694 )     (450,533 )     (440,300 )
Total stockholders' equity
  $ 274,834     $ 293,755     $ 297,839  
Number of shares of common stock
                       
Balance, beginning of year
    70,578       71,000       70,267  
Common stock issued upon exercise of stock options and restricted
                       
stock, net of tax withholding related to vesting of restricted stock units (shares)
    (124 )     (422 )     733  
Balance, end of year
    70,454       70,578       71,000  
 
See Accompanying Notes
 


AFFYMETRIX, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(In thousands)
 
     Year Ended December 31,  
   
2011
   
2010
   
2009
 
CASH FLOWS FROM OPERATING ACTIVITIES:
                 
Net loss
  $ (28,161 )   $ (10,233 )   $ (23,909 )
Adjustments to reconcile net loss to net cash provided by operating activities:
                       
Depreciation and amortization
    32,309       35,460       45,125  
Amortization of investment premiums, net
    -       -       1,219  
Excess tax benefits for share-based compensation
    (200 )     (416 )     (1,409 )
Share-based compensation
    8,771       9,910       11,148  
Unrealized gain on hedging instruments
    (826 )     -       -  
Unrealized gain on investments
    (211 )     -       -  
Realized loss (gain) on debt and equity investments
    2,717       (970 )     (204 )
Other-than-temporary impairment on securities
    2,121       5,617       1,121  
Provision for note receivable
    2,151       -       -  
Deferred tax assets
    415       (73 )     1,358  
Amortization of debt offering costs
    408       841       1,207  
Gain from repurchase of convertible notes
    -       (6,297 )     (17,447 )
Loss (gain) on disposal of property and equipment
    342       784       (231 )
Impairment of property and equipment
    1,710       348       -  
Changes in operating assets and liabilities:
                       
Accounts receivable, net
    8,260       12,599       (2,207 )
Inventories
    6,522       5,117       (3,157 )
Prepaid expenses and other assets
    3,297       10,802       4,115  
Accounts payable and accrued liabilities
    (448 )     (12,801 )     (5,374 )
Deferred revenue
    (1,740 )     (2,881 )     (1,349 )
Other long-term liabilities
    1,900       168       (677 )
Net cash provided by operating activities
    39,337       47,975       9,329  
CASH FLOWS FROM INVESTING ACTIVITIES:
                       
Capital expenditures
    (5,779 )     (7,726 )     (10,249 )
Purchases of available-for-sale securities
    (86,252 )     (453,138 )     (381,560 )
Proceeds from sales of available-for-sale securities
    189,440       417,981       261,029  
Proceeds from maturities of available-for-sale securities
    32,982       110,477       124,090  
Proceeds from sale of property and equipment
    493       -       -