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 September 30, 2012 and for the three and nine months ended September 30, 2012 and 2011 should be read in conjunction with our financial statements and accompanying notes thereto included in this Quarterly Report on Form 10-Q and with the Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2011.
All statements in this quarterly report that are not historical are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act as amended, including statements regarding our "goals," "expectations," "beliefs," "intentions," "strategies" or the like. Such statements are based on our current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Actual results or business conditions may differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, our capacity to identify and capitalize upon emerging market opportunities; risks relating to our ability to acquire new businesses and technologies and successfully integrate and realize the anticipated strategic benefits and cost savings or other synergies thereof, including our acquisition of eBioscience, in a cost-effective manner while minimizing the disruption to our business; risks that eBioscience's future performance may not be consistent with its historical performance; risks relating to our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness; risks relating to our ability to develop and successfully commercialize new products and services; uncertainties related to cost and pricing of Affymetrix products; fluctuations in overall capital spending in the academic and biotechnology sectors; changes in government funding policies; our dependence on collaborative partners; the size and structure of our current sales, technology and technical support organizations; uncertainties relating to our suppliers and manufacturing processes; risks relating to our ability to achieve and sustain higher levels of revenue, higher gross margins and reduced operating expenses; uncertainties relating to technological approaches; global credit and financial market conditions; personnel retention; uncertainties relating to the U.S. Food and Drug Administration ("FDA") and other regulatory approvals; competition; risks relating to intellectual property of others and the uncertainties of patent protection and litigation; volatility of the market price of our common stock; unpredictable fluctuations in quarterly revenues; and the risk factors disclosed under Part I, Item 1A of this Quarterly Report on Form 10-Q and Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based, except as required by law.
OVERVIEW
We develop, manufacture and sell products and services for genetic analysis to the life science research and clinical healthcare markets. Researchers around the world use our technology to better understand the role that genes play in disease, the effectiveness and safety of therapies and many other biological factors that affect human well-being. We sell our products to some of the world's largest pharmaceutical, diagnostic and biotechnology companies, as well as leading academic, government and not-for-profit research institutions and almost 26,000 peer-reviewed papers have been published based on work using our products. Including eBioscience, we have about 1,200 employees worldwide and maintain sales and distribution operations across the United States, Europe, Asia and Latin America.
We offer a comprehensive line of products for two principal applications: gene expression and genotyping. Our product sales consist primarily of sales of instruments and related consumables. We have three instrument systems, GeneTitan®, GeneChip® and GeneAtlas™, that include instruments, consumables and software. Our GeneChip® instruments run arrays packaged in cartridges and our GeneTitan® and GeneAtlasTM instruments run arrays packaged in a peg format. We also offer a variety of assays for gene expression targeting low- to mid-plex markets that are downstream of our whole genome arrays and a range of reagent kits that are compatible with our platforms as well as the products of other vendors.
As further discussed below, through our acquisition of eBioscience, we are now able to complement our traditional businesses with a stronger offering of reagents for cell and protein analysis, and augment our foundation in molecular diagnostics, including our cytogenics offering. eBioscience develops, manufactures and markets reagents and antibodies that are fundamental for research application in immunology, oncology, cell biology and stem cell biology.

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We completed an internal reorganization of our operations into business units at the end of 2011, including Expression, Genetic Analysis and Clinical Applications, and Life Science Reagents. The business units are designed to create a high level of focus for identifying and executing on opportunities in our target markets.
Expression
Our Expression business unit develops and markets our gene expression products and services, including our in vitro transcription ("IVT") arrays and our QuantiGene line targeted at low-to-mid-plex markets. Expression revenue as a percentage of total revenue is expected to decline over time as demand for expression products used in the discovery and exploration markets decline. Accordingly, we reported declining sales of IVT arrays that historically has represented more than half of expression revenue in recent years. Our primary goal in our expression business is to stabilize revenue by adding new products to our array-based expression portfolio and rejuvenating our mid-plex cell and tissue assays. We have also expanded the use of our GeneAtlasTM instrument, a desk-top entry-level microarray system, by widening the range of arrays that can be run on it. Genetic Analysis and Clinical Applications Our Genetic Analysis and Clinical Applications business unit develops and markets our genotyping and cytogenetics products. Our Axiom genotyping platform and SNP 6.0 products are targeted at the genotyping markets in human research and the agricultural biotechnology industry. In mid 2011, we launched our new CytoScan™ HD array which is targeted specifically at the cytogenetics market. We intend to continue to invest in cytogenetics and Axiom products in 2012 to continue growing our revenues in this business unit. Life Science Reagents
Our Life Science Reagents business unit develops and markets reagents, enzymes, purification kits and biochemicals used by life science researchers, and is primarily targeted at the life science reagent markets. Corporate
Our Corporate business unit primarily derives revenue from royalty arrangements, as well as field revenue from services provided by us to customers. We expect royalty revenue to decrease over time as fewer royalty arrangements are entered into and patents expire.
Acquisition of eBioscience Holding Company, Inc. On June 25, 2012, we completed our acquisition of eBioscience Holding Company, Inc. ("eBioscience"), a privately-held company based in San Diego, California engaged in the development, manufacture and sale of flow cytometry and immunoassay reagents for immunology and oncology research and diagnostics (the "Acquisition") pursuant to an Amended and Restated Agreement and Plan of Merger dated May 3, 2012 (the "Acquisition Agreement").
We believe the Acquisition is a good strategic fit for Affymetrix, allowing us to expand our addressable markets and continue to diversify our business beyond genomics discovery into cell and protein analysis. We believe eBioscience will enable us to further expand into downstream markets where validation and testing activity leverages the results of basic discovery research to achieve a more thorough understanding of disease states, and ultimately, new and/or improved diagnostics and therapeutics.
We intend to operate eBioscience as a separate business unit to minimize or avoid any disruption of services, while taking advantage of immediate opportunities to create efficiencies. We expect to achieve certain commercial synergies between the two companies, including cross-selling opportunities and complementary distribution channels, as well as realize benefits from certain research and development synergies.
The Acquisition purchase price was adjusted to a total of $314.9 million, reflecting a decrease of $0.2 million arising from a working capital adjustment recorded in the three months ended September 30, 2012, plus $17.5 million in other fees and expenses incurred since the transaction began, including $8.5 million of underwriting and financing fees, and was financed through a combination of cash on hand, the liquidation of available-for-sale securities, proceeds from a term loan (the "Term Loan") of aggregate principal amount of $85.0 million provided under our Senior Secured Credit Facility (the "Senior Secured Credit Facility") and the issuance of $105.0 million principal amount of our 4.00% Convertible Senior Notes due 2019 (the "4.00% Notes").

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Overview of the Third Quarter of 2012
In the third quarter of 2012, we reported $79.6 million in revenue, including $17.6 million from eBioscience, as compared to $64.0 million in the third quarter of 2011. We reported net loss of approximately $17.9 million, or $0.25 per diluted share, in the third quarter of 2012 compared to a net loss of $9.8 million, or $0.14 per diluted share, in the same period of 2011, primarily due to a tightening academic funding environment worldwide, which negatively affected our revenue, as well as expenses related to the Acquisition, including interest expense of $2.9 million paid on the Term Loan and 4.00% Notes, release of inventory step-up of $4.5 million, amortization expense of $5.0 million on acquired intangible assets, non-recurring integration costs of $1.6 million and other Acquisition-related costs of $0.3 million. In addition, the third quarter of 2012 included a $4.0 million impairment charge on property held for sale. Our primary goal is to expand our revenue base by entering new markets, growing our customer base and successfully commercializing our established and acquired technologies, including from eBioscience. We continue shifting our focus to the validation, translational and routine testing markets which we believe are currently expanding at a higher compound annual growth rate than the discovery and exploration markets and will provide opportunities for more recurring revenue growth in the future. We seek to expand our product line with new products that combine automated instrumentation, powerful new biological assays, and new array designs and content.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Condensed Consolidated Financial Statements, which we have prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes 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. Management has discussed the development, selection and disclosure of significant estimates with the Audit Committee of our Board of Directors. Actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. For a description of accounting changes and recent accounting standards, including the expected dates of adoption and estimated effects, if any, refer to Note 1. "Summary of Significant Accounting Policies" in the Notes to the Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q. Except as otherwise noted above, during the three and nine months ended September 30, 2012, there have been no significant changes in our critical accounting policies and estimates compared to the disclosures in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011.

RESULTS OF OPERATIONS The following discussion compares the historical results of operations for the three and nine months ended September 30, 2012 and 2011. REVENUE The components of revenue are as follows: Dollars in thousands Three Months Ended Dollar Percentage Nine Months Ended Dollar Percentage September 30, change change September 30, change change 2012 2011 from 2011 from 2011 2012 2011 from 2011 from 2011 Consumables $ 68,039 $ 52,930 $ 15,109 29 % $ 176,518 $ 170,131 $ 6,387 4 % Instruments 4,646 4,071 575 14 13,163 12,477 686 5 Product sales 72,685 57,001 15,684 28 189,681 182,608 7,073 4 Services and other revenue 6,939 6,986 (47 ) (1 ) 21,593 19,762 1,831 9 Total revenue $ 79,624 $ 63,987 15,637 24 % $ 211,274 $ 202,370 8,904 4 %

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Excluding third quarter revenue from eBioscience of $17.6 million, total product sales decreased $1.9 million in the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to lower overall chip sales volumes, partially offset by an increase in instrument revenue.
Excluding year-to-date revenue from eBioscience of $19.0 million, total product sales decreased $11.9 million in the nine months ended September 30, 2012 as compared to the same period in 2011 primarily due to decreased consumable sales resulting from lower overall chip and reagent sales volumes.
Services and other revenue remained flat for the three months ended September 30, 2012 as compared to the same period in 2011. For the nine months ended September 30, 2012, services and other revenue was higher primarily due to higher scientific services revenue and a one-time royalty payment of $0.8 million that was received in the second quarter of 2012. The following table summarizes revenue by business unit:

Dollars in thousands Three Months Ended Dollar Percentage Nine Months Ended Dollar Percentage September 30, change change September 30, change change 2012 2011 from 2011 from 2011 2012 2011 from 2011 from 2011 Expression $ 27,343 $ 30,769 $ (3,426 ) (11 %) $ 89,465 $ 103,647 $ (14,182 ) (14 %) Genetic analysis and clinical applications 21,210 18,314 2,896 16 60,181 53,796 6,385 12 Life science reagents 8,098 8,355 (257 ) (3 ) 24,297 25,896 (1,599 ) (6 ) eBioscience 17,578 - 17,578 100 18,953 - 18,953 100 Corporate 5,395 6,549 (1,154 ) (18 ) 18,378 19,031 (653 ) (3 ) Total product sales $ 79,624 $ 63,987 $ 15,637 24 % $ 211,274 $ 202,370 $ 8,904 4 % Percentage of revenue Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 Expression 34 % 48 % 42 % 51 % Genetic analysis and clinical applications 27 29 28 27 Life science reagents 10 13 12 13 eBioscience 22 - 9 - Corporate 7 10 9 9 Total product sales 100 % 100 % 100 % 100 %

Expression During the three months ended September 30, 2012, Expression revenue decreased by $3.4 million primarily due to a decline in Genechip revenue of $4.2 million, which was driven by a lower volume of sales on our in vitro transcription (IVT) arrays and lower average selling price on our miRNA arrays. The decline in Expression revenue was partially offset by higher instrument revenue of $0.6 million.
The decrease of $14.2 million in Expression revenue for the nine months ended September 30, 2012 also was primarily due to the lower volume of sales of our IVT arrays. Additionally, revenue from Expression instruments declined by $1.0 million due to lower average selling price. These decreases were partially offset by higher revenue of $1.1 million reported on our QuantiGene line products.
Genetic Analysis and Clinical Applications Genetic Analysis and Clinical Applications revenue increased for the three months ended September 30, 2012 as compared to the same period in 2011, primarily due to $4.1 million and $3.5 million increases in revenue on our CytoGenetics and Axiom products, respectively, partially offset by a decline in sales of our SNP 6.0 arrays of $2.6 million. Revenue from clinical applications as a percentage of Genetic Analysis and Clinical Applications continued to increase.
For the nine months ended September 30, 2012, revenue also increased over the prior year period primarily due to increased revenue from our Cytogenetics and Axiom products of $16.2 million and $2.8 million, respectively, as well as higher instrument sales of $2.0 million, partially offset by a decline in sales of our SNP 6.0 arrays of $9.8 million.

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Life Science Reagents For the three and nine months ended September 30, 2012, Life Science Reagents revenue decreased due to lower volume of sales. Corporate Corporate revenue decreased during the three months ended September 30, 2012, driven primarily by lower royalty revenue.
For the nine months ended September 30, 2012, Corporate revenue decreased by $0.7 million due to lower royalty revenue during the third quarter, partially offset by a one-time royalty payment of $0.8 million received during the second quarter of 2012 and a net realized gain of $0.8 million from designated cash flow hedges.

GROSS MARGIN Dollars in thousands Three Months Ended Dollar/Point Nine Months Ended Dollar/Point September 30, change from September 30, change from 2012 2011 2011 2012 2011 2011 Total gross margin on product sales $ 38,706 $ 32,354 $ 6,352 $ 107,774 $ 111,695 $ (3,921 ) Total gross margin on services and other revenue 2,980 3,985 (1,005 ) 10,536 10,135 401 Product gross margin as a percentage of products sales 53 % 57 % (4 ) 57 % 61 % (4 ) Service and other revenue gross margin as a percentage of services and other revenue 43 % 57 % (14 ) 49 % 51 % (2 )

Product gross margin increased during the three months ended September 30, 2012 as compared to 2011 was primarily due to the addition of eBioscience results that included a $4.5 million release of inventory step-up. The increase was offset by lower volume of sales and shift in mix to lower margin products. The decrease in product gross margin of $3.9 million for the nine months ended September 30, 2012 as compared to the same period in 2011 is primarily due to lower volume of sales and product mix. The decrease was partially offset by lower excess and obsolescence costs for products with finite lives and favorable cost absorption.
Service and other gross margin decreased during the three months ended September 30, 2012 as compared to the same period in 2011 primarily due to lower revenue from royalties, which have a 100% margin. This decrease was partially offset by higher scientific services activity. For the nine months ended September 30, 2012, services and gross margin was higher primarily due to increased scientific service activity, partially offset by lower revenue from royalties.

RESEARCH AND DEVELOPMENT EXPENSES Dollars in thousands Three Months Ended Dollar Percentage Nine Months Ended Dollar Percentage September 30, change change September 30, change change 2012 2011 from 2011 from 2011 2012 2011 from 2011 from 2011 Research and development $ 16,498 $ 15,328 $ 1,170 8 % $ 43,417 $ 46,894 $ (3,477 ) (7 %)

The increase in research and development expenses for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 was due primarily to the addition of eBioscience, increased costs on supplies of $1.8 million and consulting and purchased services of $0.9 million, related to clinical trials during the quarter. This increase was partially offset by savings in headcount-related costs of $1.7 million.
For the nine months ended September 30, 2012, research and development expenses excluding eBioscience expenses were lower as compared to the same period in 2011 primarily due to savings in headcount-related expenses of $4.8 million and variable compensation costs of $0.7 million. These decreases were partially offset by increases in spending on supplies related to various projects of $2.2 million and consulting and purchased services of $1.4 million, all related to clinical trials.

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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Dollars in thousands Three Months Ended Dollar Percentage Nine Months Ended Dollar Percentage September 30, change change September 30, change change 2012 2011 from 2011 from 2011 2012 2011 from 2011 from 2011 Selling, general and administrative $ 36,302 $ 26,915 $ 9,387 35 % $ 104,752 $ 80,802 $ 23,950 30 %

The increase in selling, general and administrative expenses in the three and nine months ended September 30, 2012 as compared to the same period in 2011 was primarily due to the addition of eBioscience and expenses related to the Acquisition and subsequent integration activity: Acquisitions and integration costs were $1.9 million and $7.6 million, respectively. Amortization charges increased $2.5 million and $2.7 million, respectively, as a result of intangible assets acquired from eBioscience. An $8.3 million share-based compensation charge was recorded at the Acquisition Date due to the acceleration of the eBioscience stock options during the second quarter of 2012.
These increases were partially offset by net reduced spending on facilities costs and lower depreciation costs of $2.9 million and $4.0 million, respectively, primarily as a result of our plant consolidation activities with respect to our Oakmead facilities in 2011.

INTEREST INCOME AND OTHER, NET Dollars in thousands Three Months Ended Dollar Percentage Nine Months Ended Dollar Percentage September 30, change change September 30, change change 2012 2011 from 2011 from 2011 2012 2011 from 2011 from 2011 Interest income $ 26 $ 704 $ (678 ) (96 %) $ 605 $ 1,981 $ (1,376 ) (69 %) Realized (loss) income on equity investments, net (33 ) (704 ) 671 95 489 (1,776 ) 2,265 128 Currency income (loss), net 76 (113 ) 189 167 (994 ) (1,892 ) 898 47 Other (4,002 ) (2,041 ) (1,961 ) (96 ) (1,731 ) (1,862 ) 131 7 Total interest income and other, net $ (3,933 ) $ (2,154 ) $ (1,779 ) 83 % $ (1,631 ) $ (3,549 ) $ 1,918 54 %

he decrease in interest income and other, net in the three months ended September 30, 2012 as compared to the same period in 2011 was primarily due to an impairment charge of $4.0 million recognized on our West Sacramento facility during the third quarter of 2012, as compared to a note receivable for $2.2 million that was fully reserved during the third quarter of 2011. Interest income decreased as compared to 2011 as a result of the sale of most of our available-for-sale securities during the eBioscience acquisition while realized losses on sales of equity investments also decreased due to an other-than-temporary impairment that was recognized on our available-for-sale securities of $0.7 million in 2011.
During the nine months ended September 30, 2012, interest income and other, net increased primarily due to the receipt of $2.2 million for the notes receivable that was previously fully reserved and the gain on sale of available-for-sale . . .