WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

FOR THE TRANSITION PERIOD FROM                 TO                 .

 

COMMISSION FILE NO. 0-28218

 

 

AFFYMETRIX, INC.

(Exact name of Registrant as specified in its charter)

 

 

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

 

 

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

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý  No o

 

COMMON SHARES OUTSTANDING ON JULY 31, 2004:  60,662,133

 

 

AFFYMETRIX, INC.

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION			3
	Item 1.	Financial Statements (Unaudited)	3
		Condensed Consolidated Balance Sheets at June 30, 2004 and December 31, 2003	3
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2004 and 2003	4
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003	5
		Notes to Condensed Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
	Item 4.	Controls and Procedures	28
PART II. OTHER INFORMATION			29
	Item 1.	Legal Proceedings	29
	Item 4.	Submission of Matters to a Vote of Security Holders	31
	Item 5.	Other Information	32
	Item 6.	Exhibits and Reports on Form 8-K	39
SIGNATURES			41

 

2

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

(UNAUDITED)

 

		June 30, 2004			December 31, 2003
					(Note 1)
ASSETS
Current assets:
Cash and cash equivalents		$	54,227		$	275,928
Available-for-sale securities		105,692			183,955
Accounts receivable		62,812			71,343
Inventories		18,801			22,632
Prepaid expenses and other current assets		5,510			7,443
Total current assets		247,042			561,301
Property and equipment, net		62,882			62,611
Acquired technology rights, net		67,511			27,818
Goodwill		18,601			18,601
Notes receivable from employees		2,699			1,500
Other assets		26,341			28,333
		$	425,076		$	700,164
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		$	42,028		$	71,044
Deferred revenue — current portion		32,110			30,019
Convertible subordinated notes — short-term		—			267,460
Total current liabilities		74,138			368,523
Deferred revenue — long-term portion		36,664			43,346
Other long-term liabilities		3,913			3,240
Convertible notes		120,000			120,000
Stockholders’ equity:
Common stock		606			595
Additional paid-in capital		389,689			370,304
Notes receivable from stockholders		(451		)	(428		)
Deferred stock compensation		(4,537		)	(5,185		)
Accumulated other comprehensive loss		(1,463		)	(1,572		)
Accumulated deficit		(193,483		)	(198,659		)
Total stockholders’ equity		190,361			165,055
		$	425,076		$	700,164

 

Note 1:                             The condensed consolidated balance sheet at December 31, 2003 has been derived from the audited consolidated financial statements at that date included in the Company’s Form 10-K for the fiscal year ended December 31, 2003.

 

See accompanying notes.

 

3

 

AFFYMETRIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Revenue:
Product sales		$	61,664		$	49,216		$	122,755		$	95,974
Product related revenue		13,511			13,977			27,033			28,366
Total product and product related revenue		75,175			63,193			149,788			124,340
Royalties and other revenue		3,187			2,690			5,558			5,845
Revenue from Perlegen Sciences		1,392			2,751			3,041			5,261
Total revenue		79,754			68,634			158,387			135,446
Costs and expenses:
Cost of product sales		19,388			16,997			40,120			33,817
Cost of product related revenue		2,076			2,308			4,932			4,501
Cost of revenue from Perlegen Sciences		1,099			2,751			2,470			5,261
Research and development		17,804			16,622			35,100			32,527
Selling, general and administrative		29,955			24,183			58,224			52,159
Amortization of deferred stock compensation		324			673			648			1,368
Amortization of purchased intangibles		—			281			—			562
Charge for acquired in-process technology		—			—			—			10,096
Total costs and expenses		70,646			63,815			141,494			140,291
Income (loss) from operations		9,108			4,819			16,893			(4,845		)
Interest and other income (expense), net		(940		)	5,986			135			8,362
Interest expense		(404		)	(5,266		)	(10,238		)	(10,167		)
Income (loss) before income taxes		7,764			5,539			6,790			(6,650		)
Income tax provision		(755		)	(344		)	(1,614		)	(878		)
Net income (loss)		$	7,009		$	5,195		$	5,176		$	(7,528	)
Basic net income (loss) per share		$	0.12		$	0.09		$	0.09		$	(0.13	)
Diluted net income (loss) per share		$	0.11		$	0.09		$	0.08		$	(0.13	)
Shares used in computing basic net income (loss) per share		60,376			58,708			60,140			58,628
Shares used in computing diluted net income (loss) per share		62,970			60,193			62,775			58,628

 

See accompanying notes.

 

4

 

AFFYMETRIX, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

 

		Six Months Ended June 30,
		2004			2003
Cash flows from operating activities:
Net income (loss)		$	5,176		$	(7,528	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		10,171			11,409
Gain from the repurchase of convertible subordinated notes		—			(739		)
Redemption premium and related write-off of debt issuance costs		8,095			—
Amortization of intangible assets		2,220			2,266
Amortization of investment premiums (discounts), net		(1,375		)	1,893
Stock-based compensation		648			1,368
Realized loss (gain) on sales of investments		999			(5,131		)
Write down of equity investments		1,607			496
Amortization of debt offering costs		376			866
Accretion of interest on notes receivable		(23		)	(43		)
Loss on write-off of equipment		424			398
Changes in operating assets and liabilities:
Accounts receivable, net		8,531			15,023
Inventories		3,831			63
Prepaid expenses and other current assets		(3,034		)	2,614
Accounts payable and accrued and other current liabilities		(27,995		)	(5,317		)
Deferred revenue		(4,591		)	65,037
Other long-term liabilities		673			(481		)
Net cash provided by operating activities		5,733			82,194
Cash flows from investing activities:
Capital expenditures		(10,866		)	(5,511		)
Purchases of available-for-sale securities		(97,695		)	(335,717		)
Proceeds from the sales and maturities of available-for-sale securities		175,634			330,394
Purchase of non-marketable equity investment		—			(1,000		)
Purchase of technology rights		(41,913		)	(5,903		)
Net cash provided by (used in) investing activities		25,160			(17,737		)
Cash flows from financing activities:
Issuance of common stock		19,396			5,624
Repurchase of convertible subordinated notes		—			(100,701		)
Redemption of convertible subordinated notes		(271,778		)	—
Net cash used in financing activities		(252,382		)	(95,077		)
Effect of exchange rate changes on cash		(212		)	(60		)
Net decrease in cash and cash equivalents		(221,701		)	(30,680		)
Cash and cash equivalents at beginning of period		275,928			67,888
Cash and cash equivalents at end of period		$	54,227		$	37,208

 

See accompanying notes.

 

5

 

AFFYMETRIX, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
(UNAUDITED)

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The condensed consolidated financial statements include the accounts of Affymetrix, Inc. (“Affymetrix” or the “Company”) and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, all adjustments (consisting of normal recurring entries) considered necessary for a fair presentation have been included.

 

Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. Certain amounts presented in the condensed consolidated financial statements for prior periods have been reclassified to conform to the current period presentation.

 

Use of Estimates

 

The preparation of the condensed consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates.

 

Revenue Recognition

 

Product Sales

 

Product sales as well as revenues from Perlegen Sciences, include sales of GeneChip® probe arrays and related instrumentation. Probe array and instrumentation revenues are recognized when earned, which is generally upon shipment and transfer of title to the customer and fulfillment of any significant post-delivery obligations. Accruals are provided for anticipated warranty expenses at the time the associated revenue is recognized.

 

Product Related Revenue

 

Product related revenue includes subscription fees earned under EasyAccess™ agreements; license fees, milestones and royalties earned from collaborative product development and supply agreements; service revenue; revenue from custom probe array design fees; and software revenue.

 

Revenue from subscription fees earned under EasyAccess™ agreements is recorded ratably over the related supply term.

 

The Company enters into collaborative arrangements which generally include a research and product development phase and a manufacturing and product supply phase. These arrangements may include up-front nonrefundable license fees, milestones, the rights to royalties based on the sale of final product by the partner, product supply agreements and distribution arrangements. The Company accounts for multiple element arrangements under Emerging Issues Task Force Issue No. 00-21 (“EITF 00-21”), “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 provides guidance on accounting for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 were adopted prospectively for revenue arrangements with multiple elements signed

 

6

 

subsequent to June 30, 2003. The adoption of EITF 00-21 did not have a material impact on our results of operations or financial condition.

 

In accordance with EITF 00-21, the Company allocates revenue for transactions or collaborations that include multiple elements to each unit of accounting based on its relative fair value, and recognizes revenue for each unit of accounting when the revenue recognition criteria have been met. The price charged when the element is sold separately generally determines fair value. In the absence of fair value of a delivered element, the Company allocates revenue first to the fair value of the undelivered elements and the residual revenue to the delivered elements. The Company recognizes revenue for delivered elements only when undelivered elements are not essential to the functionality of delivered elements and the fair value for all undelivered elements is known. If the fair value of any undelivered element included in a multiple element arrangement cannot be objectively determined, revenue is deferred until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements.

 

Any up-front, nonrefundable payments from collaborative product development agreements are recognized over the research and product development period, and at-risk substantive based milestones are recognized when earned. Any payments received which are not yet earned are included in deferred revenue.

 

Revenue related to extended warranty arrangements is deferred and recognized over the applicable periods. Revenue from custom probe array design fees associated with the Company’s GeneChip® CustomExpress™ and CustomSeq™ products are recognized when the associated products are shipped.

 

Royalties and Other Revenue

 

Royalties and other revenue include royalties earned from third party license agreements and research revenue which mainly consists of amounts earned under government grants. Additionally, other revenue includes fees earned through the license of the Company’s intellectual property.

 

Royalty revenues are earned from the sale of products by third parties who have been licensed under the Company’s intellectual property portfolio. Revenue from minimum royalties is amortized over the term of the creditable royalty period. Any royalties received in excess of minimum royalty payments are recognized under the terms of the related agreement, generally upon notification of manufacture or shipment of a product by a licensee.

 

Research revenue is mainly comprised of amounts earned under government grants. Research revenue is recorded in the period in which the associated costs are incurred. The costs associated with these grants are reported as research and development expense.

 

License revenues are generally recognized upon execution of the agreement unless the Company has continuing performance obligations, in which case the license revenue is recognized ratably over the period of expected performance.

 

Stock-Based Compensation

 

At June 30, 2004, the Company has six stock-based employee and non-employee director compensation plans, which are more fully described in the Company’s Annual Report on Form 10-K. The Company has elected to continue to follow the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations for these plans. During the three and six months ended June 30, 2004 and 2003, no stock-based compensation cost is reflected in net income (loss), as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant in accordance with FASB Statement No. 123, “Accounting for Stock-Based Compensation (“SFAS 123”), as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“SFAS 148”).

 

The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of SFAS 123, as amended by SFAS 148, to stock-based employee compensation (in thousands, except per share amounts):

 

7

 

 

Comprehensive Income (Loss)

 

Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss).  Other comprehensive income (loss) includes unrealized gains and losses on the Company’s available-for-sale securities and hedging contracts that are excluded from net income (loss), changes in fair value of derivatives designated as and effective as cash flow hedges, and foreign currency translation adjustments (see note 5).

 

Basic and Diluted Net Income (Loss) Per Share

 

Basic net income (loss) per share is calculated using the weighted-average number of common shares outstanding during the period less the weighted-average shares subject to repurchase. Diluted net income (loss) per share gives effect to the dilutive effect of stock options and warrants (calculated based on the treasury stock method) and convertible debt (calculated using an as if-converted method).  The calculation of diluted net income (loss) per share excludes shares of potential common stock if their effect is anti-dilutive.

 

The following table sets forth the computation of the weighted-average shares used in the basic and diluted net income (loss) per share calculations (in thousands):

 

 

8

 

Securities excluded from the computation of basic and diluted net loss per share, on an actual outstanding basis, were as follows (in thousands):

 

 

Income Taxes

 

Under the asset and liability method, deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period of enactment.

 

Contingencies

 

The Company is subject to legal proceedings principally related to intellectual property matters. Based on the information available at the balance sheet dates, the Company assesses 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, the Company will record a reserve in accordance with SFAS 5, “Accounting for Contingencies.” Any reserves recorded may change in the future due to new developments in each matter.

 

Derivative Instruments

 

In April, 2004, the Company began hedging a percentage of its assets that are held in nonfunctional currencies of its subsidiaries with forward contracts and the gains or losses on these contracts largely offset gains and losses on the change in value of the underlying asset.  The Company’s balance sheet hedging policy is designed to reduce the fluctuations in earnings due to changes in foreign currency exchange rates.  The Company’s foreign currency forward contracts are entered into for periods consistent with the related underlying exposures and do not constitute positions that are independent of those exposures. In addition, the Company does not enter into foreign currency forward contracts for trading or speculative purposes, is not party to any leveraged derivative instrument, and may only enter into derivative agreements with highly rated counterparties.

 

NOTE 2—PRODUCT SALES AND PRODUCT RELATED REVENUE

 

The components of product sales are as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Probe arrays and related supplies		$	41,597		$	33,629		$	87,122		$	72,698
Instruments		20,067			15,587			35,633			23,276
Total product sales		$	61,664		$	49,216		$	122,755		$	95,974

 

The components of product related revenue are as follows (in thousands):

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Subscription fees		$	4,956		$	5,977		$	10,515		$	13,552
Service and other		3,337			4,421			7,436			8,857
License fees and milestone revenue		5,218			3,579			9,082			5,957
Total product related revenue		$	13,511		$	13,977		$	27,033		$	28,366

 

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NOTE 3—INVENTORIES

 

Inventories consist of the following (in thousands):

 

		June 30, 2004			December 31, 2003
Raw materials		$	8,288		$	9,129
Work-in-process		4,709			4,226
Finished goods		5,804			9,277
Total		$	18,801		$	22,632

 

NOTE 4—ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

 

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

 

		June 30, 2004			December 31, 2003
Accounts payable		$	12,006		$	15,130
Accrued compensation and related liabilities		15,853			18,767
Accrued interest on convertible notes		37			4,260
Accrued taxes		6,034			3,756
Accrued legal		982			3,261
Accrued royalties		392			15,465
Accrued warranties		2,991			2,950
Other		3,733			7,455
Total		$	42,028		$	71,044

 

NOTE 5—COMPREHENSIVE INCOME (LOSS)

 

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

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2004			2003			2004			2003
Net income (loss)		$	7,009		$	5,195		$	5,176		$	(7,528	)
Foreign currency translation adjustment		(7		)	(210		)	(212		)	(60		)
Unrealized gain (loss) on available-for-sale securities		(1,214		)	711			(699		)	1,045
Unrealized gain (loss) on hedging contracts		850			(187		)	1,020			(405		)
Comprehensive income (loss)		$	6,638		$	5,509		$	5,285		$	(6,948	)

 

NOTE 6—INTANGIBLE ASSETS

 

Acquired technology rights are comprised of licenses to technology covered by patents to third parties and are amortized over the expected useful life of the underlying patents, which range from one to fifteen years. Accumulated amortization of these rights amounted to $10.3 million and $8.0 million at June 30, 2004 and December 31, 2003, respectively.

 

In May 2004, the Company reached an agreement with Oxford Gene Technology, Ltd. (“OGT”) to convert the Company’s non-exclusive royalty bearing license to certain of OGT’s patents to a fully paid-up license in return for a cash payment of $62.5 million.  The payment was comprised of approximately $41.9 million for the technology rights which was recorded in acquired technology rights, net and is being amortized over the remaining useful life of the patents of approximately 10 years, and approximately $20.6 million for previously accrued and expensed royalty obligations.

 

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

 

 

NOTE 7—CONVERTIBLE SUBORDINATED NOTES

 

On September 22, 1999, the Company completed the sale of $150 million principal amount of 5% convertible subordinated notes due 2006 (the “5% notes”). On February 14, 2000, the Company completed the sale of $225.0 million principal amount of 4.75% convertible subordinated notes due 2007 (the “4.75% notes”).  Between August 2001 and June 2003, the Company repurchased $59.5 million and $48.0 million principal amounts, of the 4.75% and 5% notes, respectively.

 

On January 9, 2004, the Company completed the redemption of its 5.0% notes ($102.0 million face value). In connection with the redemption, the Company recorded a charge of $3.2 million to interest expense in the first quarter of 2004, related to the unamortized issuance costs and redemption fee associated with the repurchased notes. On February 19, 2004, the Company also completed the redemption of its 4.75% notes ($165.5 million face value). In connection with the redemption, the Company recorded a charge of $4.9 million to interest expense related to the unamortized issuance costs and redemption fee associated with the repurchased notes.

 

NOTE 8—RELATED PARTY TRANSACTIONS

 

Perlegen Sciences, Inc.

 

As of June 30, 2004, the Company held approximately 40% ownership interest in Perlegen Sciences, Inc. (“Perlegen”), a privately-held biotechnology company in which two members of Perlegen’s board of directors are also members of the Company’s board of directors.  In addition, certain affiliates, including the Company’s chief executive officer and members of the Company’s board of directors, hold direct or indirect equity interests in Perlegen.

 

The Company formed Perlegen in 2001 as a wholly-owned subsidiary and spun it off in late 2001 in a $100 million private equity financing.  The Company acquired its initial ownership interest in Perlegen in an arrangement which provides Perlegen rights to use certain of the Company’s intellectual property in its development efforts, and also provides the Company rights to use and commercialize certain data generated by Perlegen in the array field.  The Company’s ownership interest in Perlegen is recorded at a zero cost basis for accounting purposes.

 

In January 2003, the Company licensed certain Perlegen technologies. Under the terms of the licensing agreement, the Company paid Perlegen a total of $15.0 million in cash and granted Perlegen a $3.0 million credit which will be applied against the margin on the Company’s future sales of chips to Perlegen. The credit can only be used against the margin on chips that are utilized by Perlegen for revenue generating activities. As of June 30, 2004, Perlegen has used all of the $3.0 million credit. The Company engaged an independent third party to conduct a valuation analysis of the licenses acquired. Based upon that independent valuation, the Company recorded a charge of approximately $10.1 million related to acquired in-process research and development in the first quarter of 2003. The remaining $4.9 million was recorded as intangible assets which are being amortized over their useful lives of six to ten years.

 

The Company accounts for its ownership interest in Perlegen using the equity method as the Company and its affiliates do not control the strategic, operating, investing and financing activities of Perlegen. Further, the Company has no obligations to provide funding to Perlegen nor does it guarantee or otherwise have any obligations related to the liabilities or results of operations of Perlegen or its investors. Given that the Company’s investment in Perlegen has no cost basis, the Company has not recorded any proportionate

 

11

 

share of Perlegen’s operating losses in its financial statements since the completion of Perlegen’s initial financing. In January 2004, the Company sold 400,000 shares of Perlegen common stock for a gain of $0.6 million which was included in interest and other income (expense), net during the first quarter of 2004.

 

In accordance with Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” as amended, the Company has concluded that Perlegen is a Variable Interest Entity (VIE) in which it holds a variable interest, and that the Company is not the primary beneficiary.  Accordingly, no change in accounting is appropriate and the Company will continue to account for its ownership interest in Perlegen under the equity method as described in the preceding paragraph.

 

As of June 30, 2004 and December 31, 2003, amounts due from Perlegen were $1.9 million and $2.9 million, respectively, and have been included in accounts receivable in the accompanying condensed consolidated balance sheets. Amounts due from Perlegen are payable to the Company on its normal commercial terms.

 

NOTE 9—COMMITMENTS AND CONTINGENCIES

 

Product Warranty Commitment

 

The Company provides for anticipated warranty costs at the time the associated revenue is recognized. Product warranty costs are estimated based upon the Company’s historical experience and the warranty period. Information regarding the changes in the Company’s product warranty liability for the six months ended June 30, 2004 was as follows (in thousands):

 

Balance at December 31, 2003		$	2,950
New warranties issued		868
Repairs and replacements		(1,095		)
Balance at March 31, 2004			2,723
New warranties issued		1,201
Repairs and replacements		(933		)
Balance at June 30, 2004		$	2,991

 

Funding Commitments

 

The Company has invested $6.2 million and is committed to invest up to an additional $3.8 million in a venture capital limited partnership. The Company accounts for this investment using the cost method of accounting, given that its ownership percentage is so minor that the Company has no influence over partnership operating and financial policies. The investment is included on the condensed consolidated balance sheet as a component of other assets.

 

Non-cancelable Supply Agreements

 

As of June 30, 2004, the Company had approximately $10.0 million of non-cancelable supply agreements through 2007.

 

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Indemnifications

 

From time to time the Company has entered into indemnification provisions under certain of its agreements with other companies in the ordinary course of business, typically with business partners, customers, and suppliers. Pursuant to these agreements, the Company generally indemnifies, holds harmless, and agrees to reimburse the indemnified parties on a case by case basis for losses suffered or incurred by the indemnified parties in connection with any U.S. patent or other intellectual property infringement claim by any third party with respect to its products. The term of these indemnification provisions is generally perpetual from the time of the execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As of June 30, 2004, the Company had not accrued a liability for this guarantee, because the likelihood of incurring a payment obligation in connection with this guarantee is remote.

 

Legal Proceedings – General

 

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

 

Purported Shareholder Class Action Lawsuits

 

The purported shareholder class action lawsuit brought against the Company, three of its executive officers and one outside director under the federal securities laws relating to the Company’s January 29, 2003 announcement of its financial expectations for 2003 and subsequent announcement on April 3, 2003, updating its financial guidance for the first quarter of 2003, was dismissed with prejudice by the United States District Court for the Northern District of California on June 15, 2004.

 

Multilyte Litigation

 

Multilyte Ltd., a British corporation, and Affymetrix have commenced legal proceedings in the United States, United Kingdom and German courts to address allegations made by Multilyte that the Company infringes certain patents owned by Multilyte (the “Multilyte patents”) by making and selling the GeneChip® DNA microarray products.

 

In the actions pending in Germany, on July 18, 2003, Multilyte filed proceedings in the state court of Dusseldorf, alleging infringement of the Multilyte patents. On October 16, 2003, the Dusseldorf court held its first hearing in the case and ruled that the case be divided into two formally separate cases (one dealing with European patent EP 0 134 215 and the other with European patent EP 0 304 202). Multilyte applied to stay both sets of infringement proceedings before the Dusseldorf court, pending Multilyte’s appeal of the decision of the German Federal Patent Court in Munich (as detailed further below), which held that both Multilyte’s European patents are invalid in Germany. On July 12, 2004, this stay was granted.  In a separate action in Germany, on October 15, 2003, the Company commenced nullity proceedings in German Federal Patent Court in Munich alleging that the German part of Multilyte’s two European patents are invalid. On June 28 and 29, 2004, the Munich court held that both Multilyte’s European patents are invalid in Germany.

 

In the action pending in the U.K., on August 14, 2003, the Company commenced proceedings in the English High Court seeking a declaratory judgment that three Multilyte patents are not infringed and are invalid. On September 25, 2003, Multilyte counterclaimed in the U.K. proceedings, alleging that the Company infringed two Multilyte patents (EP ‘215 and EP ‘202) in the U.K. and claiming damages, an injunction and legal costs. The English High Court has directed that the issues of whether the Multilyte patents are valid and whether they have been infringed by the Company are to be heard together.  On March 3, 2004, Multilyte

 

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notified the Company that they would be surrendering EP ‘215 and that the counterclaim of infringement would necessarily be withdrawn as a result.  On April 19, 2004, Multilyte wrote to the U.K. Patent Office to surrender EP ‘215.  The trial of the action in the English High Court is set to begin on October 11, 2004.

 

In the action pending in the U.S., on August 13, 2003, the Company commenced proceedings in the United States District Court for the Northern District of California seeking a declaratory judgment that eight Multilyte patents are not infringed and are invalid. Multilyte has agreed that the Company does not infringe five of the eight named patents. On October 24, 2003, the Company filed an amended complaint seeking a declaratory judgment as to three of the original eight named patents—U.S. Patents 5,432,099, 5,599,720 and 5,807,755. On November 12, 2003, Multilyte filed an answer to the Company’s complaint for declaratory judgment and asserted counterclaims against the Company alleging infringement of the three patents named by the Company in its complaint. Multilyte has voluntary submitted the three patents in suit to the United States Patent and Trademark Office for voluntary re-examination. Typically, re-examination proceedings take at least 12 months. On June 3, 2004, the Court stayed the case before it pending the outcome of the re-examination proceedings before the United States Patent and Trademark Office.

 

The Company believes that Multilyte’s claims are without merit and has filed the declaratory judgment and nullity actions to protect its interests. However, the Company cannot be sure that it will prevail in these matters. The Company’s failure to successfully defend against these allegations could result in a material adverse effect on its business, financial condition and results of operations.

 

Enzo Litigation

 

On October 28, 2003, Enzo Life Sciences, Inc., a wholly-owned subsidiary of Enzo Biochem, Inc. (collectively “Enzo”) filed a complaint against the Company that is now pending in the United States District Court for the Southern District of New York for breach of contract, injunctive relief and declaratory judgment. The Enzo complaint relates to a 1998 distributorship agreement with Enzo under which the Company served as a non-exclusive distributor of certain reagent labeling kits supplied by Enzo. In its complaint, Enzo seeks monetary damages and an injunction against the Company from using, manufacturing or selling Enzo products and from inducing collaborators and customers to use Enzo products in violation of the 1998 agreement. Enzo also seeks the transfer of certain Affymetrix patents to Enzo. In connection with its complaint, Enzo provided the Company with a notice of termination of the 1998 agreement effective on November 12, 2003.

 

On November 10, 2003, the Company filed a complaint against Enzo in the United States District Court for the Southern District of New York for declaratory judgment, breach of contract and injunctive relief relating to the 1998 agreement. In its complaint, the Company alleges that Enzo has engaged in a pattern of wrongful conduct against it and other Enzo labeling reagent customers by, among other things, asserting improperly broad rights in its patent portfolio, improperly using the 1998 agreement and distributorship agreements with others in order to corner the market for non-radioactive labeling reagents, and improperly using the 1998 agreement to claim ownership rights to the Company’s proprietary technology. The Company seeks declarations that it has not breached the 1998 agreement, that it is entitled to sell its remaining inventory of Enzo reagent labeling kits, and that nine Enzo patents that are identified in the 1998 agreement are invalid and/or not infringed by it. The Company also seeks damages and injunctive relief to redress Enzo’s alleged breaches of the 1998 agreement, its alleged tortious interference with the Company’s business relationships and prospective economic advantage, and Enzo’s alleged unfair competition. The Company filed a notice of related case stating that its complaint against Enzo is related to the complaints already pending in the Southern District of New York against eight other former Enzo distributors. The Southern District of New York has related the Company’s case.  In an order dated March 11, 2004, the Court set a deadline of November 5, 2004 for completion of fact discovery in all of the Enzo cases pending before the Court, including the cases between Enzo and the Company.  On April 9, 2004, the Company filed its answer to Enzo’s complaint.  Enzo filed an answer to the Company’s complaint on May 13, 2004.  There is no trial date in the actions between Enzo and the Company.

 

The Company believes that the claims set forth in Enzo’s complaint are without merit and have filed the action in the Southern District of New York to protect its interests. However, the Company cannot be sure that it will prevail in these matters. The Company’s failure to successfully defend against these allegations could result in a material adverse effect on its business, financial condition and results of operation.

 

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Administrative Litigation and Proceedings

 

The Company’s intellectual property is expected to be subject to significant additional administrative and litigation actions. For example, in Europe and Japan, third parties are expected to oppose significant patents that the Company owns or controls. Currently, Multilyte Ltd. and ProtoGene Laboratories, Inc. are parties that have filed oppositions against the Company’s EP 0 619 321 patent in the European Patent Office, and PamGene B.V. has filed an opposition against the Company’s EP 0 728 520. Also, Abbott Laboratories, Applera, Clondiag and CombiMatrix are parties in opposition against the Company’s EP 0 834 575. Abbott Laboratories, CombiMatrix, PamGene B.V., Applera and Dr. Peter Schneider have filed oppositions against the Company’s EP 0 834 576. CombiMatrix has filed an opposition against EP 0 695 941.  Agilent, CombiMatrix, Clondiag and Applera have filed an opposition against EP 0 853 679 and Applera has opposed EP 0 972 564. These procedures will result in the patents being either upheld in their entireties, allowed to issue in amended form in designated European countries, or revoked.

 

Further, in the United States, the Company expects that third parties will continue to “copy” the claims of its patents in order to provoke interferences in the United States Patent & Trademark Office, and it may copy the claims of others. These proceedings could result in the Company’s patent protection being significantly modified or reduced, and could result in significant costs and consume substantial managerial resources.

 

At this time, the Company cannot determine the outcome of any of the matters described above.

 

NOTE 10—EQUITY

 

During the six months ended June 30, 2004, the Company issued approximately 1,100,000 shares of common stock in connection with exercises of employee stock options.

 

On June 10, 2004, at the annual shareholders’ meeting, the shareholders’ approved the Company’s Amended and Restated 2000 Equity Incentive Plan (the “2000 Plan”) to increase share availability by 2,500,000 shares.

 

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

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations as of June 30, 2004 and for the three and six month periods ended June 30, 2004 and 2003 should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2003.

 

All statements in this quarterly report that do not discuss past results are forward-looking statements. Forward-looking statements are based on management’s current expectations and are therefore subject to certain risks and uncertainties, including those discussed under the section titled “Risk Factors” included in this report. Specific uncertainties which could cause our actual results to differ materially from those projected include, but are not limited to, risks of our ability to achieve and sustain higher levels of revenue, maintain gross margins, reduced operating expenses, market acceptance, personnel retention, global economic conditions, the reduction in overall capital spending in the academic, pharmaceutical and biotechnology sectors, changes in government funding policies, unpredictable fluctuations in quarterly revenues, uncertainties related to cost and pricing of Affymetrix products, dependence on collaborative partners, uncertainties relating to sole source suppliers, uncertainties relating to FDA and other regulatory approvals, competition, risks relating to intellectual property of others and the uncertainties of patent protection and litigation.

 

We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions, or circumstances on which any such statements are based.

 

Our Industry

 

Our industry is affected by a number of factors that influence its size and development. These factors include the availability of genomic sequence data for human and other organisms, technological innovation that increases throughput and lowers the cost of genomic and genetic analysis, the development of new computational techniques to handle and analyze large amounts of genomic data, the availability of government funding for basic and disease-related research, the amount of capital and ongoing expenditures allocated to research and development spending by biotechnology, pharmaceutical and diagnostic companies, the application of genomics to new areas including molecular diagnostics, agriculture, human identity and consumer goods, and the availability of genetic markers and signatures of diagnostic value.

 

Our Business and Financial Results

 

We have established our GeneChip® system as the platform of choice for acquiring, analyzing and managing complex genetic information. Our integrated GeneChip® platform includes: disposable DNA probe arrays (chips) consisting of gene sequences set out in an ordered, high density pattern, certain reagents for use with the probe arrays, a scanner and other instruments used to process the probe arrays, and software to analyze and manage genomic information obtained from the probe arrays. We currently sell our products directly to pharmaceutical, biotechnology, agrichemical, diagnostics and consumer products companies as well as academic research centers, government research laboratories, private foundation laboratories and clinical reference laboratories in North America, Europe and Japan. We also sell our products through life science supply specialists acting as authorized distributors in the Middle East, India and Asia Pacific regions.

 

For the six months ended June 30, 2004, we had net income of $5.2 million.  Prior to the year ended December 31, 2003, we incurred losses each year since our inception, and as a result have an accumulated deficit of approximately $193.5 million at June 30, 2004. Our losses have resulted principally from costs incurred in research and development, manufacturing and from selling, general and administrative costs associated with our operations, including the costs of patent related litigation. These costs have historically exceeded our revenues and interest income, which to date have been generated principally from product sales, product related revenue, technology access and other license fees, royalties, collaborative research and development agreements, and from interest earned on cash and investment balances.

 

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Our financial results are substantially dependent on our ability to generate significant revenues and maintain profitability. Revenues are impacted principally by our ability to expand our customer base and increase sales of our current and future products to new and existing customers, and by the price of product sales, royalties, design and license fees. To maintain or gain market acceptance of our products in the face of the introduction of new products by our competitors, we may have to reduce or discount the price of our products resulting in an adverse impact on revenues and gross margins. In addition to the above, our ability to enter into additional supply, license and collaborative arrangements and our ability and that of our collaborative partners to successfully manufacture and commercialize products incorporating our technologies in new applications and in new markets will also impact our revenue and profitability.

 

Our expenses are impacted principally by the cost of goods for products; the magnitude and duration of research and development; sales and marketing costs; and general and administrative expenses. General and administrative expenses are particularly subject to variation as a result of fluctuations in the intensity of legal activities. Our operating results may also fluctuate significantly depending on other factors which include: the outcome of ongoing or future litigation; the need for additional royalty bearing licenses; adoption of new technologies; the cost, quality and availability of reagents and components; regulatory actions; and third-party reimbursement policies.

 

Company Outlook

 

As management looks ahead for the remainder of 2004, the outlook for our company continues to be favorable for a number of reasons. We anticipate that continued improvements in macroeconomic factors, including access to capital markets, will favorably influence research and development expenditures of existing and potential customers; that the current regulatory market appears poised to leverage genetic information tools to improve the approval process for new drugs; and that we will see continued standardization on our technology platform for both existing and new applications. Although it is difficult to predict product demand, we expect our existing and future product offerings to provide continued growth in our product and product related revenue as the number of experiments conducted using GeneChip® technology continues to increase.  In particular, we anticipate that our new line of DNA analysis products, which were launched in the second half of 2003, will provide a meaningful contribution to our product revenue growth in 2004. Management also expects to realize additional operational efficiencies as we continue to leverage our investments in corporate infrastructure and information management systems.

 

Going forward, management is focused on growing the business and achieving sustained profitability. A key driver will be increasing the breadth of scientific and clinical applications of our technology, while also industrializing, automating and standardizing our technology to open new markets and drive revenue growth. The aim of our automation efforts is to reduce the cost per experiment, minimize operator variability and dramatically improve experimental throughput. We believe that our automation solutions will enjoy commercial success in the high-throughput markets just as our bench-top systems have in the research markets.

 

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 condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

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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 condensed consolidated financial statements.

 

There have been no changes to our critical accounting policies from those included in our Form 10-K for December 31, 2003.

 

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 price should be allocated among the deliverable elements, when to recognize revenue for each element, and the period over which revenue should be recognized. We recognize revenue for delivered elements only when the fair values of undelivered elements are known and there are no uncertainties regarding customer acceptance. Changes in the allocation of the sales price between deliverable elements might impact the timing of revenue recognition, but would not change the total revenue recognized on the contract.

 

Accounts Receivable

 

We evaluate the collectibility of our trade receivables based on a combination of factors. We regularly analyze our significant customer accounts, and, when we become aware of a specific customer’s inability to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position, we record specific bad debt reserves to reduce the related receivable to the amount we reasonably believe is collectible. We also record reserves for bad debt on a small portion of all other customer balances based on a variety of factors including the length of time the receivables are past due, the financial health of the customer, macroeconomic considerations and historical experience. If circumstances related to specific customers change, our estimates of the recoverability of receivables could be further adjusted.

 

Inventories

 

We enter into inventory purchases and commitments so that we can meet future shipment schedules based on forecasted demand for our products. The business environment in which we operate is subject to rapid changes in technology and customer demand. We perform a detailed assessment of inventory each period, which includes a review of, among other factors, demand requirements, product life cycle and development plans, component cost trends, product pricing, product expiration and quality issues. Based on this analysis, we record adjustments to inventory for potentially excess, obsolete or impaired goods, when appropriate, in order to report inventory at net realizable value. Revisions to our inventory adjustments may be required if actual demand, component costs, supplier arrangements, or product life cycles differ from our estimates.

 

Accounting for Acquired Technology Rights

 

Our intangible assets are comprised principally of technology rights. We apply judgment in determining the useful lives of our intangible assets and whether such assets are impaired. Factors we consider include the life of the underlying patent, the existence of competing technology and potential obsolescence, which can all adversely impact the expected period of benefit from the use of the technology. To date, we have not experienced any impairment on our intangible assets.

 

Contingencies

 

We are subject to legal proceedings principally related to intellectual property matters. Based on the information available at the balance sheet dates, we assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. If losses are probable and reasonably estimable, we will record a reserve in accordance with SFAS 5, “Accounting for Contingencies.” Any reserves recorded may change in the future due to new developments in each matter.

 

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Results of Operations

 

The following discussion compares the historical results of operations for the three and six months ended June 30, 2004 and 2003, respectively.

 

Product Sales

 

The components of product sales are as follows (in thousands):

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Probe arrays and related supplies		$	41,597		$	33,629		$	7,968		$	87,122		$	72,698		$	14,424
Instruments		20,067			15,587			4,480			35,633			23,276			12,357
Total product sales		$	61,664		$	49,216		$	12,448		$	122,755		$	95,974		$	26,781

 

Total product sales increased $12.4 million in the second quarter of 2004 as compared to the same period in 2003.  The increase was primarily due to growth in the unit sales and average selling price of our GeneChip® probe arrays, which includes the transition of our flagship Human, Mouse and Rat products from a two chip set to one chip and growth in unit sales of our GeneChip® related supplies as the result of new product introductions.  Instrument sales also increased primarily due to growth in unit sales of our GeneChip® Scanner 3000 instruments and upgrades which were partially offset by a decrease in unit sales of our full GeneChip® instrumentation systems.

 

Total product sales increased $26.8 million in the first six months of 2004 as compared to the same period in 2003.  The increase was primarily due to growth in the unit sales and average selling price of our GeneChip® probe arrays, which includes the transition of our flagship Human, Mouse and Rat products from a two chip set to one chip and growth in unit sales of our GeneChip® related supplies as the result of new product introductions.  Instrument sales also increased primarily due to growth in unit sales of our GeneChip® Scanner 3000 instruments and upgrades and Fluidics Station 450 upgrades which were partially offset by a decrease in unit sales of our full GeneChip® instrumentation systems.

 

Product Related Revenue

 

The components of product related revenue are as follows (in thousands):

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Subscription fees		$	4,956		$	5,977		$	(1,021	)	$	10,515		$	13,552		$	(3,037	)
Service and other		3,337			4,421			(1,084		)	7,436			8,857			(1,421		)
License fees and milestone revenue		5,218			3,579			1,639			9,082			5,957			3,125
Total product related revenue		$	13,511		$	13,977		$	(466	)	$	27,033		$	28,366		$	(1,333	)

 

Total product related revenue decreased $0.5 million in the second quarter and $1.3 million in the first six months of 2004 as compared to the same periods in 2003. The decreases were due to a decline in subscription fees earned under our EasyAccess™ agreements as we transition customers to volume-based discounting on product sales. In addition, service and other revenue declined due to decreases in the number of service contracts as pre-existing scanner customers upgraded to our GeneChip® Scanner 3000 which is covered by a one year warranty.  These decreases were partially offset by increases in license fees earned in connection with the Roche agreement and the recognition of milestone revenue due to the achievement of substantive goals as defined by our collaborative agreements.  License fees and milestone revenue earned in connection with the Roche agreement signed in January 2003, was $4.3 million and $7.8 million compared to $3.6 million and $6.0 million for the three and six months ended June 30, 2004 and 2003, respectively.

 

 

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Royalties and Other Revenue (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Royalties and other revenue		$	3,187		$	2,690		$	497		$	5,558		$	5,845		$	(287	)

 

Royalties and other revenue increased $0.5 million in the second quarter of 2004 as compared to the same period in 2003. The increase was primarily due to the execution of a license agreement with no continuing performance obligations as well as an increase in government grant activity.  These increases were partially offset by a decrease in the number and average value of our remaining non-core license agreements.

 

Royalties and other revenue decreased $0.3 million in the first six months of 2004 as compared to the same period in 2003. The decrease was primarily due to an overall decrease in the number and average value of our remaining non-core license agreements.

 

Revenue From Perlegen Sciences (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Revenue from Perlegen Sciences		$	1,392		$	2,751		$	(1,359	)	$	3,041		$	5,261		$	(2,220	)

 

Revenue from Perlegen Sciences, an affiliated party, decreased $1.4 million in the second quarter and $2.2 million in the first six months of 2004 as compared to the same periods in 2003. The decreases were consistent with the decrease in Perlegen’s contractual obligations.  During the second quarter of 2004, we recognized margin on the sale of probe arrays that were utilized by Perlegen for revenue generating activities.  In addition, during the first six months of 2004, we also sold Perlegen GeneChip® instruments on which we earned margins consistent with our sales of instruments to other customers.

 

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

 

		Three Months Ended June 30,						Dollar / Percentage Change From			Six Months Ended June 30,						Dollar / Percentage Change From
		2004			2003			2003			2004			2003			2003
Total gross margin on product sales		$	42,276		$	32,219		$	10,057		$	82,635		$	62,157		$	20,478
Total gross margin on product related revenue		11,435			11,669			(234		)	22,101			23,865			(1,764		)
Total gross margin on product and product related revenue		$	53,711		$	43,888		$	9,823		$	104,736		$	86,022		$	18,714
Product gross margin as a percentage of product sales		68.6		%	65.5		%	3.1		%	67.3		%	64.8		%	2.5		%
Product related gross margin as a percentage of product related revenue		84.6		%	83.5		%	1.1		%	81.8		%	84.1		%	(2.3		)%

 

Gross margin on product sales increased 3.1% in the second quarter and 2.5% in the first six months of 2004 as compared to the same periods in 2003.  These improvements were primarily due to an increase in instrument gross margins related to higher average selling prices and lower costs of production due to increased utilization of our Bedford facility.  The increases in gross margin were partially offset by a change in our product mix of probe arrays and related supplies.

 

Product related gross margin increased by 1.1% in the second quarter of 2004 as compared to the same period in 2003.  The increase was primarily related to the recognition of milestone revenue due to the achievement of substantive goals as defined by our collaborative agreements. The increase was partially offset by a decrease in sales of our EasyAccess™ agreements as we transition customers to volume-based discounting on product sales.

 

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Product related gross margin decreased by 2.3% in the first six months of 2004 as compared to the same period in 2003.  The decline was primarily due to a decrease in sales of our EasyAccess™ agreements as we transition customers to volume-based discounting on product sales.

 

We expect to see a positive impact in our product and product related gross margins in the second half of 2004 as a result of the conversion of our non-exclusive license to certain of OGT’s patents to a fully paid-up license and the elimination of all future royalties to Oxford Gene Technology, Ltd. (“OGT”).

 

Cost of Perlegen Revenues (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Cost of revenue from Perlegen Sciences		$	1,099		$	2,751		$	(1,652	)	$	2,470		$	5,261		$	(2,791	)

 

Pursuant to a supply agreement with Perlegen, we sell whole wafers to Perlegen for use in Perlegen’s research and development activities at our fully burdened cost of manufacturing. Cost of Perlegen revenue decreased $1.7 million in the second quarter and $2.8 million in the first six months of 2004 as compared to the same periods in 2003. The decreases in the costs of Perlegen revenue were related to the reduction in wafer purchases made by Perlegen, which is consistent with Perlegen’s declining contractual purchase obligations. This decrease was partially offset by costs associated with Perlegen’s purchase of GeneChip® instruments, on which we earned margins consistent with our sales of instruments to other customers.

 

Research and Development Expenses (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Research and development		$	17,804		$	16,622		$	1,182		$	35,100		$	32,527		$	2,573

 

Research and development expenses, which primarily consist of basic research, product research and development and manufacturing process and development, increased $1.2 million in the second quarter and $2.6 million in the first six months of 2004 as compared to the same periods in 2003. The increases were primarily due to the increased utilization of our pilot operations facility in Sunnyvale for research related to our new product development.  We also increased our spending on basic research and development.

 

We believe a substantial investment in research and development is essential to a long-term sustainable competitive advantage and critical to expansion into new markets.

 

Selling, General and Administrative Expenses (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Selling, general and administrative		$	29,955		$	24,183		$	5,772		$	58,224		$	52,159		$	6,065

 

Selling, general and administrative expenses increased $5.8 million in the second quarter of 2004 as compared to the same period in 2003.  The increase was primarily due to increases in sales and marketing expenses in our American and European regions related to new product introductions and the recovery of a $1.3 million amount receivable in the second quarter of 2003 which had been expensed in the second half of 2002.  In addition, we continued to increase expenses in 2004 related to on-going regulatory compliance efforts.

 

Selling, general and administrative expenses increased $6.1 million in the first six months of 2004 as compared to the same period in 2003.  The increase was primarily due to increases in sales and marketing expenses in our American and European regions related to new product introductions and the recovery of a $1.3 million amount receivable in the second quarter of 2003 which had been expensed in the second half of 2002.  In addition, we continued to increase expenses in 2004 related to on-going regulatory compliance efforts.  These increases were partially offset by decreased legal expenses primarily due to the cash reimbursement of

 

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legal costs in 2004 associated with the resolution of an intellectual property dispute and a decrease in sales and support costs in Japan as our Japanese operations completed their obligations associated with a prior distribution agreement.

 

Selling, general and administrative expenses are expected to continue to increase in absolute dollars as we expand sales, marketing, and technical support functions, management and administrative functions, prosecute and defend our intellectual property position and defend against claims made by third parties in ongoing litigation. We expect legal costs to vary substantially as the intensity of legal activity changes. There can be no assurance that we have adequately estimated our exposure for potential damages associated with pending or future litigation.

 

Amortization of Deferred Stock Compensation (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Amortization of deferred stock compensation		$	324		$	673		$	(349	)	$	648		$	1,368		$	(720	)

 

Stock compensation expense decreased $0.3 million in the second quarter and $0.7 million in the first six months of 2004 as compared to the same periods in 2003.  Upon the acquisition of Neomorphic in October 2000, the fair value of unvested common stock subject to restricted stock agreements and the intrinsic value of the unvested options held by employees were deducted from the purchase price and allocated to deferred stock compensation. As of June 30, 2004, approximately $0.1 million of the remaining deferred stock compensation of $4.5 million will continue to be amortized to compensation expense in the second half of 2004.  We ceased amortizing $4.4 million of deferred stock compensation related to an executive level Neomorphic employee who commenced a leave of absence during the latter part of fiscal 2001.  The remaining $4.4 million balance will be amortized if and when the employee resumes active status with us.

 

Amortization of Purchased Intangibles (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Amortization of purchased intangibles		$	—		$	281		$	(281	)	$	—		$	562		$	(562	)

 

We incurred no charges related to purchased intangibles in the second quarter and first six months of 2004 as we fully amortized all of our purchased intangibles during the fiscal year ended 2003.  Amortization of purchased intangibles was $0.3 million and $0.6 million for the three and six months ended June 30, 2003, respectively.

 

Charge for Acquired In-process Technology (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Charge for acquired in-process technology		$	—		$	—		$	—		$	—		$	10,096		$	(10,096	)

 

During the six months ended June 30, 2003, we recorded a charge of approximately $10.1 million related to acquired in-process research and development. The charge associated with licensing the Perlegen SNP database was included in acquired in-process research and development in the consolidated statement of operations as the database had no alternative future use to us. Specifically, the database contains over one million SNPs and is being used in our research and development program to develop high quality, high density DNA analysis microarray products. The value of the SNP database license was determined by estimating the net present value of future cash flows expected from the sale of DNA analysis products developed from this database using a present value discount rate of 30.0%, which was based on our weighted cost of capital adjusted for the risks associated with the in-process research project in which the SNP database content is being used. Upon entering into this license agreement in January 2003, our DNA analysis development program was approximately 33% complete.

 

The estimates used by us in valuing the licensed technologies were based upon assumptions we believe to be reasonable but which are inherently uncertain and unpredictable. Our assumptions may be incomplete or inaccurate, and no assurance can be given that unanticipated events and circumstances will not occur. Accordingly, actual results may vary from the projected results.

 

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Interest and Other Income (Expense), Net (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Interest and other income (expense), net		$	(940	)	$	5,986		$	(6,926	)	$	135		$	8,362		$	(8,227	)

 

Interest and other income (expense), net decreased $6.9 million in the second quarter of 2004 as compared to the same period in 2003. The decrease was primarily due to the acquisition by a publicly traded entity in April 2003 of a privately-held biotechnology company in which we owned an equity investment. Consistent with EITF 91-5, “Nonmonetary Exchange of Cost Method Investments”, during the second quarter of 2003 we realized a $2.6 million gain on the acquisition date, and recognized an additional gain of $1.2 million upon the subsequent sale of a portion of these securities.  In addition, we experienced lower returns on our cash and marketable securities portfolio as we had lower cash balances due to the $271.8 million of bond redemptions completed during the first quarter of 2004 and a payment in the second quarter of 2004 of approximately $41.9 million to Oxford Gene Technology, Ltd. (“OGT”) to convert our non-exclusive royalty bearing license to certain of OGT’s patents to a fully paid-up license which resulted in a $0.9 million loss associated with the liquidation of a portion of our investment portfolio. We also experienced a decline in favorable currency variances.

 

Interest and other income (expense), net decreased $8.2 million in the first six months of 2004 as compared to the same period in 2003. The decrease was primarily due to the acquisition by a publicly traded entity in April 2003 of a privately-held biotechnology company in which we owned an equity investment. Consistent with EITF 91-5, “Nonmonetary Exchange of Cost Method Investments”, during the second quarter of 2003 we realized a $2.6 million gain on the acquisition date, and recognized an additional gain of $1.2 million upon the subsequent sale of a portion of these securities.  In addition, we incurred a $1.6 million impairment charge due to an other-than-temporary decline in the carrying value of a non-marketable equity security and experienced lower returns on our cash and marketable securities portfolio as we had lower cash balances due to the $271.8 million of bond redemptions completed in the first quarter of 2004 and a payment in the second quarter of 2004 of approximately $41.9 million to OGT to convert our non-exclusive royalty bearing license to certain of OGT’s patents to a fully paid-up license which resulted in a $0.9 million loss associated with the liquidation of a portion of our investment portfolio. These decreases were partially offset by a $0.6 million gain recognized on the sale of a portion of our investment in Perlegen common stock.

 

Interest Expense (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Interest expense		$	404		$	5,266		$	(4,862	)	$	10,238		$	10,167		$	71

 

Interest expense decreased $4.9 million in the second quarter of 2004 as compared to the same period in 2003. The decrease was primarily due to the $271.8 million of bond redemptions completed in the first quarter of 2004 of our 5% and 4.75% convertible subordinated notes. This decrease was partially offset by the interest expense associated with the $120 million of 0.75% senior convertible notes issued in December 2003.

 

Interest expense was relatively flat in the first six months of 2004 as compared to the same period in 2003.  We incurred expenses in the first six months of 2004 related to the write off of approximately $3.8 million in issuance costs plus $4.3 million in redemption premiums due to the $271.8 million of bond redemptions completed in the first quarter of 2004 of our 5% and 4.75% convertible subordinated notes.  We also incurred interest expense associated with the $120 million of 0.75% senior convertible notes issued in December 2003.  In the first six months of 2003, we incurred interest expense primarily related to our 5% and 4.75% notes.

 

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Income Tax Provision (in thousands)

 

		Three Months Ended June 30,						Three Months Dollar Change			Six Months Ended June 30,						Six Months Dollar Change
		2004			2003			From 2003			2004			2003			From 2003
Income Tax Provision		$	755		$	344		$	411		$	1,614		$	878		$	736

 

The provision for income tax increased $0.4 million in the second quarter and $0.7 million in the first six months of 2004 as compared to the same periods in 2003. For the three and six months ended June 30, 2004 and 2003, the provision consists of foreign, federal and state taxes and increased primarily due to taxes related to our foreign operations.  Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”) provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes the historical operating performance and the reported cumulative net losses in all prior years, at June 30, 2004, we provided a full valuation allowance against our net deferred tax assets.

 

Liquidity and Capital Resources

 

Cashflow (in thousands)

 

		Six Months Ended June 30,
		2004			2003
Net cash provided by operating activities		$	5,733		$	82,194
Net cash provided by (used in) investing activities		25,160			(17,737		)
Net cash used in financing activities		(252,382		)	(95,077		)
Effect of foreign currency translation on cash and cash equivalents		(212		)	(60		)
Net decrease in cash and cash equivalents		$	(221,701	)	$	(30,680	)

 

Net cash provided by operating activities was $5.7 million for the six months ended June 30, 2004, as compared to $82.2 million for the six months ended June 30, 2003. The decrease in our net cash flow from operating activities was primarily due to the $70.0 million Roche collaboration agreement up-front, nonrefundable license fee received in January 2003, partially offset by the $10.1 million charge recorded in January 2003 related to the acquisition of in-process research and development and $28.0 million in payments related to a reduction in accounts payable and accrued liabilities for the six months ended June 30, 2004.

 

Our investing activities, other than purchases, sales and maturities of available-for-sale securities, primarily consisted of the purchase of technology rights of $41.9 million to convert our non-exclusive royalty bearing license to certain of OGT’s patents to a fully paid-up license and capital expenditures of $10.9 million for the six months ended June 30, 2004, as compared to the purchase of technology rights, non-marketable equity investment and capital expenditures of $5.9 million, $1.0 million and $5.5 million, respectively, for the six months ended June 30, 2003. Capital expenditures during the six months ended June 30, 2004 related primarily to continued expansion in other operating facilities along with investments in information management systems.

 

Net cash used in financing activities was $252.4 million for the six months ended June 30, 2004, as compared to $95.1 million for the six months ended June 30, 2003.  The increase primarily relates to the $271.8 million cash outflow for the redemption of the remaining 5% and 4.75% notes during the six months ended June 30, 2004 as compared to the $100.7 million cash outflow for the repurchase of a portion of the convertible subordinated notes during the six months ended June 30, 2003.  This was partially offset by the increase of $13.8 million from the issuance of common stock from stock option exercises pursuant to our equity incentive plans.

 

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Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

 

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of June 30, 2004, we are not involved in any SPE transactions.

 

The impact that our contractual obligations as of June 30, 2004 are expected to have on our liquidity and cash flow in future periods is as follows (in thousands):

 

 

(1)                                  Our 0.75% senior convertible notes are due in 2033, however holders may require us to repurchase all or a portion of their notes on December 31, 2008, 2013, 2018, 2023, and 2028.

 

(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.

 

(3)                                  Other commitments relate to an obligation held by the Company to contribute money in a venture capital limited partnership. The venture capital limited partnership may call in this amount, in part or in full at any time according to the contract terms. Other commitments also include a funding obligation related to a research and development agreement which expires in 2005 and funding to support two fellowships under the Bio-X Program at Stanford.

 

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We have financed our operations primarily through product sales, sales of equity and debt securities, collaborative agreements, interest income, and licensing of our technology. As of June 30, 2004, we had cash, cash equivalents and available-for-sale securities of $159.9 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, and planned capital expenditures (estimated to be between $23.0 million and $27.0 million for the year ending December 31, 2004), for the foreseeable future. However, this expectation is based on our current operating, financing and capital expenditure plans, which are subject to change, and therefore we could require additional funding. We also expect that our capital requirements will increase over the next several years as we expand our worldwide commercial operations, expand our manufacturing capabilities, increase our investments in third parties and expand our research and development efforts. Our long-term capital expenditure requirements will depend on numerous factors, including: the expansion of commercial scale manufacturing capabilities; our ability to maintain existing collaborative and customer arrangements and establish and maintain new collaborative 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.

 

As of June 30, 2004, 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.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

In the six months ended June 30, 2004, we redeemed all our outstanding 4.75% and 5% convertible subordinated notes at their $267.5 million face amount.  As of June 30, 2004, only our .75% senior convertible notes were outstanding and had a carrying amount and fair value of $120.0 million.  As of June 30, 2004, our investments in available-for-sale debt securities had a carrying value of $145.8 million and a fair value of $146.2 million, which was lower compared to December 31, 2003 primarily because a portion of our investments was liquidated to fund the bond redemption during the first quarter of 2004 and to convert our non-exclusive royalty bearing license to certain of OGT’s patents to a fully paid-up license during the second quarter of 2004.

 

In April, 2004, we began hedging a percentage of our assets that are held in nonfunctional currencies of our subsidiaries with forward contracts and the gains or losses on these contracts largely offset gains and losses on the change in value of the underlying asset.  Our balance sheet hedging policy is designed to reduce the fluctuations in earnings due to changes in foreign currency exchange rates.

 

We do not use derivative contracts for speculative purposes. At June 30, 2004, total outstanding contracts included the notional equivalent of $55.1 million in foreign currency forward exchange contracts with a fair value of $0.9 million. As of June 30, 2004, all contracts were set to expire at various times through March 2005. The bank counterparties in these contracts expose us to credit-related losses in the event of their nonperformance. However, to mitigate that risk we only contract with reputable institutions. We apply hedge accounting based upon the criteria established by Statement of Financial Accounting Standards No. 133 (“SFAS 133”), whereby we designate our derivatives for revenue hedging purposes as cash flow hedges.  We have elected not to designate our derivatives for balance sheet purposes as fair value hedges under SFAS 133 and have appropriately recorded any changes in fair value to interest and other income (expense), net.

 

A sensitivity analysis was performed on all of our foreign exchange derivatives as of June 30, 2004. This sensitivity analysis was based on a modeling technique that measures the hypothetical market value resulting from a 10% shift in the value of exchange rates relative to the U.S. dollar. For our forward contracts, we used a hypothetical change made to the spot rates of the currency. A 10% increase in the value of the U.S. dollar would lead to an increase in the fair value of our financial hedging instruments by $5.3 million. Conversely, a 10% decrease in the value of the U.S. dollar would result in a decrease in the fair value of these financial instruments by $5.6 million.

 

There have been no other significant changes in our market risk compared to the disclosures in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2003.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

(a)           Evaluation of disclosure controls and procedures. Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

(b)           Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

 

General

 

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

 

Purported Shareholder Class Action Lawsuit

 

The purported shareholder class action lawsuit brought against us, three of our executive officers and one outside director under the federal securities laws relating to our January 29, 2003 announcement of our financial expectations for 2003 and subsequent announcement on April 3, 2003, updating our financial guidance for the first quarter of 2003, was dismissed with prejudice by the United States District Court for the Northern District of California June 15, 2004.

 

Multilyte Litigation

 

Multilyte Ltd., a British corporation, and Affymetrix have commenced legal proceedings in the United States, United Kingdom and German courts to address allegations made by Multilyte that we infringe certain patents owned by Multilyte (the “Multilyte patents”) by making and selling the GeneChip® DNA microarray products.

 

In the actions pending in Germany, on July 18, 2003, Multilyte filed proceedings in the state court of Dusseldorf, alleging infringement of the Multilyte patents. On October 16, 2003, the Dusseldorf court held its first hearing in the case and ruled that the case be divided into two formally separate cases (one dealing with European patent EP 0 134 215 and the other with European patent EP 0 304 202).  Multilyte applied to stay both sets of infringement proceedings before the Dusseldorf court, pending Multilyte’s appeal of the decision of the German Federal Patent Court in Munich (as detailed further below), which held that both Multilyte’s European patents are invalid in Germany.  On July 12, 2004, this stay was granted.  In a separate action in Germany, on October 15, 2003, we commenced nullity proceedings in German Federal Patent Court in Munich alleging that the German part of Multilyte’s two European patents are invalid. On June 28 and 29, 2004, the Munich court held that both Multilyte’s European patents are invalid in Germany.

 

In the action pending in the U.K., on August 14, 2003, we commenced proceedings in the English High Court seeking a declaratory judgment that three Multilyte patents are not infringed and are invalid. On September 25, 2003, Multilyte counterclaimed in the U.K. proceedings, alleging that we infringed two Multilyte patents (EP ‘215 and EP ‘202) in the U.K. and claiming damages, an injunction and legal costs. The English High Court has directed that the issues of whether the Multilyte patents are valid and whether they have been infringed by us are to be heard together.  On March 3, 2004, Multilyte notified us that they would be surrendering EP ‘215 and that the counterclaim of infringement would necessarily be withdrawn as a result.  On April 19, 2004, Multilyte wrote to the U.K. Patent Office to surrender EP ‘215.  The trial of the action in the English High Court is set to begin on October 11, 2004.

 

In the action pending in the U.S., on August 13, 2003, we commenced proceedings in the United States District Court for the Northern District of California seeking a declaratory judgment that eight Multilyte patents are not infringed and are invalid. Multilyte has agreed that we do not infringe five of the eight named patents. On October 24, 2003, we filed an amended complaint seeking a declaratory judgment as to three of the original eight named patents—U.S. Patents 5,432,099, 5,599,720 and 5,807,755. On November 12, 2003, Multilyte filed an answer to our complaint for declaratory judgment and asserted counterclaims against us alleging infringement of the three patents named by us in our complaint. Multilyte has voluntary submitted the three patents in suit to the

 

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United States Patent and Trademark Office for voluntary re-examination. Typically, re-examination proceedings take at least 12 months.  On June 3, 2004, the Court stayed the case before it pending the outcome of the re-examination proceedings before the United States Patent and Trademark Office.

 

We believe that Multilyte’s claims are without merit and have filed the declaratory judgment and nullity actions to protect our interests. However, we cannot be sure that we will prevail in these matters. Our failure to successfully defend against these allegations could result in a material adverse effect on our business, financial condition and results of operations.

 

Enzo Litigation

 

On October 28, 2003, Enzo Life Sciences, Inc., a wholly-owned subsidiary of Enzo Biochem, Inc. (collectively “Enzo”) filed a complaint against us that is now pending in the United States District Court for the Southern District of New York for breach of contract, injunctive relief and declaratory judgment. The Enzo complaint relates to a 1998 distributorship agreement with Enzo under which we served as a non-exclusive distributor of certain reagent labeling kits supplied by Enzo. In its complaint, Enzo seeks monetary damages and an injunction against us from using, manufacturing or selling Enzo products and from inducing collaborators and customers to use Enzo products in violation of the 1998 agreement. Enzo also seeks the transfer of certain Affymetrix patents to Enzo. In connection with its complaint, Enzo provided us with a notice of termination of the 1998 agreement effective on November 12, 2003.

 

On November 10, 2003, we filed a complaint against Enzo in the United States District Court for the Southern District of New York for declaratory judgment, breach of contract and injunctive relief relating to the 1998 agreement. In our complaint, we allege that Enzo has engaged in a pattern of wrongful conduct against us and other Enzo labeling reagent customers by, among other things, asserting improperly broad rights in its patent portfolio, improperly using the 1998 agreement and distributorship agreements with others in order to corner the market for non-radioactive labeling reagents, and improperly using the 1998 agreement to claim ownership rights to our proprietary technology. We seek declarations that we have not breached the 1998 agreement, that we are entitled to sell our remaining inventory of Enzo reagent labeling kits, and that nine Enzo patents that are identified in the 1998 agreement are invalid and/or not infringed by us. We also seek damages and injunctive relief to redress Enzo’s alleged breaches of the 1998 agreement, its alleged tortious interference with the Company’s business relationships and prospective economic advantage, and Enzo’s alleged unfair competition. We filed a notice of related case stating that our complaint against Enzo is related to the complaints already pending in the Southern District of New York against eight other former Enzo distributors. The Southern District of New York has related our case.  In an order dated March 11, 2004, the Court set a deadline of November 5, 2004 for completion of fact discovery in all of the Enzo cases pending before the Court, including the cases between Enzo and us.  On April 9, 2004, we filed our answer to Enzo’s complaint.  Enzo filed an answer to our complaint on May 13, 2004.  There is no trial date in the actions between Enzo and us.

 

We believe that the claims set forth in Enzo’s complaint are without merit and have filed the action in the Southern District of New York to protect our interests. However, we cannot be sure that we will prevail in these matters. Our failure to successfully defend against these allegations could result in a material adverse effect on our business, financial condition and results of operation.

 

Administrative Litigation and Proceedings

 

Our intellectual property is expected to be subject to significant additional administrative and litigation actions. For example, in Europe and Japan, third parties are expected to oppose significant patents that we own or control. Currently, Multilyte Ltd. and ProtoGene Laboratories, Inc. are parties that have filed oppositions against our EP 0 619 321 patent in the European Patent Office, and PamGene B.V. has filed an opposition against our EP 0 728 520. Also, Abbott Laboratories, Applera, Clondiag and CombiMatrix are parties in opposition against our EP 0 834 575. Abbott Laboratories, CombiMatrix, PamGene B.V., Applera and Dr. Peter Schneider have filed oppositions against our EP 0 834 576. CombiMatrix has filed an opposition against EP 0 695 941.  Agilent, CombiMatrix, Clondiag and Applera have filed an opposition against EP 0 853 679 and Applera has opposed EP 0 972 564. These procedures will result in the patents being either upheld in their entireties, allowed to issue in amended form in designated European countries, or revoked.

 

Further, in the United States, we expect that third parties will continue to “copy” the claims of our patents in order to provoke interferences in the United States Patent & Trademark Office, and we may copy the claims of others. These proceedings could result in our patent protection being significantly modified or reduced, and could result in significant costs and consume substantial managerial resources.

 

At this time, we cannot determine the outcome of any of the matters described above.

 

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

 

(a)           Date of Meeting

 

The Annual Meeting of the Stockholders of Affymetrix, Inc. was held on June 10, 2004.

 

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

 

 

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ITEM 5. OTHER INFORMATION

 

RISKS RELATED TO OUR BUSINESS

 

We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. The following discussion highlights some of these risks and others are discussed elsewhere in this Quarterly Report on Form 10-Q.

 

We have a history of operating losses and may incur future losses.

 

For the six months ended June 30, 2004, we had net income of $5.2 million.  Prior to the year ended December 31, 2003, we incurred losses each year since our inception, and as a result have an accumulated deficit of approximately $193.5 million at June 30, 2004. We expect to continue experiencing fluctuations in our operating results and cannot assure sustained profitability. Our losses have resulted principally from costs incurred in research and development, manufacturing and from selling, general and administrative costs associated with our operations, including the costs of patent related litigation.

 

Our ability to generate significant revenues and maintain profitability is dependent in large part on our ability to expand our customer base, increase sales of our current products to existing customers, manage our expense growth, and enter into additional supply, license and collaborative arrangements as well as on our ability and that of our collaborative partners to successfully manufacture and commercialize products incorporating our technologies in new applications and in new markets.

 

Our quarterly results have historically fluctuated significantly and may continue to fluctuate unpredictably, which could cause our stock price to decrease.

 

Our revenues and operating results may fluctuate significantly due in part to factors that are beyond our control and which we cannot predict. The timing of our customers’ orders may fluctuate from quarter to quarter. However, we have historically experienced customer ordering patterns for GeneChip® instrumentation and GeneChip® arrays where the majority of the shipments occur in the last month of the quarter. These ordering patterns may limit management’s ability to accurately forecast our future revenues. Because our expenses are largely fixed in the short to medium term, any material shortfall in revenues will materially reduce our profitability and may cause us to experience losses. In particular, our revenue growth and profitability depend on sales of our GeneChip® products. Factors that could cause sales for these products to fluctuate include:

 

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

 

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

 

•                                          the frequency of experiments conducted by our customers;

 

•                                          our customers’ inventory of GeneChip® products;

 

•                                          the receipt of relatively large orders with short lead times; and

 

•                                          our customers’ expectations as to how long it takes us to fill future orders.

 

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

 

•                                          weakness in the global economy and changing market conditions;

 

•                                          general economic conditions affecting our target customers;

 

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

 

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

 

•                                          changes in the competitive landscape.

 

Many of these factors have impacted, and may in the future impact, the demand for our products and our quarterly operating results. Although we are expanding our customer base, our revenues are generated from a relatively small number of pharmaceutical and biotechnology companies and academic research centers. We expect that these customers will in the aggregate continue to account for a substantial portion of revenues for the foreseeable future. In the event that we experience cautious capital spending by academic and biotech customers and general economic weakness in the biotechnology sector, revenue expectations from these customer segments may continue to fluctuate.

 

Our business depends on research and development spending levels for pharmaceutical and biotechnology companies and academic and governmental research institutions.

 

We expect that our revenues in the foreseeable future will be derived primarily from products and services provided to pharmaceutical and biotechnology companies and academic, governmental and other research institutions. Our success will depend upon their demand for and use of our products and services. Our operating results may fluctuate substantially due to reductions and delays in research and development expenditures by these customers. For example, reductions in capital expenditures by these customers may result in lower than expected instrumentation sales and similarly, reductions in operating expenditures by these customers could result in lower than expected GeneChip® array sales. These reductions and delays may result from factors that are not within our control, such as:

 

•                                          changes in economic conditions;

 

•                                          changes in government programs that provide funding to companies and research institutions;

 

•                                          changes in the regulatory environment affecting life sciences companies and life sciences research;

 

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

 

•                                          other factors affecting research and development spending.

 

We may lose customers if we are unable to manufacture our products and ensure their proper performance and quality.

 

We produce our GeneChip® products in an innovative and complicated manufacturing process which has the potential for significant variability in manufacturing yields. We have encountered and may in the future encounter difficulties in manufacturing our products and, due to the complexity of our products and our manufacturing process, we cannot be sure we fully understand all of the factors that affect our manufacturing processes or product performance. Manufacturing and product quality issues may arise as we increase production rates at our manufacturing facility and launch new products. As a result, we may experience difficulties in meeting customer, collaborator and internal demand, in which case we could lose customers or be required to delay new product introductions, and demand for our products could decline. Although we rely on internal quality control procedures to verify our manufacturing process, due to the complexity of our products and manufacturing process, it is possible that probe arrays that do not meet all of our performance specifications may not be identified before they are shipped. If our products do not consistently meet our customers’ performance expectations, demand for our products will decline. In addition, we do not maintain any backup manufacturing capabilities for the production of our GeneChip® instruments. Any interruption in our ability to continue operations at our existing manufacturing facilities could delay our ability to develop or sell our products, which could result in lost revenue and seriously harm our business, financial condition and results of operations.

 

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We may not be able to deliver acceptable products to our customers due to the rapidly evolving nature of genetic sequence information upon which our products are based.

 

The genetic sequence information upon which we rely to develop and manufacture our products is contained in a variety of public databases throughout the world. These genetic sequence databases are rapidly expanding and evolving. In addition, the accuracy of such databases and resulting genetic research is dependent on various scientific interpretations and it is not expected that global genetic research efforts will result in standardized genetic sequence databases for particular genomes in the near future. Although we have implemented ongoing internal quality control efforts to help ensure the quality and accuracy of our products, the fundamental nature of our products requires us to rely on genetic sequence databases and scientific interpretations which are continuously evolving. As a result, these variables may cause us to develop and manufacture products that incorporate sequence errors or ambiguities. The magnitude and importance of these errors depends on multiple and complex factors that would be considered in

 

determining the appropriate actions required to remedy any inaccuracies. Our inability to timely deliver acceptable products as a result of these factors would likely adversely affect our relationship with customers, and could have a material adverse effect on our business, financial condition and results of operations.

 

We depend on a limited number of suppliers and we will be unable to manufacture our products if shipments from these suppliers are delayed or interrupted.

 

We depend on our vendors to provide components of our products in required volumes, at appropriate quality and reliability levels, and in compliance with regulatory requirements. Key parts of the GeneChip® product line, such as the hybridization oven, certain reagent kits and lithographic masks as well as certain raw materials used in the synthesis of probe arrays, are currently available only from a single source or limited sources. For example, we have relied on Enzo Life Sciences, Inc. to manufacture various labeling kits recommended for the processing of samples for use with probe arrays in expression analysis applications. In connection with Enzo’s lawsuit against us, effective November 12, 2003, Enzo terminated its agreement under which Affymetrix served as a non-exclusive distributor of certain reagent labeling kits supplied by Enzo. (See Part II, Item 1, Legal Proceedings.) Although we have met the demands of our customers’ needs by selling our own GeneChip® brand labeling kits, our inability to do so either as a result of Enzo’s legal proceedings against us or our inability to obtain a supply of components from other vendors that meet our customers’ performance and quality demands, could result in lost revenue and harm our business, financial condition and results of operations.

 

In addition, components of our manufacturing equipment and certain raw materials used in the synthesis of probe arrays are available from one of only a few suppliers. If supplies from these vendors were delayed or interrupted for any reason, we would not be able to get manufacturing equipment, produce probe arrays, or sell scanners or other components for our GeneChip® products in a timely fashion or in sufficient quantities or under acceptable terms.

 

Our success will require that we establish a strong intellectual property position and that we can defend ourselves against intellectual property claims from others.

 

Maintaining a strong patent position is critical to our competitive advantage. Litigation on these matters has been prevalent in our industry and we expect that this will continue. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and the extent of future protection is highly uncertain, so there can be no assurance that the patent rights that we have or may obtain will be valuable. Others have filed, and in the future are likely to file, patent applications that are similar or identical to ours or those of our licensors. To determine the priority of inventions, we will have to participate in interference proceedings declared by the United States Patent and Trademark Office that could result in substantial costs in legal fees and could substantially affect the scope of our patent protection. We cannot assure investors that any such patent applications will not have priority over our patent applications. Also, our intellectual property may be subject to significant administrative and litigation proceedings such as opposition proceedings against our patents in Europe, Japan and other jurisdictions. In addition, we have incurred and may in future periods incur substantial costs in litigation to defend against patent suits brought by third parties and when we initiate such suits.  For example, we currently are engaged in litigation regarding intellectual property rights with Multilyte Ltd and Enzo Life Sciences, Inc. For additional information concerning intellectual property litigation and administrative proceedings, see the section of this Form 10-Q entitled “Legal Proceedings.”

 

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In addition to patent protection, we also rely upon copyright and trade secret protection for our confidential and proprietary information. There can be no assurance, however, that such measures will provide adequate protection for our copyrights, trade secrets or other proprietary information. In addition, there can be no assurance that trade secrets and other proprietary information will not be disclosed, that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to or disclose our trade secrets and other proprietary information. There can be no assurance that we can effectively protect our copyrights, trade secrets or other proprietary information. If we cannot obtain, maintain or enforce intellectual property rights, competitors can design probe array systems similar to our GeneChip® technology.

 

Our success depends in part on us neither infringing patents or other proprietary rights of third parties nor breaching any licenses that may relate to our technologies and products. We are aware of third-party patents that may relate to our technology, including reagents used in probe array synthesis and in probe array assays, probe array scanners, synthesis techniques, polynucleotide amplification techniques, assays, and probe arrays. We routinely receive notices claiming infringement from third parties as well as invitations to take licenses under third party patents. There can be no assurance that we will not infringe on these patents or other patents or proprietary rights or that we would be able to obtain a license to such patents or proprietary rights on commercially acceptable terms, if at all.

 

We expect to face increasing competition.

 

The market for molecular diagnostics products is currently limited and highly competitive, with several large companies already having significant market share. Companies such as Abbott Laboratories, Becton Dickinson, Bayer AG, Celera Diagnostics,, Roche Diagnostics, Johnson & Johnson, bioMérieux and Beckman Coulter 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 the GeneChip® system and could deter acceptance of our products. In addition, these companies have formed alliances with genomics companies which provide them access to genetic information that may be incorporated into their diagnostic tests.

 

Future competition will likely come from existing competitors as well as other companies seeking to develop new technologies for analyzing genetic information. For example companies such as Applied Biosystems, Illumina and Agilent Technologies have introduced new products for gene expression research and analysis. In addition, pharmaceutical and biotechnology companies have significant needs for genomic information and may choose to develop or acquire competing technologies to meet these needs. In the molecular diagnostics field, competition will likely come from established diagnostic companies, companies developing and marketing DNA probe tests for genetic and other diseases and other companies conducting research on new technologies to ascertain and analyze genetic information. Further, in the event that we develop new technology and products that compete with existing technology and products of well established companies, there can be no guarantee that the marketplace will readily adopt any such new technology and products that we may introduce in the future.

 

If we are unable to maintain our relationships with collaborative partners, we may have difficulty developing and selling our products and services.

 

We believe that our success in penetrating our target markets depends in part on our ability to develop and maintain collaborative relationships with key companies as well as with key academic researchers. Currently, our significant collaborative partners include Qiagen GmBH for the sample preparation and purification systems, Invitrogen Corporation for reagents and Ingenuity Systems, Inc. for analytical software. We collaborate with both Beckman Coulter Inc. and Caliper Life Sciences in the development of automation for GeneChip® technology applications for use in drug discovery and development. Roche and bioMérieux are collaborative partners in the development of chip products for medical diagnostic and applied testing markets. Relying on these or other collaborative relationships is risky to our future success because:

 

•                                          our partners may develop technologies or components competitive with our GeneChip® products;

 

•                                          our existing collaborations may preclude us from entering into additional future arrangements;

 

•                                          our partners may not obtain regulatory approvals necessary to continue the collaborations in a timely manner;

 

•                                          some of our agreements may terminate prematurely due to disagreements between us and our partners;

 

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•                                          our partners may not devote sufficient resources to the development and sale of our products;

 

•                                          our partners may be unable to provide the resources required for us to progress in the collaboration on a timely basis;

 

•                                          our collaborations may be unsuccessful; or

 

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

 

Our success depends on the continuous development of new products.

 

We compete in markets that are new, intensely competitive, highly fragmented and rapidly changing, and many of our current and potential competitors have significantly greater financial, technical, marketing and other resources. In addition, many current and potential competitors have greater name recognition, more extensive customer bases and access to proprietary genetic content. The continued success of our GeneChip® products will depend on our ability to produce products with smaller feature sizes, our ability to dice the wafer, and create greater information capacity at our current or lower costs. If we fail to keep pace with emerging technologies our products will become uncompetitive, our pricing and margins will decline and our business will suffer.

 

Our success in penetrating emerging market opportunities in molecular diagnostics depends on the ability of our GeneChip® technologies to be used in clinical applications for diagnosing and informing the treatment of disease.

 

The clinical applications of GeneChip® technologies for diagnosing and informing the treatment of disease is an emerging market opportunity in molecular diagnostics that seeks to improve the effectiveness of health care by collecting information about DNA variation and RNA expression in patients at various times from prognosis, through diagnosis and on to the end of therapy. Our success depends on our ability to continue to explore and develop market opportunities in molecular diagnostics for clinical applications of our GeneChip® technologies. These markets, however, are new and emerging and there can be no assurances that they will develop as quickly as we expect or that they will reach their full potential. In addition, although we believe that there will be clinical applications of our GeneChip® technologies that will be utilized for diagnosing and informing the treatment of disease, there can be no assurance that the application of our GeneChip® technologies in molecular diagnostics will achieve technical or commercial success.

 

Risks associated with technological obsolescence and emergence of standardized systems for genetic analysis.

 

The RNA/DNA probe array field is undergoing rapid technological changes. New technologies, techniques or products could emerge which might allow the packaging and analysis of genomic information at a similar or higher density to our microarray technology. Other companies may begin to offer products that are directly competitive with, or are technologically superior to our products. Although we know of no such technology at the present time, there can be no guarantee that we will be able to maintain our technological advantages over emerging technologies in the future. Over time, we will need to respond to technological innovation in a rapidly changing industry. In addition, although we believe that we are recognized as a market leader in creating systems for genetic analysis in the life sciences, standardization of tools and systems for genetic research is still ongoing and there can be no assurance that our products will emerge as the standard for genetic research. The emergence of competing technologies and systems as market standards for genetic research may result in our products becoming uncompetitive and could cause our business to suffer.

 

Our current sales, marketing and technical support organization may limit our ability to sell our products.

 

Although we have invested significant other resources to expand our direct sales force and our technical and support staff, we may not be able to establish a sufficiently sized global sales, marketing or technical support organization to sell, market or support our products globally. To assist our sales and support activities, we have entered into distribution agreements through certain distributors, principally in markets outside of North America, Europe and Japan. These and other third parties on whom we rely for sales, marketing and technical support in these geographic areas may decide to develop and sell competitive products or otherwise become our competitors, which could harm our business.

 

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Due to the international nature of our business, political or economic changes or other factors could harm our business.

 

A significant amount of our revenue is currently generated from sales outside the United States. Though such transactions are denominated in both U.S. dollars and foreign currencies, our future revenue, gross margin, expenses and financial condition are still affected by such factors as changes in foreign currency exchange rates, unexpected changes in, or impositions of, legislative or regulatory requirements, including export and trade barriers and taxes; longer payment cycles and greater difficulty in accounts receivable collection. We are also subject to general geopolitical risks in connection with international operations, such as political, social and economic instability, potential hostilities and changes in diplomatic and trade relationships. We cannot assure investors that one or more of the foregoing factors will not have a material adverse effect on our business, financial condition and operating results or require us to modify our current business practices.

 

We may be exposed to liability due to product defects.

 

The risk of product liability claims is inherent in the testing, manufacturing, marketing and sale of human diagnostic and therapeutic products. We may seek to acquire additional insurance for clinical liability risks. We may not be able to obtain such insurance or general product liability insurance on acceptable terms or in sufficient amounts. A product liability claim or recall could have a serious adverse effect on our business, financial condition and results of operations.

 

Ethical, legal and social concerns surrounding the use of genetic information could reduce demand for our products.

 

Genetic testing has raised ethical issues regarding privacy and the appropriate uses of the resulting information. For these reasons, governmental authorities may call for limits on or regulation of the use of genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Similarly, such concerns may lead individuals to refuse to use genetics tests even if permissible. Any of these scenarios could reduce the potential markets for our molecular diagnostic products, which could have a material adverse effect on our business, financial condition and results of operations.

 

Healthcare reform and restrictions on reimbursements may limit our returns on molecular diagnostic products that we may develop with our collaborators.

 

We are currently developing diagnostic and therapeutic products with our collaborators. The ability of our collaborators to commercialize such products may depend, in part, on the extent to which reimbursement for the cost of these products will be available under U.S. and foreign regulations governing reimbursement for clinical testing services by government authorities, private health insurers and other organizations. In the U.S., third-party payor price resistance, the trend towards managed health care and legislative proposals to reform health care or reduce government insurance programs could reduce prices for health care products and services, adversely affect the profits of our customers and collaborative partners and reduce our future royalties.

 

We may not successfully obtain regulatory approval of any diagnostic or other product which we or our collaborative partners develop.

 

The United States Food and Drug Administration must approve certain in-vitro diagnostic products before they can be marketed in the U.S. Certain in-vitro diagnostic products must also be approved by the regulatory agencies of foreign governments or jurisdictions before the product can be sold outside the U.S. Commercialization of in-vitro diagnostic products outside of the research environment that we or our collaborators may develop, may depend upon successful completion of clinical trials. Clinical development is a long, expensive and an 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 of testing. Delays or rejections of potential products may be encountered based on changes in regulatory policy for product approval during the period of product development and regulatory agency review. Moreover, if and when our projects reach clinical trials, we or our collaborative partners may decide to discontinue development of any or all of these projects at any time for commercial, scientific or other reasons. Any of the foregoing matters could have a material adverse effect on our business, financial condition and results of operations.

 

Even where a product is exempted from FDA clearance or approval, the FDA may impose restrictions as to the types of customers to which we can market and sell our products. Such restrictions may materially and adversely affect our business, financial condition and results of operations.

 

Medical device laws and regulations are also in effect in many countries, ranging from comprehensive device approval requirements to requests for product data or certifications. The number and scope of these requirements are increasing. We may not be

 

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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.

 

Because our business depends on key executives and scientists, our inability to recruit and retain these people could hinder our business expansion plans.

 

We are highly dependent on our officers and our senior scientists and engineers, including scientific advisors. Our product development and marketing efforts could be delayed or curtailed if we are unable to attract or retain key talent.

 

We 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. Some of them also consult for companies that may be our competitors. A scientific advisor’s other obligations may prevent him or her from assisting us in developing our technical and business strategies.

 

To expand our research, product development and sales efforts we need additional people skilled in areas such as bioinformatics, organic chemistry, information services, regulatory affairs, manufacturing, sales, marketing and technical support. Competition for these people is intense. We will not be able to expand our business if we are unable to hire, train and retain a sufficient number of qualified employees. There can be no assurance that we will be successful in hiring or retaining qualified personnel and our failure to do so could have a material adverse impact on our business, financial condition and results of operations.

 

Our strategic equity investments may result in losses.

 

We periodically make strategic equity investments in various publicly traded and non-publicly traded companies with businesses or technologies that may complement our business. The market values of these strategic equity investments may fluctuate due to market conditions and other conditions over which we have no control. Other than temporary fluctuations in the market price and valuations of the securities that we hold in other companies will require us to record losses relative to our ownership interest. This could result in future charges on our earnings and as a result, it is uncertain whether or not we will realize any long term benefits associated with these strategic investments.

 

Future acquisitions may disrupt our business and distract our management.

 

We have previously engaged in acquisitions and may do so in the future in order to exploit technology or market opportunities. If we acquire another company, we may not be able to successfully integrate the acquired business into our existing business in a timely and non-disruptive manner or at all. Furthermore, an acquisition may not produce the revenues, earnings or business synergies that we anticipate. If we fail to integrate the acquired business effectively or if key employees of that business leave, the anticipated benefits of the acquisition would be jeopardized. The time, capital management and other resources spent on an acquisition that fails to meet our expectations could cause our business and financial condition to be materially and adversely affected. In addition, acquisitions can involve substantial charges and amortization of significant amounts of deferred stock compensation that could adversely affect our results of operations.

 

The market price of our common stock has been extremely volatile.

 

The market price of our common stock is extremely volatile. To demonstrate the volatility of our stock price, during the twelve-month period ending on June 30, 2004, the volume of our common stock traded on any given day has ranged from 286,700 to 8,633,200 shares. Moreover, during that period, our common stock has traded as low as $19.08 per share and as high as $37.46 per share.

 

Furthermore, volatility in the stock price of other companies has often led to securities class action litigation against those companies. For example, purported securities class action lawsuits were filed against us in the United States District Court for the Northern District of California after a drop in our stock price following our April 3, 2003 announcement updating our financial guidance for the first quarter of 2003.  These proceedings have been dismissed by the Court with prejudice.  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.

 

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                  EXHIBITS:

 

 

Exhibit Number		Description of Document
3.1(1)		Restated Certification of Incorporation.
3.2(2)		Bylaws.
3.3(3)		Amendment No. 1 to the Bylaws dated as of April 25, 2001.
4.1(4)		Rights Agreement dated October 15, 1998 between Affymetrix, Inc. and American Stock Transfer & Trust Company, as Rights Agent.
4.2(5)		Indenture dated as of September 22, 1999, between Affymetrix, Inc. and The Bank of New York, as Trustee.
4.3(6)		Amendment No. 1 to Rights Agreement, dated as of February 7, 2000, between Affymetrix, Inc. and American Stock Transfer & Trust Company, as Rights Agent.
4.4(7)		Indenture, dated as of February 14, 2000 between Affymetrix, Inc. and The Bank of New York, as Trustee.
4.5(8)		Registration Rights Agreement, dated as of February 14, 2000, between Affymetrix, Inc. and certain purchasers listed on the signature page thereto.
10.66(9)		Affymetrix, Inc. Amended and Restated 2000 Equity Incentive Plan
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002

 

(1)                                  Incorporated by reference to Exhibit 3.1 to the Registrant’s Form 8-K as filed on June 13, 2000 (File No. 000-28218).

 

(2)                                  Incorporated by reference to Appendix C to the Registrant’s definitive proxy statement on Schedule 14A as filed on April 29, 1998 (File No. 000-28218).

 

(3)                                  Incorporated by reference to Exhibit 3.3 to the Registrant’s Form 10-Q as filed on May 15, 2001 (File No. 000-28218).

 

(4)                                  Incorporated by reference to Exhibit 1 to the Registrant’s Form 8-A as filed on October 16, 1998 (File No. 000-28218).

 

(5)                                  Incorporated by reference to Exhibit 4.2 to the Registrant’s registration statement on Form S-4 as filed on October 14, 1999 (File No. 333-88987).

 

(6)                                  Incorporated by reference to Exhibit 4.1 to the Registrant’s Form 8-A/A as filed on March 29, 2000 (File No. 000-28218).

 

(7)                                  Incorporated by reference to Exhibit 4.4 to the Registrant’s registration statement on Form S-3 as filed on May 11, 2000 (File No. 333-36790).

 

(8)                                  Incorporated by reference to Exhibit 4.3 filed with Registrant’s registration statement on Form S-3 as filed on May 11, 2000 (File No. 333-36790).

 

(9)                                  Incorporated by reference to Appendix D filed with the Registrant’s definitive proxy statement on Schedule 14A as filed on April 29, 2004 (File No. 000-28218).

 

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(b)           REPORTS ON FORM 8-K.

 

On April 21, 2004, the Company filed a Report on Form 8-K to report under Item 7 (Financial Statements and Exhibits) and Item 12 (Results of Operations and Financial Condition) that the Company issued a press release announcing the Company’s operating results for the quarter ended March 31, 2004.

 

On April 21, 2004, the Company filed a Report on Form 8-K to report under Item 7 (Financial Statements and Exhibits) and Item 12 (Results of Operations and Financial Condition) that the Company issued a press release reaffirming its financial guidance for fiscal year 2004.

 

On June 14, 2004, the Company filed a Report on Form 8-K to report under Item 5 (Other Events) and Item 9 (Regulation FD Disclosure) that the Company had reached agreement with Oxford Gene Technology, Ltd. (“OGT”) to convert Affymetrix’ non-exclusive license to OGT’s patents to a fully paid-up license in return for a one time payment to OGT.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	By:	/s/ GREGORY T. SCHIFFMAN
	Name:	Gregory T. Schiffman
	Title:	Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
August 9, 2004

 

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AFFYMETRIX, INC.

EXHIBIT INDEX

JUNE 30, 2004

 

Exhibit Number		Description of Document
3.1(1)		Restated Certification of Incorporation.
3.2(2)		Bylaws.
3.3(3)		Amendment No. 1 to the Bylaws dated as of April 25, 2001.
4.1(4)		Rights Agreement dated October 15, 1998 between Affymetrix, Inc. and American Stock Transfer & Trust Company, as Rights Agent.
4.2(5)		Indenture dated as of September 22, 1999, between Affymetrix, Inc. and The Bank of New York, as Trustee.
4.3(6)		Amendment No. 1 to Rights Agreement, dated as of February 7, 2000, between Affymetrix, Inc. and American Stock Transfer & Trust Company, as Rights Agent.
4.4(7)		Indenture, dated as of February 14, 2000 between Affymetrix, Inc. and The Bank of New York, as Trustee.
4.5(8)		Registration Rights Agreement, dated as of February 14, 2000, between Affymetrix, Inc. and certain purchasers listed on the signature page thereto.
10.66(9)		Affymetrix, Inc. Amended and Restated 2000 Equity Incentive Plan
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002

 

(1)                                  Incorporated by reference to Exhibit 3.1 to the Registrant’s Form 8-K as filed on June 13, 2000 (File No. 000-28218).

 

(2)                                  Incorporated by reference to Appendix C to the Registrant’s definitive proxy statement on Schedule 14A as filed on April 29, 1998 (File No. 000-28218).

 

(3)                                  Incorporated by reference to Exhibit 3.3 to the Registrant’s Form 10-Q as filed on May 15, 2001 (File No. 000-28218).

 

(4)                                  Incorporated by reference to Exhibit 1 to the Registrant’s Form 8-A as filed on October 16, 1998 (File No. 000-28218).

 

(5)                                  Incorporated by reference to Exhibit 4.2 to the Registrant’s registration statement on Form S-4 as filed on October 14, 1999 (File No. 333-88987).

 

(6)                                  Incorporated by reference to Exhibit 4.1 to the Registrant’s Form 8-A/A as filed on March 29, 2000 (File No. 000-28218).

 

(7)                                  Incorporated by reference to Exhibit 4.4 to the Registrant’s registration statement on Form S-3 as filed on May 11, 2000 (File No. 333-36790).

 

(8)                                  Incorporated by reference to Exhibit 4.3 filed with Registrant’s registration statement on Form S-3 as filed on May 11, 2000 (File No. 333-36790).

 

(9)                                  Incorporated by reference to Appendix D filed with the Registrant’s definitive proxy statement on Schedule 14A as filed on April 29, 2004 (File No. 000-28218).

 

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