**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

----

**FORM 10-K**

**(Mark One)**

**x**                               ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005**

**OR**

**o**                                  TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934 (NO FEE REQUIRED)

**FOR THE TRANSITION PERIOD FROM ***            * TO *            *

**COMMISSION FILE NUMBER 0-28218**

----

**AFFYMETRIX, INC.**

(Exactname of registrant as specified in its charter)

| **DELAWARE**                                                    |   | **77-0319159**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (IRS Employer  Identification Number) |
| **3420 CENTRAL EXPRESSWAY  SANTA CLARA, CALIFORNIA**            |   | **95051**                             |
| (Address of principal executive offices)                        |   | (Zip Code)                            |

 

**(408) 731-5000**

(Registrant’stelephone number, including area code)

Securities registered pursuant to Section 12(b) ofthe Act:

**None**

Securities registered pursuant to Section 12(g) ofthe Act:

**Common Stock, $0.01**

**PreferredStock Purchase Rights**

----

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes x  No o

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.Yes o  No x

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

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

| Large accelerated  filer x |   | Accelerated filer o |   | Non-accelerated filer o |
|---------------------------------|--------|--------------------------|--------|------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o  No ý

Theaggregate market value of the registrant’s common stock held by non-affiliatesof the registrant at June 30, 2005, based on the closing price of suchstock on the Nasdaq National Market on such date, was approximately $1.44billion. The number of shares of the registrant’s Common Stock, $0.01 parvalue, outstanding on March 2, 2006, was 67,398,440.

**DOCUMENTS INCORPORATED BY REFERENCE**

Certainsections of the Proxy Statement to be filed in connection with the 2006 AnnualMeeting of Stockholders are incorporated by reference into Part III ofthis Form 10-K where indicated.

 

----

**AFFYMETRIX, INC.**

**FORM 10-KDECEMBER 31, 2005**

**TABLE OF CONTENTS**
| Item No. | ** ** | ** **                                                                                                            | ** ** | **Page** |   |
|----------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|----------|--------|
|     |       | PART I                                                                                                           |       |     |   |
| 1.       |       | Business                                                                                                              |       | 3        |   |
| 1A.      |       | Risk Factors                                                                                                          |       | 24       |   |
| 1B.      |       | Unresolved  Staff Comments                                                                                            |       | 34       |   |
| 2.       |       | Properties                                                                                                            |       | 34       |   |
| 3.       |       | Legal  Proceedings                                                                                                    |       | 34       |   |
| 4.       |       | Submission  of Matters to a Vote of Security Holders                                                                  |       | 36       |   |
|     |       | PART II                                                                                                          |       |     |   |
| 5.       |       | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Repurchases of Equity Securities |       | 37       |   |
| 6.       |       | Selected  Financial Data                                                                                              |       | 38       |   |
| 7.       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                      |       | 39       |   |
| 7A.      |       | Quantitative  and Qualitative Disclosures About Market Risk                                                           |       | 54       |   |
| 8.       |       | Financial  Statements and Supplementary Data                                                                          |       | 56       |   |
| 9.       |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                            |       | 95       |   |
| 9A.      |       | Controls  and Procedures                                                                                              |       | 95       |   |
| 9B.      |       | Other  Information                                                                                                    |       | 97       |   |
|     |       | PART III                                                                                                         |       |     |   |
| 10.      |       | Directors  and Executive Officers of the Registrant                                                                   |       | 97       |   |
| 11.      |       | Executive  Compensation                                                                                               |       | 97       |   |
| 12.      |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                      |       | 97       |   |
| 13.      |       | Certain  Relationships and Related Transactions                                                                       |       | 97       |   |
| 14.      |       | Principal  Accounting Fees and Services                                                                               |       | 97       |   |
|     |       | PART IV                                                                                                          |       |     |   |
| 15.      |       | Exhibits  and Financial Statement Schedules                                                                           |       | 98       |   |
|     |       | Signatures                                                                                                            |       | 103      |   |
|          |            |                                                                                                                       |            |          |        |  |  |

 

2

----

**PART I**

**ITEM 1.**                BUSINESS

**Forward-Looking Statements**

All statements in thisAnnual Report on Form 10-K that are not historical are “forward-lookingstatements” within the meaning of the federal securities laws, includingstatements regarding our “expectations,” “beliefs,” “hopes,” “intentions,” “strategies”or the like. Such statements are based on our current expectations and aresubject to a number of factors and uncertainties that could cause actualresults to differ materially from those described in the forward-lookingstatements. We caution investors that there can be no assurance that actualresults or business conditions will not differ materially from those projectedor suggested in such forward-looking statements as a result of variousfactors, including, but not limited to, the risk factors discussed in “RiskFactors” contained in Item 1A of this report and elsewhere in thisreport. We expressly disclaim any obligation or undertaking to release publiclyany updates or revisions to any forward-looking statements containedherein to reflect any change in our expectations with regard thereto or anychange in events, conditions, or circumstances on which any such statements arebased.

**Narrative Description of Business**

***Overview***

We are engaged in the development, manufacture, saleand service of consumables and systems for genetic analysis in the lifesciences and clinical healthcare and are recognized as a market leader increating breakthrough tools that are advancing our understanding of the molecularbasis of life. The markets for our products currently include all aspects ofmolecular biology research in the life sciences, including basic human diseaseresearch, genetic analysis, pharmaceutical drug discovery and development,pharmacogenomics (research relating to how a person’s genes affect the body’sresponse to drug treatments), toxicogenomics (research relating to themeasurement of gene expression as a predictor of toxicity) and moleculardiagnostics. Additional markets are emerging in agricultural research, plantbreeding, food testing, pathogen identification and consumer genetics. Ourintegrated GeneChip® microarray platform includes: disposable DNA probe arrays(chips) consisting of nucleic acid sequences set out in an ordered, highdensity pattern, certain reagents for use with the probe arrays, a scanner andother instruments used to process the probe arrays, and software to analyze andmanage genomic or genetic information obtained from the probe arrays. Relatedmicroarray technology also offered by us includes licenses for fabricating,scanning, collecting and analyzing results from complementary technologies.

Our business strategy is to capitalize on ourleadership position in the DNA microarray field by marketing our GeneChip® technologiesto customers based on two central applications: gene expression monitoring andDNA variation detection. Due to the novel, massively parallel approach tostudying biological systems that GeneChip® technology enables, numerousdiscoveries across many disciplines have already been made, as evidenced by theover 4,000 peer-reviewed publications released that have cited GeneChip®technology. The molecular diagnostic application of GeneChip® technologies fordiagnosing and guiding treatment of disease is an emerging market opportunityin health management that seeks to improve the effectiveness of health care bycollecting information about DNA variation and RNA expression in patients atvarious times from screening and diagnosis through prognosis and throughouttherapeutic monitoring. We currently sell our products directly topharmaceutical, biotechnology, agrichemical, diagnostics and consumer productscompanies as well as academic research centers, government researchlaboratories, private foundation laboratories and clinical referencelaboratories in North America and Europe. We also sell our products throughlife science supply specialists acting as authorized distributors in LatinAmerica, India, the Middle East and Asia Pacific regions, including China.

3

----

In March 1992,Affymetrix, Inc. was incorporated in California as a wholly-ownedsubsidiary of Affymax N.V. (Affymax) and we have continued our business andoperations as Affymetrix. We completed our initial public offering in June 1996and in September 1998 we reincorporated as a Delaware corporation. Ourheadquarters and principal research and development facilities are located inSanta Clara, California, and we maintain facilities in West Sacramento,California (probe array manufacturing), Sunnyvale, California (sales,marketing, administration, and array research and development), Emeryville,California (bioinformatics and software development), South San Francisco,California (manufacturing and research and development), Bedford, Massachusetts(instrument development and manufacturing), and additional sales offices in theUnited Kingdom, Singapore and Japan.

*Acquisition*

On October 21, 2005,Affymetrix acquired 100% of the outstanding shares of ParAlleleBioScience, Inc. (“ParAllele”), a provider of comprehensive geneticdiscovery solutions to the life science research, pharmaceutical and diagnosticsectors. ParAllele’s products and services utilize a unique approach thatleverages novel biochemical processes rather than complex instrumentation to discoverand analyze minute variations in the human genome. Affymetrix expects theacquisition to accelerate the development and commercialization of new productsand create greater opportunities for market penetration and revenue generationas well as increase Affymetrix’ core assay development capabilities.

**ScientificBackground and Technology**

*Introduction to theGenome and its Opportunity*

The genetic content of an organism is known as its “genome.”All known genomes are composed of either deoxyribonucleic acid (DNA) orribonucleic acid (RNA). The instructions required for every living cell todevelop its characteristic form and function are believed to be representedwithin discrete regions of the DNA or RNA known as genes. The instructionscontained within genes are embodied in the specific sequences of the fournucleotide bases—adenine-A, cytosine-C, guanine-G and thymine-T (uracil-Ureplaces T in RNA)—that are the chemical building blocks of DNA and RNA. Inprotein coding genes, the sequence of these building blocks forms a code whichinstructs the cell to build a protein, comprised of a string of amino acids,ordered in a way which matches the sequence code of the gene. These proteinsare an example of a “hard copy” output of the genetic code and contribute tothe structure, biochemical functions and communication mechanisms of the cellin which they are formed.

The DNA molecule possesses a chemical structure whichconsists of a combination of two DNA strands with hydrogen bonds betweennucleotide bases on one strand to complementary nucleotide bases on the otherstrand. Only certain pairs of the bases can form these complementary bonds: Cpairs with G, and A pairs with T. Therefore, a single DNA strand containingbases in the sequence CGTACGGAT can form a bond with a DNA strandcontaining bases in the sequence GCATGCCTA. Such paired DNA strands are said tobe “complementary” and can form a double helix structure in a processcalled “hybridization.” Our GeneChip® technology uses the principle ofhybridization to recognize the presence of specific gene sequences and toanalyze genetic information.

Genes are segments of DNA that serve as informationpackets of the genome. In general, a gene’s functional information is madeavailable to a cell through the process of transcription or “gene expression,”whereby the sequence is copied into an RNA molecule. Protein coding genes mayspan thousands to hundreds of thousands, or even millions, of nucleotide basessince the non-coding regions of a gene (called “introns”) and the codingregions of a gene (called “exons”) are usually distributed within neighboringgenomic sequences that are not translated into proteins or used, or to theextent currently understood, as a functional part of the gene. The number ofdistinct protein coding genes in the human genome is estimated to be between25,000 to 30,000. The number of functional non-coding sequences is the focus ofcurrent research interest. Though currently unknown, the number of functionalnon-coding 

4

----

sequences is estimated tobe significantly larger than the number of protein coding genes in the humangenome.

A primary goal in life sciences research and modernmolecular medicine is to unravel the complexities of the genome. This hasgenerated a worldwide effort to identify and sequence the genomes of manyorganisms. In the human genome, this effort includes more than three billionnucleotide pairs. In recent years, the effort led by the Human Genome Projectand related academic, government and industry research projects resulted in afirst near complete draft of the human genome sequence. It is anticipated thatmany years of research will be required to gain a better understanding of thecomplexities of the genome, and its characteristics in normal and diseasedconditions. We believe that this will lead to a new healthcare paradigm wheredisease is understood at the molecular level, allowing patients to be diagnosedaccording to genetic information and then treated with drugs designed to workon specific molecular targets. Ultimately, in addition to diagnosis andtreatment, prevention and cure of disease might also be possible based ongenetic information.

While scientists arelearning more and more about the functions of genes and their variability,there is a great deal more to discover. We believe that the efforts of scienceto understand the complexities of gene expression, the interaction of geneswith our environment and the role of genes in disease and health will continueto provide growth opportunities for our existing gene expression and DNAanalysis products, and will continue to create new opportunities in clinicalmedicine. Toward this end we have partnered with the National Cancer Instituteto assemble the first complete map of the human transcriptome (a catalog of allof the RNA transcripts made by the genome). This ongoing effort has already ledto the discovery of many novel protein coding and non-protein coding sequencesthat we expect to include in future products. This effort is also promptingcontinued development of our sample preparation, array, instrumentation anddata analysis technologies.

*Genetic Variabilityand Disease*

For the most part, each cell in a complex organismcontains a complete copy of the genome. In a population of organisms,individuals vary from one another because of differences in gene sequenceswhich are inherited from each parent and sometimes through the introduction ofsequence changes due to environmental damage or biological errors in processeslike gene replication. In some cases these variations, or polymorphisms, havelittle detectable effect on the biology of the organism, while in other casesthey may result in an altered biological response to the environment whichcould thereby lead to disease. By screening for these polymorphisms,researchers seek to identify those that might be implicated in specificdiseases. Sometimes it is not a single variation, but the combination of thesesequence differences that leads to a diseased state. For this reason,researchers look at the patterns of these polymorphisms in a large number ofhealthy and affected organisms in order to correlate specific genepolymorphisms with specific diseases.

Another major mechanism by which the fate and functionof cells is regulated is the timing and level of gene expression, which canreflect the interface between genes and the environment. Although most cellscontain an organism’s full set of genes, each cell expresses only a fraction ofthis set of genes in different quantities and at different times. Theexpression patterns of genes can be correlated with many human diseases such ascancer, as well as with the effectiveness of treatment in specific patientpopulations for which new therapies can be developed. By identifying genes thatare differentially expressed in particular diseases or patient populations,novel molecular targets and treatments may be identified and validated. Inaddition, gene expression signatures may be identified that allow the selectionof optimal treatment for a single individual.

In order to understand theimpact of genomics on health, disease and other aspects of the human condition,scientists must compare both the sequence variation and the gene expressionpatterns of healthy and diseased individuals, tissues and cells. We believethat our GeneChip® platform not only enables 

5

----

scientiststo attain ambitious goals, from identifying genetic variations associated withdisease to discovering new drug targets, but also simplifies, accelerates andreduces the cost of understanding this genetic information.

*GeneChip® ProbeArray Technology*

Our GeneChip® technology leverages semiconductor-basedphotolithographic fabrication techniques, which enables us to synthesize alarge variety of predetermined DNA sequences simultaneously in predeterminedlocations on a small glass chip called a “probe array.” Photolithography is atechnique which uses light to create exposure patterns on the glass chip anddirect chemical reactions. The process begins by coating the chip with light-sensitivechemical compounds that prevent chemical coupling. These light-sensitivecompounds are called “protecting groups.” Lithographic masks, which consist ofpredetermined transparent patterns etched into a glass plate that either blockor transmit light, are used to selectively illuminate the glass surface of thechip. Only those areas exposed to light are deprotected, and thus activated forchemical coupling through removal of the light-sensitive protectinggroups. The entire surface is then flooded with a solution containing the firstin a series of DNA building blocks (A, C, G or T). Couplingonly occurs in those regions that have been deprotected through illumination.The new DNA building block also bears a light-sensitive protectinggroup so that the cycle can be repeated.

This process of exposure to light and subsequentchemical coupling can be repeated many times on the same chip in order togenerate a complex array of DNA sequences of defined length. The intricateillumination patterns allow us to build high-density arrays of many diverse DNAsequences in a small area. Unlike conventional synthesis techniques, whichgenerally use a linear process to create compounds, our synthesis technique iscombinatorial, in that the number of different compounds synthesized growsexponentially with the number of cycles in the synthesis. Currently availablecommercial arrays contain over 6.0 million unique sequences. Each uniquesequence is 25 nucleotides in length and is represented millions of timeswithin a specified area of the probe array. Just as in the semiconductorindustry, we manufacture probe arrays in a wafer format. Each wafer isapproximately five inches square and can contain over 300 million uniqueprobe sequences based on current technology. Whole wafers have been used by arelated party of Affymetrix, Perlegen Sciences, Inc., in its work toresequence multiple samples of the human genome. For our commercial arrayproducts, we can manufacture a large number of identical or different DNA probearrays on a glass wafer, which is then diced into individual chips. Given thelarge amount of unique sequences represented in our probe arrays, ourtechnology enables the efficient analysis of a multitude of DNA probes toanalyze DNA or RNA sequences in a test sample.

In the semiconductor industry, the principle that thenumber of transistors in a semiconductor chip doubles every 18 monthsbased on feature shrink, or increased resolution, is known as Moore’s Law.Because we leverage photolithographic manufacturing processes adapted from thesemiconductor industry, we have also been able to continually “shrink” the sizeof features, or oligonucleotide probes of a given sequence, on our GeneChip®arrays. Our first commercial GeneChip® products, which we shipped in 1994,had a feature size of 100 microns and by 2005, we introduced our Human ExonArray product with a 5 micron feature size. We have thus been able to increasethe amount of genetic information packaged onto our GeneChip® arrays by nearly400 times since the introduction of our first products.

Because we manufacture ourchips in wafer format, we can vary the number of chips manufactured per wafer.We can therefore manufacture thousands of chips per wafer with low informationcontent and lower cost of goods sold or decrease the number of chips per waferand increase the information content. We expect that we will continue tobenefit from this manufacturing leverage as our technology developmentactivities enable further feature shrink. We believe that our unique manufacturingprocess is a significant competitive advantage.

6

----

***Products***

*Overview*

Our products form an integral part of our GeneChip®system that is designed for use by pharmaceutical, biotechnology, agrichemical,diagnostics and consumer products companies, as well as academic researchcenters, private government research foundations and clinical referencelaboratories. The GeneChip® system consists of several integrated components:disposable probe arrays containing genetic information on a chip, reagents forextracting, amplifying and labeling target nucleic acids, a fluidics stationfor introducing the test sample to the probe arrays, a hybridization oven foroptimizing the binding of samples to the probe arrays, a scanner to read thefluorescent image from the probe arrays, and software to analyze and manage theresulting genetic information. The function of each single-strandedsequence on the GeneChip® probe array is to bind to its complementary singlestrand of DNA or RNA from a biological sample. Each unique sequencefeature on the GeneChip® probe array contains multiple copies of the samesingle strand of DNA. The nucleic acid (DNA or RNA) to be tested is isolatedfrom a sample, such as blood or biopsy tissue, amplified and fluorescentlylabeled by one of several standard biochemical methods. The test sample is thenwashed over the probe array, where the now labeled individual nucleic acidsequences that represent the genetic content or expressed genes of the samplehybridize to their complementary sequences bound on the array. When scanned bya laser, which is part of the scanner instrument, the test sample generates afluorescent signal. The locations where a fluorescent signal is detected by anoptical detection system on the scanner instrument correspond to sequencescomplementary to the test sample. Sequence variation, or the quantification ofspecific sequences of nucleic acids in the sample, can be determined bydetecting the relative strength of these signals since the sequence andposition of each complementary DNA probe on the probe array is known. Thecombination of a particular GeneChip® probe array, together with an optimizedset of reagents and a user protocol describing how to carry out the procedure,is referred to as an “assay.”

We currently market products for two principalapplications: monitoring of gene expression levels and investigation of geneticvariation (DNA analysis including single nucleotide polymorphism (SNP) genotypeanalysis and resequencing). Our GeneChip® expression monitoring arrays enableour customers to qualitatively and quantitatively measure gene expressionlevels in a number of biologically relevant organisms. Our catalog GeneChip®expression arrays are available for the study of human, rat, mouse and a broadrange of other mammalian and model organisms. Additionally, we marketCustomExpressTM, CustomSeqTM and NimbleExpressTM products which enable ourcustomers to design their own custom GeneChip® expression arrays or sequencearrays for organisms of interest to them. Our GeneChip® DNA analysisarrays and variant detection systems are available to enable researchers toperform high throughput polymorphism analysis and to carry out large scaleresequencing (comparing the DNA sequence of multiple samples against a knownreference sequence, e.g. the published human genome sequence). With its unique,parallel analysis capability, GeneChip® technology enables our customers toperform accurate and cost-effective genetic analysis, using minute amounts ofsample DNA, in their own laboratories on a scale that was previously onlypossible in specialist high throughput centers.

In addition, we believethat genetic analysis and testing products will be a core component in the areaof clinical research and molecular diagnostic applications and we aredeveloping our GeneChip® system for clinical research and diagnostic analysisof both gene expression and DNA analysis. Together with our collaborativepartners, we are focusing on the development and commercialization ofdiagnostic products in cancer, osteoporosis, cardiovascular, inflammatory,metabolic, infectious and other diseases, and believe that our GeneChip® assayswill facilitate more efficient and effective disease detection, prognosis andtreatment selection, leading to overall improved patient management. To furtherour clinical research and molecular diagnostics strategy, we have establishedpartnerships and customer relationships with leading academic researchers,pharmaceutical and biotechnology companies, including F. Hoffmann-LaRoche Ltd. (“Roche”), bioMérieux, Inc. (“bioMérieux”), and Veridex,LLC, a Johnson & Johnson 

7

----

company(“Veridex”). We believe that the rapid growth of the clinical research and thediagnostic devices markets holds the potential for GeneChip® technology applicationsranging from basic research to clinical trials and, ultimately, diagnosticdevices. As a result we are working with leaders in molecular diagnostics toprovide custom made GeneChip® probe arrays to their specifications. Ourpartners subsequently package the chips into kits, seek regulatory approval fortheir diagnostic use, and sell them into the diagnostic markets using theirsales channels. We are leveraging our partners’ strengths in research,development, regulatory practices and distribution while leveraging ourstrengths in array technology. These products are marketed as being Powered byAffymetrixTM.

*Gene ExpressionMonitoring Arrays*

Gene expression monitoring is a valuable tool foridentifying correlations between genes, determining their biological functionsand identifying patterns that might be useful in classifying diseases. Tomonitor gene expression, we design and manufacture probe arrays with single-strandedDNA molecules that are complementary to sequences within genes of interest. Bysynthesizing specific probes for multiple genes on a single probe array, weenable researchers to quickly, quantitatively and simultaneously monitor theexpression of a large number of genes of interest. By monitoring the expressionof such genes under different conditions and at different times, researcherscan use the probe arrays to understand the dynamic relationship between geneexpression and biological activity. We believe such information will be animportant tool in understanding gene function and for the development of newdrugs and diagnostic tools. Increasingly, clinical research is showing that geneexpression patterns in tissue samples, particularly those from canceroustissues, can be used to characterize disease sub-types and hopefully to predicttherapeutic responses and likely outcomes.

The range ofGeneChip® Expression products is described below:

·       *Standard Expression Monitoring Arrays*.   Weare currently selling a portfolio of standard expression monitoring GeneChip®arrays. Our current offering of standard arrays includes products that monitorthe expression of the majority of full-length and partial gene sequencescontained in publicly available sequence databases, which correspond withhuman, mouse, rat, canine, Drosophila melanogaster (fruit fly), Caenorhabditiselegans (nematode), Xenopus laevis (frog), Danio rario (zebrafish), Saccharomycescerevisiae (yeast), Escherichia coli (bacteria), Pseudomonas aeruginosa(bacteria), Plasmodium falciparum (malarial parasite), Anopheles (mosquitovector of malaria), Arabidopsis thaliana (mustard plant, a common model organismfor plants), bovine (cow), chicken, maize (corn), medicago (alfalfa), poplar(tree), porcine (pig), Rhesus macaque (monkey), rice, soy, sugar cane, tomato,Vitis vinifera (wine grapes) and citrus arrays.

·       *GeneChip® Exon Arrays*.   We are now offering exon arraysthat interrogate the expression of individual exons, the building blocks thatmake up a transcript. It is well known that alternative utilization ofdifferent exons from the same gene (known as alternative splicing) leads to thegeneration of various protein products, leading to diverse functionalconsequences. In addition, mis-regulation of splicing has been associated withmany different diseases including cancer and diabetes. The exon array is thefirst experimental tool to discover new splicing events on a genome-wide scaleto help researchers better understand disease mechanisms which can lead to thedesign of novel therapies for treatment and more informative diagnosticsignatures.

·       *Whole Genome Tiling Arrays.*   We offertiling arrays for the genomes of a number of major organisms including human,mouse, drosophila, C.elegans and yeast. These designs use evenly spaced probesacross the non-repetitive portion of the genome and rely only on genomic DNA sequenceand not functional annotation for their design. The arrays are used for mappingthe entire collection of transcribed elements (including non-coding RNAs thatare used for structural and regulatory purposes), identifying protein bindingand methylation sites and identification of genomic origins of replication.

8

----

·       *Custom Express Arrays*.   We haveestablished a GeneChip® CustomExpressTM Array Program enabling customers todesign affordable arrays tailored to their specific research needs. OurCustomExpressTM arrays enable customers to select probes from any of our probesequences on our catalog arrays and/or to incorporate probes from their ownproprietary gene sequences. These arrays are then produced utilizing the samemanufacturing technologies as our other GeneChip® whole genome expressionarrays.

·       *Made-to-Order Arrays*.   We offer the GeneChip®Made-to-Order Array Program to enable our customers to use arrays from selectedcustom designs and previous-generation GeneChip® arrays which are nolonger available as catalog products.

*DNA Analysis Arrays*

As genes and regulatory regions in the human genomeare mapped, identified, and sequenced, the value of understanding thevariability of sequences among individuals increases. Researchers seek todetermine the normal sequence of the gene, which mutations or polymorphismsexist in a population, and whether these variations correlate with a disease orother aspect of the human condition. Studies of the genetics of complexdiseases have historically been challenging due to high costs of sequencing orgenotyping of large numbers of affected and unaffected individuals. Geneticvariation also impacts how individuals respond to therapeutics. The study ofthese effects is known as pharmacogenetics. This is part of the broader fieldof pharmacogenomics, which seeks to understand how the overall composition andexpression of the genome affects therapeutic response, drug efficacy and theincidence of adverse side effects to therapy. We believe pharmacogenomics willbecome increasingly important both in clinical drug trials and patient care. Byusing our resequencing and genotyping technologies, we believe that ourGeneChip® probe arrays could significantly reduce the cost and time requiredfor high-volume polymorphism analysis, which is currently performed throughmore labor-intensive techniques.

We have initiatedproduct research and development efforts on several genetic analysis probearrays and variant detection analysis systems and formed collaborations toaccelerate the development of our genotyping products. For additionalinformation concerning these efforts and collaborations see the sections ofthis Form 10-K entitled “Research and Development” and “OurCollaborative Partners.” We currently market the following DNA analysisproducts:

·       *GeneChip® Human Mapping 500K Set.  *The Mapping 500K Setis our newest whole genome genotyping product and the third in a family ofproducts for large scale genome-wide genotyping using a simple, scalable,one-primer assay. The 500K Set genotypes over 500,000 SNPs on a two array set. The500K Set is enabling novel genetic experiments (called genome-wide associationstudies) to understand the genes involved in complex disease and drug responseusing real-world disease populations. Researchers have for many years sought tostudy major diseases in unrelated populations, but the information density(hundreds of thousands of markers) and experiment size (hundreds or thousandsof samples) made these experiments unaffordable. The 500K Set is the first andmarket leading product in making large scale whole genome analysis costeffective.

·       *GeneChip**® Human Mapping 100K Set and 10K Array*.   Weoffer two other products based on the same scalable one primer assay as our500K product: the 100K Set and the 10K Array. The 100K Set genotypes over 100,000SNPs on a two array set and the 10K Array genotypes over 10,000 SNPs on asingle array. The 100K Set was the first product to enable genome-wideassociation studies and is also used for chromosomal copy number analysis. The10K Array is used primarily for linkage analysis, the study of the inheritanceof disease in families.

·       *Targeted Genotyping Products.  *We offer a variety oftargeted genotyping products for the analysis of between 1,500 and 20,000 SNPsper sample, using a highly multiplexed assay for use with GeneChip® UniversalTag Arrays. This innovative assay enables customers to genotype selected 

9

----

SNPs in a single assaywith only one primer per SNP. We offer the widest variety of standard panels ofpre-selected SNPs for major diseases (e.g., inflammatory disease), modelorganisms (e.g., mouse), and specific applications (e.g., drug metabolizingenzymes), as well as custom capabilities that offer customers the highestconversion rates to genotype more of the SNPs they want.

Theassay described above and the products offered through this product linerepresent the technology and products acquired through the ParAllele acquisitiondescribed elsewhere in this report.

·       *GeneChip**® CustomSeqTM Resequencing Arrays*.   Version2 of this product line was released in 2005, increasing sequence content per arrayby tenfold. The CustomSeqTM sequence variation product line now enablescustomers to sequence up to 300,000 bases on one array in just two days withhigh accuracy. CustomSeqTM arrays offer researchers a powerful complementarytool to our whole genome genotyping and whole genome expression products on thesame industry-standard GeneChip® platform, and are currently being usedin a wide variety of applications ranging from infectious disease research todetailed sequence analysis following up association studies to full mitochondrialgenome sequencing.

*DNA AnalysisProducts Powered by AffymetrixTM*

·       *Roche AmpliChipTM CYP450*.   The Powered by AffymetrixTMprogram and collaboration with Roche announced in January 2003 resulted inthe June 2003 release of the Roche AmpliChipTM CYP450 microarray. TheAmpliChip CYP450 microarray allows for complex sequence information to beanalyzed for the purpose of genotyping the CYP2D6 and CYP2C19 genes. Sequencevariation in these genes can result in marked differences in the wayindividuals metabolize, and hence respond to, an estimated 25% of all drugs. Inlate 2004, Roche obtained in-vitro diagnostic status for the product in theUnited States and Europe.

*Access Programs forOur GeneChip® Arrays*

We offer a variety ofsales programs for our gene expression monitoring and DNA analysis arrays,tailored to the needs of industrial, biotech and academic/government customers.These programs are tied to volume usage and customers can select a program thatbest meets their needs to receive favorable pricing per array.

*Reagents for OurGeneChip*® Systems

Our GeneChip® reagent kits contain validated reagentscritical for the success of expression monitoring and DNA analysis experiments.The 2005 additions to the Affymetrix GeneChip® reagent family are listed below:

*WholeTranscript Reagents.**  *Withthe launch of the GeneChip® Whole Transcript (WT) Sense Target Labeling Assay,we introduced: GeneChip® WT Terminal Labeling Kit and GeneChip® WT cDNASynthesis and Amplification Kit, each available in 10 or 30 reactions.

*ArrayStation Reagents.  **We*introduced two newGeneChip® reagent kits developed and optimized specifically for targetpreparation on the GeneChip® Array Station: GeneChip® HT One-Cycle cDNA synthesisKit and GeneChip® HT IVT Labeling Kit in 96 reactions.

*Mapping500K Reagents.**  *With thelaunch of the GeneChip® Human Mapping 500K Array Set, we introduced theGeneChip® Mapping 250K Sty Assay Kit and the GeneChip® Mapping 250K Nsp AssayKit, each available in 30 or 100 reactions.

10

----

*HybridizationWash and Stain Reagents.**  *InDecember 2005 we introduced the GeneChip® Hybridization Wash and Stain Kitwhich contains reagents formulated into the fewest number of individualcomponents possible.

For our expression probe arrays, we offer thefollowing reagents: One-Cycle cDNA Synthesis Kit, Two-Cycle cDNA Synthesis Kit,GeneChip® Expression 3’-Amplification Reagents for IVT Labeling, GeneChip®Sample Cleanup Module, GeneChip® IVT cRNA Clean up Kit, T7-Oligo(dT)Promoter Primer Kit, Eukaryotic Poly-A RNA Control Kit and EukaryoticHybridization Control Kit, GeneChip® WT Terminal Labeling Kit, GeneChip® WTcDNA Synthesis and Amplification Kit, GeneChip® HT One-Cycle cDNA synthesisKit, GeneChip® HT IVT Labeling Kit, and the GeneChip® Hybridization Wash andStain Kit.

For our DNA analysisarrays, we offer the following reagents: GeneChip® Resequencing Assay Kit,GeneChip® Mapping 10K Xba Assay Kit, GeneChip® Mapping 50K Xba Assay Kit,GeneChip® Mapping 50K Hind Assay Kit, GeneChip® Mapping 250K Sty Assay Kit andthe GeneChip® Mapping 250K Nsp Assay Kit.

*Instruments for OurGeneChip*® Systems

Our GeneChip® instruments provide a fully integratedsystem for conducting research using GeneChip® probe arrays. The instrumentsystem consists of four hardware devices, each providing for robust preparationand analysis of samples using GeneChip® arrays. The first device is ahybridization oven to control the timing and temperature required forhybridization of the test sample to the probe array. The second device is afluidics station that controls exposure of the probe array to solutionscontaining prepared sample and labeled detection reagents across the probearray. The fluidics station can process four probe arrays simultaneously. Thefluidics station protocols conclude with a reagent wash that leaves thelabeled, hybridized test sample bound to the probe array.

The third device, a laser scanner, is used aftercompletion of protocols on the fluidics and hybridization stations, at whichtime the cartridge containing the probe array is placed in the scanner andread. The scanner consists of a laser, high-resolution optics, robotics toposition and scan the probe array, a fluorescence detector and an interface toa computer workstation. The labeled material that is bound to the hybridizedtest sample emits fluorescent signals when exposed to the light from the laser.The locations and intensities of the fluorescent signals are recorded by thescanner and stored in the computer for analysis. The fourth device is anautoloader, which is a 48-array carousel that interfaces with the scannerto allow walk-away automation of the scanning steps, while maintaining theloaded arrays at the optimum storage temperature.

The individualcomponents of our GeneChip® instrument system are described in more detailbelow.

·       *GeneChip**® Hybridization Oven 640*.   TheGeneChip® Hybridization Oven 640 is used to control the timing and temperaturerequired for hybridization of the test sample to the probe array. The GeneChip®Hybridization Oven 640 holds up to eight probe array cartridge carriers (eachwith eight cartridge slots) that rotate for controlled hybridization of up to64 probe arrays. This unit delivers temperature control for consistentperformance across all probe array applications.

·       *Fluidics Station 450*.   The FluidicsStation 450 is used to control exposure of the probe array to solutionscontaining prepared sample and labeled detection reagents across the probearray and can independently process four probe arrays simultaneously. Thefluidics station protocols conclude with a reagent wash that leaves thelabeled, hybridized test sample bound to the probe array. Multiple fluidicsstations can be connected to the same computer workstation in order to expeditearray processing in high throughput laboratories.

11

----

·       *GeneChip**® Scanner 3000*.   The GeneChip®Scanner 3000 uses proprietary laser scanning technology and high resolutionoptics to read the fluorescent signal from GeneChip® arrays. The GeneChip®Scanner 3000, developed and manufactured by Affymetrix, represents the nextgeneration in scanner technology. The Flying ObjectiveTM scanning technologyincorporated into this scanner has been adapted to provide faster scanning ofGeneChip® probe arrays with a high degree of image uniformity and accuracy. Thecurrent version of the GeneChip® Scanner 3000 has been validated to allowimaging of GeneChip® arrays with feature sizes as small as 5 microns and cansupport multicolor assays. The GeneChip® Scanner 3000 is purchased with acomputer workstation loaded with Affymetrix GeneChip® Operating Software (“GCOS”)(discussed below under “Software for Our GeneChip® Systems and Analysis Tools”).

·       *GeneChip**® AutoLoader*.   The GeneChip® AutoLoader,developed and manufactured by Affymetrix, is a 48-array carousel thatautomatically loads and unloads arrays from the scanner, helping researchersautomate their array processing and providing walk-away use in the lab. TheGeneChip® Scanner with AutoLoader can load and scan 48 current catalog arraysin 28 hours or less, depending on the feature size and array format thatis scanned. Thermostatic control allows the stored arrays to be held in acooled environment and then warmed to optimum temperature for scanning. TheAutoLoader attaches to the top of the scanner, saving valuable bench space, anddoes not require any additional power source.

·       *Workstations*.   We offer workstationsto accommodate varied research needs. The Type I GeneChip® Workstation (WindowsNT) is configured with system software enabling it to operate the GeneChip®Scanner 3000 and multiple Fluidics Stations. Our Type II GeneChip® Workstation(Windows NT and Windows 2000) can operate independently of the scanner andfluidics station instruments.

·       *GeneChip®Array Station*.   Through our collaboration with Caliper LifeSciences, Inc., we launched the Affymetrix GeneChip® Array Station that has thecapacity to process hundreds of biological samples per week with minimal humansupervision, reducing operating costs and variability in target preparation in2005. The GeneChip® Array Station is designed to perform target preparation forboth cartridges and array plates as well as perform the wash and stain functionfor the array plates. The GeneChip® Array Station adapts the same industry-standardGeneChip® technology to a standard 96-well microtiter plate, and runs onan automated system built with off-the-shelf robotic components. In addition,we launched the GeneChip® HT Scanner that utilizes CCD based technology forimaging of the new array plates. The GeneChip® Array Station automates the mostlabor intensive steps in GeneChip® probe array processing, dramaticallyreducing the cost per assay. The decrease in cost and increase in throughputmakes the GeneChip® Array Station well suited for downstream developmentapplications such as compound profiling, molecular toxicology and clinicaltrials.

*Software for OurGeneChip*® Systems and Analysis Tools

Our “GCOS” software is supplied as part of anintegrated system and runs on an industry standard PC platform. Thefluorescence intensity data captured from the scanner are used in conjunctionwith computer files containing the probe sequence and location of all theprobes on the probe array to determine the expression level of a particulargene or to identify particular DNA sequence variations of the test sample.

Our Data Mining Tool® and GeneChip® Operating SoftwareServer (“GCOS Server”) software products allow for sophisticated analyses ofgene expression results and provide a means of linking and integrating thisinformation with other databases.

12

----

Customers may choose operating or other software productsprovided by third party vendors that have been developed through ourOpenSystemsTM program, which includes the provision of a Software Developer’sKit to interested commercial and academic parties. Through this program weintend to stimulate a wide range of independent groups to develop tools for usewith our platform, further enhancing our customers’ capability to generateunique biological insights from the high quality data provided by the GeneChip®platform.

Finally, our NetAffxTMAnalysis Center (www.affymetrix.com/analysis/) is our exclusive onlineinformatics resource for our customers and provides streamlined, open access todesign information and biological annotations associated with our GeneChip®arrays. It was created to assist genomic researchers with the design andanalysis of DNA array based experiments. NetAffxTM offers researchers asearchable catalog of Affymetrix GeneChip® probe array content, a range ofpublicly available and Affymetrix generated databases, and links to importantthird party resources.

*Instruments for Usein Molecular Diagnostics*

The GeneChip® System 3000Dx (GCS3000Dx) is configuredespecially for the molecular diagnostic market. In September 2004, theGCS3000Dx received Conformite Europeene (CE) certification, clearing it for useas an in-vitro diagnostic (IVD) product in the European Union. In December 2004,the GCS3000Dx was also cleared by the United States Food and DrugAdministration (FDA) as an IVD to be used in conjunction with the RocheDiagnostics AmpliChipTM CYP450 Test. The AmpliChipTM CYP450 Test also received CEcertification and FDA clearance in 2004 making it the first Powered byAffymetrixTM IVD test. This test, which utilizes an Affymetrix microarrayproduced specifically for Roche Diagnostics, analyzes a patient’s CytochromeP450 2D6 and 2C19 genotypes to look for variations that can influence drugmetabolism. The GCS3000Dx will support all Powered by AffymetrixTM moleculardiagnostic tests. The system includes the GCS3000Dx Scanner with Autoloader Dx,FS450Dx Fluidics Station, and Workstation with GCOS Dx software.

We believe that our GeneChip® technology can beeffectively applied to complex molecular diagnostic testing. We have formedcollaborations and intend to further partner with, or license technology to,established diagnostic and medical device companies to develop, obtain regulatoryapproval for, and commercialize probe arrays and instrumentation. We anticipatebroader use of probe arrays as components of diagnostic products and clinicalresearch applications. We believe that to support large central laboratories,additional instrumentation and automation will need to be developed to allowfor handling the large volume testing of the clinical diagnostic setting. Tofurther our molecular diagnostics strategy, we have established a number ofcollaborations with leading academic researchers, diagnostic companies,pharmaceutical and biotechnology companies.

For example, we are non-exclusively collaborating withRoche to develop and commercialize GeneChip® diagnostic tests for DNA analysis,genotyping and resequencing applications, as well as for RNA expressionanalysis, in a broad range of human disease areas. Using our GeneChip®technologies,Roche intends to develop and market diagnostic tests for diseases such ascancer and osteoporosis and cardiovascular, metabolic, infectious and inflammatorydiseases.

In oncology, we are non-exclusively collaborating withVeridex, a Johnson & Johnson company, to develop and commercializeGeneChip® diagnostic tests for oncology. Using our GeneChip® technologies,Veridex intends to develop and market tests for cancer.

We have a non-exclusive collaborative developmentagreement and an associated supply agreement for probe arrays with bioMérieux, Inc.in breast cancer and in bacteriology to identify the species and drugresistance profiles of those bacteria causing human infection. The agreementsalso allow for non-exclusive development of DNA probe arrays for certaindiagnostic viral tests and for the fields of food and industrial testing.

13

----

We have also entered into non-exclusive collaborativedevelopment and associated supply agreement with a number of other smallercompanies in focused areas of cancer and certain other diseases.

We and our Powered by AffymetrixTM partners believethat developing diagnostic products for cancer and other human diseases willestablish new standards for molecular diagnostic testing. Ultimately, theseproducts will allow physicians to better diagnose and treat human disease.

We have also entered into a series of agreements withBeckman Coulter that give it the right to develop probe array-baseddiagnostic products using some elements of our GeneChip® technology. Underthese agreements, we have also agreed to grant Beckman Coulter licenses tocommercialize probe arrays manufactured using certain of our technologies otherthan light-directed synthesis. Under the arrangement, Beckman Coulterwould pay us transfer prices and royalties on sales of these products.

For additional informationconcerning our collaborations, see the section of this Form 10-Kentitled “Our Collaborative Partners.”

**Our Collaborative Partners**

Our strategy is toestablish the GeneChip® system as the platform of choice for analyzing complexgenetic information, to expand the applications of our technology and toacquire access to complementary technologies and resources. Accordingly, wehave entered into and intend to enter into additional collaborative agreementsto further this strategy. The information below is a selected listing ofcollaborators with whom we have current agreements, together with the relatedproducts and programs and the commencement dates of the most recent agreementwith each. The section is organized by reference to the product area thatrepresents the most significant portion of the collaboration; however, thecollaboration may also involve other areas of our business and product line.

*Gene ExpressionMonitoring*

*Qiagen,GmbH.*   InFebruary 2002, we entered into a three-year supply agreement with Qiagen,GmbH (“Qiagen”) for Qiagen to supply us with certain nucleic acid purificationproducts for use with our GeneChip® arrays for target labeling in expressionanalysis and have collaboration and co-marketing agreements in place thatsupport the complementary use of Qiagen’s sample prep instrumentation andreagents with Affymetrix GeneChip® arrays. The term of this supply agreementhas been extended for an additional two-year period.

*PreAnalytiXGmbH.*   InOctober 2003, we entered into a collaborative agreement with PreAnalytiXGmbH, a joint venture between QIAGEN N.V. and Becton, Dickinson and Company.The goal of the collaboration will be to develop improved methods for the useof PreAnalytiX technology with GeneChip® expression analysis arrays. Bycombining PreAnalytiX and Affymetrix technologies, our goal is to develop acomplete, standardized process for expression profiling starting from wholeblood samples.

*InvitrogenCorporation.**   In November 2003 we signed acollaboration and supply agreement to develop and market a new line of GeneChip®brand expression reagents including two new cDNA Synthesis Kits. Both of thenew cDNA Synthesis Kits were developed in collaboration with Invitrogen andcontain Invitrogen’s industry-leading SuperScriptTM reverse transcriptase(RT). These reagents have been optimized for use with Affymetrix GeneChip®technology, offering a complete, standardized sample preparation system that iseasier to use and will help customers produce more robust and consistent arrayresults. The One-Cycle cDNA Synthesis Kit offers all necessary reagents forstandard target labeling. This protocol has been used by the majority ofAffymetrix customers already, but the new kit provides improved configurationand greater convenience. The new Two-Cycle cDNA Synthesis Kit offers customersa streamlined procedure for preparing samples using a small amount of material,such as biopsy or laser capture dissected samples*.

14

----

*DNA Analysis*

*Perlegen Sciences, Inc.**  *In March 2001, we contributedto Perlegen the rights to use certain intellectual property with no cost basisand received from Perlegen the rights to use and commercialize certain datagenerated by Perlegen in the array field. Using access to whole-wafer technologydeveloped by Affymetrix, Perlegen focuses on identifying the millions ofgenetic variations (known as single nucleotide polymorphisms or “SNPs”) amongindividuals, and finding patterns in those variations that might be predictiveof disease susceptibility or drug response. In January 2003, we obtainedaccelerated access to Perlegen’s SNP database which was used to help developour Mapping 500K Array Set and will also be used in future products. Inaddition, our collaborative arrangement with Perlegen provides us with accessand commercialization rights to certain whole genome technologies, including248,000 chip-optimized assays covering the genome that we intend to makeavailable to our customers for use in resequencing and genotyping. For additionalinformation concerning our relationship with Perlegen, including our ownershipinterest in Perlegen, our collaborative relationship with Perlegen and existingrelationships between certain of our directors and officers and Perlegen, seethe section of this Form 10-K entitled “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and Note 11 toour Consolidated Financial Statements.

*MolecularDiagnostics*

*bioMérieux, Inc.**  *In September 1996, we enteredinto a collaborative development agreement and associated supply agreement forprobe arrays with bioMérieux, Inc. (“bioMérieux”) to identify the speciesand drug resistance profiles of bacteria causing human infection. As part ofthe collaboration, bioMérieux is developing instrumentation for the use ofthese probe arrays in a molecular diagnostic setting. Under the terms of theagreements, bioMérieux provides research and development support and makespayments to us upon achievement of certain milestones. In addition, bioMérieuxpays specified prices for the supply of probe arrays and royalties on anyresulting product sales. In December 1997 and January 1998, weexpanded the collaboration with bioMérieux to include the non-exclusivedevelopment of DNA probe arrays for molecular diagnostic tests in the fields ofvirology and food and industrial testing. In March 2003, the collaborationagreement was amended in order to reinstate bioMérieux’s licenses and in March2005, the collaboration was further expanded to include breast cancer.bioMérieux has launched the FoodExpertID array under this collaboration. Foradditional information, see the section of this 10-K entitled “DNAAnalysis Products Powered by AffymetrixTM.”

*F.Hoffmann-La Roche Ltd.**  *In February 1998, we entered into anon-exclusive collaborative development agreement with F. Hoffmann-LaRoche Ltd. (“Roche”) to initially develop human probe array-baseddiagnostic products. Under the terms of the agreement the parties arecollaborating to develop mutually agreed upon arrays, as well as associatedinstrumentation and reagents. In January 2003, we expanded ourcollaboration with Roche by granting Roche access to our GeneChip*®* technologies to develop and commercialize GeneChip®diagnostic laboratory tests for DNA analysis, genotyping and resequencingapplications, as well as for RNA expression analysis, in a broad range of humandisease areas. Using our GeneChip® technologies, Roche intends to develop andmarket diagnostic tests for diseases such as cancer and osteoporosis andcardiovascular, metabolic, infectious and inflammatory diseases. Affymetrix andRoche believe that developing targeted microarray expression profiles forcancer, plus genotyping and resequencing profiles for other diseases willenable the creation and commercialization of novel standardized diagnosticsolutions. These solutions ultimately will allow physicians to better diagnoseand treat human disease. Under the terms of the collaborative agreement, Rochepaid us an access fee of $70 million relating to the first five years ofthe arrangement. The agreement, which is subject to Roche’s option to terminateon December 31, 2007, or any time on or after June 2, 2013 with oneyear’s prior notice, includes a broad range of other compensation payable byRoche to Affymetrix throughout the life of the agreement based on royalties onsales of diagnostic kits, milestone 

15

----

payments for technical andcommercial achievements, a manufacturing and supply agreement, and relatedlicense installments. As part of the agreement, Affymetrix will manufacture andsupply Roche with microarrays and related instrumentation based on Affymetrix’GeneChip® platform. In 2003, Roche launched the AmpliChip® CYP450 array productinitially for research use only, but in late 2004 obtained CE marking and FDAregulatory approvals of the product for in-vitro diagnostic use.

*Veridex, LLC.**  *In December 2004, we enteredinto a non-exclusive collaboration agreement with Veridex LLC, a Johnson &Johnson company, to develop and commercialize GeneChip® based diagnosticproducts for use in the field of oncology. Veridex was granted long-term andcomprehensive access to our GeneChip® technology to create and market in-vitrodiagnostics for cancer. The agreement, made under the Powered by AffymetrixTM program,gives Veridex non-exclusive rights to Affymetrix’ patented arrays,instrumentation systems and planned improvements to these technologies.

*OtherCollaborations*

*TheBroad Institute.**  *InSeptember 2004, we entered into a supply and research collaboration agreementwith the Broad Institute and Massachusetts Institute of Technology. Theagreement provides Affymetrix technology on preferential terms to the BroadInstitute for applications development in return for the option to makecommercial products available from the resulting research. The collaboration isfocused on whole genome SNP analysis, resequencing and high throughputexpression analysis.

*NationalCancer Institute.**  *InJanuary 2001, we entered into a collaboration agreement with the NationalCancer Institute on a human transcriptome initiative which seeks to constructmaps locating the sites of RNA transcription across the entire human genomeusing high-density whole-genome arrays interrogating at resolutions andthroughput rates never before attempted. The transcriptome is defined as thecomplete collection of transcribed elements of the genome. In addition tomRNAs, it also represents non-coding RNAs that are used for structural and generegulation purposes. Alterations in the structure or levels of expression ofany one of these RNAs or their proteins could contribute to disease. Anunderstanding of the transcriptome may provide valuable insights in theresearch for novel drugs. We have made the data from this initiative freelyavailable to the public via the Web through a version of the data integrationand analysis software platform developed by Biotique Systems, Inc., acompany that provides decision support tools and services for the emergingfield of pharmacogenomics. We are using the Biotique Local Integration Systemto house this transcriptome data and to provide an interface for researchers toaccess, query and use this information. This collaboration was extended duringfiscal 2003 to address the identification of transcriptional binding sites,methylation sites, origins of replication and other genomic features.

*Caliper Life Sciences, Inc.**  *In January 2004, we signed acollaboration and supply agreement to develop and provide automated targetpreparation instruments for the GeneChip® Probe Array system. These newautomation systems are expected to cut array processing, reduce variability andlabor costs, and enable researchers to industrialize their genomic research.The two companies will develop products that leverage Caliper’s expertise inhigh-throughput automation and microfluidics with our expertise in microarraytechnology and applications. The first products were launched in 2004 andautomate GeneChip® microarray target preparation steps including hybridization,washing and staining for expression and DNA analysis. The automated systemenables a single operator to run up to 96 RNA samples at a time, compared tothe manual rate of 20 to 24 samples. In 2005 we launched the AffymetrixGeneChip® Array Station that has the capacity to process hundreds of biologicalsamples per week with minimal human supervision, reducing operating costs andvariability in target preparation. The GeneChip® Array Station is designed toperform target preparation for both cartridges and array plates as well asperform the wash and stain function for the array plates. The GeneChip® Array Stationadapts the same industry-standard GeneChip® technology to a standard 96-wellmicrotiter plate, and runs on an automated system built with off-the-shelfrobotic components.

16

----

**Marketing and Distribution**

The markets for ourproducts include all aspects of molecular biology research in the lifesciences, including basic human disease research, clinical research,pharmaceutical drug discovery and development, including pharmacogenomics andtoxicogenomics and agricultural research, amongst others. Our customers includepharmaceutical, biotechnology, agrichemical, diagnostics, industrial andconsumer products companies, as well as academic research centers, laboratoriesin government agencies, private research foundations and clinical andindustrial reference laboratories. The following factors, among others,influence the size and development of our markets:

·       theavailability of genomic sequence and sequence variation data for the humanpopulation and for other organisms;

·       technologicalinnovation that increases throughput and lowers the cost of genomic and geneticanalysis;

·       thedevelopment of new computational techniques to handle and analyze large amountsof genomic data;

·       theavailability of government funding for basic and disease-relatedresearch;

·       theamount of capital and ongoing expenditures allocated to research and developmentand outsourced spending by biotechnology, pharmaceutical and diagnosticcompanies for products and services;

·       theapplication of genomics to new areas including molecular diagnostics,agriculture, human identity and consumer goods; and

·       theavailability of genetic markers and signatures of diagnostic value.

In North America and major European markets, ourGeneChip® products are marketed principally through our own sales anddistribution organizations. We own or lease sales and service offices in theUnited States, Europe, Japan and Singapore. We are finalizing plans to openoffices in China in 2006, although our primary route to market in China willcontinue to be through distributors. In markets outside of North America andEurope, we sell our GeneChip® products principally through third partydistributors, primarily in Mexico, India, the Middle East and Asia Pacific.These distributors are life science supply specialists within their owncountries and operate as our sole distributors within a defined country orother geographic area.

For molecular diagnosticand industrial applications market opportunities, we supply our partners witharrays and instruments, which they incorporate into diagnostic products andtake on the primary commercialization responsibilities. Current collaborativepartners include Roche, bioMérieux, and Veridex, a Johnson & Johnsoncompany. For additional information concerning our collaborative partners, seethe section of this Form 10-K entitled “Our Collaborative Partners.”

**Manufacturing and Raw Materials**

We manufacture our GeneChip® probe arrays, GCS 3000scanner, fluidics stations, instrument control software and certain reagentsin-house and contract with third-party suppliers to manufacture ourhybridization oven, GCAS and HT Scanner and certain reagents for our GeneChip®system. Additionally, through our GeneChip-compatibleTM application program, anumber of third-party software suppliers develop, market and sell genomicdata analysis software that interfaces with data files generated by ourGeneChip® system.

17

----

Our probe array manufacturing process involves waferpreparation, probe synthesis, dicing of synthesized wafers into chips, assemblyof chips and quality control. We have developed software programs thatextensively automate the design of photolithographic masks used in probe arraymanufacturing and that control the probe array manufacturing lines. Glasswafers are prepared for synthesis through the application of chemical coatings.GeneChip® probe arrays are synthesized on the wafers using our proprietary,combinatorial photolithographic process. The completed wafers can then be dicedto yield individual probe arrays, which are assembled and packaged forshipment.

We are currently manufacturing GeneChip® probe arraysfor sale to customers as well as for internal and collaborative purposes. Probearrays are manufactured at our dedicated manufacturing facility located in WestSacramento, California. We also maintain a manufacturing process engineeringand development facility in Santa Clara, California, and a manufacturing anddevelopment facility in Bedford, Massachusetts to support our instrumentationproducts. All of our instrument and array manufacturing facilities comply withGood Manufacturing Practices as a subset of the Quality System Regulation (21CFR 820).

Currently, we have physical capacity under optimalconditions to produce approximately 27,000 wafers annually. The actual numberof probe arrays we are able to manufacture depends on the available equipmentcapacity, the yield of probe arrays that pass quality control testing and thenumber of probe arrays manufactured on each wafer. For instance, in 2005, we announcedthat due to low initial-production yields of our commercial Mapping 500K ArraySet, shipment volumes had been constrained and, as a result, we were unable tomanufacture enough product to meet our revenue targets for the third and fourthquarters of 2005. We are taking steps to increase our manufacturing capacity,including an expansion of our existing West Sacramento, California probe arraymanufacturing facility and are scheduled to begin commercial probe array productionat our Singapore facility in the second half of 2006. We will continue toinvest in additional capital equipment for our West Sacramento facility and ournew facility in Singapore to both increase production capacity and increase theflexibility of this capacity to produce a broader range of products. See Item7. Off-Balance Sheet Arrangements and Aggregate Contractual Obligations forfurther information.

We perform quality tests on selected probe arrays fromeach wafer and selected probes on such probe arrays. We largely rely onin-process and internal quality control procedures, including controls on themanufacturing process and sample testing, to verify the correct completion ofthe manufacturing process. In addition, we and our customers rely on theaccuracy of genetic sequence information contained in the public databases uponwhich our products are based. Our probe array manufacturing process is designedto allow us to meet our performance specifications before arrays are shipped.We have a customer inquiry and complaint process in place and we rely on thisprocess to identify and resolve product performance issues that may arise fromtime to time.

We perform quality tests on in-house and third partyreagents to verify performance of reagent components and assembled reagentkits. We have qualified second source vendors for labeling reagents andoligonucleotides.

Key parts of the GeneChip®product line, such as hybridization ovens are available from single sources. Wetake such steps as we believe are appropriate to ensure that supplies fromthese vendors are not materially delayed or interrupted, since any such delaysor interruptions could in turn delay our ability to deliver these products toour customers. Likewise, certain raw materials or components used in thesynthesis of probe arrays or the assembly of instrumentation are currentlyavailable only from a single source or limited sources. We take such steps aswe believe are appropriate to ensure that materials and components from these vendorsare not materially delayed or interrupted, since any such delays orinterruptions could in turn delay our ability to produce probe arrays or othercomponents for our GeneChip® system in a timely fashion, in sufficientquantities or under acceptable terms. Alternative sources of supply may be timeconsuming and expensive to qualify. In addition, we are dependent on our 

18

----

vendorsto provide components of appropriate quality and reliability, and to meetapplicable regulatory requirements. Accordingly, we also take what we believeare appropriate measures to prevent the delay or interruption of supplies fromthese vendors and to ensure the appropriate quality for our customers.

**Research andDevelopment**

We believe a substantialinvestment in research and development is essential to a long-term sustainablecompetitive advantage and critical to expansion into high-value markets such astoxicogenomics, pharmacogenomics, and molecular diagnostic and applied testingapplications. Our research and development effort is divided into the majorareas of basic research, product research and development, and manufacturingprocess development. Our research and development expenses for the years ended December 31,2005, 2004 and 2003, were $77.4 million, $73.4 million and $65.9 million,respectively. In addition, on October 21, 2005, we recorded a charge ofapproximately $8.3 million to acquired in-process technology related toour acquisition of ParAllele BioScience, Inc. (“ParAllele”), a providerof comprehensive genetic discovery solutions to the life science research,pharmaceutical and diagnostic sectors.

*Basic Research*

Basic research efforts arecarried out through our Affymetrix Research Laboratories to further advance ourGeneChip® platform, develop new concepts that can be rapidly productized, andcreate innovations that will influence our business model in the future. Ourinitial focus is on basic technology research including high throughputsystems, high resolution chip fabrication and detection, genotyping, and geneexpression and analysis of the human transcriptome and of other model organismgenomes. We are focusing our genotyping research efforts on the development ofnew assays principally designed to perform whole genome analysis at variousresolutions. We believe that products based on this research will ultimatelyhelp researchers understand the molecular biology of genomes, to develop moreeffective therapeutics and help identify the diagnostic markers and testsuseful in molecular diagnostic applications.

*Product Researchand Development*

Our product research anddevelopment efforts are focused primarily on expanding the applications of theGeneChip® technology including development of new probe array products,improving the overall performance of GeneChip® assays, increasing theinformation capacity per probe array and simplifying highly complex assays. Ourresearch and development efforts are intended to continue to develop newproducts based on information from the human and other model organism genomesas well as new genotyping and DNA analysis products. In addition, we intend tocontinue developing custom product lines for both expression and DNA analysisso that customers can analyze gene expression or DNA variability for anyorganism. We plan continued software and instrumentation development efforts toenhance the performance and level of automation of our entire GeneChip® systemsolution.

*ManufacturingProcess and Development*

We are conducting researchaimed at enhancing the manufacturing process currently employed in theproduction of our GeneChip® probe arrays. This process, which leveragessemiconductor photolithographic fabrication techniques, is combinatorial inthat the number of different compounds synthesized grows exponentially with thenumber of cycles in the synthesis. The objective of this research is to allowus to produce arrays with higher information density in the same unit area,similar to advances achieved in the semiconductor industry, which has producedsilicon chip capacity closely following Moore’s Law. Moore’s Law is theobservation that the number of transistors per square inch on a silicon chiphad doubled every 18 months since the silicon chip was invented. To date,we have also been able to achieve rapid advances in genetic informationcontent, reducing commercial product feature size from 100 microns 

19

----

in 1994to 5 microns in 2005 with the introduction of our Human Exon Array product. Weare continuing research aimed at using smaller feature technology in commercialproducts and implementing novel, cost-effective packaging approaches for thesmall array formats including packaging these into the standard industrymicrotiter plate format.

**Intellectual Property**

We rely on a combination of patent, copyright, and trade secret laws, know-howand licensing opportunities to establish and protect our proprietarytechnologies and products. Our success depends in part on our ability to obtainpatent protection for our products and processes, to preserve our copyrightsand trade secrets, to operate without infringing the proprietary rights ofthird parties and to acquire licenses related to enabling technology orproducts used with our GeneChip® technology.

We are pursuing a patent strategy designed to facilitate our research anddevelopment program and the commercialization of our current and futureproducts. We have been issued 335 patents in the United States and we holdapproximately 537 pending United States patent applications. Many of thesepatents and applications have been filed and/or issued in one or more foreigncountries. While no one patent is considered essential to our success, weaggressively seek to protect our patent rights as our patent portfolio as awhole is material to the success of the business.

There are a significant number of United States and foreign patents andpatent applications in our areas of interest, and we believe that there willcontinue to be significant litigation in the industry regarding patent andother intellectual property rights. Others have filed, and in the future arelikely to file, patent applications that are similar or identical to ours orthose of our licensors. It may be necessary for us to enter into litigation todefend against or assert claims of infringement, to enforce patents issued tous, to protect trade secrets or know-how owned by us or to determine the scopeand validity of the proprietary rights of others. To determine the priority ofinventions, it may be necessary for us to participate in interferenceproceedings declared by the United States Patent and Trademark Office.Litigation or interference proceedings could result in substantial costs to anddistraction from our core business and our efforts in respect to suchproceedings may not be successful. For further information see Item 3, LegalProceedings.

We also rely upon copyright and trade secrets to protect our confidentialand proprietary information. We seek to protect our proprietary technology andprocesses by confidentiality agreements with our employees and certainconsultants and contractors. These agreements may be breached, we may not haveadequate remedies for any breach and our trade secrets may otherwise becomeknown or be independently discovered by competitors. To the extent that ouremployees or our consultants or contractors use intellectual property owned byothers in their work for us, disputes may also arise as to the rights inrelated or resulting know-how and inventions.

We are party to various option, supply andlicense agreements with third parties which grant us rights to use certainaspects of our technologies. We take such measures as we believe areappropriate to maintain rights to such technology under these agreements. Inaddition, our academic collaborators have certain rights to publish data andinformation in which we have rights. There is considerable pressure on academicinstitutions to publish discoveries in the genetics and genomics fields. Wetake such steps as we believe are appropriate to ensure that such publicationwill not adversely affect our ability to obtain patent protection forinformation in which we may have a commercial interest.

**Competition**

Competition in gene expression monitoring, DNAanalysis and molecular diagnostics is intense and is expected to increase.Further, the technologies for monitoring gene expression, discovering andanalyzing polymorphisms associated with significant diseases, and approachesfor commercializing those discoveries 

20

----

are new and rapidlyevolving. Currently, our principal competition comes from existing technologiesand other DNA array technologies that are used to perform many of the samefunctions for which we market our GeneChip® systems.

In the gene expression monitoring and DNA analysisfields, existing competitive technologies include gel-based sequencing usinginstruments provided by companies such as Applied Biosystems, Inc. (anApplera company), Beckman Coulter, Inc. and General Electric (GE)Healthcare. Other companies developing or marketing potentially competitive DNAarray technology include: Agilent Technologies, Inc., Applied Biosystems, Inc.,BD Biosciences, Clontech, CombiMatrix Corporation, Digital Gene Technologies, Inc.,GE Healthcare, Illumina, Inc., Invitrogen Corporation (formerly Xeotron, Inc.),Molecular Devices, Inc. (formerly Axon Instruments, Inc.), Nanogen, Inc.,NimbleGen Systems, Inc., Sequenom, Inc., Solexa, Inc. (formerlyLynx Therapeutics, Inc.), and Visible Genetics Inc. (recentlyacquired by Bayer). For example, companies such as Agilent Technologies, Inc.,Applied Biosystems, Inc., GE Healthcare and Illumina, Inc. haveproducts for DNA analysis which are directly competitive with our GeneChip®Mapping Array products. In order to compete against existing and emergingtechnologies, we will need to be successful in demonstrating to customers thatthe GeneChip® system provides a competitive advantage.

In Japan, the former Amersham Biosciences K.K.(acquired by GE Healthcare), from which we transitioned to our own salesoperation during 2003, is a competitor, as well as a licensee of certain of ourtechnology. In addition, we have several other third party licensees that couldoffer products that compete with our product offering.

The market for molecular diagnostic products derivedfrom gene discovery is currently limited and highly competitive, with severallarge corporations already having significant market share. Establisheddiagnostic companies could compete with us by developing new products.Companies such as Abbott Laboratories, Bayer AG, Beckman Coulter, BectonDickinson, bioMérieux , Johnson & Johnson and Roche have the strategiccommitment to diagnostics, the financial and other resources to invest in newtechnologies, substantial intellectual property portfolios, substantialexperience in new product development, regulatory expertise, manufacturingcapabilities and the distribution channels to deliver products to customers.Established diagnostic companies also have an installed base of instruments inseveral markets, including clinical and reference laboratories, which are notcompatible with the GeneChip® system and could slow acceptance of our products.In addition, these companies have formed alliances with genomics companieswhich provide them access to genetic information that may be incorporated intotheir diagnostic tests.

Future competition inexisting and potential markets will likely come from existing competitors aswell as other companies seeking to develop new technologies for sequencing andanalyzing genetic information. In addition, pharmaceutical and biotechnologycompanies have significant needs for genomic information and may choose todevelop or acquire competing technologies to meet these needs. Through 2005 wehave significantly expanded our network of approved service providers inAmerica, Japan and Europe. While these companies expand the reach of Affymetrixtechnology and make its analytical power available to a wider base of usersthey may act as a substitute for outright purchase of instruments and arrays bythose end users. In the molecular diagnostic field, competition will likelycome from established diagnostic companies, companies developing and marketingDNA probe tests for genetic and other diseases, and other companies conductingresearch on new technologies to ascertain and analyze genetic information.

**Government Regulation**

Regulation by governmental authorities in the United States and othercountries will likely be a significant factor in the manufacturing, labeling,distribution and marketing of certain products and services that may bedeveloped by us or our collaborative partners. In particular, diagnosticproducts we 

21

----

are developing with our collaborativepartners may require regulatory approval by governmental agencies whendistributed outside of the research environment.

Commercially available diagnostic tests are regulated as medical devicesand are generally subject to rigorous testing and other approval procedures bythe United States Food and Drug Administration (FDA). The FDA’s Quality SystemRegulations also apply in connection with our manufacture of arrays and systemsas components for use in diagnostic products developed by our partners.Obtaining these clearances or approvals and the compliance with theseregulations require the expenditure of substantial resources over a significantperiod of time, and there can be no assurance that any clearances or approvalswill be granted on a timely basis, if at all. Once granted, a clearance orapproval may place substantial restrictions on how the device is marketed orlabeled or to whom it may be sold. In addition, various federal and statestatutes and regulations govern or influence the manufacturing, safety, storageof our products and components of our products and our record keeping.

Medical device laws and regulations, including those covering in vitrodiagnostic products, are also in effect in the European Union, and many ofthe countries in which we may do business outside the United States. Theserange from comprehensive device approval requirements for some or all of ourmedical device products to requests for product data or self-certifications. Wemay not be able to obtain regulatory approvals in such countries or may incursignificant costs in obtaining or maintaining our non-US regulatory approvals.In addition, the export by us of certain of our products which have not yetbeen cleared for domestic commercial distribution may be subject to FDA orother export restrictions.

Our diagnostic clinicallaboratory will be subject to extensive federal and state regulationincluding the requirements of the Clinical Laboratory Improvement Act of 1988(CLIA). CLIA is intended to ensure the quality and reliability of clinicallaboratories in the United States by requiring all laboratories to meetspecified standards in the areas of personnel qualification, administration,participation in proficiency testing, patient test management, quality control,quality assurance and inspections. There can be no assurance that regulationsunder and future administrative interpretations of CLIA will not have anadverse impact on the potential market for our diagnostic clinical laboratory.

**Reimbursement**

The design of our products and the potential market for their use may bedirectly or indirectly affected by U.S. and other government regulationsgoverning reimbursement for clinical testing services. The availability ofthird-party reimbursement for our products and services may be limited oruncertain, particularly with respect to genetic tests and other clinicalapplications products.

Third-party payors may deny reimbursement if they determine that aprescribed health care product or service has not received appropriate FDA orother governmental regulatory clearances, is not used in accordance withcost-effective treatment methods as determined by the payor, or is deemed bythe third-party payor to be experimental, unnecessary or inappropriate.Furthermore, third-party payors are increasingly challenging the pricescharged for health care products and services.

Currently, sales of our products and services are not subject to third-partyreimbursement. However, we are currently developing diagnostic and therapeuticproducts with our collaborative partners which may be subject toreimbursement issues. The ability of our collaborators to commercialize suchproducts may depend, in part, on the extent to which reimbursement for the costof these products will be available under U.S. and foreign regulationsgoverning reimbursement for clinical testing services by governmentauthorities, private health insurers and other organizations. In addition, we are establishing a diagnosticclinical laboratory which will provide subcontract services to primary clinicallaboratories. Our diagnostic clinical laboratory may be subject toreimbursement issues and the ability of primary clinical laboratories toutilize our laboratory services may depend, in part, on the extent towhich reimbursement for the cost of clinical services will beavailable.

22

----

In the United States, third-partypayor price resistance, the trend towards managed health care and legislativeproposals to reform health care or reduce government insurance programs couldreduce prices for health care products and services, adversely affect theprofits of our customers and collaborative partners and reduce our future royaltiesand product sales.

**Environmental Matters**

We are dedicated tocompliance and protection of the environment and individuals. Our operationsrequire the use of hazardous materials (including biological materials) whichsubject us to a variety of federal, state and local environmental and safetylaws and regulations. We believe we are in material compliance with current andapplicable laws and regulations. However, some of the regulations under thecurrent regulatory structure allow for “strict liability,” holding a partypotentially liable without regard to fault or negligence. We could be heldliable for damages and fines as a result of our, or others’, businessoperations should contamination of the environment or individual exposure tohazardous substances occur. We cannot predict how changes in these laws ordevelopment of new regulations will affect our business operations or the costof compliance.

**Employees**

As of March 2, 2006,we had 1,101 full-time employees. The employee group includes chemists,engineers, computer scientists, mathematicians and molecular biologists withexperience in the diagnostic products, medical products, semiconductor,computer software and electronics industries. None of our employees arerepresented by a collective bargaining agreement, nor have we experienced workstoppages. We believe that we maintain good relationships with our employees.Our success depends in large part on our ability to attract and retain skilledand experienced employees.

**Seasonality**

Customer demand for probearrays and instrumentation systems is typically highest in the fourth quarterof the calendar year as customers spend unused budget allocations before theend of the financial year.

**Backlog**

Because most customer orders are shippedin the quarter in which they are received, we believe that backlog atquarter end is typically not a material indicator of future sales. Inaddition, backlog may not result in sales because of cancellation of orders orother factors. On a few occasions we have experienced, and made publicannouncements about, short-term increases in backlog as a result of factorssuch as new product introductions or supply constraints. For example, dueto low initial production yields on our new Mapping 500K Array product we announcedthat probe array shipments were constrained during the third and fourthquarters of fiscal 2005. Although these capacity constraints may haveincreased our backlog with respect to our Mapping 500K Array product, wecontinue to believe that backlog information is not material to anunderstanding of our business taken as a whole.

**FinancialInformation About Industry Segments**

We operate in one businesssegment, for the development, manufacture, and commercialization of systems forgenetic analysis in the life sciences and diagnostic industry. Our operationsare treated as one segment as we only report operating information on a totalenterprise level to our chief operating decision-makers. Further,resource allocations are also made at the enterprise level by our chiefoperating decision-makers.

23

----

**FinancialInformation About Geographic Areas**

Our consolidated productand product related revenue from customers outside of the United States forfiscal years 2005, 2004 and 2003 was $176.7 million, $159.2 million and$127.8 million, or 50.5%, 48.1% and 45.5%, respectively, of ourconsolidated product and product related revenue. A summary of revenues fromexternal customers attributed to each of our geographic areas for the fiscalyears ended December 31, 2005, 2004 and 2003, is included in Note 17of our Consolidated Financial Statements included in this report.

**Available Information**

Our internet address is *www.affymetrix.com*. Information includedin our website is not part of this Form 10-K. We make available freeof charge on our website our annual reports on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K, andall amendments to those reports as soon as reasonably practicable after suchmaterial is electronically filed with or furnished to the SEC. In addition,copies of our annual reports are available free of charge upon written request.The SEC also maintains an Internet site that contains reports, proxy andinformation statements, and other information regarding issuers that file electronicallywith the SEC. The address of that site is *http://www.sec.gov*.

**ITEM 1A.   RISK FACTORS**

This Form 10-Kcontains forward-looking information based on our current expectations. Becauseour actual results may differ materially from any forward-looking statementsmade by or on behalf of Affymetrix, this section includes a discussion ofimportant risk factors that could affect our actual future results.

**We may not maintain profitability.**

We incurred losses each year from our inceptionthrough the year ended December 31, 2003, and as a result we had anaccumulated deficit of approximately $93.5 million at December 31,2005. We expect to continue experiencing fluctuations in our operating resultsand cannot assure sustained profitability. Our losses have resulted principallyfrom costs incurred in research and development, manufacturing and fromselling, general and administrative costs associated with our operations.

Our ability to generatesignificant revenues and maintain profitability is dependent in large part onour ability to expand our customer base, increase sales of our current productsto existing customers, manage our expense growth, and enter into additionalsupply, license and collaborative arrangements as well as on our ability andthat of our collaborative partners to successfully manufacture andcommercialize products incorporating our technologies in new applications andin new markets. If our revenues grow more slowly than we anticipate, or if ouroperating expenses increase more than we expect or cannot be reduced in theevent of lower revenues, our business will be materially and adverselyaffected.

**Ourquarterly results have historically fluctuated significantly and may continueto fluctuate unpredictably and any failure to meet financial expectations maydisappoint securities analysts or investors and result in a decline in ourstock price.**

Our revenues andoperating results may fluctuate significantly due in part to factors that arebeyond our control and which we cannot predict. The timing of our customers’orders may fluctuate from quarter to quarter. However, we have historicallyexperienced customer ordering patterns for GeneChip® instrumentation andGeneChip® arrays where the majority of the shipments occur in the last month ofthe quarter. These ordering patterns may limit management’s ability toaccurately forecast our future revenues. Because our expenses are largely fixedin the short to medium term, any material shortfall in revenues will materiallyreduce our profitability and may cause us to experience losses. In particular,our 

24

----

revenuegrowth and profitability depend on sales of our GeneChip® products. Factorsthat could cause sales for these products to fluctuate include:

·        ourinability to produce products in sufficient quantities and with appropriatequality;

·        theloss of or reduction in orders from key customers;

·        thefrequency of experiments conducted by our customers;

·        ourcustomers’ inventory of GeneChip® products;

·        thereceipt of relatively large orders with short lead times; and

·        ourcustomers’ expectations as to how long it takes us to fill future orders.

Some additionalfactors that could cause our operating results to fluctuate include:

·        weaknessin the global economy and changing market conditions;

·        generaleconomic conditions affecting our target customers;

·        changesin the amounts or timing of government funding to companies and researchinstitutions;

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

·        changesin the competitive landscape.

We cannot forecast withany certainty the impact of these and other factors on our sales and operatingresults in any future period. Results of operations in any period, therefore,should not be considered indicative of the results to be expected for anyfuture period. Because of this difficulty in predicting future performance, ouroperating results may fall below the expectations of securities analysts orinvestors in some future quarter or quarters. Our failure in the past to meet theseexpectations has adversely affected the market price of our common stock andmay continue to do so.

**Wemay lose customers or experience lost sales if we are unable to manufacture ourproducts and ensure their proper performance and quality.**

We produce our GeneChip® products in an innovative andcomplicated manufacturing process which has the potential for significantvariability in manufacturing yields. We have encountered and may in the futureencounter difficulties in manufacturing our products and, due to the complexityof our products and our manufacturing process, we may not fully understand allof the factors that affect our manufacturing processes or product performance.For example, in 2005, we announced that due to low initial-production yields ofour commercial Mapping 500K Array Set, shipment volumes had been constrainedand, as a result, we were unable to manufacture enough product to meet ourrevenue targets for the third and fourth quarters of 2005.

25

----

Although we are taking steps to increase ourmanufacturing capacity, including the expansion of our existing WestSacramento, California probe array manufacturing facility and the developmentof a new probe array manufacturing facility in Singapore, there areuncertainties inherent in the expansion of our manufacturing capabilities andthere can be no assurance as to when any additional capacity may be availableto us. For example, manufacturing and product quality issues may arise as webegin our manufacturing operations at the new Singapore facility or as weincrease production rates at our West Sacramento facility and launch newproducts. In addition, we base our manufacturing capabilities on our forecastedproduct mix for the quarter. If the actual product mix varies significantlyfrom our forecast, we may not be able to fill some orders during that quarter,which could adversely impact our financial results. Difficulties in meetingcustomer, collaborator and internal demand could also cause us to lose customersor require us to delay new product introductions, which could in turn result inreduced demand for our products.

We rely on internalquality control procedures to verify our manufacturing processes. Due to thecomplexity of our products and manufacturing process, however, it is possiblethat probe arrays that do not meet all of our performance specifications maynot be identified before they are shipped. If our products do not consistentlymeet our customers’ performance expectations, demand for our products willdecline. In addition, we do not maintain any backup manufacturing capabilitiesfor the production of our GeneChip® instruments. Any interruption in ourability to continue operations at our existing manufacturing facilities coulddelay our ability to develop or sell our products, which could result in lostrevenue and seriously harm our business, financial condition and results ofoperations.

**We may not be ableto deliver acceptable products to our customers due to the rapidly evolvingnature of genetic sequence information upon which our products are based.**

The genetic sequenceinformation upon which we rely to develop and manufacture our products iscontained in a variety of public databases throughout the world. Thesedatabases are rapidly expanding and evolving. In addition, the accuracy of suchdatabases and resulting genetic research is dependent on various scientificinterpretations and it is not expected that global genetic research effortswill result in standardized genetic sequence databases for particular genomesin the near future. Although we have implemented ongoing internal qualitycontrol efforts to help ensure the quality and accuracy of our products, thefundamental nature of our products requires us to rely on genetic sequencedatabases and scientific interpretations which are continuously evolving. As aresult, these variables may cause us to develop and manufacture products thatincorporate sequence errors or ambiguities. The magnitude and importance ofthese errors depends on multiple and complex factors that would be consideredin determining the appropriate actions required to remedy any inaccuracies. Ourinability to timely deliver acceptable products as a result of these factorswould likely adversely affect our relationship with customers, and could have amaterial adverse effect on our business, financial condition and results ofoperations.

**Weface risks associated with technological obsolescence and emergence ofstandardized systems for genetic analysis.**

The RNA/DNA probe arrayfield is undergoing rapid technological changes. New technologies, techniquesor products could emerge which might allow the packaging and analysis ofgenomic information at densities similar to or higher than our microarraytechnology. Other companies may begin to offer products that are directlycompetitive with, or are technologically superior, to our products. There canbe no guarantee that we will be able to maintain our technological advantagesover emerging technologies in the future. Over time, we will need to respond totechnological innovation in a rapidly changing industry. In addition, althoughwe believe that we are recognized as a market leader in creating systems forgenetic analysis in the life sciences, standardization of tools and systems forgenetic research is still ongoing and 

26

----

therecan be no assurance that our products will emerge as the standard for geneticresearch. The emergence of competing technologies and systems as marketstandards for genetic research may result in our products becominguncompetitive and could cause our business to suffer.

**Oursuccess depends on the continuous development of new products and our abilityto manage the transition from our older products to new products.**

We compete in markets that are new, intensely competitive, highlyfragmented and rapidly changing, and many of our current and potentialcompetitors have significantly greater financial, technical, marketing andother resources than we do. In addition, many current and potential competitorshave greater name recognition, more extensive customer bases and access toproprietary genetic content. The continued success of our GeneChip® productswill depend on our ability to produce products with smaller feature sizes, ourability to dice the wafer, and create greater information capacity at ourcurrent or lower costs. The successful development, manufacture andintroduction of our new products is a complicated process and depends on ourability to manufacture enough products in sufficient quantity and at acceptablecost in order to meet customer demand. If we fail to keep pace with emergingtechnologies or are unable to develop, manufacture and introduce new products,we will become uncompetitive, our pricing and margins will decline and ourbusiness will suffer.

Our failure tosuccessfully manage the transition between our older products and our newproducts may adversely affect our financial results. As we introduce new orenhanced products, we must successfully manage the transition from older productsto minimize disruption in customers’ ordering patterns, avoid excessive levelsof older product inventories and provide sufficient supplies of new products tomeet customer demands. When we introduce new or enhanced products, we facenumerous risks relating to product transitions, including the inability toaccurately forecast demand and difficulties in managing different sales andsupport requirements due to the type or complexity of the new products. Forinstance, many of our existing customers are currently scaling up production onthe Mapping 500K Array Set and some of these customers are experiencingchallenges in the scale up which may affect the timing of future 500K Set productreorders.

**Weexpect to face increasing competition.**

Future competition will likely come from existingcompetitors as well as other companies seeking to develop new technologies foranalyzing genetic information. For example, companies such as AgilentTechnologies, Applied Biosystems, GE Healthcare (through its acquisition ofAmersham Biosciences) and Illumina have products for gene expression researchand analysis which are directly competitive with our GeneChip® Mapping arrayproducts. In addition, pharmaceutical and biotechnology companies havesignificant needs for genomic information and may choose to develop or acquirecompeting technologies to meet these needs. In the molecular diagnostics field,competition will likely come from established diagnostic companies, companiesdeveloping and marketing DNA probe tests for genetic and other diseases andother companies conducting research on new technologies to ascertain andanalyze genetic information. Further, in the event that we develop newtechnology and products that compete with existing technology and products ofwell established companies, there can be no guarantee that the marketplace willreadily adopt any such new technology and products that we may introduce in thefuture.

The market for moleculardiagnostics products is currently limited and highly competitive, with severallarge companies already having significant market share. Companies such asAbbott Laboratories, Bayer AG, Beckman Coulter, Becton Dickinson, bioMérieux,Celera Diagnostics, Johnson & Johnson and Roche Diagnostics have madestrategic commitments to diagnostics, have financial and other resources toinvest in new technologies, and have substantial intellectual propertyportfolios, substantial experience in new product development, regulatoryexpertise, manufacturing capabilities and the distribution channels to deliverproducts to customers. Established diagnostic companies also have an installedbase of 

27

----

instrumentsin several markets, including clinical and reference laboratories, which arenot compatible with the GeneChip® system and could deter acceptance of ourproducts. In addition, these companies have formed alliances with genomicscompanies which provide them access to genetic information that may beincorporated into their diagnostic tests.

**Recentaccounting pronouncements may impact our future financial position and resultsof operations.**

There have been newaccounting pronouncements or regulatory rulings that will have an impact on ourfuture financial position and results of operations. For instance, on December 16,2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123(revised 2004), “Share-Based Payment”, which is a revision of FASB Statement No. 123,“Accounting for Stock-BasedCompensation”. SFAS 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”,and amends FASB Statement No. 95, “Statementof Cash Flows”. Generally, the approach in SFAS 123(R) is similarto the approach described in Statement 123. However, SFAS 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in theincome statement based on their fair values. Pro forma disclosure is no longeran alternative. We expect to adopt SFAS 123(R) effective January 1, 2006under the modified-prospective method. The adoption of SFAS 123(R)’s fair valuemethod will have a significant impact on our result of operations, although itwill have no impact on our overall financial position. With the adoption ofSFAS 123(R), we expect to record stock-based compensation of approximately$11.0 million, net of tax, or $0.15 per diluted share in 2006. Our estimate ofstock-based compensation expense is affected by our stock price, the number ofstock-based awards we may grant in 2006, as well as a number of complex andsubjective valuation assumptions and the related tax effect. These valuationassumptions include, but are not limited to, the volatility of our stock price,the estimated forfeiture rates and employee stock option exercise behaviors.

**Oureffective tax rate may vary significantly.**

Our future effective taxrates could be adversely affected by various internal and external factors.These factors include, but are not limited to, earnings being lower thananticipated in countries where we have lower statutory rates and higher thananticipated in countries where we have higher statutory rates; changes in thevaluation of our deferred tax assets and liabilities; or changes in tax laws orinterpretations thereof; changes in tax rates, future levels of research anddevelopment spending, and changes in overall levels of pretax earnings. Any newinterpretative accounting guidance related to accounting for uncertain taxpositions could adversely affect our tax provision.

**Ourbusiness depends on research and development spending levels for pharmaceuticaland biotechnology companies and academic and governmental researchinstitutions.**

We expect that ourrevenues in the foreseeable future will be derived primarily from products andservices provided to a relatively small number of pharmaceutical andbiotechnology companies and academic, governmental and other researchinstitutions. Our success will depend upon their demand for and use of ourproducts and services. Our operating results may fluctuate substantially due toreductions and delays in research and development expenditures by thesecustomers. For example, reductions in capital expenditures by these customersmay result in lower than expected instrumentation sales and similarly, reductionsin operating expenditures by these customers could result in lower thanexpected GeneChip® array and reagent sales. These reductions and delays mayresult from factors that are not within our control, such as:

·       changesin economic conditions;

·       changesin government programs that provide funding to companies and researchinstitutions;

·       changesin the regulatory environment affecting life sciences companies and lifesciences research;

28

----

·       market-drivenpressures on companies to consolidate and reduce costs; and

·       other factors affectingresearch and development spending.

**Oursuccess in penetrating emerging market opportunities in molecular diagnosticsdepends on the efforts of our partners and the ability of our GeneChip®technologies to be used in clinical applications for diagnosing and informingthe treatment of disease.**

The clinical applications of GeneChip® technologiesfor diagnosing and informing the treatment of disease is an emerging marketopportunity in molecular diagnostics that seeks to improve the effectiveness ofhealth care by collecting information about DNA variation and RNA expression inpatients at various times from diagnosis through prognosis and on to the end oftherapy. However, there can be no assurances that molecular diagnostic marketswill develop as quickly as we expect or reach what we believe is their fullpotential. Although we believe that there will be clinical applications of ourGeneChip® technologies that will be utilized for diagnosing and informing thetreatment of disease, there can be no certainty of the technical or commercialsuccess our technologies will achieve in such markets.

The molecular diagnosticsmarket is relatively new for us and presents us with new risks anduncertainties. Our success in this area depends to a large extent on ourcollaborative relationships and the ability of our collaborative partners tosuccessfully market and sell products using our GeneChip® technologies. As aresult, we are also dependent on the ability of our collaborative partners toachieve regulatory approval for such products in the United States and inoverseas markets. Although Roche received FDA approval of the first diagnosticgenotyping test for use with our GeneChip® System 3000Dx in late 2004, therecan be no assurance that other products using our GeneChip® technologies willachieve needed approvals.

**Wemay not successfully obtain regulatory approval of any diagnostic or otherproduct or service that we or our collaborative partners develop.**

The FDA must approve certain in-vitro diagnosticproducts before they can be marketed in the U.S. Certain in-vitro diagnosticproducts must also be approved by the regulatory agencies of foreigngovernments or jurisdictions before the product can be sold outside the U.S.Commercialization of our and our collaborative partners’ in-vitro diagnosticproducts outside of the research environment that may depend upon successfulcompletion of clinical trials. Clinical development is a long, expensive anduncertain process and we do not know whether we, or any of our collaborativepartners, will be permitted to undertake clinical trials of any potentialin-vitro diagnostic products. It may take us or our collaborative partners manyyears to complete any such testing, and failure can occur at any stage. Delaysor rejections of potential products may be encountered based on changes inregulatory policy for product approval during the period of product developmentand regulatory agency review. Moreover, if and when our projects reach clinicaltrials, we or our collaborative partners may decide to discontinue developmentof any or all of these projects at any time for commercial, scientific or otherreasons. Any of the foregoing matters could have a material adverse effect onour business, financial condition and results of operations.

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

Medical device laws and regulations are also in effectin many countries, ranging from comprehensive device approval requirements torequests for product data or certifications. The number and scope of theserequirements are increasing. We may not be able to obtain regulatory approvalsin such countries or may incur significant costs in obtaining or maintainingour foreign regulatory approvals. In addition, the export by us of certain of ourproducts which have not yet been cleared for domestic commercial distributionmay be subject to FDA or other export restrictions.

29

----

Our diagnostic clinicallaboratory will be subject to extensive federal and state regulationincluding the requirements of the Clinical Laboratory Improvement Act of 1988(CLIA). CLIA is intended to ensure the quality and reliability of clinicallaboratories in the United States by requiring all laboratories to meetspecified standards in the areas of personnel qualification, administration,participation in proficiency testing, patient test management, quality control,quality assurance and inspections. There can be no assurance that regulationsunder and future administrative interpretations of CLIA will not have anadverse impact on the potential market for our diagnostic clinical laboratory.

**Healthcarereform and restrictions on reimbursements may limit our returns on moleculardiagnostic products that we may develop with our collaborators.**

We are currentlydeveloping diagnostic and therapeutic products with our collaborators. Theability of our collaborators to commercialize such products may depend, inpart, on the extent to which reimbursement for the cost of these products willbe available under U.S. and foreign regulations that govern reimbursement forclinical testing services by government authorities, private health insurersand other organizations. In the U.S., third-party payor price resistance, thetrend towards managed health care and legislative proposals to reform healthcare or reduce government insurance programs could reduce prices for healthcare products and services, adversely affect the profits of our customers andcollaborative partners and reduce our future royalties.

**Wedepend on a limited number of suppliers and we will be unable to manufactureour products if shipments from these suppliers are delayed or interrupted.**

We depend on our vendorsto provide components of our products in required volumes, at appropriatequality and reliability levels, and in compliance with regulatory requirements.Key parts of the GeneChip® product line are currently available only from asingle source or limited sources. In addition, components of our manufacturingequipment and certain raw materials used in the synthesis of probe arrays areavailable from limited sources. If supplies from these vendors were delayed orinterrupted for any reason, we would not be able to get manufacturingequipment, produce probe arrays, or sell scanners or other components for ourGeneChip® products in a timely fashion or in sufficient quantities or underacceptable terms. Furthermore, our business is dependent on our ability toforecast the needs for components and products in the GeneChip® product lineand our suppliers’ ability to deliver such components and products in time tomeet critical manufacturing and product release schedules. Our business couldbe adversely affected, for example, if suppliers fail to meet product releaseschedules, if we experience supply constraints, if we fail to negotiatefavorable pricing or if we experience any other interruption or delay in thesupply chain which interferes with our ability to manufacture our products ormanage our inventory levels.

**Oursuccess will require that we establish a strong intellectual property positionand that we can defend ourselves against intellectual property claims fromothers.**

Maintaining a strong patent position is critical toour business. Litigation on these matters has been prevalent in our industryand we expect that this will continue. Patent law relating to the scope ofclaims in the technology fields in which we operate is still evolving and theextent of future protection is highly uncertain, so there can be no assurancethat the patent rights that we have or may obtain will be valuable. Others havefiled, and in the future are likely to file, patent applications that aresimilar or identical to ours or those of our licensors. To determine thepriority of inventions, we will have to participate in interference proceedingsdeclared by the United States Patent and Trademark Office that could result insubstantial costs in legal fees and could substantially affect the scope of ourpatent protection. We cannot assure investors that any such patent applicationswill not have priority over our patent applications. Also, our intellectualproperty may be subject to significant administrative and litigationproceedings such as 

30

----

opposition proceedingsagainst our patents in Europe, Japan and other jurisdictions. In addition, wehave incurred and may in future periods incur substantial costs in litigationto defend against patent suits brought by third parties or initiated by us. Forexample, we currently are engaged in litigation regarding intellectual propertyrights with Multilyte Ltd. and Enzo Life Sciences, Inc. Foradditional information concerning intellectual property litigation andadministrative proceedings, see Part I, Item 3, Legal Proceedings, of thisForm 10-K.

In addition to patent protection, we also rely uponcopyright and trade secret protection for our confidential and proprietaryinformation. There can be no assurance, however, that such measures willprovide adequate protection for our copyrights, trade secrets or otherproprietary information. In addition, there can be no assurance that tradesecrets and other proprietary information will not be disclosed, or that otherswill not independently develop substantially equivalent proprietary informationand techniques or otherwise gain access to or disclose our trade secrets andother proprietary information. There can also be no assurance that we will beable to effectively protect our copyrights, trade secrets or other proprietaryinformation. If we cannot obtain, maintain or enforce intellectual propertyrights, our competitors may be able to offer probe array systems similar to ourGeneChip® technology.

Our success also dependsin part on us neither infringing patents or other proprietary rights of thirdparties nor breaching any licenses that may relate to our technologies andproducts. We are aware of third-party patents that may relate to ourtechnology, including reagents used in probe array synthesis and in probe arrayassays, probe array scanners, synthesis techniques, polynucleotideamplification techniques, assays, and probe arrays. We routinely receivenotices claiming infringement from third parties as well as invitations to takelicenses under third party patents. There can be no assurance that we will notinfringe on these patents or other patents or proprietary rights or that wewould be able to obtain a license to such patents or proprietary rights oncommercially acceptable terms, if at all.

**If weare unable to maintain our relationships with collaborative partners, we mayhave difficulty developing and selling our products and services.**

We believe that oursuccess in penetrating our target markets depends in part on our ability todevelop and maintain collaborative relationships with key companies as well aswith key academic researchers. Currently, our significant collaborativepartners include Qiagen GmBH for sample preparation and purification systems,Invitrogen Corporation for reagents, and Ingenuity Systems, Inc. foranalytical software. We collaborate with both Beckman Coulter Inc. andCaliper Life Sciences in the development of automation for GeneChip® technologyapplications for use in drug discovery, drug development and clinical research.Roche, bioMérieux and Veridex are collaborative partners in the development ofchip products for medical diagnostic and applied testing markets. Relying onthese or other collaborative relationships is risky to our future successbecause:

·        ourpartners may develop technologies or components competitive with our GeneChip®products;

·        ourexisting collaborations may preclude us from entering into additional futurearrangements;

·        ourpartners may not obtain regulatory approvals necessary to continue thecollaborations in a timely manner;

·        someof our agreements may terminate prematurely due to disagreements between us andour partners;

·        ourpartners may not devote sufficient resources to the development and sale of ourproducts;

·        ourpartners may be unable to provide the resources required for us to progress inthe collaboration on a timely basis;

·        ourcollaborations may be unsuccessful; or

31

----

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

**Thesize and structure of our current sales, marketing and technical supportorganizations may limit our ability to sell our products.**

Although we have investedsignificant other resources to expand our direct sales force and our technicaland support staff, we may not be able to establish a sufficiently sized globalsales, marketing or technical support organization to sell, market or supportour products globally. To assist our sales and support activities, we haveentered into distribution agreements through certain distributors, principallyin markets outside of North America and Europe. These and other third partieson whom we rely for sales, marketing and technical support in these geographicareas may decide to develop and sell competitive products or otherwise becomeour competitors, which could harm our business.

**Dueto the international nature of our business, political or economic changes orother factors could harm our business.**

A significant amount ofour revenue is currently generated from sales outside the United States. Thoughsuch transactions are denominated in both U.S. dollars and foreign currencies,our future revenue, gross margin, expenses and financial condition are stillaffected by such factors as changes in foreign currency exchange rates;unexpected changes in, or impositions of, legislative or regulatoryrequirements, including export and trade barriers and taxes; longer paymentcycles and greater difficulty in accounts receivable collection. We are alsosubject to general geopolitical risks in connection with internationaloperations, such as political, social and economic instability, potentialhostilities and changes in diplomatic and trade relationships. We cannot assureinvestors that one or more of the foregoing factors will not have a materialadverse effect on our business, financial condition and operating results orrequire us to modify our current business practices.

**Wemay be exposed to liability due to product defects.**

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

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

Genetic testing has raisedethical issues regarding privacy and the appropriate uses of the resultinginformation. For these reasons, governmental authorities may call for limits onor regulation of the use of genetic testing or prohibit testing for geneticpredisposition to certain conditions, particularly for those that have no knowncure. Similarly, such concerns may lead individuals to refuse to use geneticstests even if permissible. Any of these scenarios could reduce the potentialmarkets for our molecular diagnostic products, which could have a materialadverse effect on our business, financial condition and results of operations.

**Becauseour business depends on key executives and scientists, our inability to recruitand retain these people could hinder our business expansion plans.**

We are highly dependent on our officers and our seniorscientists and engineers, including scientific advisors. Our productdevelopment and marketing efforts could be delayed or curtailed if we areunable to attract or retain key talent.

32

----

We rely on our scientific advisors and consultants toassist us in formulating our research, development and commercializationstrategy. All of these individuals are engaged by other employers and havecommitments to other entities that may limit their availability to us. Ascientific advisor’s other obligations may prevent him or her from assisting usin developing our technical and business strategies.

To expand our research,product development and sales efforts we need additional people skilled inareas 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 ourbusiness if we are unable to hire, train and retain a sufficient number ofqualified employees. There can be no assurance that we will be successful inhiring or retaining qualified personnel and our failure to do so could have amaterial adverse impact on our business, financial condition and results ofoperations.

**Ourstrategic equity investments may result in losses.**

We periodically makestrategic equity investments in various publicly traded and non-publicly tradedcompanies with businesses or technologies that may complement our business. Themarket values of these strategic equity investments may fluctuate due to marketconditions and other conditions over which we have no control. Other thantemporary declines in the market price and valuations of the securities that wehold in other companies will require us to record losses relative to ourownership interest. This could result in future charges on our earnings and asa result, it is uncertain whether or not we will realize any long term benefitsassociated with these strategic investments.

**Futureacquisitions may disrupt our business and distract our management.**

We have previously engagedin acquisitions and may do so in the future in order to exploit technology ormarket opportunities. If we acquire another company, we may not be able tosuccessfully integrate the acquired business into our existing business in atimely and non-disruptive manner, or at all. Furthermore, an acquisition maynot produce the revenues, earnings or business synergies that we anticipate. Ifwe fail to integrate the acquired business effectively or if key employees ofthat business leave, the anticipated benefits of the acquisition would bejeopardized. The time, capital management and other resources spent on anacquisition that fails to meet our expectations could cause our business andfinancial condition to be materially and adversely affected. For example, on October 21,2005, we completed the acquisition of ParAllele BioScience, Inc. We maynot realize the anticipated benefits of the acquisition because of integrationand other challenges which include, among others, unanticipated incompatibilityof corporate and administrative infrastructures, the ability to retain keyemployees, including key scientists, the diversion of management’s attentionfrom ongoing business concerns, and the potential adverse reaction of customersto the merger or resulting changes to the combined company’s product andservices offerings. In addition, acquisitions can involve substantial chargesand amortization of significant amounts of deferred stock compensation thatcould adversely affect our results of operations.

**Themarket price of our common stock has been volatile.**

The market price of our common stock is volatile. Todemonstrate this volatility, during the twelve-month period ending on December 31,2005, the volume of our common stock traded on any given day ranged from215,200 to 11,118,700 shares. Moreover, during that period, our common stocktraded as low as $33.94 per share and as high as $59.73 per share.

Furthermore, volatility inthe stock price of other companies has often led to securities class action litigationagainst those companies. Any future securities litigation against us couldresult in substantial costs and divert management’s attention and resources,which could seriously harm our business, financial condition and results ofoperations.

33

----

**ITEM 1B.   UNRESOLVED STAFF COMMENTS**

None.

**ITEM 2.   PROPERTIES**

Thefollowing chart indicates the facilities that we own or lease, the location andsize of each such facility and their designated use. We expect our facilitiesneeds to increase over the next several years as we continue to expand ourworldwide commercial operations and our manufacturing capabilities.

| **Location**            | ** ** | ** **      | ** ** | **Approximate  Square Feet**            | ** ** | **Operation**           | ** ** | **Own or Lease (Expiration)** |
|-------------------------|------------|-----------------|------------|-----------------------------------------|------------|-------------------------|------------|-------------------------------|
| Bedford, MA             |       | 80,000 sq. ft.  |       | R&D, Manufacturing,  Administrative |       | Lease expires 2013      |
| Emeryville, CA          |       | 11,000 sq. ft.  |       | Software Development                    |       | Lease expires 2010      |
| Osaka, Japan            |       | 710 sq. ft.     |       | Administrative                          |       | Lease expires 2007      |
| Santa Clara, CA         |       | 200,000 sq. ft. |       | R&D, Administrative                 |       | Lease expires 2013      |
| Singapore               |       | 1,700 sq. ft.   |       | Administrative                          |       | Lease expires 2007      |
|                    |       | 147,000 sq. ft  |       | Manufacturing                           |       | Lease expires 2008      |
| Sunnyvale, CA           |       | 31,000 sq. ft.  |       | R&D                                 |       | Lease expires 2008      |
|                    |       | 57,000 sq. ft.  |       | Administrative                          |       | Lease expires 2010      |
| Tokyo, Japan            |       | 11,000 sq. ft.  |       | Administrative                          |       | Lease expires 2007      |
| Wooburn Green, UK       |       | 10,000 sq. ft.  |       | Administrative                          |       | Lease expires 2016      |
| West Sacramento, CA     |       | 52,000 sq. ft.  |       | Manufacturing                           |       | Own (facility and land) |
|                    |       | 3,800 sq. ft.   |       | Warehouse                               |       | Lease expires 2006      |
| Shanghai, China         |       | 4,000 sq. ft.   |       | Administrative                          |       | Lease expires 2009      |
| South San Francisco, CA |       | 35,000 sq.ft.   |       | R&D, Manufacturing, Administrative  |       | Lease expires 2007      |

 

**ITEM 3.   LEGAL PROCEEDINGS**

**GENERAL**

We have been in the pastand continue to be a party to litigation which has consumed and may in thefuture continue to consume substantial financial and managerial resources whichcould adversely affect our business, financial condition and results ofoperations. If in any pending or future intellectual property litigationinvolving us or our collaborative partners, we are found to have infringed thevalid intellectual property rights of third parties, we, or our collaborativepartners, could be subject to significant liability for damages, could berequired to obtain a license from a third party, which may not be available onreasonable terms or at all, or could be prevented from manufacturing andselling our products. In addition, if we are unable to enforce our patents andother intellectual property rights against others, or if our patents are foundto be invalid or unenforceable, third parties may more easily be able tointroduce and sell DNA array technologies that compete with our GeneChip® brandtechnology, and our competitive position could suffer. We expect to devotesubstantial financial and managerial resources to protect our intellectualproperty rights and to defend against the claims described below as well as anyfuture claims asserted against us. Further, because of the substantial amountof discovery required in connection with any litigation, there is a risk thatconfidential information could be compromised by disclosure.

*MultilyteLitigation*

Multilyte Ltd., aBritish corporation, and Affymetrix are engaged in legal proceedings in Germanyand the United States to address allegations made by Multilyte that we infringecertain patents owned by Multilyte (the “Multilyte patents”) by making andselling our GeneChip® DNA microarray products.

34

----

*Germany*

In the actions pending inGermany, on July 18, 2003, Multilyte filed proceedings in the state courtof Düsseldorf, alleging infringement of the Multilyte patents. In a separateaction in Germany, on October 15, 2003, we commenced nullity proceedingsin German Federal Patent Court in Munich alleging that the German part ofMultilyte’s two European patents (EPs 0 134 215 and0 304 202) are invalid. On June 29 and 30, 2004, the GermanFederal Patent Court in Munich held that both Multilyte European patents areinvalid in Germany. Following that ruling, on July 12, 2004, theDüsseldorf court stayed both sets of infringement proceedings before it,pending Multilyte’s appeal of the decisions of the German Federal Patent Courtin Munich nullifying both Multilyte patents. We were notified on April 5,2005 that Multilyte has abandoned its appeal of the decision nullifying theEuropean Patent 0 134 215.

*United States*

In the U.S. action, on August 13, 2003, wecommenced proceedings in the United States District Court for the NorthernDistrict of California seeking a declaratory judgment that eight Multilytepatents are not infringed and are invalid. Multilyte has agreed that we do notinfringe five of the eight named patents. On October 24, 2003, we filed anamended complaint seeking a declaratory judgment as to three of the originaleight named patents—U.S. Patents 5,432,099, 5,599,720 and 5,807,755. Multilyteanswered our complaint for declaratory judgment and asserted counterclaimsagainst us alleging infringement of the three patents named by us in ourcomplaint. Multilyte has submitted the three patents-in-suit to the UnitedStates Patent and Trademark Office for voluntary re-examination. These patentsremain in re-examination in the USPTO. On April 28, 2005, the Courtgranted our motions for summary judgment of non-infringement and entered afinal judgment in the action in favor of us against Multilyte. On May 5,2005, Multilyte filed a notice of motion to amend the judgment asserting thatthe Court’s entry of final judgment was premature because it did not giveMultilyte the opportunity to present evidence showing infringement under theCourt’s most recent claim construction. On June 23, 2005, the Court againgranted summary judgment of non-infringement in favor of us. Multilyte hasappealed the Court’s decision to the United States Court of Appeals for theFederal Circuit which held oral argument on the appeal on March 7, 2006.

We believe that Multilyte’sremaining claims against us are without merit and have filed the declaratoryjudgment and nullity actions to protect our interests. However, we cannot besure that we will prevail in these matters. Our failure to successfully defendagainst these allegations could result in a material adverse effect on ourbusiness, 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 DistrictCourt for the Southern District of New York for breach of contract, injunctiverelief and declaratory judgment. The Enzo complaint relates to a 1998distributorship agreement with Enzo under which we served as a non-exclusivedistributor of certain reagent labeling kits supplied by Enzo. In itscomplaint, Enzo seeks monetary damages and an injunction against us from using,manufacturing or selling Enzo products and from inducing collaborators andcustomers to use Enzo products in violation of the 1998 agreement. Enzo alsoseeks the transfer of certain Affymetrix patents to Enzo. In connection withits complaint, Enzo provided us with a notice of termination of the 1998agreement effective on November 12, 2003.

On November 10, 2003, we filed a complaintagainst Enzo in the United States District Court for the Southern District ofNew York for declaratory judgment, breach of contract and injunctive reliefrelating to the 1998 agreement. In our complaint, we allege that Enzo hasengaged in a pattern of wrongful conduct against us and other Enzo labelingreagent customers by, among other things, asserting improperly broad rights inits patent portfolio, improperly using the 1998 agreement and distributorshipagreements with 

35

----

others in order to cornerthe market for non-radioactive labeling reagents, and improperly using the 1998agreement to claim ownership rights to our proprietary technology. We seekdeclarations that we have not breached the 1998 agreement, that we are entitledto sell our remaining inventory of Enzo reagent labeling kits, and that nineEnzo patents that are identified in the 1998 agreement are invalid and/or notinfringed by us. We also seek damages and injunctive relief to redress Enzo’salleged breaches of the 1998 agreement, its alleged tortious interference withthe Company’s business relationships and prospective economic advantage, andEnzo’s alleged unfair competition. We filed a notice of related case statingthat our complaint against Enzo is related to the complaints already pending inthe Southern District of New York against eight other former Enzo distributors.The U.S. District Court for the Southern District of New York has related ourcase. There is no trial date in the actions between Enzo and us***.***

We believe that the claimsset forth in Enzo’s complaint are without merit and have filed the action inthe Southern District of New York to protect our interests. However, we cannotbe sure that we will prevail in these matters. Our failure to successfullydefend against these allegations could result in a material adverse effect onour business, financial condition and results of operation.

*AdministrativeLitigation and Proceedings*

Our intellectual property is subject to a number ofsignificant administrative and litigation actions. For example, in Europe andJapan, we expect third parties to oppose significant patents that we own orcontrol. Currently, Multilyte Ltd. and ProtoGene Laboratories, Inc.have filed oppositions against our EP 0 619 321 patent in the EuropeanPatent Office. PamGene B.V. filed an opposition against our EP 0 728520 patent and it was revoked at oral proceedings on January 14, 2004. Affymetrixhas appealed this ruling. Also, Abbott Laboratories, Applera, Clondiag andCombiMatrix are parties in opposition against our EP 0 834 575. An oral hearingwas conducted by the Opposition Division which upheld the patent on December 4,2004, and this decision has been appealed. Abbott Laboratories, CombiMatrix,PamGene B.V., Applera and Dr. Peter Schneider filed an opposition againstour EP 0 834 576 patent. The Opposition Division revoked the patent during anoral hearing on February 23, 2005 and we have appealed this ruling. CombiMatrixhas filed an opposition against EP 0 695 941, Agilent, CombiMatrix, Clondiagand Applera have filed an opposition against EP 0 853 679, Applera has opposedEP 0 972 564 and Degussa AG has filed an opposition against EP 1 086 742. Theseprocedures will result in the respective patents being either upheld in theirentirety, allowed to issue in amended form in designated European countries, orrevoked.

Further, in the United States, we expect that thirdparties will continue to “copy” the claims of our patents in order to provokeinterferences in the United States Patent & Trademark Office, and wemay copy the claims of others. These proceedings could result in our patentprotection being significantly modified or reduced, and could result insignificant costs and consume substantial managerial resources.

At this time, we cannotdetermine the outcome of any of the matters described above.

**ITEM 4.    SUBMISSION OF MATTERSTO A VOTE OF SECURITY HOLDERS**

No matters were submitted during the fourth quarter ofthe year ended December 31, 2005.

36

----

**PART II**

**ITEM5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASESOF EQUITY SECURITIES

Ourcommon stock is traded on the Nasdaq National Market System under the symbol ofAFFX. The following table sets forth, for the periods indicated, the low andhigh bid prices per share for our common stock as reported by the NasdaqNational Market.

| ** **     | ** ** | **Low** | ** ** | **High** | ** ** |
|----------------|------------|---------|------------|----------|------------|
| **2004**       |       |    |       |     |       |
| First Quarter  |       | $       | 23.18      |     | $          | 36.30 |   |
| Second Quarter |       | $       | 26.56      |     | $          | 38.20 |   |
| Third Quarter  |       | $       | 24.48      |     | $          | 32.52 |   |
| Fourth Quarter |       | $       | 28.89      |     | $          | 37.48 |   |
| **2005**       |       |    |       |     |       |
| First Quarter  |       | $       | 33.94      |     | $          | 45.47 |   |
| Second Quarter |       | $       | 42.18      |     | $          | 55.10 |   |
| Third Quarter  |       | $       | 40.03      |     | $          | 59.73 |   |
| Fourth Quarter |       | $       | 42.19      |     | $          | 52.44 |   |

 

As of March 8, 2006, there wereapproximately 475 holders of record of our common stock, one of which is Cede& Co., a nominee for Depository Trust Company (“DTC”).  All of the shares of common stock held bybrokerage firms, banks and other financial institutions as nominees for beneficialowners are deposited into participant accounts at DTC, and therefore, areconsidered to be held of record by Cede & Co. as one shareholder.

No dividends have beenpaid on our common stock. We currently intend to retain all future earnings, ifany, for use in our business and do not anticipate paying any cash dividends onour common stock in the foreseeable future.

37

----

**ITEM 6.**                SELECTEDFINANCIAL DATA

Thefollowing selected historical consolidated financial information has beenderived from our audited consolidated financial statements. The balance sheetdata as of December 31, 2005 and 2004 and statements of operations datafor each of the three years in the period ended December 31, 2005 arederived from audited consolidated financial statements included in this Form 10-K.You should read this table in conjunction with Item 7, “Management’s Discussionand Analysis of Financial Condition and Results of Operations,” and Item 8, “FinancialStatements and Supplementary Data.”

| ** **                                                 | ** ** | **Year Ended December 31,**                            | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                 | ** ** | **(In thousands, except per share amounts)** | ** ** |
| **Consolidated  Statement of Operations Data:**            |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Revenue:                                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Product and product related revenue                        |       | $                                                                     | 350,190    |   | $ | 330,885 |   | $ | 280,780 |   | $ | 248,538 |   | $ | 194,936 |   |
| Royalties and other revenue                                |       | 8,339                                                                 |       | 9,832 |   | 10,556 |   | 19,777 |   | 18,447 |   |
| Revenue from Perlegen Sciences                             |       | 9,073                                                                 |       | 5,245 |   | 9,460 |   | 21,559 |   | 11,491 |   |
| Total revenue                                              |       | 367,602                                                               |       | 345,962 |   | 300,796 |   | 289,874 |   | 224,874 |   |
| Income (loss) from operations                              |       | 57,413                                                                |       | 59,719 |   | 17,544 |   | 5,266 |   | (40,596 | ) |
| Net income (loss)                                          |       | $                                                                     | 57,516     |   | $ | 47,608 |   | $ | 14,285 |   | $ | (1,630 | ) | $ | (33,121 | ) |
| Basic net income  (loss) per common share                  |       | $                                                                     | 0.90       |   | $ | 0.79 |   | $ | 0.24 |   | $ | (0.03 | ) | $ | (0.58 | ) |
| Diluted net income  (loss) per common share                |       | $                                                                     | 0.84       |   | $ | 0.74 |   | $ | 0.24 |   | $ | (0.03 | ) | $ | (0.58 | ) |
| **Consolidated Balance Sheet Data:**                       |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents, and available-for-sale securities |       | $                                                                     | 284,932    |   | $ | 205,715 |   | $ | 459,883 |   | $ | 361,458 |   | $ | 368,823 |   |
| Working capital                                            |       | 345,566                                                               |       | 226,211 |   | 192,778 |   | 371,708 |   | 372,718 |   |
| Total assets(2)                                            |       | 766,823                                                               |       | 499,771 |   | 700,164 |   | 601,403 |   | 580,015 |   |
| Long-term  obligations(1)                                  |       | 139,790                                                               |       | 153,845 |   | 166,586 |   | 380,222 |   | 378,000 |   |

----

(1)    In September 1999,we issued $150.0 million principal amount of 5% convertible subordinatednotes. In February 2000, we issued $225.0 million principal amount of4.75% convertible subordinated notes. In August 2001, we repurchased$5.0 million principal amount of the 4.75% notes for total considerationof $3.3 million. In connection with the transaction, we recorded anextraordinary gain of approximately $1.7 million in fiscal 2001 which wasreclassified during fiscal 2002 to interest income and other, net in accordancewith Financial Accounting Standard (“FAS”) 145, “Rescission of FASB Statements No. 4,44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.”In December 2002, we repurchased $1.1 million principal amount of the4.75% notes for total consideration of approximately $0.9 million. Inconnection with the transaction we recorded a gain of $0.2 million whichis included in interest income and other, net. In the second quarter of 2003,we repurchased $53.4 million principal amount of our 4.75% convertiblesubordinated notes due in 2007 and $48.0 million principal amount of our5.0% convertible subordinated notes due in 2006. In connection with thesetransactions, we recognized a net loss of approximately $1.0 million whichis included in interest income and other, net. In December 2003, we issued$120.0 million principal amount of 0.75% senior convertible notes. In January 2004,we completed the redemption of our 5.0% notes ($102.0 million face value).In connection with the redemption, we recorded a charge of $3.2 million tointerest expense in the first quarter of 2004, related to the unamortizedissuance costs and redemption fee associated with the repurchased 5.0% notes.In February 2004, we also completed the redemption of our 4.75% notes($165.5 million face value). In connection with the redemption, werecorded a charge of $4.9 million to interest expense related to theunamortized issuance costs and redemption fee associated with the repurchased4.75% notes.

Included in long-term obligations in 2003 through 2005is the long term portion of deferred revenue relating primarily to our collaborationagreement with Roche. In January 2003, we expanded our collaboration withRoche. Under the terms of the collaborative agreement, Roche paid us anup-front, nonrefundable license fee of $70.0 million. We are recognizingthis amount as a component of product related revenue over the research andproduct development phase which is expected to approximate five years.

(2)    On October 21, 2005, we completed the $122.4million acquisition of ParAllele BioScience, Inc. (“ParAllele”), aprovider of comprehensive genetic discovery solutions to the life scienceresearch, pharmaceutical and diagnostic sectors.

38

----

**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*The followingdiscussion should be read in conjunction with the consolidated financialstatements and the related notes that appear elsewhere in this document.*

This discussion should be read in conjunction with theother sections of this Annual Report on Form 10-K, including “Item1: Business”; “Item 1A: Risk Factors”; “Item 6: Selected Financial Data”;and “Item 8: Financial Statements and Supplementary Data.” The various sectionsof this discussion contain a number of forward-looking statements, all ofwhich are based on our current expectations and could be affected by theuncertainties and risk factors described throughout this filing. Our actualresults may differ materially.

All statements in this Annual Report on Form 10-Kthat are not historical are “forward-looking statements” within themeaning of Section 21E of the Securities Exchange Act of 1934 as amended,including statements regarding our “expectations,” “beliefs,” “hopes,”“intentions,” “strategies” or the like. Such statements are based on ourcurrent expectations and are subject to a number of factors and uncertaintiesthat could cause actual results to differ materially from those described inthe forward-looking statements. We caution investors that there can be noassurance that actual results or business conditions will not differ materiallyfrom those projected or suggested in such forward-looking statements as aresult of various factors, including, but not limited to, the risk factorsdiscussed in this Annual Report on Form 10-K in Item 1A. Weexpressly disclaim any obligation or undertaking to release publicly anyupdates or revisions to any forward-looking statements contained hereinto reflect any change in our expectations with regard thereto or any change inevents, conditions, or circumstances on which any such statements are based.

*Overview*

We are engaged in the development, manufacture, saleand service of consumables and systems for genetic analysis for use in the lifesciences and in clinical diagnostics, and emerging markets outside ofhealthcare including agricultural markets, environmental testing andbio-defense applications. Our industry is affected by a number of factors thatinfluence its size and development. These factors include the availability ofgenomic sequence data for human and other organisms, technological innovation thatincreases throughput and lowers the cost of genomic and genetic analysis, thedevelopment of new computational techniques to handle and analyze large amountsof genomic data, the availability of government and private funding for basicand disease-related research, the amount of capital and ongoing expendituresallocated to research and development spending by biotechnology, pharmaceuticaland diagnostic companies, the application of genomics to new areas includingmolecular diagnostics, agriculture, human identity and consumer goods, and theavailability of genetic markers and signatures of diagnostic value.

We have established our GeneChip® system as theplatform of choice for acquiring, analyzing and managing complex geneticinformation. Our integrated GeneChip® platform includes disposable DNA probearrays (chips) consisting of gene sequences set out in an ordered, high densitypattern; certain reagents for use with the probe arrays; a scanner and otherinstruments used to process the probe arrays; and software to analyze andmanage genomic information obtained from the probe arrays. We currently sellour products directly to pharmaceutical, biotechnology, agrichemical,diagnostics and consumer products companies as well as academic researchcenters, government research laboratories, private foundation laboratories andclinical reference laboratories in North America, Europe and Japan. We alsosell our products through life science supply specialists acting as authorizeddistributors in Latin America, India, the Middle East, and Asia Pacificregions, including China. We have incurred net losses and negative cash flowsfrom operations in the past, but have now achieved profitability for threeconsecutive fiscal years. The following overview describes key elements of ourbusiness strategy and our goals for fiscal 2006:

39

----

*Continueto develop and expand sales of our GeneChip® system.**  *We intend to continue to enhanceour GeneChip® technology through substantial investments in research anddevelopment and collaborations. As we continue to enhance the functionality anddecrease the unit costs of our GeneChip® products, we aim to encourage ourcustomers to expand their research uses for our GeneChip® system, which willcreate new market opportunities for us.

*Leverageour technologies into new markets.*   A key driverwill be increasing the breadth of scientific and diagnostic applications of ourtechnology, while also industrializing, automating and standardizing ourtechnology to open new markets which will assist us in driving revenue growth.The aim of our automation efforts is to reduce the cost per experiment,minimize operator variability and improve experimental throughput. We believethat our automation solutions will enjoy commercial success in industrialapplications and high-volume markets just as our bench-top systems have in theresearch markets. We have several active collaborations aimed at extending ourexisting technologies and products into diagnostic applications and we continueto look for new applications for our technology, new collaborativeopportunities and new markets.

*Increasesales related to our consumables:*   Our goal in2006 is to continue to grow our product and product related revenue. We expectto achieve this goal through continued growth in sales of our consumable probearrays and reagents as well as related services as we expand our product lines,applications and add new customers. We anticipate that our continued growth inconsumables will offset an expected decline in instrument sales as we finishour instrument upgrade cycle.

*Maintain our operatingmargins.**  *Managementis focused on growing the business and increasing its operating profitability.In addition to the revenue growth opportunities described above, we willcontinue to closely manage our manufacturing costs and operating expenses. Weexpect a slight decline in gross margins for 2006 as we continue to expand ourmanufacturing capacity to support our anticipated sales growth in consumables. Inaddition, we will see increased operating costs and expenses related to ouradoption of SFAS 123(R) and our integration of the ParAllele acquisition.

*Acquisition*

On October 21, 2005, Affymetrix acquired 100% ofthe outstanding shares of ParAllele BioScience, Inc. (“ParAllele”), aprovider of comprehensive genetic discovery solutions to the life scienceresearch, pharmaceutical and diagnostic sectors. ParAllele’s products andservices utilize a unique approach that leverages novel biochemical processesrather than complex instrumentation to discover and analyze minute variationsin the human genome. We expect the acquisition to accelerate the developmentand commercialization of new products and create greater opportunities formarket penetration and revenue generation as well as increase our core assaydevelopment capabilities.

Thetotal purchase price of the ParAllele acquisition was $122.4 million andincludes the following components (in thousands):

| Fair value of  Affymetrix common stock issued |   | $      | 99,446  |   |
|-----------------------------------------------|--------|--------|---------|--------|
| Merger  consideration paid in cash            |   | 11,723 |    |
| Fair value of  stock options assumed          |   | 7,666  |    |
| Direct  transaction costs                     |   | 3,582  |    |
| Total purchase  price                         |   | $      | 122,417 |   |

 

The results of operationsof ParAllele have been included in the accompanying consolidated financialstatements from the date of acquisition. See Note 3 for further informationregarding this acquisition.

40

----

**CRITICALACCOUNTING POLICIES & ESTIMATES**

*General*

The following section of Management’s Discussion andAnalysis of Financial Condition and Results of Operations is based upon ourconsolidated financial statements, which have been prepared in accordance with U.S.generally accepted accounting principles. The preparation of these financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenue and expenses, and relateddisclosure of contingent assets and liabilities. Management bases its estimateson historical experience and on various other assumptions that are believed tobe reasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

Our significant accountingpolicies are fully described in Note 2 to our consolidated financialstatements. However, certain accounting policies are particularly important tothe reporting of our financial position and results of operations and requirethe application of significant judgment by our management. An accounting policyis deemed to be critical if it requires an accounting estimate to be made basedon assumptions about matters that are highly uncertain at the time the estimateis made, and if different estimates that reasonably could have been used, or changesin the accounting estimates that are reasonably likely to occur periodically,could materially impact the financial statements. Management believes thefollowing critical accounting policies reflect its more significant estimatesand assumptions used in the preparation of the Consolidated FinancialStatements.

***REVENUE RECOGNITION***

We enter into contracts tosell our products and, while the majority of our sales agreements containstandard terms and conditions, there are agreements that contain multipleelements or non-standard terms and conditions. As a result, significantcontract interpretation is sometimes required to determine the appropriateaccounting, including whether the deliverables specified in a multiple elementarrangement should be treated as separate units of accounting for revenuerecognition purposes, and if so, how the value of the arrangement should beallocated among the deliverable elements, when and how to recognize revenue foreach element, and the period over which revenue should be recognized. Werecognize revenue for delivered elements only when the fair values ofundelivered elements are known and customer acceptance has occurred. Changes inthe allocation of the sales price between delivered to undelivered elementsmight impact the timing of revenue recognition, but would not change the totalrevenue recognized on any arrangement.

***ACCOUNTS RECEIVABLE***

We evaluate thecollectibility of our trade receivables based on a combination of factors. Weregularly analyze our significant customer accounts, and, when we become awareof 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’soperating results or financial position, we record specific bad debt allowancesto reduce the related receivable to the amount we reasonably believe iscollectible. We also record allowances for bad debt on a small portion of allother customer balances based on a variety of factors including the length oftime the receivables are past due, the financial health of the customer,macroeconomic considerations and historical experience. If circumstancesrelated to specific customers change, our estimates of the recoverability ofreceivables could be further adjusted.

41

----

***INVENTORIES***

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

***NONMARKETABLE EQUITY SECURITIES***

As part of our strategicefforts to gain access to potential new products and technologies, we invest inequity securities of certain private biotechnology companies. Our nonmarketableequity securities are carried at cost unless we determine that an impairmentthat is other than temporary has occurred, in which case we write theinvestment down to its impaired value. We periodically review our investmentsfor impairment; however, the impairment analysis requires significant judgmentin identifying events or circumstances that would likely have significantadverse effect on the fair value of the investment. The analysis may includeassessment of the investee’s (i) revenue and earnings trend, (ii) businessoutlook for its products and technologies, (iii) liquidity position andthe rate at which it is using its cash, and (iv) likelihood of obtainingsubsequent rounds of financing. If an investee obtains additional funding at avaluation lower than our carrying value, we presume that the investment isother than temporarily impaired. We have experienced impairments in ourportfolio due to the decline in equity markets over the past few years.However, we are not able to determine at the present time which specificinvestments are likely to be impaired in the future, or the extent or timing ofthe individual impairments.

***DEFERRED TAXES***

Income tax expense isbased on pretax financial accounting income under the liability method.Deferred tax assets and liabilities are determined based on the differencebetween the financial statement and tax basis of assets and liabilities usingenacted tax rates in effect for the year in which the differences are expectedto reverse. We must then assess the likelihood that the resulting deferred taxassets will be realized. To the extent we believe that realization is not morelikely than not, we establish a valuation allowance. Significant estimates arerequired in determining our provision for income taxes, our deferred tax assetsand liabilities, and any valuation allowance to be recorded against our netdeferred tax asset. Some of these estimates are based on interpretations ofexisting tax laws or regulations. We believe that our estimates are reasonableand that our reserves for income tax related uncertainties are adequate.Various internal and external factors may have favorable or unfavorable effectson our future effective tax rate. These factors include, but are not limitedto, changes in tax laws, regulations and/or rates, changing interpretations ofexisting tax laws or regulations, changes in the valuation of our deferred taxassets or liabilities, future levels of research and development spending, andchanges in overall levels and mix of pretax earnings.

***CONTINGENCIES***

We are subject to legalproceedings principally related to intellectual property matters. Based on theinformation available at the balance sheet dates, we assess the likelihood ofany adverse judgments or outcomes to these matters, as well as potential rangesof probable losses. If losses are probable and reasonably estimable, we willrecord a reserve in accordance with SFAS 5, “Accounting for Contingencies.” Anyreserves recorded may change in the future due to new developments in eachmatter.

42

----

***RECENT ACCOUNTING PRONOUNCEMENTS***

On December 16, 2004,the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised2004), “Share-Based Payment”, which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”.SFAS 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends FASBStatement No. 95, “Statement ofCash Flows”. Generally, the approach in SFAS 123(R) is similar tothe approach described in Statement 123. However, SFAS 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thestatement of operations based on their estimated fair values. SFAS 123(R)also requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under current accounting standards. Thisrequirement will reduce net operating cash flows and increase net financingcash flows in periods after adoption. Pro forma disclosure in our notes to ourconsolidated financial statements will no longer be an alternative. We willadopt SFAS 123(R) effective January 1, 2006 under themodified-prospective method. As permitted by Statement 123, we currently accountfor share-based payments to employees using Opinion 25’s intrinsic value methodand, as such, generally recognize no compensation cost for employee stockoptions. Accordingly, the adoption of SFAS 123(R)’s fair value method willhave a significant impact on our results of operations, although it will haveno impact on our overall financial position. With the adoption of SFAS 123(R),we expect to record stock-based compensation of approximately $11.0 million,net of tax, or $0.15 per diluted share in 2006. Our estimate of stock-basedcompensation expense is affected by our stock price, the number of stock-basedawards it may grant in 2006, as well as a number of complex and subjectivevaluation assumptions and the related tax effect. These valuation assumptionsinclude, but are not limited to, the volatility of our stock price, theestimated forfeiture rates and employee stock option exercise behaviors.

**RESULTS OF OPERATIONS**

The following discussioncompares the historical results of operations for the years ended December 31,2005, 2004 and 2003.

**PRODUCT SALES**

Thecomponents of product sales are as follows (in thousands,****exceptpercentage amounts):

| ** **           | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|----------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **           | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Probe arrays         |       | $                                          | 197,949    |                         | $          | 168,243                          |       | $ | 139,591 |   | $ | 29,706 |   | $ | 28,652 |   |   | 18 | % |   |   | 21 | % |   |
| Reagents             |       | 42,428                                     |       | 31,744                       |       | 20,419                           |       | 10,684 |   | 11,325 |   |   | 34 |   |   |   | 55 |   |   |
| Instruments          |       | 62,636                                     |       | 77,269                       |       | 62,738                           |       | (14,633 | ) | 14,531 |   |   | (19 | ) |   |   | 23 |   |   |
| Total product  sales |       | $                                          | 303,013    |                         | $          | 277,256                          |       | $ | 222,748 |   | $ | 25,757 |   | $ | 54,508 |   |   | 9 |   |   |   | 24 |   |   |

 

Total product sales increased in 2005 as compared to2004. Probe array sales increased primarily due to an increase of $69.3 millionin revenue related to growth in unit sales of our GeneChip® probe arrays. Thisincrease was partially offset by a decrease of $39.6 million in revenuerelated to a decline in the average selling price of our arrays due to a changein product mix. Reagent sales increased primarily due to an increase in theaverage selling price of our reagents related to a change in product mix andgrowth in reagent unit sales associated with increased probe array unit sales. Instrumentsales decreased primarily due to a decrease of $16.4 million in revenue relatedto a decline in unit sales of our GeneChip® Scanner 3000 upgrades as weend our GeneArray® Scanner 2500 upgrade cycle as well as a decrease of $4.4million in revenue related to a decline in unit sales and in the averageselling price of our Fluidics Station 450. These decreases were partiallyoffset by growth of $4.4 million in revenue related to increased 

43

----

unit sales of our newautomation equipment and growth of $4.1 million in revenue related to increasedunit sales of our GeneChip® Scanner 3000 high-resolution upgrades.

Total product salesincreased in 2004 as compared to 2003. Probe array sales increased primarilydue to an increase of $32.4 million in revenue related to growth in unitsales of our GeneChip® probe arrays. This increase was partially offset by adecrease of $4.6 million in revenue related to a decline in the averageselling price of our probe arrays due to a change in product mix. The increasein unit sales of our probe arrays was primarily the result of new productintroductions. Reagent sales increased primarily due to increased probe arraysales and continued market acceptance of our new internally manufacturedreagents. Instrument sales increased primarily due to growth of$2.5 million in revenue related to increased unit sales of our GeneChip®Scanner 3000 instruments and upgrades, growth of $6.9 million in revenuerelated to increased unit sales of full GeneChip® instrumentation systemsincluding our new GCS 3000Dx system, and growth of $3.8 million in revenuerelated to an increase in the average selling price of our instruments due to achange in product mix.

**PRODUCT RELATED REVENUE**

Thecomponents of product related revenue are as follows (in thousands,****exceptpercentage amounts):

| ** **                                | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Subscription fees                         |       | $                                          | 12,448     |                         | $          | 20,669                           |       | $ | 26,208 |   | $ | (8,221 | ) | $ | (5,539 | ) |   | (40 | )% |   |   | (21 | )% |   |
| Service and other                         |       | 20,172                                     |       | 15,526                       |       | 18,451                           |       | 4,646 |   | (2,925 | ) |   | 30 |   |   |   | (16 | ) |   |
| License fees and  milestone revenue  |       | 14,557                                     |       | 17,434                       |       | 13,373                           |       | (2,877 | ) | 4,061 |   |   | (17 | ) |   |   | 30 |   |   |
| Total product  related revenue            |       | $                                          | 47,177     |                         | $          | 53,629                           |       | $ | 58,032 |   | $ | (6,452 | ) | $ | (4,403 | ) |   | (12 | ) |   |   | (8 | ) |   |

 

Total productrelated revenue decreased in 2005 as compared to 2004. The decrease wasprimarily due to the decline in subscription fees earned under our GeneChip®array access programs as we continue to transition customers to volume-basedpricing on array sales. Additionally, the recognition of $2.2 million inmilestone revenue due to the achievement of substantive goals as defined by ourcollaborative agreements in 2004 contributed to the decrease. Service and otherrevenue increased in 2005 primarily due to an increase of approximately $3.2million in other revenue related to DNA analysis services pertaining to thecompletion of certain contracts assumed by us upon the acquisition of ParAllelein the fourth quarter of 2005 and due to increased sales of service contractsfor our GeneChip® Scanner 3000.

Total product relatedrevenue decreased in 2004 as compared to 2003. The decrease was primarily dueto a decline in subscription fees earned under GeneChip® array access programsas we continue to transition customers to volume-based pricing on arraysales. In addition, service and other revenue declined primarily due to a$1.8 million decline in service contract revenue due to a decrease in thenumber of contracts as pre-existing scanner customers upgraded to our GeneChip®Scanner 3000 which is covered by a one year warranty. These decreases werepartially offset by an additional $1.1 million of license fees earned froma full year of amortization of the Roche agreement and the recognition of $2.2 millionin milestone revenue due to the achievement of substantive at risk goals asdefined by our collaborative agreements.

**ROYALTYAND OTHER REVENUE (in thousands, except percentage amounts)**

| ** **                   | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Royalties and  other revenue |       | $                                          | 8,339      |                         | $          | 9,832                            |       | $ | 10,556 |   | $ | (1,493 | ) | $ | (724 | ) |   | (15 | )% |   |   | (7 | )% |   |
|                              |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

44

----

Royalties and otherrevenue decreased in 2005 as compared to 2004. The decrease was primarily dueto a decline in the number of our non-core license agreements and therecognition of one monetary and one non-monetary license agreement with nocontinuing performance obligations in 2004 partially offset by the recognitionof a $1.5 million license agreement with no continuing performance obligationsin the fourth quarter of 2005.

Royalties and other revenue decreased in 2004 ascompared to 2003. The decrease was primarily due to a decline in the number andaverage value of our remaining non-core license agreements.

**REVENUEFROM PERLEGEN SCIENCES, INC. (in thousands, except percentage amounts)**

| ** **                      | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue from  Perlegen Sciences |       | $                                          | 9,073      |                         | $          | 5,245                            |       | $ | 9,460 |   | $ | 3,828 |   | $ | (4,215 | ) |   | 73 | % |   |   | (45 | )% |   |
|                                 |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Revenue from Perlegen Sciences, a related party,increased in 2005 as compared to 2004. These increases were primarily due toincreased demand by Perlegen for our probe arrays and whole wafers. Probearrays and wafers used by Perlegen for use in their research and developmentactivities are sold at our fully burdened cost of manufacturing. We also earn aroyalty on certain of these wafers if these products are used by Perlegen forcertain revenue activities. Royalties recognized were $2.8 million and $1.4million in 2005 and 2004. Beginning in the fourth quarter of 2005, we alsobegan selling probe arrays and reagents to Perlegen for use in certain newapplications, with 2005 revenues totaling $1.0 million.

Revenue from PerlegenSciences, a related party, decreased in 2004 as compared to 2003. The declinewas primarily due to decreased demand by Perlegen for our whole wafers. We sellwhole wafers to Perlegen for use in Perlegen’s research and developmentactivities at our fully burdened cost of manufacturing. Starting in the secondquarter of 2004, we began recognizing royalties on the sale of probe arrays thatwere utilized by Perlegen for revenue generating activities. The royalitiesearned on the sale of these probe arrays was $1.4 million in 2004.

**PRODUCTAND PRODUCT RELATED GROSS MARGINS (in thousands, except percentage amounts)**

| ** **                                                               | ** ** | **Year ended December 31,** | ** ** | **Dollar /Point  change from** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                               | ** ** | **2005**                                   | ** ** | **2004**                                 | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Gross margin on  product sales                                           |       | $                                          | 218,305    |                                     | $          | 195,556 |   | $ | 142,590 |   | $ | 22,749 |   | $ | 52,966 |   |
| Gross margin on  product related revenue                                 |       | 35,627                                     |       | 43,995                                   |       | 48,375 |   | (8,368 | ) | (4,380 | ) |
| Gross margin on  product and product related revenue                     |       | $                                          | 253,932    |                                     | $          | 239,551 |   | $ | 190,965 |   | $ | 14,381 |   | $ | 48,586 |   |
| Product gross  margin as a percentage of product sales                   |       | 72.0                                       | %          | 70.5                                     | %          | 64.0 | % | 1.5 |   | 6.5 |   |
| Product related gross  margin as a percentage of product related revenue |       | 75.5                                       | %          | 82.0                                     | %          | 83.4 | % | (6.5 | ) | (1.4 | ) |

 

The gross margin percentage on product sales increasedin 2005 as compared to 2004. Of the 1.5 point increase in product grossmargins, approximately 1.0 point of the increase can be attributed to anincrease in probe array gross margins due to the conversion of a royaltybearing technology license from Oxford Gene Technology (OGT) to a fully paid-upnon-royalty bearing license in the second half of 2004. The remainder of thegross margin increase can be attributed to decreased unit costs associated withthe increased utilization of our probe array manufacturing facility due toincreased sales volume and a change in our overall product mix towards ourhigher margin products such as probe arrays and reagents. The increase waspartially offset by a decrease in gross margin of approximately 1.0 point whichcan be 

45

----

attributed to a $2.0million warranty adjustment and related yield issues associated with therelease of our Mapping 500K Array product in the third quarter of 2005.

The gross margin percentage on product related revenuedecreased in 2005 as compared to 2004. The margin decreases were primarily dueto a decline in sales of our access agreements as we continue to transitioncustomers to volume-based pricing on array sales and the recognition of $2.2million in milestone revenue due to the achievement of substantive goals asdefined by our collaborative agreements in 2004. We also incurred costs relatedto the completion of contracts entered into by ParAllele prior to the closingof the acquisition in the fourth quarter of 2005.

The gross margin percentage on product sales increasedfrom in 2004 as compared to 2003. Of the 6.5 point increase in productgross margins, approximately 2.1 points of the increase can be attributed to anincrease in probe array gross margins due to the conversion of a royaltybearing technology license from OGT to a fully paid-up non-royalty bearinglicense in the second half of 2004. The remainder of the gross margin increasecan be attributed to increased utilization of our chip and instrumentmanufacturing facilities due to increased sales volume as well as a change inour overall product mix.

The gross marginpercentage on product related revenue decreased in 2004 as compared to 2003.The 1.4 point decrease was primarily due to a decline in sales of our accessagreements as we continue to transition customers to volume-baseddiscounting on product sales and due to an increase in expenses related tocertain of our service agreements. These margin decreases were partially offsetby the recognition of $2.2 million in milestone revenue due to theachievement of substantive at risk goals as defined by our collaborativeagreements.

**COSTOF PERLEGEN REVENUES (in thousands, except percentage amounts)**

| ** **                              | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **2005**                              | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cost of revenue  from Perlegen Sciences |       | $                                     | 5,154      |                         | $          | 3,611                            |       | $ | 9,460 |   | $ | 1,543 |   | $ | (5,849 | ) |   | 43 | % |   |   | (62 | )% |   |
|                                         |            |                                       |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cost of Perlegen revenue increased in 2005 andincreased as compared to 2004 primarily due to increased demand by Perlegen forour probe arrays and whole wafers.

Cost of Perlegen revenuedecreased in 2004 as compared to 2003 primarily due to the reduction in waferpurchases made by Perlegen. This decrease was partially offset by costsassociated with Perlegen’s purchase of GeneChip® instruments in the first halfof 2004.

**RESEARCHAND DEVELOPMENT EXPENSES (in thousands, except percentage amounts)**

| ** **                | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------|------------|---------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2005**                              | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Research and  development |       | $                                     | 77,404     |                         | $          | 73,405                           |       | $ | 65,909 |   | $ | 3,999 |   | $ | 7,496 |   |   | 5 | % |   |   | 11 | % |   |
|                           |            |                                       |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research and development expenses increased in 2005 ascompared to 2004. These increases were primarily due to an increase in theconsumption of development supply materials of $2.1 million and an increase of$1.9 million in co-development costs. These increases are as a result of ourpreparation for new product introductions and applications expected to be introducedin the next twelve months. These increases were partially offset by a decreaseof $2.5 million in performance based compensation. 

Research and development expenses, which primarilyconsist of basic research, product research and development and manufacturingprocess and development increased in 2004 as compared to 2003. The growth wasprimarily due to $4.2 million in increased costs associated with theexpanded use of our pilot 

46

----

operations facility inSunnyvale for new product development. We also increased our spending on basicresearch and product research and development.

We believe a substantialinvestment in research and development is essential to a long-term sustainablecompetitive advantage and critical to expansion into additional markets andexpect our expenses to increase as we integrate our ParAllele acquisition,develop new products and incorporate ourstock-based compensation charges related to our adoption of SFAS 123(R).

**SELLING,GENERAL AND ADMINISTRATIVE EXPENSES (in thousands, except percentage amounts)**

| ** **                          | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Selling, general and administrative |       | $                                          | 121,952    |                         | $          | 116,973                          |       | $ | 104,797 |   | $ | 4,979 |   | $ | 12,176 |   |   | 4 | % |   |   | 12 | % |   |
|                                     |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Selling, general and administrative expenses increasedin 2005 as compared to 2004. These increases were primarily due to higherheadcount-related costs from hiring new employees and normal salary increasesfor existing employees of $6.3 million and an increase of $2.5 million inconsulting costs. Our increased headcount expenses and consulting costs wereprimarily due to our continued international expansion, investments in newstrategic initiatives, and in anticipation of our new product introductions. Theseincreases were partially offset by a decrease of $6.2 million in performancebased compensation. 

Selling, general and administrative expenses increasedin 2004 as compared to 2003. The growth was partially due to an increase of$5.2 million in sales and marketing expenses which was comprised of$8.0 million related to new product introductions and increased salesvolume in our American and European regions, partially offset by a decrease insales and support costs of $2.8 million in Japan as our Japanese operationscompleted their obligations associated with a prior distribution agreement. Inaddition, general and administrative expenses increased by $7.0 millionrelated to on-going regulatory compliance efforts and other generaladministrative costs. This increase is net of $3.7 million in lower legalexpenses and the receipt of a cash settlement in 2004 of approximately$1.0 million in connection with the resolution of an intellectual propertydispute.

Selling, general andadministrative expenses are expected to continue to increase as we expandsales, marketing, and technical support functions, management andadministrative functions, prosecute and defend our intellectual propertyposition, defend against claims made by third parties in ongoing litigation, andincorporate our stock-based compensation charges related to our adoption ofSFAS 123(R). We expect legal costs to vary substantially as the intensity oflegal activity changes. There can be no assurance that we have adequatelyestimated our exposure for potential damages associated with pending or futurelitigation.

**STOCK-BASEDCOMPENSATION (in thousands, except percentage amounts)**

| ** **                | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Stock-based  compensation |       | $                                          | 1,106      |                         | $          | 920                              |       | $ | 2,238 |   | $ | 186 |   | $ | (1,318 | ) |   | 20 | % |   |   | (59 | )% |   |
|                           |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Stock-based compensation increased in 2005 as comparedto 2004. In 2005, we recorded stock-based compensation expense related torestricted stock awards granted to certain employees and one fully vestedrestricted stock award granted to a non-employee. Also in 2005, stock-basedcompensation included the amortization of deferred stock compensation generatedupon the acquisition of ParAllele in October 2005. The amortization of deferred stock-based compensation isprincipally attributable to research and development and selling, general andadministrative employees. In 2004, stock-based compensation related 

47

----

to the amortization ofdeferred stock compensation generated upon the acquisition of Neomorphic in October 2000,this was fully amortized as of December 31, 2004, except for approximately $4.3 million related to an executive levelNeomorphic employee.

Stock-based compensation, which primarilyincludes the amortization of deferred stock compensation in fiscal 2004 and2003, decreased $1.3 million in 2004 as compared to 2003. Upon theacquisition of Neomorphic in October 2000, the fair value of unvestedcommon stock subject to restricted stock agreements and the intrinsic value ofthe unvested options held by employees were deducted from the purchase priceand allocated to deferred stock compensation. The amortization of deferredstock-based compensation is principally attributable to research anddevelopment and selling, general and administrative employees. As of December 31,2004, all of the remaining deferred stock compensation related to theNeomorphic acquisition has been amortized except for approximately$4.3 million of deferred stock compensation.

We ceased amortizing $4.3 million of deferred stockcompensation related to an executive level Neomorphic employee who commenced aleave of absence during the latter part of fiscal 2001. The terms of thisrestricted stock arrangement permit an extended leave of absence under certaincircumstances and as such, any remaining deferred compensation will beamortized if and when the employee resumes active employee status with us. Weexpect to continue to grant restricted stock awards to certain employees. Accordingly,since these awards will be amortized to the appropriate cost and expense linesconsistent with the vesting terms, the timing or size of these restricted stockawards upon the adoption of SFAS 123(R) could have a significant impact on ourfuture results of operations.

With our adoption of SFAS123(R), we expect to record stock-based compensation of approximately $11.0million, net of tax, or $0.15 per diluted share in 2006. However, our estimateof future stock-based compensation expense is affected by our stock price, thenumber of stock-based awards we may grant in 2006, as well as a number ofcomplex and subjective valuation assumptions and the related tax effect. Thesevaluation assumptions include, but are not limited to, the volatility of ourstock price, the estimated forfeiture rates and employee stock option exercisebehaviors. The costs associated with stock-based compensation will be includedin the appropriate cost and expense lines on our Consolidated Statement ofOperations for our results in 2006. 

**AMORTIZATIONOF PURCHASED INTANGIBLES (in thousands, except percentage amounts)**

| ** **                             | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Amortization of  purchased intangibles |       |                                       | $          | —                       |       |                             |       | $ | — |   |   | $ | 937 |   |   | $ | — |   |   | $ | (937 | ) |   | — | % |   | (100 | )% |
|                                        |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We incurred no charges related to the amortization ofpurchased intangibles in 2004 or 2005 as we fully amortized all of ourpurchased intangibles during the fiscal year ended 2003. 

For fiscal 2003, the amortization of purchasedintangibles represents the amortization of intangibles related to theacquisition of Neomorphic, Inc. We adopted Statement of FinancialAccounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”)on January 1, 2002. In accordance with SFAS 142, we reclassified$0.8 million of assembled workforce to goodwill and ceased theamortization of goodwill.

We completed our reviewfor potential impairment of goodwill as of June 30, 2005, and concludedthere was no impairment of goodwill. In addition, there have been no indicatorsof potential impairment through December 31, 2005.

48

----

**ACQUIREDIN-PROCESS TECHNOLOGY (in thousands, except percentage amounts)**

| ** **                      | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Acquired in-process  technology |       | $                                          | 8,315      |                         |       | $                                | —     |   |   | $ | 10,096 |   | $ | 8,315 |   | $ | (10,096 | ) |   | — | % |   | (100 | )% |
|                                 |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the year ended December 31, 2005, werecorded a charge of approximately $8.3 million to acquired in-processtechnology upon the October 21, 2005 completion of our acquisition ofParAllele BioScience, Inc. (“ParAllele”), a provider of comprehensivegenetic discovery solutions to the life science research, pharmaceutical anddiagnostic sectors. We utilized the assistance of a third party valuationspecialist to help us determine the estimated fair value of certain researchand development programs in-process at the acquisition date that had not yetreached technological feasibility and had no alternative future use. Theseprojects primarily included the development of a DNA genotyping product and toa lesser extent certain RNA and other expression products. The fair values ofthese projects were determined using the Income Approach whereby we estimatedeach project’s related future net cash flows between 2005 and 2015 anddiscounted them to their present value using a risk adjusted discount rate of28%. This discount rate is based on our estimated weighted average cost ofcapital adjusted upward for the risks associated with the projects acquired.The projected cash flows from the acquired projects were based on estimates ofrevenues and operating profits related to the projects considering the stage ofdevelopment of each potential product acquired, the time and resources neededto complete the development and approval of each product, the life of eachpotential commercialized product and the inherent difficulties anduncertainties in developing products and services based on complex genetictechnologies and biochemical processes. As of October 21, 2005 and December 31,2005, the DNA genotyping project was 33% complete and the RNA & otherprojects were 40% complete. We expect to incur costs of approximately $5.6million to complete the DNA genotyping project and costs of $1.5 million tocomplete the RNA & other projects. We expect significant cash flowsfrom these projects to begin in 2006 and do not anticipate any material changesto historical pricing, expense levels or gross margins related to theseproducts.

During the year ended December 31, 2003, werecorded a charge of approximately $10.1 million to acquired in-processtechnology. The associated charge was for advanced access to the Perlegen SNPdatabase and was recorded as the database has no alternative future use to usbeyond our developing a limited number of closely related DNA analysisproducts. We did not acquire any in-process research projects from Perlegen.Therefore, as of the license date, we did not forecast any material changesfrom our historical gross margins for any of our DNA analysis products.

We engaged an independent third party valuationprofessional to assist us in determining the relative fair values of eachintangible asset licensed and the allocation of the consideration paid. Whilewe considered the work of the independent third party valuation professional,we took primary responsibility for allocating the consideration paid for theintangible assets acquired. We determined the value of the SNP database licenseby using the Income Approach. In applying this approach, we estimated the netpresent value of future cash flows expected from the sale of DNA analysisproducts to be developed in reliance on the content from the Perlegen SNPdatabase. The analysis included forecasted future cash flows that were expectedfrom the progress made on our DNA microarray development projects prior to thedate of the Perlegen SNP database license. These cash flows were firstestimated by forecasting total revenue associated with sales of certain of ourfuture DNA analysis products. A portion of this revenue was then removed toaccount for the contribution provided by our existing core technology that wasconsidered to benefit the DNA products under development. Appropriate operatingexpenses, cash flow adjustments, and contributory asset returns were deductedfrom the estimated cash flows to establish a forecast of net cash flows.Finally, these net cash flows were converted to a present value using adiscount rate of 30%, which was based on our weighted average cost of capitaladjusted for the technical and market 

49

----

risks associated with ourongoing research project in which the SNP database content would be used.Significant cash inflows from the associated DNA products were forecasted tocontinue through 2008.

The estimates used by usin valuing the licensed technologies and acquired in process technologies werebased upon assumptions we believe to be reasonable but which are inherentlyuncertain and unpredictable. Our assumptions may be incomplete or inaccurate,and no assurance can be given that unanticipated events and circumstances willnot occur. Accordingly, actual results may vary from the projected results.

**INTERESTINCOME AND OTHER, NET (in thousands, except percentage amounts)**

Thecomponents of interest income and other, net, are as follows:

| ** **                                 | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest income                            |       | $                                          | 8,118      |                         | $          | 4,189                            |       | $ | 7,382 |   | $ | 3,929 |   | $ | (3,193 | ) | 94 | % | (43 | )% |
| Realized loss in  Perlegen                 |       | (2,000                                     | )          | —                       |       | —                           |       | (2,000 | ) | — |   | (100 | ) | — |   |
| Write (down) up  of equity investment, net |       | (171                                       | )          | (2,283                       | )          | 4,876                            |       | 2,112 |   | (7,159 | ) | 93 |   | (147 | ) |
| Currency gains  (losses), net              |       | 470                                        |       | (458                         | )          | 3,574                            |       | 928 |   | (4,032 | ) | 203 |   | (113 | ) |
| Other                                      |       | 323                                        |       | 869                          |       | 830                              |       | (546 | ) | 39 |   | (63 | ) | 5 |   |
| Interest income and  other, net            |       | $                                          | 6,740      |                         | $          | 2,317                            |       | $ | 16,662 |   | $ | 4,423 |   | $ | (14,345 | ) | 191 |   | (86 | ) |

 

Interest income and other, net, increased in 2005 ascompared to 2004. The increase was primarily due to an increase in our cash andmarketable securities balances as we continue to generate positive cashflowsfrom operations and financing activities. However, these increases werepartially offset by a realized loss related to the recognition of ourproportionate share of Perlegen’s net loss. The carrying value of our investmentin Perlegen has now been written down to zero at December 31, 2005;therefore, to the extent we do not make any additional future investments inPerlegen, we do not expect further charges related to this investment.

Interest income and other,net decreased in 2004 as compared to 2003. The decrease in interest income andother, net was primarily due to the recognition of a $4.4 million gain in2003 on an equity investment in a privately-held biotechnology companyfollowing its acquisition by a publicly traded entity and a $1.4 milliongain realized in 2003 on the sale of some of our Perlegen stock. In 2003, wealso realized currency gains of $3.5 million prior to the date we beganhedging a percentage of our assets in 2004 that are held in various foreigncurrencies of our subsidiaries with forward contracts, with the gains or losseson these contracts largely offsetting gains and losses on the change in valueof the underlying assets. Interest income declined in 2004 due to lower cashand marketable securities balances following the $271.8 million of bondredemptions completed in the first quarter of 2004 and a $41.9 millionlicense payment to OGT in the second quarter of 2004. Finally, we realizedimpairment charges of $2.3 million in 2004 due to other-than-temporarydeclines in the carrying values of certain non-marketable equity securities.

**INTERESTEXPENSE (in thousands, except percentage amounts)**

| ** **       | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|------------------|------------|---------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **       | ** ** | **2005**                              | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Interest expense |       | $                                     | 1,545      |                         | $          | 11,102                           |       | $ | 17,358 |   | $ | (9,557 | ) | $ | (6,256 | ) |   | (86 | )% |   |   | (36 | )% |   |
|                  |            |                                       |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest expense decreased in 2005 as compared to 2004.Interest expense in 2005 primarily consists of interest and amortization of thedebt issuance costs associated with our $120.0 million 0.75% senior 

50

----

convertible notes issuedin December 2003. Interest expense was higher in 2004 primarily due to thewrite off of approximately $3.8 million in issuance costs plus $4.3 million inredemption premiums incurred by us in connection with the redemption of our 5%and 4.75% convertible subordinated notes in January 2004.

Interest expense decreasedin 2004 as compared to 2003. The decrease was primarily due to lower interestcharges following the $271.8 million of bond redemptions completed in thefirst quarter of 2004 of our 5% and 4.75% convertible subordinated notes. Thisdecrease was primarily due to the write off of approximately $3.8 million inissuance costs plus $4.3 million in redemption premiums incurred by us inconnection with the redemption of our 5% and 4.75% convertible subordinatednotes. In addition, the decrease was also offset by $1.7 million ininterest expense and the amortization of debt issuancecosts associated with the $120.0 million of 0.75% senior convertible notesissued in December 2003.

**INCOMETAX PROVISION (in thousands, except percentage amounts)**

| ** **            | ** ** | **Year ended December 31,** | ** ** | **Dollar  change from** | ** ** | **Percentage  change from** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **            | ** ** | **2005**                                   | ** ** | **2004**                     | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Income tax  provision |       | $                                          | 5,092      |                         | $          | 3,326                            |       | $ | 2,563 |   | $ | 1,766 |   | $ | 763 |   |   | 53 | % |   |   | 30 | % |   |
|                       |            |                                            |            |                              |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The provision for income tax was approximately$5.1 million in 2005, up from $3.3 million in 2004. In 2005, theprovision principally consists of federal taxes, state taxes, and taxes payableon the taxable profits generated by our foreign operations. The provision forincome tax was approximately $3.3 million in 2004, up from$2.6 million in 2003. In 2004 and 2003, the provision consists of currenttaxes payable on the profits attributable to our foreign operations, statetaxes and federal alternative minimum tax.

Statement of Financial Accounting Standards No. 109,“Accounting for Income Taxes” (“SFAS 109”) provides for the recognition ofdeferred tax assets if realization of such assets is more likely than not.Based upon the weight of available evidence, which included an analysis ofprojected future book and taxable income, as of December 31, 2005, weprovided for a valuation allowance of $82.3 million.

During fiscal 2005, we reduced our deferred tax assetvaluation allowance by approximately $35.9 million. In assessing therealizability of deferred tax assets, we considered whether it is more likelythan not that some portion or all of the deferred tax assets will not be realized.We considered historical book income, the scheduled reversal of deferred taxassets, and projected future book and taxable income in making this assessment.Based upon a detailed analysis of historical and projected book and taxableincome, we determined that the realization of certain deferred tax assets forwhich a valuation allowance had been recorded is considered more likely thannot for purposes of reversing the valuation allowance.

As of December 31, 2005, we had total netoperating loss carryforwards of $186.9 million, comprised of $144.2 million forU.S. federal and $42.7 million for state. The net operating loss carryforwardsexpire in the years 2018 through 2023. Additionally, we have federal and stateresearch and development tax credit carryforwards and other various tax creditcarryforwards of approximately $35.6 million, which expire in the years 2007through 2025. Utilization of our net operating loss and tax creditcarryforwards may be subject to substantial annual limitations due to theownership change limitations provided by the Internal Revenue Code and similarstate provisions. Such an annual limitation could result in the expiration ofthe net operating loss before utilization.

51

----

**LIQUIDITY AND CAPITAL RESOURCES**

*Cashflow (in thousands)*

| ** **                                                           | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net cash provided  by operating activities                           |       | $                                          | 64,613     |   | $ | 48,932 |   | $ | 89,858 |   |
| Net cash (used  in) provided by investing activities                 |       | (82,304                                    | )          | (46,785 | ) | 86,396 |   |
| Net cash provided  by (used in) financing activities                 |       | 74,846                                     |       | (235,083 | ) | 32,140 |   |
| Effect of foreign  currency translation on cash and cash equivalents |       | 486                                        |       | (397 | ) | (354 | ) |
| Net increase (decrease)  in cash and cash equivalents                |       | $                                          | 57,641     |   | $ | (233,333 | ) | $ | 208,040 |   |

 

**NetCash Provided by Operating Activities**

Cash provided by operating activities is primarilydriven by increases in our net income. However, operating cash flows differfrom net income as a result of non-cash charges or differences in the timing ofcash flows and earnings recognition. Significant components of the change incash provided by operating activities are as follows:

Net cash used to purchase inventories totaled $15.1million during 2005. This was related to our decision to stock finished goodsinstrument inventory at year-end as this is generally our largest sales period.

Deferred revenues declined$13.2 million during 2005 compared to a decrease of $10.1 million in 2004.The decrease in 2005 was primarily due to the amortization of the Rochecollaboration fee.

**NetCash Provided by (Used in) Investing Activities**

Our investing activities,other than purchases, sales and maturities of available-for-sale securities,primarily consist of capital expenditures, strategic investments and purchasedtechnology rights. Cash used for capital expenditures was $40.2 million,$21.9 million and $12.4 million for the years ended 2005, 2004 and2003, respectively. Capital expenditures in 2003 through 2005 related tocontinued expansion in our operating facilities, investments in informationmanagement systems, and purchases of production and lab equipment. In 2005, inaddition to the common stock we issued, we also used $10.9 million in cash, netof cash assumed, for our acquisition of ParAllele in October 2005. Cashused for the purchase of technology rights was $0.8 million, $43.1 millionand $3.3 million in the years ended 2005, 2004 and 2003, respectively. In2004, the primary component of purchased technology rights related to a$41.9 million license payment to OGT in the second quarter of 2004.

**NetCash Provided by (Used in) Financing Activities**

Our financing activitiesprimarily consist of activity under our employee stock plan or funds used inthe redemption of or provided by the issuance of our convertible notes. Cashprovided by the issuance of stock under our employee stock plan was $74.7million, $36.2 million and $12.5 million for the years ended 2005, 2004 and2003, respectively. Net cash used in financing activities in 2004 was primarilyattributable to the $271.8 million cash outflow for the redemption of our 5%and 4.75% convertible subordinated notes. In2003, we repurchased $53.4 million principal amount of our 4.75%convertible subordinated notes due in 2007 and $48.0 million principal amountof our 5.0% convertible subordinated notes due in 2006. Additionally, in December 2003we raised $120.0 million from the sale of 0.75% senior convertible notesdue 2033.

52

----

*Off-Balance SheetArrangements and Aggregate Contractual Obligations*

As part of our ongoing business, we do not participatein transactions that generate relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities (“SPEs”), which would have been establishedfor the purpose of facilitating off-balance sheet arrangements or othercontractually narrow or limited purposes. As of December 31, 2005, we arenot involved in any SPE transactions.

Theimpact that our contractual obligations as of December 31, 2005 areexpected to have on our liquidity and cash flow in future periods is as follows(in thousands):

| ** **                                | ** ** | **Total** | ** ** | **2006** | ** ** | **2007-2008** | ** ** | **2009-2010** | ** ** | **After 2010** | ** ** |
|-------------------------------------------|------------|-----------|------------|----------|------------|---------------|------------|---------------|------------|---------------------|------------|
| Senior  convertible notes(1)              |       | $         | 120,000    |     | $          | —        |       | $             | 120,000    |                |       | $ | — |   |   |   | $ | — |   |   |
| Interest on  senior convertible  notes(1) |       | 2,700     |       | 900      |       | 1,800         |       |          | —     |                |       |   | — |   |   |
| Operating leases                          |       | 61,278    |       | 11,085   |       | 20,446        |       |          | 13,270     |                |       |   | 16,477 |   |   |
| Purchase  commitments(2)                  |       | 10,042    |       | 8,979    |       | 922           |       |          | 141        |                |       |   | — |   |   |
| Other commitments(3)                      |       | 2,100     |       | 1,500    |       | 600           |       |          | —     |                |       |   | — |   |   |
| Total contractual  obligations            |       | $         | 196,120    |     | $          | 22,464        |       | $             | 143,768    |                |       | $ | 13,411 |   |   |   | $ | 16,477 |   |   |

----

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

(2)          Purchase commitmentsinclude agreements to purchase goods or services that are enforceable andlegally binding on Affymetrix and that specify all significant terms,including: fixed or minimum quantities to be purchased; fixed, minimum orvariable price provisions; and the approximate timing of the transaction.Purchase obligations exclude agreements that are cancelable without penalty.

(3)          Other commitments relateto an ongoing obligation held by the Company to contribute $1.5 million ina venture capital limited partnership. The venture capital limited partnershipmay call in this amount, in part or in full at any time according to thecontract terms. Other commitments also includes a funding obligation to supporttwo fellowships under the Bio-X Program at Stanford.

We have financed our operations primarily throughproduct sales, sales of equity and debt securities, collaborative agreements,interest income, and licensing of our technology. As of December 31, 2005,we had cash, cash equivalents, and available-for-sale securities ofapproximately $284.9 million. We anticipate that our existing capitalresources along with the cash to be generated from operations will enable us tomaintain currently planned operations and planned capital expenditures(estimated to be approximately $65.0 million for the year ending December 31,2006, which includes our Sacramento and Singapore expansion), for theforeseeable future. However, this expectation is based on our currentoperating, financing and capital expenditure plans, which are subject tochange, and therefore we could require additional funding. We also expect thatour capital requirements will increase over the next several years as we expandour worldwide commercial operations, expand our manufacturing capabilities, increaseour investments in third parties and expand our research and developmentefforts. Our long-term capital expenditure requirements will depend on numerousfactors, including: the expansion of commercial scale manufacturingcapabilities; our ability to maintain existing collaborative and customerarrangements and establish and maintain new collaborative and customerarrangements; the progress of our research and development programs; initiationor expansion of research programs and collaborations; the costs involved inpreparing, filing, prosecuting, defending and enforcing intellectual propertyrights; the effectiveness of product commercialization activities andarrangements; the purchase of patent licenses; and other factors.

As of December 31,2005, we have no credit facility or other committed sources of capital. To theextent capital resources are insufficient to meet future capital requirements;we will have to raise 

53

----

additionalfunds to continue the development of our technologies. There can be no assurancethat such funds will be available on favorable terms, or at all. To the extentthat additional capital is raised through the sale of equity or convertibledebt securities, the issuance of such securities could result in dilution toour stockholders. If adequate funds are not available, we may be required tocurtail operations significantly or to obtain funds by entering intocollaboration agreements on unattractive terms. Our inability to raise capitalwould have a material adverse effect on our business, financial condition andresults of operations.

**ITEM 7A.   QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

*Interest Rate Risk*

Our exposure to interest rate risk relates primarilyto our investment portfolio. Fixed rate securities may have their fair marketvalue adversely impacted due to fluctuations in interest rates, while floatingrate securities may produce less income than expected if interest rates fall.Due in part to these factors, our future investment income may fall short ofexpectations due to changes in interest rates or we may suffer losses inprincipal if forced to sell securities which have declined in market value dueto changes in interest rates.

The primary objective of our investment activities isto preserve principal while at the same time maximize yields withoutsignificantly increasing risk. To achieve this objective, we invest our excesscash in debt instruments of the U.S. Government and its agencies andhigh-quality corporate issuers, and, by policy, restrict our exposure to anysingle corporate issuer by imposing concentration limits. To minimize theexposure due to adverse shifts in interest rates, we maintain investments at anaverage maturity of less than three years.

Thetable below presents principal amounts and related weighted interest rates byyear of maturity for our available-for-sale securities and debt obligations,all of which are denominated in United States dollars, and the fair value ofeach as of December 31, 2005 and 2004.

| ** **                                    | ** ** | **Periods of Maturity** | ** ** | ** ** | ** ** | **Fair  Value at  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                          | ** ** | **2007**   | ** ** | **2008**                                   | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **2005** | ** ** |
| **ASSETS:**                                   |       |                              |       |       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Available-for-sale  securities                |       | $                                 | 229,207    |       | $          | 31,109                                     |       | $ | — |   |   | $ | — |   |   | $ | 260,316 |   |   | $ | 261,314 |   |   |
| Average interest  rate                        |       | 2.2                               | %          | 3.3        | %          |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **LIABILITIES:**                              |       |                              |       |       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| 0.75% senior  convertible notes due 2033 |       | $                                 | —     |       | $          | —                                     |       | $ | 120,000 |   |   | $ | — |   |   | $ | 120,000 |   |   | $ | 189,886 |   |   |
| Average interest rate                         |       |                              |       |       |       | 0.75                                       | %          |   |   |   |   |   |   |   |   |   |   |

 

| ** **                                    | ** ** | **Periods of Maturity** | ** ** | ** ** | ** ** | **Fair  Value at  December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                          | ** ** | **2006**   | ** ** | **2007**                                   | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **2004** | ** ** |
| **ASSETS:**                                   |       |                              |       |       |       |                                       |       |   |   |   |   |   |   |   |   |
| Available-for-sale  securities                |       | $                                 | 145,126    |       | $          | 34,552                                     |       | $ | 106 |   | $ | — |   | $ | 179,784 |   |   | $ | 180,608 |   |   |
| Average interest  rate                        |       | 2.4                               | %          | 3.0        | %          | 3.3                                        | %          |   |   |   |   |   |   |   |   |
| **LIABILITIES:**                              |       |                              |       |       |       |                                       |       |   |   |   |   |   |   |   |   |
| 0.75% senior  convertible notes due 2033 |       | $                                 | —     |       | $          | —                                     |       | $ | — |   | $ | 120,000 |   | $ | 120,000 |   |   | $ | 162,300 |   |   |
| Average interest rate                         |       |                              |       |       |       |                                       |       | 0.75 | % |   |   |   |   |   |   |

 

54

----

*Foreign CurrencyExchange Rate Risk*

We derive a portion of our revenues in foreigncurrencies, predominantly in Europe and Japan. In addition, a portion of ourassets are held in nonfunctional currencies of our subsidiaries. In early 2003,we began hedging activities by using currency forward contracts to manage aportion of the currency exposures created from our activities denominated inforeign currencies. (See Note 1 of the notes to our Consolidated FinancialStatements included in this report.) Our hedging program reduces, but does notentirely eliminate, the impact of currency exchange rate movements.

We hedge a percentage of forecasted internationalrevenue with forward contracts and the gains and losses on these contractslargely offset gains and losses on the transactions being hedged. Our revenuehedging policy is designed to reduce the negative impact on our forecastedrevenue due to foreign currency exchange rate movements. We also hedge apercentage of our assets that are held in nonfunctional currencies of oursubsidiaries with forward contracts and the gains or losses on these contractslargely offset gains and losses on the change in value of the underlying asset.Our balance sheet hedging policy is designed to reduce the fluctuations inearnings due to changes in foreign currency exchange rates. We do not usederivative contracts for speculative purposes. At December 31, 2005, totaloutstanding contracts included the notional equivalent of $21.6 million inforeign currency forward exchange contracts with a fair market value of $0.8million. As of December 31, 2005, all contracts were set to expire atvarious times through December 2006. The bank counterparties in thesecontracts expose us to credit-related losses in the event of theirnonperformance. However, to mitigate that risk we only contract with reputableinstitutions. We apply hedge accounting based upon the criteria established byStatement of Financial Accounting Standards No. 133 (“SFAS 133”),whereby we designate our derivatives for revenue hedging purposes as cash flowhedges. We have elected not to designate our derivatives for balance sheetpurposes as fair value hedges under SFAS 133 and have appropriatelyrecorded any changes in fair value to interest income and other, net.

A sensitivity analysis was performed on all of ourforeign exchange derivatives as of December 31, 2005. This sensitivityanalysis was based on a modeling technique that measures the hypotheticalmarket value resulting from a 10% shift in the value of exchange rates relativeto the U.S. dollar. For our forward contracts, we used a hypothetical changemade 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 hedginginstruments by $1.9 million. Conversely, a 10% decrease in the value ofthe U.S. dollar would result in a decrease in the fair value of these financialinstruments by $2.2 million.

55

----

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTSAFFYMETRIX, INC.**

|                                                          | ** ** | **Page No.** | ** ** |
|----------------------------------------------------------|------------|-------------------|------------|
| Report of Independent  Registered Public Accounting Firm |       |              | 57         |   |   |
| Consolidated Balance Sheets                              |       |              | 58         |   |   |
| Consolidated Statements of  Operations                   |       |              | 59         |   |   |
| Consolidated Statements of  Comprehensive Income         |       |              | 60         |   |   |
| Consolidated Statements of  Stockholders’ Equity    |       |              | 61         |   |   |
| Consolidated Statements of  Cash Flows                   |       |              | 62         |   |   |
| Notes to Consolidated  Financial Statements              |       |              | 63         |   |   |

 

56

----

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRMON CONSOLIDATED FINANCIAL STATEMENTS**

To the Board of Directors and Stockholders ofAffymetrix, Inc.

We have audited the accompanying consolidated balancesheets of Affymetrix, Inc. as of December 31, 2005 and 2004, and therelated consolidated statements of operations, comprehensive income,stockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2005. Our audits also included the financial statementschedule listed in the Index at Item 15(a). These financial statements andschedule are the responsibility of the Company’s management. Our responsibilityis to express an opinion on these financial statements and schedule based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement.An audit includes examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements. An audit also includes assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financial positionof Affymetrix, Inc. at December 31, 2005 and 2004, and theconsolidated results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2005, in conformity with U.S. generallyaccepted accounting principles. Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic financialstatements taken as a whole, presents fairly in all material respects theinformation set forth therein.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Affymetrix, Inc.’s internal controlover financial reporting as of December 31, 2005, based on criteria establishedin Internal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 2, 2006expressed an unqualified opinion thereon.
| /s/ ERNST &  YOUNG LLP |   |
|---------------------------------|--------|
| Palo Alto,  California,         |
| March 2,  2006             |

 

57

----

**AFFYMETRIX, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except per share amounts)**

| ** **                                                                                                                                                   | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                   | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS:**                                                                                                                                                  |       |                  |       |   |   |
| Current assets:                                                                                                                                              |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                    |       | $                     | 100,236    |   | $ | 42,595 |   |
| Available-for-sale securities                                                                                                                                |       | 184,696               |       | 163,120 |   |
| Accounts receivable (net of allowances of $415 in  2005 and $841 in 2004)                                                                                    |       | 93,028                |       | 89,441 |   |
| Accounts receivable from Perlegen Sciences                                                                                                                   |       | 4,082                 |       | 3,964 |   |
| Inventories                                                                                                                                                  |       | 35,980                |       | 17,997 |   |
| Deferred tax assets—current portion                                                                                                                     |       | 22,117                |       | — |   |
| Prepaid expenses and other current assets                                                                                                                    |       | 12,622                |       | 5,833 |   |
| Total current assets                                                                                                                                         |       | 452,761               |       | 322,950 |   |
| Property and  equipment, net                                                                                                                                 |       | 85,560                |       | 64,179 |   |
| Acquired  technology rights, net                                                                                                                             |       | 61,426                |       | 64,334 |   |
| Goodwill                                                                                                                                                     |       | 124,498               |       | 18,601 |   |
| Deferred tax  assets—long-term portion                                                                                                                  |       | 13,436                |       | — |   |
| Notes receivable  from employees                                                                                                                             |       | 1,824                 |       | 1,900 |   |
| Other assets                                                                                                                                                 |       | 27,318                |       | 27,807 |   |
| Total assets                                                                                                                                                 |       | $                     | 766,823    |   | $ | 499,771 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY:**                                                                                                              |       |                  |       |   |   |
| Current liabilities:                                                                                                                                         |       |                  |       |   |   |
| Accounts payable and accrued liabilities                                                                                                                     |       | $                     | 71,551     |   | $ | 61,265 |   |
| Deferred revenue—current portion                                                                                                                        |       | 35,644                |       | 33,776 |   |
| Other current liabilities                                                                                                                                    |       | —                |       | 1,698 |   |
| Total current liabilities                                                                                                                                    |       | 107,195               |       | 96,739 |   |
| Deferred  revenue—long-term portion                                                                                                                     |       | 15,606                |       | 29,463 |   |
| Other long-term  liabilities                                                                                                                                 |       | 4,184                 |       | 4,382 |   |
| Convertible notes                                                                                                                                            |       | 120,000               |       | 120,000 |   |
| Commitments and  contingencies (Note 12)                                                                                                                     |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                   |       |                  |       |   |   |
| Convertible redeemable preferred stock, $0.01 par  value; 5,000 shares authorized; no shares issued and outstanding at  December 31, 2005  and 2004     |       | —                |       | — |   |
| Common stock, $0.01 par value; 200,000 shares  authorized; 67,220 and 61,588 shares issued and outstanding at  December 31, 2005 and 2004, respectively |       | 672                   |       | 616 |   |
| Additional paid-in capital                                                                                                                                   |       | 624,727               |       | 407,258 |   |
| Deferred stock compensation                                                                                                                                  |       | (10,799               | )          | (4,265 | ) |
| Accumulated other comprehensive loss                                                                                                                         |       | (1,227                | )          | (3,371 | ) |
| Accumulated deficit                                                                                                                                          |       | (93,535               | )          | (151,051 | ) |
| Total stockholders’ equity                                                                                                                              |       | 519,838               |       | 249,187 |   |
|                                                                                                                                                         |       | $                     | 766,823    |   | $ | 499,771 |   |

 

See Accompanying Notes

58

----

**AFFYMETRIX, INC.CONSOLIDATED STATEMENTSOF OPERATIONS(In thousands, except per share amounts)**

| ** **                                             | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **REVENUE:**                                           |       |                                       |       |   |   |   |   |
| Product sales                                          |       | $                                          | 303,013    |   | $ | 277,256 |   | $ | 222,748 |   |
| Product related revenue                                |       | 47,177                                     |       | 53,629 |   | 58,032 |   |
| Total product and product related revenue              |       | 350,190                                    |       | 330,885 |   | 280,780 |   |
| Royalties and other revenue                            |       | 8,339                                      |       | 9,832 |   | 10,556 |   |
| Revenue from Perlegen Sciences                         |       | 9,073                                      |       | 5,245 |   | 9,460 |   |
| Total revenue                                          |       | 367,602                                    |       | 345,962 |   | 300,796 |   |
| **COSTS  AND EXPENSES:**                               |       |                                       |       |   |   |   |   |
| Cost of product sales                                  |       | 84,708                                     |       | 81,700 |   | 80,158 |   |
| Cost of product related revenue                        |       | 11,550                                     |       | 9,634 |   | 9,657 |   |
| Cost of revenue from Perlegen Sciences                 |       | 5,154                                      |       | 3,611 |   | 9,460 |   |
| Research and development                               |       | 77,404                                     |       | 73,405 |   | 65,909 |   |
| Selling, general and administrative                    |       | 121,952                                    |       | 116,973 |   | 104,797 |   |
| Stock-based compensation(1)                            |       | 1,106                                      |       | 920 |   | 2,238 |   |
| Amortization of purchased intangibles                  |       | —                                     |       | — |   | 937 |   |
| Acquired in-process technology                         |       | 8,315                                      |       | — |   | 10,096 |   |
| Total costs and expenses                               |       | 310,189                                    |       | 286,243 |   | 283,252 |   |
| Income from operations                                 |       | 57,413                                     |       | 59,719 |   | 17,544 |   |
| Interest income  and other, net                        |       | 6,740                                      |       | 2,317 |   | 16,662 |   |
| Interest expense                                       |       | (1,545                                     | )          | (11,102 | ) | (17,358 | ) |
| Income before  income taxes                            |       | 62,608                                     |       | 50,934 |   | 16,848 |   |
| Income tax  provision                                  |       | (5,092                                     | )          | (3,326 | ) | (2,563 | ) |
| Net income                                             |       | $                                          | 57,516     |   | $ | 47,608 |   | $ | 14,285 |   |
| Basic net income  per common share                     |       | $                                          | 0.90       |   | $ | 0.79 |   | $ | 0.24 |   |
| Diluted net  income per common share                   |       | $                                          | 0.84       |   | $ | 0.74 |   | $ | 0.24 |   |
| Shares used in  computing basic net income per share   |       | 63,816                                     |       | 60,512 |   | 58,860 |   |
| Shares used in  computing diluted net income per share |       | 70,586                                     |       | 66,878 |   | 60,852 |   |

----

| (1)   Stock-based compensation related to the  following: |   |   |   |   |   |   |   |
|---------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
| Cost of product sales                                               |   | $      | 134    |   | $      | — |   | $ | — |   |
| Research and development                                            |   | 342    |   | 720    |   | 1,713  |   |
| Selling, general and administrative                                 |   | 630    |   | 200    |   | 525    |   |
|                                                                |   | $      | 1,106  |   | $      | 920    |   | $ | 2,238 |   |

 

See Accompanying Notes

59

----

**AFFYMETRIX, INC.CONSOLIDATED STATEMENTSOF COMPREHENSIVE INCOME(In thousands)**

| ** **                                                                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                                                                 |       | $                                          | 57,516     |   | $ | 47,608 |   | $ | 14,285 |   |
| Other comprehensive  income (loss):                                                        |       |                                       |       |   |   |   |   |
| Foreign currency translation, net of tax                                                   |       | 486                                        |       | (397 | ) | (354 | ) |
| Unrealized gains (losses) on available-for-sale and  non-marketable securities, net of tax |       | 119                                        |       | (1,500 | ) | (6,827 | ) |
| Reclassification adjustment for (losses) gains in  net income                              |       | (157                                       | )          | 287 |   | 6,057 |   |
| Unrealized gains (losses) on cash flow hedges, net  of tax                                 |       | 544                                        |       | (1,152 | ) | (963 | ) |
| Reclassification adjustment for gains in net income                                        |       | 1,152                                      |       | 963 |   | — |   |
| Net change in  other comprehensive income (loss)                                           |       | 2,144                                      |       | (1,799 | ) | (2,087 | ) |
| Comprehensive income                                                                       |       | $                                          | 59,660     |   | $ | 45,809 |   | $ | 12,198 |   |

 

See Accompanying Notes

60

----

**AFFYMETRIX, INC.CONSOLIDATED STATEMENTSOF STOCKHOLDER EQUITY(In thousands)**

| ** **                                                                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Convertible redeemable preferred stock:                                     |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | $                                          | —     |   | $ | — |   | $ | — |   |
| Balance, end of year                                                        |       | —                                     |       | — |   | — |   |
| Common stock:                                                               |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | 616                                        |       | 595 |   | 585 |   |
| Common stock issued                                                         |       | 56                                         |       | 21 |   | 10 |   |
| Balance, end of year                                                        |       | 672                                        |       | 616 |   | 595 |   |
| Additional paid-in capital:                                                 |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | 407,258                                    |       | 370,304 |   | 355,515 |   |
| Issuance of common stock  upon exercise of stock options and warrants  |       | 74,649                                     |       | 36,220 |   | 12,487 |   |
| Issuance of common stock  upon exercise of stock purchase right             |       | —                                     |       | — |   | 3,000 |   |
| Issuance of restricted  stock                                               |       | 2,636                                      |       | — |   | — |   |
| Cancellation of notes or  deferred compensation                             |       | —                                     |       | — |   | (698 | ) |
| Income tax benefit from  employee stock option exercises                    |       | 33,072                                     |       | 734 |   | — |   |
| Issuance of common stock  from acquisition of ParAllele                     |       | 107,112                                    |       | — |   | — |   |
| Balance, end of year                                                        |       | 624,727                                    |       | 407,258 |   | 370,304 |   |
| Notes receivable from stockholders:                                         |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | —                                     |       | (428 | ) | (720 | ) |
| Repayment of notes  receivable                                              |       | —                                     |       | 454 |   | 344 |   |
| Accretion of interest on  notes receivable                                  |       | —                                     |       | (26 | ) | (158 | ) |
| Cancellation of common  stock                                               |       | —                                     |       | — |   | 106 |   |
| Balance, end of year                                                        |       | —                                     |       | — |   | (428 | ) |
| Deferred stock compensation:                                                |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | (4,265                                     | )          | (5,185 | ) | (8,015 | ) |
| Amortization of deferred  stock compensation                                |       | 1,022                                      |       | 920 |   | 2,238 |   |
| Unearned stock  compensation, net of cancellations                          |       | (7,556                                     | )          | — |   | 592 |   |
| Balance, end of year                                                        |       | (10,799                                    | )          | (4,265 | ) | (5,185 | ) |
| Accumulated other comprehensive loss:                                       |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | (3,371                                     | )          | (1,572 | ) | 515 |   |
| Unrealized gain (loss)  on investments, net of tax                          |       | (38                                        | )          | (1,213 | ) | (770 | ) |
| Unrealized gain (loss)  on hedging contracts, net of tax                    |       | 1,696                                      |       | (189 | ) | (963 | ) |
| Foreign currency  translation adjustment, net of tax                        |       | 486                                        |       | (397 | ) | (354 | ) |
| Balance, end of year                                                        |       | (1,227                                     | )          | (3,371 | ) | (1,572 | ) |
| Accumulated deficit:                                                        |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | (151,051                                   | )          | (198,659 | ) | (212,944 | ) |
| Net income                                                                  |       | 57,516                                     |       | 47,608 |   | 14,285 |   |
| Balance, end of year                                                        |       | (93,535                                    | )          | (151,051 | ) | (198,659 | ) |
| Total stockholders  equity                                                  |       | $                                          | 519,838    |   | $ | 249,187 |   | $ | 165,055 |   |
| **Number of shares of common stock**                                        |       |                                       |       |   |   |   |   |
| Balance, beginning of  year                                                 |       | 61,588                                     |       | 59,474 |   | 58,504 |   |
| Issuance of common stock  for cash or services                              |       | 3,346                                      |       | 2,114 |   | 970 |   |
| Issuance of common stock  for acquisition of ParAllele                      |       | 2,286                                      |       | — |   | — |   |
| Balance, end of year                                                        |       | 67,220                                     |       | 61,588 |   | 59,474 |   |

 

See Accompanying Notes

61

----

**AFFYMETRIX, INC.CONSOLIDATED STATEMENTSOF CASH FLOWS(In thousands)**

| ** **                                                                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                              |       |                                       |       |   |   |   |   |
| Net income                                                                              |       | $                                          | 57,516     |   | $ | 47,608 |   | $ | 14,285 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                       |       |   |   |   |   |
| Depreciation and amortization                                                           |       | 20,467                                     |       | 19,660 |   | 22,214 |   |
| Amortization of intangible assets                                                       |       | 7,731                                      |       | 6,075 |   | 4,463 |   |
| Gain from repurchase of convertible notes                                               |       | —                                     |       | — |   | (739 | ) |
| Redemption premium and related write-off of debt issuance costs                         |       | —                                     |       | 8,095 |   | — |   |
| Charge for acquired in-process technology                                               |       | 8,315                                      |       | — |   | — |   |
| Amortization of investment premiums, net                                                |       | (1,177                                     | )          | (1,142 | ) | 2,013 |   |
| Stock-based compensation                                                                |       | 1,106                                      |       | 920 |   | 2,238 |   |
| Write down of equity investments                                                        |       | 172                                        |       | 2,283 |   | 938 |   |
| Realized loss on equity method investment in Perlegen  Sciences                         |       | 2,000                                      |       | — |   | — |   |
| Realized loss (gain) on the sales of investments                                        |       | 145                                        |       | 859 |   | (5,603 | ) |
| Deferred tax assets                                                                     |       | (2,700                                     | )          | — |   | — |   |
| Amortization of debt offering costs                                                     |       | 759                                        |       | 756 |   | 1,538 |   |
| Accretion of interest on notes receivable                                               |       | (98                                        | )          | (26 | ) | (158 | ) |
| Loss on disposal of equipment                                                           |       | 12                                         |       | 657 |   | 447 |   |
| Changes  in operating assets and liabilities:                                           |       |                                       |       |   |   |   |   |
| Accounts receivable, net                                                                |       | (94                                        | )          | (22,062 | ) | (5,357 | ) |
| Inventories                                                                             |       | (15,137                                    | )          | 4,635 |   | 4,107 |   |
| Prepaid expenses and other assets                                                       |       | 3,143                                      |       | (2,867 | ) | (2,647 | ) |
| Accounts payable and accrued liabilities                                                |       | (4,115                                     | )          | (7,535 | ) | 3,217 |   |
| Deferred revenue                                                                        |       | (13,203                                    | )          | (10,126 | ) | 53,984 |   |
| Other long-term liabilities                                                             |       | (229                                       | )          | 1,142 |   | (5,082 | ) |
| Net cash provided by operating activities                                               |       | 64,613                                     |       | 48,932 |   | 89,858 |   |
| **CASH FLOWS FROM  INVESTING ACTIVITIES:**                                              |       |                                       |       |   |   |   |   |
| Capital expenditures                                                                    |       | (40,166                                    | )          | (21,885 | ) | (12,436 | ) |
| Purchases of available-for-sale securities                                              |       | (227,290                                   | )          | (182,876 | ) | (447,422 | ) |
| Proceeds from sales and maturities of available-for-sale  securities                    |       | 206,395                                    |       | 202,780 |   | 560,057 |   |
| Purchase of non-marketable equity investments                                           |       | (3,500                                     | )          | (1,741 | ) | (7,500 | ) |
| Purchase of non-marketable equity investments in Perlegen                               |       | (2,000                                     | )          | — |   | — |   |
| Capital distribution from non-marketable investment                                     |       | 411                                        |       | — |   | — |   |
| Purchases of technology rights                                                          |       | (750                                       | )          | (43,063 | ) | (3,303 | ) |
| Purchase of option to license technology                                                |       | —                                     |       | — |   | (3,000 | ) |
| Issuance of loan to ParAllele BioScience, Inc.                                     |       | (4,500                                     | )          | — |   | — |   |
| Acquisition of ParAllele BioScience, Inc., net of cash acquired                    |       | (10,904                                    | )          | — |   | — |   |
| Net cash (used in) provided by investing activities                                     |       | (82,304                                    | )          | (46,785 | ) | 86,396 |   |
| **CASH FLOWS FROM  FINANCING ACTIVITIES:**                                              |       |                                       |       |   |   |   |   |
| Issuance of common stock                                                                |       | 74,705                                     |       | 36,241 |   | 12,497 |   |
| Repayment of notes receivable from stockholders                                         |       | 141                                        |       | 454 |   | 344 |   |
| Issuance of senior convertible notes                                                    |       | —                                     |       | — |   | 120,000 |   |
| Repurchase of convertible subordinated notes                                            |       | —                                     |       | — |   | (100,701 | ) |
| Redemption of convertible subordinated notes                                            |       | —                                     |       | (271,778 | ) | — |   |
| Net cash provided by (used in) financing activities                                     |       | 74,846                                     |       | (235,083 | ) | 32,140 |   |
| Effect of foreign currency translation on cash and cash equivalents                     |       | 486                                        |       | (397 | ) | (354 | ) |
| Net increase (decrease) in cash and cash equivalents                                    |       | 57,641                                     |       | (233,333 | ) | 208,040 |   |
| Cash and cash equivalents at beginning of year                                          |       | 42,595                                     |       | 275,928 |   | 67,888 |   |
| Cash and cash equivalents at end of year                                                |       | $                                          | 100,236    |   | $ | 42,595 |   | $ | 275,928 |   |
| **SUPPLEMENTAL DISCLOSURE  OF NONCASH ACTIVITIES:**                                     |       |                                       |       |   |   |   |   |
| Recognition of deferred tax assets relating to tax benefits from  employee stock plans  |       | $                                          | 32,853     |   | $ | — |   | $ | — |   |
| Acquisition of technology rights                                                        |       | $                                          | —     |   | $ | — |   | $ | 3,000 |   |
| Issuance of common stock upon exercise of common stock purchase right                   |       | $                                          | —     |   | $ | — |   | $ | 3,000 |   |
| **SUPPLEMENTAL DISCLOSURE  OF CASH FLOW INFORMATION:**                                  |       |                                       |       |   |   |   |   |
| Cash paid for interest                                                                  |       | $                                          | 900        |   | $ | 10,623 |   | $ | 17,346 |   |
| Cash paid for income taxes                                                              |       | $                                          | 2,001      |   | $ | 1,127 |   | $ | 1,751 |   |

 

See Accompanying Notes

62

----

**AFFYMETRIX, INC.NOTES TO CONSOLIDATEDFINANCIAL STATEMENTSDECEMBER 31, 2005**

**NOTE 1—NATURE OF OPERATIONS**

Affymetrix, Inc. (“Affymetrix”or the “Company”) is engaged in the development, manufacture, sale and serviceof systems for genetic analysis for use in the life sciences and in clinicaldiagnostics. Affymetrix has developed its GeneChip® system and relatedmicroarray technology as the platform of choice for acquiring, analyzing andmanaging complex genetic information. The Company’s integrated GeneChip®platform includes: disposable DNA probe arrays (chips) consisting of genesequences set out in an ordered, high density pattern, certain reagents for usewith the probe arrays, a scanner and other instruments used to process theprobe arrays, and software to analyze and manage genomic information obtainedfrom the probe arrays. Related microarray technology also offered by Affymetrixincludes instrumentation, software and licenses for fabricating, scanning,collecting and analyzing results from low density microarrays. The Companycommenced the first commercial sale for research use in August 1994, withbroader commercial sales beginning in April 1996. The Company currentlysells its products directly to pharmaceutical, biotechnology, agrichemical,diagnostics and consumer products companies as well as academic researchcenters, government research laboratories, private foundation laboratories andclinical reference laboratories in North America and Europe. The Company alsosells some of its products through life science supply specialists acting asauthorized distributors in Latin America, India, the Middle East and AsiaPacific regions, including China.

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

**BASIS OF PRESENTATION**

The consolidated financialstatements include the accounts of Affymetrix and its wholly ownedsubsidiaries. All significant intercompany accounts and transactions have beeneliminated. The Company has accounted for its ownership interest in PerlegenSciences, Inc. (“Perlegen”) using the equity method since March 30,2001 (see Note 11). In addition, the Company acquired ParAllele BioScience, Inc.on October 21, 2005 and it is included in the Company’s operations fromthat date (see Note 3).

**USE OF ESTIMATES**

The preparation of theconsolidated financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect amounts reported in the financial statements and accompanyingnotes. Actual results could differ materially from those estimates.

**FOREIGN CURRENCY**

Assets and liabilities ofnon-U.S. subsidiaries that operate in a local currency environment aretranslated to U.S. dollars at exchange rates in effect at the balance sheetdate, with the resulting translation adjustments directly recorded to aseparate component of accumulated other comprehensive income (loss) withinstockholders’ equity. Income and expense accounts are translated at averageexchange rates during the year. Foreign currency transaction gains and lossesare recognized in interest income and other, net and were comprised of netgains of $0.5 million, $0.5 million and $3.6 million for the yearsended December 31, 2005, 2004, and 2003, respectively.

63

----

**CASHEQUIVALENTS, AVAILABLE-FOR-SALE SECURITIES AND INVESTMENTS**

*MarketableSecurities*

The Company’s investmentsconsist of U.S. government notes and bonds; corporate notes, bonds and asset-backedsecurities; municipal notes and bonds; and publicly traded equity securities.The Company reports all debt securities with maturities at the date of purchaseof three months or less that are readily convertible into cash and haveinsignificant interest rate risk as cash equivalents. Cash equivalents andavailable-for-sale securities consist of marketable equity and debt securities.Management determines the appropriate classification of debt securities at thetime of purchase. As of December 31, 2005 and 2004, the Company’sinvestments in debt securities are classified as available-for-sale and are carriedat fair value with unrealized gains and losses reported in accumulated othercomprehensive income (loss) in stockholders’ equity. The cost of debtsecurities is adjusted for amortization of premiums and discounts to maturity.This amortization is included in interest income and other, net. Realized gainsand losses, as well as interest income, on available-for-salesecurities are also included in interest income and other, net. The cost ofsecurities sold is based on the specific identification method. The fair valuesof securities are based on quoted market prices. All of the Company’savailable-for-sale securities are included in current assets as managementconsiders the securities readily available to fund current operations. TheCompany monitors its investment portfolio for impairment on a periodic basis.In the event that the carrying value of an investment exceeds its fair valueand the decline in value is determined to be other-than-temporary, animpairment charge is recorded and a new cost basis for the investment isestablished. Fair values for investments in public companies are determinedusing quoted market prices.

*Non-marketableSecurities*

The Company also hasinvestments in non-marketable securities issued by privately held companies.These investments are included in other assets in the Consolidated BalanceSheets and are primarily carried at cost. The Company periodically monitors theliquidity and financing activities of the respective issuers to determine ifany impairment exists and accordingly writes down to the extent necessary, thecost basis of our non-marketable equity securities to their estimated fairvalues. In order to determine whether a decline in value isother-than-temporary, the Company evaluates, among other factors: the durationand extent to which the fair value has been less than the carrying value; thefinancial condition of and business outlook of the issuer for the company,including key operational and cash flow metrics, current market conditions; andthe Company’s intent and ability to retain the investment for a period of timesufficient to allow for any anticipated recovery in estimated fair value.

**ACCOUNTS RECEIVABLE**

Trade accounts receivableare recorded at net invoice value. The Company considers amounts past due basedon the related terms of the invoice. The Company reviews its exposure toamounts receivable and provides an allowance for specific amounts ifcollectibility is no longer reasonably assured. The Company also provides anallowance for a percentage of the gross trade receivable balance (excluding anyspecifically reserved amounts) based on its collection history.

**DERIVATIVE INSTRUMENTS**

The Company has international operations and duringthe normal course of business is exposed to foreign currency exchange risks asa result of transactions that are denominated in currencies other than theUnited States dollar. Early in 2003, the Company began entering into foreigncurrency forward contracts to manage a portion of the volatility of transactionsthat are denominated in foreign currencies. The Company’s foreign currencyforward contracts are entered into for periods consistent with the relatedunderlying exposures and do not constitute positions that are independent ofthose exposures. In addition, 

64

----

the Company does not enterinto foreign currency forward contracts for trading or speculative purposes, isnot party to any leveraged derivative instrument, and may only enter intoderivative agreements with highly rated counterparties.

The foreign currencyforward contracts used by the Company are generally short-term in nature,maturing within one year, and are accounted for as cash flow hedges. The effectof exchange rate changes on foreign currency forward contracts is expected tooffset the effect of exchange rate changes on the underlying hedged items. Forthese contracts, unrealized gains or losses from the effective portion of thehedge is reported as a component of other comprehensive income (loss) instockholders’ equity and is reclassified using the specific identificationmethod into earnings in the same period or periods in which the hedgedtransaction affects earnings, and within the same consolidated statement ofoperations line item. The gain or loss from the ineffective portion of thehedge in excess of the cumulative change in the present value of future cashflows of the hedged item, if any, is recognized in interest income and other,net during the period of change.

**INVENTORIES**

Inventory cost is computedon an adjusted standard basis (which approximates actual cost on a first-in,first-out basis). Provisions for slow moving, potentially excess and obsoleteinventories are provided based on estimated demand requirements, product lifecycle and development plans, component cost trends, product pricing, productexpiration and quality issues.

**PROPERTY AND EQUIPMENT**

Property and equipment arerecorded at cost and are depreciated using the straight-line method over theestimated useful lives of the assets or the lease term, whichever is shorter.Equipment and furniture is depreciated over useful lives generally ranging from3 to 7 years, company-owned buildings are depreciated over 25 yearsand leasehold improvements are depreciated over lease terms generally rangingfrom 3 to 15 years. Maintenance and repair costs are expensed as incurred.

**GOODWILLAND ACQUIRED TECHNOLOGY RIGHTS**

Goodwill represents the difference between thepurchase price and the estimated fair value of the net assets acquired arisingfrom business combinations. In accordance with Statement of FinancialAccounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),goodwill is subject to impairment tests annually, or earlier if indicators ofpotential impairment exist, using a fair-value-based approach. As of December 31,2005 and 2004, goodwill relates to the acquisition of Neomorphic in October 2000and the acquisition of ParAllele in October 2005. There is no impairmentof goodwill for any period presented.

Acquired technology rightsare carried at cost less accumulated amortization and are comprised of licensesto technology covered by patents held by third parties or acquired by theCompany. Amortization is computed over the estimated useful life of theunderlying patents, which has historically ranged from one to thirteen years.SFAS 142 requires purchased intangible assets other than goodwill to beamortized over their useful lives unless these lives are determined to beindefinite.

**IMPAIRMENT OF LONG-LIVED ASSETS**

Long-lived assets andcertain identifiable intangible assets are reviewed for impairment when eventsor changes in circumstances indicate that the carrying amount of such assetsmay not be recoverable. Determination of recoverability is based on an estimateof undiscounted future cash flows resulting from the use of the asset and itseventual disposition. In the event that such cash flows are not expected to be 

65

----

sufficientto recover the carrying amount of the assets, the assets are written down totheir estimated fair values.

**INCOME TAXES**

Income tax expense isbased on pretax financial accounting income. Deferred tax assets andliabilities are determined based on the difference between the financialstatement and tax basis of assets and liabilities using enacted tax rates ineffect for the year in which the differences are expected to reverse. Significantestimates and management judgment are required in determining the provision forincome taxes. Some of these estimates are based on interpretations of existingtax laws or regulations. The Company believes that their estimates arereasonable and that their reserves for income tax related uncertainties areadequate. Deferred tax assets are assessed for the likelihood that they arerecoverable. The assessment considers recent historic results, future marketgrowth, forecasted earnings, future taxable income, and the mix of earnings injurisdictions in which the Company operates. To the extent management believesthat the recovery is not likely, a valuation allowance is recorded to reducethe deferred tax assets to the amount that the Company believes is more likelythan not to be realized. Future changes in tax laws, regulations and rates,changes in the interpretations of existing tax laws or regulations, changes inoverall levels and mix of income before tax, and ultimate outcomes of incometax audits could have an impact on the Company’s future effective tax rate.

**CONTINGENCIES**

The Company is subject tovarious legal proceedings principally related to intellectual property matters.Based on the information available at the most recent balance sheet date, theCompany assesses the likelihood of any material adverse judgments or outcomesthat may result from these matters, as well as the range of possible orprobable loss, if any. If losses are probable and reasonably estimable, theCompany will record a reserve in accordance with SFAS 5, “Accounting forContingencies.” Any reserves recorded may change in the future due to newdevelopments in each matter.

**REVENUE RECOGNITION**

*Overview*

The Company recognizes revenue when persuasiveevidence of an arrangement exists, delivery has occurred, the amount is fixedor determinable, and collectibility is reasonably assured. In instances wherefinal acceptance of the product or system is required, revenue is deferreduntil all the acceptance criteria have been met.

The Company derives the majority of its revenue fromproduct sales of GeneChip® probe arrays, reagents, and related instrumentationthat may be sold individually or combined with any of the product or productrelated revenue items listed below. When a sale combines multiple elements, theCompany accounts for multiple element arrangements under Emerging Issues TaskForce Issue No. 00-21 (“EITF 00-21”), “RevenueArrangements with Multiple Deliverables.”

EITF 00-21 providesguidance on accounting for arrangements that involve the delivery orperformance of multiple products, services and/or rights to use assets. Inaccordance with EITF 00-21, the Company allocates revenue fortransactions or collaborations that include multiple elements to each unit ofaccounting based on its relative fair value, and recognizes revenue for eachunit of accounting when the revenue recognition criteria have been met. Theprice charged when the element is sold separately generally determines its fairvalue. In the absence of fair value of a delivered element, the Companyallocates revenue first to the fair value of the undelivered elements and theresidual revenue to the delivered elements. The Company recognizes revenue fordelivered elements when the delivered elements have standalone value and theCompany has objective and reliable evidence of fair value for each 

66

----

undeliveredelement. If the fair value of any undelivered element included in a multipleelement arrangement cannot be objectively determined, revenue is deferred untilall elements are delivered and services have been performed, or until fairvalue can objectively be determined for any remaining undelivered elements.

*Product Sales*

Product sales, as well asrevenues from Perlegen Sciences, include sales of GeneChip® probe arrays,reagents and related instrumentation. Probe array, reagent and instrumentationrevenues are recognized when earned, which is generally upon shipment andtransfer of title to the customer and fulfillment of any significantpost-delivery obligations. Accruals are provided for anticipated warrantyexpenses at the time the associated revenue is recognized.

*Product RelatedRevenue*

Product related revenue includes subscription feesearned under GeneChip® array access programs; license fees; milestones androyalties earned from collaborative product development and supply agreements;extended warranty and equipment service revenue; product related scientificservices revenue; and revenue from custom probe array design fees.

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

The Company enters into collaborative arrangementswhich generally include a research and product development phase and amanufacturing and product supply phase. These arrangements may include up-frontnonrefundable license fees, milestones, the rights to royalties based on thesale of final product by the partner, product supply agreements anddistribution arrangements.

Any up-front, nonrefundable payments fromcollaborative product development agreements are recognized over the researchand product development period, and at-risk substantive based milestones arerecognized when earned. Any payments received which are not yet earned areincluded in deferred revenue.

Revenue related to extended warranty arrangements isdeferred and recognized over the applicable periods. Revenue from custom probearray design fees associated with the Company’s GeneChip® CustomExpressTM andCustomSeqTM products are recognized when the associated products are shipped.

Revenue from scientificand DNA analysis services are generally recognized upon shipment of therequired data to the customer.

*Royalties and OtherRevenue*

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

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

Research revenues result primarily from researchgrants received from U.S. Government entities or from subcontracts with otherlife science research-based companies which receive their research grantfunding from the U.S. Government. Revenues from research contracts aregenerated from the efforts of 

67

----

the Company’s technicalstaff and include the costs for material and subcontract efforts. The Company’sresearch grant contracts generally provide for the payment of negotiated fixedhourly rates for labor hours incurred plus reimbursement of other allowablecosts. Research revenue is recorded in the period in which the associated costsare incurred, up to the limit of the prior approval funding amounts containedin each agreement. The costs associated with these grants are reported asresearch and development expense.

License revenues aregenerally recognized upon execution of the agreement unless the Company hascontinuing performance obligations, in which case the license revenue isrecognized ratably over the period of expected performance.

*Transactions withDistributors*

The Company recognizesrevenue on sales to distributors in accordance with SEC Staff AccountingBulletin No. 104, “Revenue Recognition,” or SAB 104. The Companyrecognizes revenue when persuasive evidence of an arrangement exists, deliveryhas occurred or services have been rendered, the seller’s price is fixed ordeterminable, and collectibility is reasonably assured. The Company’sagreements with distributors do not include rights of return.

**RESEARCH AND DEVELOPMENT EXPENSES**

Research and developmentexpenses consist of costs incurred for internal, collaborative and grant-sponsoredresearch and development. Research and development expenses include salaries,contractor fees, building costs, utilities and allocations of shared corporateservices. In addition, the Company funds research and development at othercompanies and research institutions under agreements which are generallycancelable. All such costs are charged to research and development expense asincurred.

**SOFTWARE DEVELOPMENT COSTS**

Statement of Financial Accounting Standards No. 86,“Accounting for the Costs of Computer Software to be Sold, Leased or OtherwiseMarketed,” requires the capitalization of certain software development costssubsequent to the establishment of technological feasibility. The Company’ssoftware is deemed to have achieved technologically feasibility at the point aworking model of the software product is developed. The Company has capitalizedapproximately $0.5 million and zero costs incurred subsequent to theestablishment of technological feasibility for the years ended December 31,2005 and 2004, respectively. These costs will be amortized to cost of productsales from the date of general release of the related instrument. The costs ofdeveloping routine software enhancements are expensed as research anddevelopment as incurred because of the short time between the determination oftechnological feasibility and the date of general release of the relatedproducts.

The Company appliesStatement of Position No. 98-1, “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.” Historically, exceptfor the implementation of an enterprise resource planning system in 2002,internal use software costs were insignificant. The Company begins amortizingthe costs associated with software developed for internal use at the time inwhich the software is ready for its intended use.

**ADVERTISING COSTS**

The Company expensesadvertising costs as incurred. Advertising costs were $1.9 million for2005, $1.9 million for 2004, and $1.5 million for 2003.

68

----

**STOCK-BASED COMPENSATION**

At December 31, 2005, the Company has seven stock-basedemployee and non-employee director compensation plans, which are described morefully in Note 15. The Company has elected to continue to follow therecognition and measurement principles of Accounting Principles Board Opinion No. 25,“*Accounting for Stock Issued to Employees”*(“APB 25”) and related Interpretations for these plans.

Thefollowing table illustrates the effect on reported net income (loss) and netincome (loss) per common share if the Company had applied the fair valuerecognition provisions of SFAS 123, as amended by SFAS 148, to stock-basedemployee compensation (in thousands, except per share amounts):

| ** **                                                                                                                   | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income—as  reported                                                                                                 |       | $                                          | 57,516     |   | $ | 47,608 |   | $ | 14,285 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net  of tax                       |       | 384                                        |       | 920 |   | 2,238 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair  value method for all awards, net of tax |       | (15,800                                    | )          | (15,984 | ) | (29,220 | ) |
| Pro forma net  income (loss)                                                                                                 |       | $                                          | 42,100     |   | $ | 32,544 |   | $ | (12,697 | ) |
| Net income (loss)  per share:                                                                                                |       |                                       |       |   |   |   |   |
| Basic net income per common share—as reported                                                                           |       | $                                          | 0.90       |   | $ | 0.79 |   | $ | 0.24 |   |
| Diluted net income per common share—as reported                                                                         |       | $                                          | 0.84       |   | $ | 0.74 |   | $ | 0.24 |   |
| Basic net income (loss) per common share—pro forma                                                                      |       | $                                          | 0.66       |   | $ | 0.54 |   | $ | (0.22 | ) |
| Diluted net  income (loss) per common share—pro forma                                                                   |       | $                                          | 0.60       |   | $ | 0.51 |   | $ | (0.22 | ) |

 

Thefair value of options was estimated at the date of grant using a Black-Scholesoption pricing model with the following weighted average assumptions:

| ** **                       | ** ** | **Year Ended  December 31,** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|
| ** **                       | ** ** | **2005**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk free  interest rate         |       | 4.1                                    | %          | 3.2 | % | 2.0 | % |
| Expected dividend  yield         |       | 0.0                                    | %          | 0.0 | % | 0.0 | % |
| Expected  volatility             |       | 0.45                                   |       | 0.56 |   | 0.72 |   |
| Expected option term (in  years) |       | 3.6                                    |       | 3.4 |   | 2.9 |   |

 

Based on this calculation, the weighted average fairvalue of options granted during 2005, 2004 and 2003 was $18.97, $12.99 and$10.72, respectively. For purposes of pro forma disclosures pursuant toSFAS 123, as amended by SFAS 148, the estimated fair value of optionsis amortized to expense in accordance with FASB Interpretation No.28 over theoptions’ vesting period, generally four years.

In the fourth quarter of2005, the Company evaluated its assumptions used in determining fair value inpreparation of the adoption of SFAS 123(R). Under the fair value recognitionprovisions of SFAS 123, as amended by SFAS 148, the Company had usedits historical stock price volatility for purposes of its pro formainformation. The Company has changed its expected stock price volatilityassumption to a combination of historical and implied volatility of the Company’scommon stock. The Company’s assessment is that this combined method is morerepresentative of future stock price trends than historical volatility alone. Theselection of the historical and implied volatility combination approach wasbased upon the availability of actively traded options on the Company’s commonstock.

69

----

**COMPREHENSIVE INCOME**

Comprehensive income is comprised of net income andother comprehensive income (loss). Other comprehensive income (loss) includesunrealized gains and losses on the Company’s available-for-sale securities thatare excluded from net income, changes in fair value of derivatives designatedas and effective as cash flow hedges, and foreign currency translationadjustments. Total comprehensive income has been disclosed in the consolidatedstatement of comprehensive income.

The components of accumulated other comprehensive lossesare as follows (in thousands):

| ** **                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                              | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Foreign currency  translation adjustment, net of tax                                    |       | $                     | (909       | ) | $ | (1,395 | ) |
| Unrealized losses  on available-for-sale and non-marketable securities, net of tax |       | (862                  | )          | (824 | ) |
| Unrealized gains  (losses) on hedging contracts, net of tax                             |       | 544                   |       | (1,152 | ) |
| Accumulated other  comprehensive loss                                                   |       | $                     | (1,227     | ) | $ | (3,371 | ) |

 

**NET INCOME PER COMMON SHARE**

Basic net income per common share is calculated usingthe weighted-average number of common shares outstanding during theperiod less the weighted-average shares subject to repurchase. Dilutedincome per common share gives effect to the dilutive common stock subject torepurchase, stock options and warrants (calculated based on the treasury stockmethod), and convertible debt (calculated using an as if-converted method).

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

| ** **                                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Numerator:                                                                        |       |                                       |       |   |   |   |   |
| Net income—basic                                                             |       | $                                          | 57,516     |   | $ | 47,608 |   | $ | 14,285 |   |
| Add effect of  dilutive securities:                                               |       |                                       |       |   |   |   |   |
| Interest on convertible notes (inclusive of  amortization of debt issuance costs) |       | 1,659                                      |       | 1,655 |   | 74 |   |
| Net income—diluted                                                           |       | $                                          | 59,175     |   | $ | 49,263 |   | $ | 14,359 |   |
| Denominator:                                                                      |       |                                       |       |   |   |   |   |
| Weighted-average shares outstanding                                               |       | 63,912                                     |       | 60,591 |   | 58,970 |   |
| Less: weighted-average shares of common stock  subject to repurchase              |       | (96                                        | )          | (79 | ) | (110 | ) |
| Shares used in  computing basic net income per common share                       |       | 63,816                                     |       | 60,512 |   | 58,860 |   |
| Add effect of  dilutive securities:                                               |       |                                       |       |   |   |   |   |
| Employee stock options                                                            |       | 2,799                                      |       | 2,380 |   | 1,685 |   |
| Common stock subject to repurchase                                                |       | 96                                         |       | 79 |   | 110 |   |
| Warrants to purchase common stock                                                 |       | 5                                          |       | 37 |   | 38 |   |
| Convertible notes                                                                 |       | 3,870                                      |       | 3,870 |   | 159 |   |
| Shares used in  computing diluted net income per common share                     |       | 70,586                                     |       | 66,878 |   | 60,852 |   |
| Basic net income  per common share                                                |       | $                                          | 0.90       |   | $ | 0.79 |   | $ | 0.24 |   |
| Diluted net income per  common share                                              |       | $                                          | 0.84       |   | $ | 0.74 |   | $ | 0.24 |   |

 

70

----

In September 2004, the Emerging Issues Task Forcereached a consensus on Issue No. 04-8, “The Effect of ContingentlyConvertible Debt on Diluted Earnings Per Share,” (“EITF 04-8”) whichaddresses when the dilutive effect of contingently convertible debt instrumentsshould be included in diluted earnings per share. EITF 04-8 requires thatcontingently convertible debt instruments be included in the computation ofdiluted earnings per share regardless of whether the market price trigger hasbeen met. EITF 04-8 also requires that prior period diluted earnings pershare amounts presented for comparative purposes be restated. EITF 04-8was effective for reporting periods ending after December 15, 2004. Theadoption of EITF 04-8 resulted in a $0.02 decrease in diluted earningsper share for the year ended December 31, 2004 and had no impact for theyear ended December 31, 2003.

Diluted earnings per share include certain commonshare equivalents from outstanding stock options (on the treasury stockmethod), common stock subject to repurchase, outstanding warrants to purchasecommon stock and convertible notes (on the as-if-converted basis).

Thesecurities excluded from diluted earnings per common share, on an actualoutstanding basis, were as follows (in thousands):

| ** **              | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|
| ** **              | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **              | ** ** | **(in thousands)**                    | ** ** |
| Employee stock  options |       | 1,427                                      |       | 2,613 |   | 5,253 |   |
| Convertible notes       |       | —                                     |       | — |   | 2,689 |   |
| Total                   |       | 1,427                                      |       | 2,613 |   | 7,942 |   |

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

On December 16, 2004,the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123(revised 2004), “Share-Based Payment”, which is a revision of FASB Statement No. 123,“Accounting for Stock-BasedCompensation”. SFAS 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”,and amends FASB Statement No. 95, “Statementof Cash Flows”. Generally, the approach in SFAS 123(R) is similarto the approach described in Statement 123. However, SFAS 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thestatement of operations based on their estimated fair values. SFAS 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current accounting standards. This requirement willreduce net operating cash flows and increase net financing cash flows inperiods after adoption. Pro forma disclosure will no longer be an alternative.The Company will adopt SFAS 123(R) effective January 1, 2006 underthe modified-prospective method. As permitted by Statement 123, the Companycurrently accounts for share-based payments to employees using Opinion 25’sintrinsic value method and, as such, generally recognizes no compensation costfor employee stock options. Accordingly, the adoption of SFAS 123(R)’s fairvalue method will have a significant impact on the Company’s results ofoperations, although it will have no impact on the Company’s overall financialposition. With the adoption of SFAS 123(R), the Company expects to recordstock-based compensation of approximately $11.0 million, net of tax, or $0.15per diluted share in 2006. The Company’s estimate of stock-based compensationexpense is affected by its stock price, the number of stock-based awards it maygrant in 2006, as well as a number of complex and subjective valuationassumptions and the related tax effect. These valuation assumptions include,but are not limited to, the volatility of the Company’s stock price, theestimated forfeiture rates and employee stock option exercise behaviors.

71

----

**NOTE 3—ACQUISITION**

On October 21, 2005, Affymetrix acquired 100% ofthe outstanding shares of ParAllele BioScience, Inc. (“ParAllele”), aprovider of comprehensive genetic discovery solutions to the life scienceresearch, pharmaceutical and diagnostic sectors. ParAllele’s products andservices utilize a unique approach that leverages novel biochemical processesrather than complex instrumentation to discover and analyze minute variationsin the human genome. Affymetrix expects the acquisition to accelerate thedevelopment and commercialization of new products and create greateropportunities for market penetration and revenue generation as well as increaseAffymetrix’ core assay development capabilities.

Affymetrix accounted forthe merger under the purchase method of accounting in accordance with theprovisions of Statement of Financial Accounting Standards No. 141, “BusinessCombinations.” Under this accounting method, the Company recorded the assetsacquired and liabilities assumed at their estimated fair value, with the excesspurchase price reflected as goodwill. Additionally, certain costs directlyrelated to the merger were reflected as additional purchase price in excess ofnet assets acquired. The results of operations of ParAllele since October 21,2005 have been included in Affymetrix’ consolidated financial statements forthe year ended December 31, 2005.

*Purchase Price*

Thetotal purchase price of the ParAllele acquisition was $122.4 million andincludes the following components (in thousands):

| Fair value of  Affymetrix common stock issued |   | $      | 99,446  |   |
|-----------------------------------------------|--------|--------|---------|--------|
| Merger  consideration paid in cash            |   | 11,723 |    |
| Fair value of  stock options assumed          |   | 7,666  |    |
| Direct  transaction costs                     |   | 3,582  |    |
| Total purchase  price                         |   | $      | 122,417 |   |

 

The fair value of the 2.29million shares of Affymetrix’ common stock issued was derived using the averagemarket price of Affymetrix’ common stock of $43.66 per share, which was basedon the closing price for a range of trading days (October 18, 2005 throughOctober 21, 2005) around the measurement date. The fair value of ParAlleleoptions assumed and common stock subject to repurchase was determined using theBlack-Scholes option pricing model with the following weighted averageassumptions: volatility of 0.39, expected life of 2.94 years, risk-freeinterest rate of 4.24%, and expected dividend yield of 0%. The expected stockprice volatility assumption was determined using a combination of historicaland implied volatility of the Company’s common stock.

72

----

*Purchase PriceAllocation*

Thefollowing table allocates the purchase price based on the fair values of theassets acquired and liabilities assumed as of the acquisition date (inthousands):

| Tangible assets and liabilities:     |   |    |    |
|--------------------------------------|--------|---------|---------|
| Current assets                       |   | $       | 7,387   |   |
| Long-term assets                     |   | 4,088   |    |
| Current liabilities                  |   | (9,596  | )       |
| Long-term liabilities                |   | (8,013  | )       |
| Total net tangible  liabilities      |   | (6,134  | )       |
| Amortizable intangible assets:       |   |    |    |
| Developed technology                 |   | 1,853   |    |
| Patents                              |   | 3,082   |    |
| Backlog                              |   | 251     |    |
| Total amortizable  intangible assets |   | 5,186   |    |
| Goodwill                             |   | 105,679 |    |
| Deferred tax asset                   |   | 4,368   |    |
| Deferred stock  compensation         |   | 5,003   |    |
| In-process technology                |   | 8,315   |    |
| Total                                |   | $       | 122,417 |   |

 

In April 2004,Affymetrix and ParAllele had entered into a two-year product collaborationagreement in which Affymetrix distributed ParAllele products and suppliedParAllele with probe arrays. No value was assigned to this pre-existingrelationship in the purchase accounting summarized above. Current assetsinclude $0.6 million of trade receivables from Affymetrix and currentliabilities include $0.7 million of trade payables to Affymetrix as well as$4.5 million loan from Affymetrix to fund ParAllele’s operations. Uponcompletion of the acquisition, these balances were eliminated in Affymetrix’consolidated financial statements.

*Intangible Assets and Goodwill*

A valuation of thepurchased intangibles was undertaken by a third party valuation specialist toassist Affymetrix’ management in its determination of estimated fair value ofsuch assets. The $4.9 million value assigned to developed technology andpatents is included in acquired technology rights on the Company’s ConsolidatedBalance Sheet and will be amortized to cost of product sales over the estimateduseful lives of these assets, generally five to eight years. Affymetrix hadrecorded amortization expense of approximately $0.2 million for the year ended December 31,2005 related to these acquired patents and technology. The $0.3 millionvalue assigned to backlog will be amortized to selling, general &administrative expenses within one year. Goodwill of $105.7 million wasrecorded as the excess of the purchase price over the net assets acquired. Nogoodwill was deemed to be deductible for income tax purposes.

*Deferred Stock Compensation*

The $5.0 million ofdeferred compensation represents the intrinsic value of the unvested stockoptions assumed by Affymetrix in the transaction. This amount will be amortizedto the appropriate costs and expense line items over the remaining vestingperiods of the underlying equity awards, which extend through September 2009.

73

----

*In-process Technology*

Management utilized the assistance of a third partyvaluation specialist to help it determine the estimated fair value of certainresearch and development programs in-process at the acquisition date that hadnot yet reached technological feasibility and had no alternative future use. Theseprojects primarily included the development of a DNA genotyping product and toa lesser extent certain RNA and other expression products. The fair values ofthese projects were determined using the Income Approach whereby managementestimated each project’s related future net cash flows between 2005 and 2015and discounted them to their present value using a risk adjusted discount rateof 28%. This discount rate is based on our estimated weighted average cost ofcapital adjusted upward for the risks associated with the projects acquired.The projected cash flows from the acquired projects were based on estimates ofrevenues and operating profits related to the projects considering the stage ofdevelopment of each potential product acquired, the time and resources neededto complete the development and approval of each product, the life of each potentialcommercialized product and the inherent difficulties and uncertainties indeveloping products and services based on complex genetic technologies andbiochemical processes. The Company expects significant cash flows from theseprojects to begin in 2006 and is not anticipating any material changes to itshistorical pricing, expense levels or gross margins related to these products.

As of October 21,2005 and December 31, 2005, the DNA genotyping project was 33% completeand the RNA & other projects were 40% complete. The Company expects toincur costs of approximately $5.6 million to complete the DNA genotypingproject and costs of $1.5 million to complete the RNA & other projects.Upon consummation of the acquisition on October 21, 2005 and completion ofour valuation efforts, $8.3 million was charged to acquired in-processtechnology in the Consolidated Statement of Operations.

*Pro Forma Results*

The following pro forma data summarizes the results ofoperations for the periods indicated as if the ParAllele acquisition had beencompleted as of the beginning of each of the periods presented. The pro formadata give effect to actual operating results prior to the acquisition as wellas amortization of intangibles acquired in the acquisition, however, no effecthas been given to cost reductions or operating synergies. In addition, certaintransactions related to the Company’s pre-existing relationship with ParAllelehave been excluded as well as accretion charges associated with ParAllele’spreferred stock. These pro forma amounts do not purport to be indicative of theresults that would have actually been obtained if the acquisition had occurredas of the beginning of the periods presented or that may be obtained in thefuture.

Thepro forma results are as follows (in thousands, except per share amounts):

| ** **                           | ** ** | **Year ended  December 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net revenue                          |       | $                                      | 371,662    |   | $ | 347,978 |   |
| Net income                           |       | $                                      | 47,489     |   | $ | 24,889 |   |
| Basic net income per common share    |       | $                                      | 0.72       |   | $ | 0.40 |   |
| Diluted net income per  common share |       | $                                      | 0.68       |   | $ | 0.38 |   |

 

**NOTE 4—COLLABORATIVE AGREEMENTS**

The Company has agreementswith several entities to develop and test probe arrays for the detection ofcertain gene sequences, mutations or organisms. Under such agreements, theCompany may receive development fees and may receive payments upon achievementof certain technical goals. The Company 

74

----

also hasresearch agreements with many universities and research organizations. TheCompany’s material agreements are described below:

**BECKMAN COULTER, INC. (“Beckman”)**

In July 1998, the Company entered into anarrangement with Beckman that involved the execution of a series of agreementsincluding an Asset Purchase Agreement (the “APA”). Pursuant to the APA, whichwas implemented and became effective in June 1999, the Company purchasedBeckman’s array business. Under the APA, the Company agreed to grant Beckmanlicenses to commercialize probe arrays manufactured using certain Affymetrixtechnologies other than light-directed synthesis, and an OEM supplyagreement for products that use the Company’s GeneChip® array technology. Under the arrangement,Beckman would pay Affymetrix transfer prices and royalties on sales of theseproducts.

Under the agreements,Affymetrix made a $5.9 million payment to Beckman in 1998 and agreed toprovide a credit of $5.0 million to be applied against research anddevelopment services to be performed by the Company. Affymetrix had the optionof performing or agreeing to perform such services by July 2003, or payingthe amount of the unapplied credit in cash or stock to Beckman. In addition,under the agreement Affymetrix contracted to establish a joint venture withBeckman. The Company determined after review of EITF 98-3, “DeterminingWhether a Nonmonetary Transaction Involves Receipt of Productive Assets or aBusiness” that the purchase should be accounted for as the receipt of anintangible asset. Therefore, the payments and credit obligation to Beckman wereaccounted for as the purchase of an intangible asset which is being amortizedon a straight-line basis over its estimated useful life of 15 years. At December 31,2005 and 2004, accumulated amortization amounted to $11.3 million and$6.6 million, respectively. During the year ended December 31, 2003,the Company paid to Beckman $5.0 million in settlement of the obligationto perform research and development activities and established a joint venturewith Beckman called Array Automation, LLC. (See Note 11 Related Parties).

**F. HOFFMANN-LA ROCHE LTD. (“Roche”)**

In February 1998,Affymetrix entered into a non-exclusive collaborative development agreementwith Roche to initially develop probe array-based diagnostic products.Under the terms of the agreement the parties were collaborating to developmutually agreed upon arrays directed to selected genes, as well to develop theassociated instrumentation and reagents. In January 2003, the Companyexpanded its collaboration with Roche by granting Roche access to its GeneChip® technologies to develop and commercializeGeneChip® diagnostic laboratory tests for DNA analysis,genotyping and resequencing applications, as well as for RNA expressionanalysis, in a broad range of human disease areas. Using Affymetrix’ GeneChip® technologies, Roche is seeking to develop andmarket diagnostic tests for diseases such as cancer, osteoporosis,cardiovascular, metabolic, infectious and inflammatory diseases. Affymetrix andRoche believe that developing targeted microarray expression profiles forcancer and genotyping and resequencing profiles for other diseases will enablethe creation and commercialization of novel standardized diagnostic solutions.These solutions ultimately may allow physicians to better diagnose and treathuman disease. Under the terms of the expanded collaborative agreement, Rochepaid Affymetrix an access fee of $70 million, which the Company isrecognizing as a component of product related revenue over the estimatedresearch and development period of approximately five years. Research revenueunder this contract was approximately $14.2 million and $14.2 millionfor the years ended December 31, 2005 and 2004, respectively. Milestonerevenue earned under this contract was zero and $1.5 million for the year endedDecember 31, 2005 and 2004, respectively. The associated research costsare not significant for each of the years presented. The expanded collaborationagreement, which is subject to Roche’s option to terminate on December 31,2007, December 31, 2010 or any time on or after December 31, 2015,with one year’s prior notice, includes a broad range of other compensationpayable by Roche to Affymetrix throughout the life of the agreement based onannual royalties on sales of diagnostic kits, milestone 

75

----

paymentsfor technical and commercial achievements, a manufacturing and supplyagreement, and related license installments.

**NOTE 5—CONCENTRATIONS OF RISK**

Cash equivalents and investments are financialinstruments that potentially subject Affymetrix to concentrations of risk tothe extent of amounts recorded in the consolidated balance sheet. Companypolicy restricts the amount of credit exposure to any one issuer and to any onetype of investment, other than securities issued by the United StatesGovernment.

The Company has not experienced significant creditlosses from its accounts receivable. Affymetrix performs a regular review ofits customer activity and associated credit risks and does not requirecollateral from its customers. The Company maintains an allowance for doubtfulaccounts receivable based upon the expected collectibility of accounts receivable.

Certain raw materials or components used in thesynthesis of probe arrays or the assembly of instrumentation, are currentlyavailable only from a single source or limited sources. No assurance can begiven that these raw materials or other components of the GeneChip® system will be available in commercialquantities at acceptable costs from other vendors should the need arise. If theCompany is required to seek alternative sources of supply, it could be timeconsuming and expensive.

In addition, the Company is dependent on its vendorsto provide components of appropriate quality and reliability and to meetapplicable regulatory requirements. Consequently, in the event that suppliesfrom these vendors are delayed or interrupted for any reason, the Company’sability to develop and supply its products could be impaired, which could havea material adverse effect on the Company’s business, financial condition andresults of operations.

Approximately 50% of theCompany’s product and product related revenue is generated from sales outsidethe United States. Though such transactions are denominated in either UnitedStates dollars and foreign currencies, the Company’s results of operations arestill affected by such factors as changes in foreign currency exchange rates,trade protection measures, longer accounts receivable collection patterns andchanges in regional or worldwide economic or political conditions. The risks ofthe Company’s international operations are mitigated in part by the extent towhich its sales are geographically distributed and its foreign currency hedgingprogram.

76

----

**NOTE 6—AVAILABLE-FOR-SALESECURITIES AND OTHER FINANCIAL INSTRUMENTS**

**INVESTMENTSIN DEBT AND EQUITY SECURITIES**

Thefair values of all available-for-sale securities are based on quoted marketprices and are included in current assets as management considers thesecurities readily available to fund current operations. The following is asummary of available-for-sale securities as of December 31, 2005 (inthousands):

| ** **                                         | ** ** | **Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|----------------------------------------------------|------------|----------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| U.S. Government  obligations and agency securities |       | $        | 138,114    |                         |       | $                             | 1          |                |       |   | $ | (605 | ) |   | $ | 137,510 |   |
| U.S. corporate  debt securities                    |       | 124,198  |       |                         | 34         |                          |       |                | (428       | ) |   | 123,804 |   |
| Total securities                                   |       | $        | 262,312    |                         |       | $                             | 35         |                |       |   | $ | (1,033 | ) |   | $ | 261,314 |   |
| Amounts included in:                               |       |     |       |                         |       |                          |       |                |       |   |   |   |   |
| Cash equivalents                                   |       | $        | 76,617     |                         |       | $                             | 2          |                |       |   | $ | (1 | ) |   | $ | 76,618 |   |
| Available-for-sale securities                      |       | 185,695  |       |                         | 33         |                          |       |                | (1,032     | ) |   | 184,696 |   |
| Total securities                                   |       | $        | 262,312    |                         |       | $                             | 35         |                |       |   | $ | (1,033 | ) |   | $ | 261,314 |   |
| Amounts mature in:                                 |       |     |       |                         |       |                          |       |                |       |   |   |   |   |
| Less than one year                                 |       | $        | 230,739    |                         |       | $35                           |       |                |       | $ | (801 | ) |   | $ | 229,973 |   |
| One to two years                                   |       | 31,573   |       |                         | —     |                          |       |                | (232       | ) |   | 31,341 |   |
| Total securities                                   |       | $        | 262,312    |                         |       | $                             | 35         |                |       |   | $ | (1,033 | ) |   | $ | 261,314 |   |

 

Thefollowing is a summary of available-for-sale securities as of December 31,2004 (in thousands):

| ** **                                         | ** ** | **Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|----------------------------------------------------|------------|----------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| U.S. Government  obligations and agency securities |       | $        | 68,253     |                         |       | $                             | 3          |                |       |   | $ | (289 | ) |   | $ | 67,967 |   |
| U.S. corporate  debt securities                    |       | 113,179  |       |                         | 14         |                          |       |                | (552       | ) |   | 112,641 |   |
| Total securities                                   |       | $        | 181,432    |                         |       | $                             | 17         |                |       |   | $ | (841 | ) |   | $ | 180,608 |   |
| Amounts included in:                               |       |     |       |                         |       |                          |       |                |       |   |   |   |   |
| Cash equivalents                                   |       | $        | 17,487     |                         |       | $                             | 1          |                |       |   | $ | — |   |   | $ | 17,488 |   |
| Available-for-sale securities                      |       | 163,945  |       |                         | 16         |                          |       |                | (841       | ) |   | 163,120 |   |
| Total securities                                   |       | $        | 181,432    |                         |       | $                             | 17         |                |       |   | $ | (841 | ) |   | $ | 180,608 |   |
| Amounts mature in:                                 |       |     |       |                         |       |                          |       |                |       |   |   |   |   |
| Less than one year                                 |       | $        | 146,316    |                         |       | $                             | 17         |                |       |   | $ | (613 | ) |   | $ | 145,720 |   |
| One to three years                                 |       | 35,116   |       |                         | —     |                          |       |                | (228       | ) |   | 34,888 |   |
| Total securities                                   |       | $        | 181,432    |                         |       | $                             | 17         |                |       |   | $ | (841 | ) |   | $ | 180,608 |   |

 

Realized gains and losses for the year ended December 31,2005 were $0.1 million and $0.4 million, respectively. Realized gains andlosses for the year ended December 31, 2004 were $0.3 million and$1.2 million, respectively. Realized gains and losses are included ininterest income and other, net in the accompanying Consolidated Statements ofOperations. The gross unrealized losses as at December 31, 2005 and 2004,above were caused by interest rate increases. No significant facts orcircumstances have arisen to indicate that there has been any deterioration inthe creditworthiness of the issuers of our securities. Based on the Company’sreview of these securities, including the assessment of the severity of therelated unrealized losses, the Company has not recorded anyother-than-temporary impairments on these securities.

Excluding ouravailable-for-sale marketable securities, the declines in estimated fair valuesof certain investments were determined to be other-than-temporary. Accordingly,the Company recorded net 

77

----

impairmentlosses on certain investments in both publicly-traded and non-marketableequity securities of $2.2 million, $2.3 million and $0.9 millionduring the years ended December 31, 2005, 2004 and 2003, respectively. Netinvestment losses are included in interest income and other, net on theConsolidated Statement of Operations. Depending on market conditions, theCompany may incur additional charges on this investment portfolio in thefuture.

**DERIVATIVE FINANCIAL INSTRUMENTS**

The Company is exposed toforeign currency exchange rate fluctuations in the normal course of itsbusiness. As part of its risk management strategy, the Company uses derivativeinstruments to hedge certain foreign currency exposures. The Company hedges apercentage of forecasted international revenue with forward contracts and thegains and losses on these contracts largely offset gains and losses on thetransactions being hedged. The Company’s revenue hedging policy is designed toreduce the impact on its revenue of foreign currency exchange rate movements.The Company also hedges a percentage of its assets that are held innonfunctional currencies of our subsidiaries with forward contracts and thegains or losses on these contracts largely offset gains and losses on thechange in value of the underlying asset. The Company’s balance sheet hedgingpolicy is designed to reduce the fluctuations in earnings due to changes inforeign currency exchange rates. The Company does not use derivative contractsfor speculative purposes. During the years ended December 31, 2005 and2004, all of the Company’s hedges were deemed effective. At December 31,2005 and 2004, total outstanding contracts included the notional equivalent of$21.6 million and $62.6 million, respectively, in foreign currencyforward exchange contracts with a fair value of $0.8 million and$(1.7) million, respectively, which are included in other current assets(liabilities) on the Consolidated Balance Sheets. As of December 31, 2005,all contracts were set to expire at various times through December 2006.The Company applies hedge accounting based upon the criteria established byStatement of Financial Accounting Standards No. 133, whereby the Companydesignates its derivatives for revenue hedging purposes as cash flow hedges. TheCompany has elected not to designate its derivatives for balance sheet purposesas fair value hedges under SFAS 133 and have appropriately recorded anychanges in fair value to interest income and other, net. The net realizedforeign currency gains (losses) related to the foreign currency forwardcontracts were $1.4 million and ($1.1) million for the years ended December 31,2005 and 2004, respectively.

**OTHER FINANCIAL INSTRUMENTS**

Thecarrying amounts and estimated fair values of financial instruments, other thanthose accounted for in accordance with Statement of Financial AccountingStandards No. 115, were as follows at December 31, 2005 and 2004 (inthousands):

| ** **                       | ** ** | **2005**             | ** ** | **2004**                       | ** ** |
|----------------------------------|------------|----------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | **Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** | **Carrying  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
| Assets:                          |       |                 |       |                           |       |   |   |   |   |
| Non-marketable equity securities |       | $                    | 18,120     |                           | $          | 18,120 |   | $ | 14,890 |   | $ | 14,890 |   |
| Note receivable from Nuvelo      |       | 5,240                |       | 5,240                          |       | 4,940 |   | 4,940 |   |
| Employee loans receivable        |       | 1,824                |       | 1,824                          |       | 1,900 |   | 1,900 |   |
| Liability:                       |       |                 |       |                           |       |   |   |   |   |
| Convertible notes                |       | 120,000              |       | 189,886                        |       | 120,000 |   | 162,300 |   |
|                                  |            |                      |            |                                |            |  |  |  |  |  |  |  |  |

 

The fair value estimatesprovided above for the Company’s convertible notes were based on quoted marketprices available at December 31, 2005 and 2004. All other fair values werebased on current market rates, liquidation and net realizable values.

78

----

**NOTE 7—INVENTORIES**

Inventoriesconsist of the following at December 31, 2005 and 2004 (in thousands):

| ** **      | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
| Raw materials   |       | $        | 13,094     |     | $          | 6,719 |   |
| Work-in-process |       | 10,423   |       | 4,181    |       |
| Finished goods  |       | 12,463   |       | 7,097    |       |
| Total           |       | $        | 35,980     |     | $          | 17,997 |   |

 

**NOTE 8—PROPERTY AND EQUIPMENT**

Propertyand equipment consists of the following as of December 31, 2005 and 2004(in thousands):

| ** **                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Property and equipment:                        |       |     |       |     |       |
| Construction-in-progress                       |       | $        | 25,233     |     | $          | 16,927 |   |
| Equipment and furniture                        |       | 115,143  |       | 96,843   |       |
| Building and leasehold improvements            |       | 55,477   |       | 41,597   |       |
| Land                                           |       | 1,310    |       | 1,310    |       |
|                                           |       | 197,163  |       | 156,677  |       |
| Less accumulated depreciation and amortization |       | (111,603 | )          | (92,498  | )          |
| Net property and  equipment                    |       | $        | 85,560     |     | $          | 64,179 |   |

 

Construction-in-progressincludes construction costs for new and upgraded facilities in Singapore andWest Sacramento as well as related purchased equipment not yet placed inservice.

**NOTE 9—ACQUIRED TECHNOLOGY RIGHTS**

Acquired technology rights are comprised of licensesto technology covered by patents owned by third parties or patents acquired bythe Company and are amortized over the expected useful lives of these assets,which range from one to fifteen years. Accumulated amortization of these rightsamounted to $22.2 million and $14.6 million at December 31, 2005and 2004, respectively.

In May 2004, the Company reached an agreementwith Oxford Gene Technology, Ltd. (“OGT”) that required the Company tomake a total cash payment of $62.5 million to OGT. The agreement includedtwo distinct components. The first component related to the payment ofapproximately $20.6 million due in connection with previously accrued andexpensed royalty obligations through May 2004 calculated using the termsof the original license agreement. The second component related to a cashpayment of approximately $41.9 million to convert the Company’s nonexclusive royalty bearing license to certain OGT patents to a fully paid uplicense. The Company determined that the $41.9 million cash payment isless than the net present value of the future estimated royalty obligationsunder the terms of the original license agreement. In accordance with Statementof Financial Accounting Standard 142 (“SFAS 142”), *Goodwill and Other Intangible Assets*, the$41.9 million was recorded as an intangible asset. Consistent with theguidance in SFAS 142 and with Statement of Financial Accounting Standard141 (“SFAS 141”), *Business Combinations*,this fully paid license is being amortized over its remaining useful life ofapproximately ten years.

79

----

Theexpected future annual amortization expense of the Company’s acquiredtechnology rights is as follows (in thousands):

| **For the Year Ending December 31,** | ** ** | ** ** | ** ** | **Amortization  Expense** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|---------------------------|------------|
| 2006                                                          |       |       | $          | 7,942                     |       |   |
| 2007                                                          |       |       | 7,942      |                      |       |
| 2008                                                          |       |       | 7,930      |                      |       |
| 2009                                                          |       |       | 7,061      |                      |       |
| 2010                                                          |       |       | 6,321      |                      |       |
| Thereafter                                                    |       |       | 24,230     |                      |       |
| Total expected  future annual amortization                    |       |       | $          | 61,426                    |       |   |

 

**NOTE10—ACCOUNTS PAYABLE AND ACCRUED LIABILITIES**

Accountspayable and accrued liabilities as of December 31, 2005 and 2004 consistof the following (in thousands):

| ** **                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| Accounts payable                              |       | $        | 29,718     |     | $          | 14,000 |   |
| Accrued  compensation and related liabilities |       | 20,419   |       | 27,416   |       |
| Accrued taxes                                 |       | 10,354   |       | 10,158   |       |
| Accrued legal                                 |       | 1,357    |       | 694      |       |
| Accrued  warranties                           |       | 6,223    |       | 4,113    |       |
| Other                                         |       | 3,480    |       | 4,884    |       |
| Total                                         |       | $        | 71,551     |     | $          | 61,265 |   |

 

**NOTE11—RELATED PARTY TRANSACTIONS AND NOTES RECEIVABLE FROM EMPLOYEES**

***RELATED PARTY TRANSACTIONS***

**PERLEGEN SCIENCES,INC.**

As of December 31, 2005, theCompany, and certain of its affiliates, including the Company’s chief executiveofficer and members of the board of directors, held approximately 25% ownershipinterest in Perlegen Sciences, Inc. (“Perlegen”), a privately-heldbiotechnology company. In addition, two members of Perlegen’s board ofdirectors are also members of the Company’s board of directors.

The Company formed Perlegen in October 2000 as a wholly-ownedsubsidiary and spun it off in March 2001 in a $100 million private equityfinancing. The Company acquired its initial ownership interest in Perlegen inan arrangement which provides Perlegen rights to use certain of the Company’sintellectual property in its development efforts, and also provides the Companyrights to use and commercialize certain data generated by Perlegen in the arrayfield.

The Company accounts for its ownership interest in Perlegen using theequity method as the Company and its affiliates do not control the strategic,operating, investing and financing activities of Perlegen. Further, the Companyhas no obligations to provide funding to Perlegen nor does it guarantee orotherwise have any obligations related to the liabilities or results ofoperations of Perlegen or its investors. Through January 2005, the Company’sinvestment in Perlegen had no cost basis; accordingly, the Company has notrecorded its proportionate share of Perlegen’s operating losses in itsfinancial statements since the completion of Perlegen’s initial financing. In February 2005,the Company participated in Perlegen’s Series D preferred stock financingand recorded a $2.0 million investment related to this transaction, which wasincluded in the Company’s Consolidated Balance Sheet as a component of otherassets. As of June 30, 

80

----

2005 the Company had reduced the carryingvalue of its investment to zero through the recording of its proportionateshare of Perlegen’s operating losses it incurred since February 2005,which is included as a component of interest and other income, net, in theCompany’s Consolidated Statement of Operations for the year ended December 31,2005.

In accordance with Financial Accounting Standards Board Interpretation No. 46R(“FIN 46R”), “Consolidation of Variable Interest Entities, an Interpretation ofARB No. 51” as amended, the Company has concluded that Perlegen is aVariable Interest Entity (VIE) in which it holds a variable interest, and thatthe Company is not the primary beneficiary. Accordingly, no change to theCompany’s historical accounting for Perlegen is required.

On January 9, 2003, the Company entered into an agreement withPerlegen to in-license certain intangible assets that are expected toaccelerate its plans to design and commercialize the Company’s microarrays forwhole genome and candidate region DNA analysis. In addition to broadening itsaccess to certain specific Perlegen technologies, this licensing agreementadvanced by approximately three years its prior commercialization rights to thePerlegen single nucleotide polymorphism (SNP) database for the development ofAffymetrix microarray DNA products that the Company already had underdevelopment prior to January 2003. This agreement also eliminated anyfuture royalty obligations for array products that the Company may commercializebased on information contained in Perlegen’s SNP database. Under the terms ofthe licensing agreement, the Company paid Perlegen a total of$15.0 million in cash and granted Perlegen a $3.0 million credit tobe applied against the margin on the Company’s future sales of chips toPerlegen that were utilized by Perlegen in their revenue generating activities.In the second quarter of 2004, Perlegen had used all of the $3.0 millioncredit and as such, the Company has started to record margin on specific salesto Perlegen.

The $15.0 million of cash consideration in this transaction wasallocated to the following intangible asset categories based upon theirrelative estimated fair values: (i) The advancement by three years of itsaccess to the Perlegen SNP database, which allowed the Company to substantiallyaccelerate its ongoing development of a limited number of DNA analysisproducts; and (ii)Various licenses or modification of existing licenses forseveral Perlegen technologies which provided the Company benefits across alarger number of its microarray products;

In connection with the advanced access to the Perlegen SNP database, theCompany recorded a charge of approximately $10.1 million related to thelicense in the first quarter of 2003. The remaining $4.9 million wasrecorded as intangible assets which are being amortized over their useful livesof six to ten years.

The Company’s management engaged an independent third party valuationprofessional to assist them in determining the relative fair values of eachintangible asset licensed and the allocation of the consideration paid. Whilemanagement considered the work of the independent third party valuationprofessional, management took primary responsibility for allocating theconsideration paid for the intangible assets acquired. The $10.1 millioncharge associated with advanced access to the Perlegen SNP database wasincluded in acquired in-process technology in the Consolidated Statement ofOperations as the database has no alternative future use to us beyond itsdeveloping a limited number of closely related DNA analysis products. Theadvanced access to the Perlegen SNP database was obtained for use in developinga finite number of products within its DNA analysis product line. Therefore, asof the license date, the Company did not forecast any material changes from itshistorical gross margins for any of its DNA analysis products.

The Company determined the value of the SNP database license by using theIncome Approach. In applying this approach, the Company estimated the netpresent value of future cash flows expected from the sale of DNA analysisproducts to be developed in reliance on the content from the Perlegen SNPdatabase. The analysis included forecasted future cash flows that the Companyexpected from the progress 

81

----

made on its DNA microarray developmentprojects prior to the date of the Perlegen SNP database license. These cashflows were first estimated by forecasting total revenue associated with salesof certain of its future DNA analysis products. A portion of this revenue wasthen removed to account for the contribution provided by its existing coretechnology that was considered to benefit the DNA products under development.Appropriate operating expenses, cash flow adjustments, and contributory assetreturns were deducted from the estimated cash flows to establish a forecast ofnet cash flows. Finally, these net cash flows were converted to a present valueusing a discount rate of 30%, which was based on its weighted average cost ofcapital adjusted for the technical and market risks associated with its ongoingresearch project in which the SNP database content would be used. Significantcash inflows from the associated DNA products were forecasted to begin in 2004and continue through 2008.

The remaining various licenses or substantive modification of existinglicenses for several other Perlegen in-licensed technologies had alternativefuture uses to us beyond the development of a limited number of closely relatedDNA analysis products. The Company determined the relative fair value assignedto these assets using the Royalty Savings approach. In applying this approach,the Company estimated the value of the licenses by capitalizing the royaltiessaved because the Company obtained royalty-free access to these licenses. Thesecash flows were estimated by forecasting total royalty savings by multiplyingthe assumed royalty rates by the estimated annual revenues for certain productsfor the fiscal years 2004 through 2012. Finally, these cash flows werediscounted to a present value using a lower discount rate of 17%, which theCompany believes appropriately reflects the risk associated with its futureproduct revenue streams.

In December 2003, the Company sold 950,000 shares of Perlegen commonstock and realized a gain of $1.4 million which was included in interestand other income, net. Additionally, In January 2004, the Company sold400,000 shares of Perlegen common stock and realized a gain of$0.6 million which was included in interest income and other, net.

On June 28, 2005, the Company executed an agreement with a customerpursuant to which the Company agreed to provide genotypic data in the contextof whole genome association studies. The Company has subcontracted certainelements of this agreement to Perlegen which will use AffymetrixGeneChip® technology to provide the genotypic data. TheCompany may incur up to $3.6 million in expenses related to subcontractservices from Perlegen through the term of the agreement, which is expected toend in 2006. As of December 31, 2005, no expenses have been incurred.

In the third andfourth quarters of 2005, the Company supplied Perlegenwith probe arrays for use in providing genotyping services tothird parties in specific projects. These sales to Perlegenare outside the scope of the existingsupply arrangement with Perlegen and are included inrevenue from Perlegen on the Consolidated Statement of Operations for theyear ended December 31, 2005.

**ARRAY AUTOMATION, LLC**

The Company is currently a partner in ArrayAutomation, LLC (“AAL”), a joint venture with Beckman Coulter, Inc. (“Beckman”).In July 1998, the Company entered into an asset purchase agreement withBeckman. As part of the asset purchase agreement, the Company agreed toestablish a joint venture with Beckman. AAL was incorporated in July 2003,with the primary purpose of product research and development in the field ofnon-photolithographic arrays of polynucleotide sequences and instruments. Inaccordance with the agreement between the Company and Beckman, 100% of thelosses generated by AAL are allocated to Beckman. Future net income generatedby AAL, if any, is allocated 51% to the Company and 49% to Beckman, afterBeckman has recovered all of the cumulative losses it has recorded.

Based on the applicationof FIN 46R, the Company has concluded that AAL is a VIE, but that the Companyis not the primary beneficiary of AAL. Accordingly, the Company will accountfor its investment in AAL using the equity method. Since the cost basis of theCompany’s assets contributed to AAL were of 

82

----

zerovalue, the Company’s investment in AAL is also recorded at zero value. As aresult, the Company will not record any impact of AAL’s operating results inits consolidated statements of operations until, and only if, Beckman hasrecovered all of the losses that it will absorb pursuant to the terms of thejoint venture agreement. If AAL is terminated with a cumulative deficit, theCompany is not obligated to fund any such losses. In addition, the Company doesnot have any obligation to provide funding to AAL, guarantee or otherwise haveany obligations related to the liabilities of AAL or its investors.

***NOTES RECEIVABLE FROM EMPLOYEES***

The Company has notesreceivable from employees totaling $1.8 million and $1.9 million asof December 31, 2005 and 2004, respectively. The notes are generally duefour to five years after the date of issuance and accrued interest is due basedon the Internal Revenue Service imputed interest rate at the date of issuance.Interest rates have generally been between 2% and 6%. In July 2001, theCompany entered into a credit arrangement with an officer of the Company for anamount not to exceed $1.2 million. In January 2004, the officerborrowed the entire $1.2 million available under the arrangement.Repayment of the $1.2 million is due on the earlier date of i) fouryears from the date of withdrawal or ii) the date the executive leaves theCompany. The note bears interest at the IRS imputed rate of 3.5%, and accruedinterest is payable after two years.

**NOTE12—COMMITMENTS AND CONTINGENCIES**

***OPERATING LEASES***

Affymetrixleases laboratory, office and manufacturing facilities under non-cancelableoperating leases that expire at various times through 2016. Some of theseleases contain renewal options ranging from two to five years and escalationclauses. Rent expense related to operating leases was approximately$8.9 million in 2005, $8.6 million in 2004, and $6.9 million in2003. In connection with some of these facility leases, the Company has madesecurity deposits totaling $2.7 million, which are included in long-termother assets in the Consolidated Balance Sheets. Future minimum leaseobligations at December 31, 2005 under all non-cancelable operating leasesare as follows (in thousands):

| **Year Ending December 31,** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2006                                        |       | $          | 11,085     |       |
| 2007                                        |       | 10,375     |       |
| 2008                                        |       | 10,071     |       |
| 2009                                        |       | 7,171      |       |
| 2010                                        |       | 6,098      |       |
| Thereafter                                  |       | 16,478     |       |
| Total minimum lease  payments               |       | $          | 61,278     |       |

 

83

----

***PRODUCT WARRANTY COMMITMENT***

TheCompany provides for anticipated warranty costs at the time the associatedrevenue is recognized. Product warranty costs are estimated based upon theCompany’s historical experience and the warranty period. The Companyperiodically reviews the adequacy of its warranty reserve, and adjusts, if necessary,the warranty percentage and accrual based on actual experience and estimatedcosts to be incurred. In the third quarter of 2005, the Company adjusted itswarranty reserve by approximately $2.0 million for anticipated costs associatedwith its decision to replace the Mapping 500K Array sets purchased by certainof its early access customers. Information regarding the changes in the Company’sproduct warranty liability for the years ended December 31, 2004 and December 31,2005 is as follows (in thousands):

| ** **                         | ** ** | **Amount** | ** ** |
|------------------------------------|------------|------------|------------|
| Balance at  December 31, 2003 |       | $          | 2,950      |   |
| New warranties  issued             |       | 4,684      |       |
| Repairs and  replacements          |       | (3,521     | )          |
| Adjustments                        |       | —     |       |
| Balance at  December 31, 2004 |       | 4,113      |       |
| New warranties  issued             |       | 5,002      |       |
| Repairs and  replacements          |       | (4,918     | )          |
| Adjustments                        |       | 2,026      |       |
| Balance at  December 31, 2005 |       | $          | 6,223      |   |

 

***FUNDING COMMITMENTS***

The Company has invested$8.5 million and is committed to invest up to an additional$1.5 million in a venture capital limited partnership. The investment isincluded on the Consolidated Balance Sheet as a component of other assets andis accounted for under the equity method.

***NON-CANCELABLE SUPPLY AGREEMENTS***

As of December 31,2005, the Company had approximately $3.9 million of non-cancelableinventory supply agreements that are in effect through 2009.

***INDEMNIFICATIONS***

From time to time theCompany has entered into indemnification provisions under certain of itsagreements with other companies in the ordinary course of business, typicallywith business partners, customers, and suppliers. Pursuant to these agreements,the Company generally indemnifies, holds harmless, and agrees to reimburse theindemnified parties on a case by case basis for losses suffered or incurred bythe indemnified parties in connection with any U.S. patent or otherintellectual property infringement claim by any third party with respect to itsproducts. The term of these indemnification provisions is generally perpetualfrom the time of the execution of the agreement. The maximum potential amount offuture payments the Company could be required to make under theseindemnification provisions is unlimited. In addition, the Company has enteredinto indemnification agreements with its officers and directors. The Companyhas not incurred material costs to defend lawsuits or settle claims related tothese indemnification provisions. As of December 31, 2005, the Company hadnot accrued a liability for this guarantee, because the likelihood of incurringa payment obligation in connection with this guarantee is remote.

84

----

***LEGAL PROCEEDINGS***

**GENERAL**

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

*MultilyteLitigation*

Multilyte Ltd., aBritish corporation, and Affymetrix are engaged in legal proceedings in Germanyand the United States to address allegations made by Multilyte that the Companyinfringes certain patents owned by Multilyte (the “Multilyte patents”) bymaking and selling our GeneChip® DNA microarray products.

*Germany*

In the actions pending inGermany, on July 18, 2003, Multilyte filed proceedings in the state courtof Düsseldorf, alleging infringement of the Multilyte patents. In a separateaction in Germany, on October 15, 2003, the Company commenced nullityproceedings in German Federal Patent Court in Munich alleging that the Germanpart of Multilyte’s two European patents (EPs 0 134 215 and 0304 202) are invalid. On June 29 and 30, 2004, the German Federal PatentCourt in Munich held that both Multilyte European patents are invalid inGermany. Following that ruling, on July 12, 2004, the Düsseldorf courtstayed both sets of infringement proceedings before it, pending Multilyte’sappeal of the decisions of the German Federal Patent Court in Munich nullifyingboth Multilyte patents. The Company was notified on April 5, 2005 thatMultilyte has abandoned its appeal of the decision nullifying the EuropeanPatent 0 134 215.

*United States*

In the U.S. action, on August 13, 2003, theCompany commenced proceedings in the United States District Court for theNorthern District of California seeking a declaratory judgment that eightMultilyte patents are not infringed and are invalid. Multilyte has agreed thatthe Company does not infringe five of the eight named patents. On October 24,2003, the Company filed an amended complaint seeking a declaratory judgment asto three of the original eight named patents—U.S. Patents 5,432,099, 5,599,720and 5,807,755. Multilyte answered the Company’s complaint for declaratoryjudgment and asserted counterclaims against the Company alleging infringementof the three patents named by the Company in its complaint. Multilyte hassubmitted the three patents-in-suit to the United States Patent and TrademarkOffice for voluntary re-examination. These patents remain in re-examination inthe USPTO. On April 28, 2005, the Court granted the Company’s motions forsummary judgment of non-infringement and entered a 

85

----

final judgment in theaction in favor of the Company against Multilyte. On May 5, 2005,Multilyte filed a notice of motion to amend the judgment asserting that theCourt’s entry of final judgment was premature because it did not give Multilytethe opportunity to present evidence showing infringement under the Court’s mostrecent claim construction. On June 23, 2005, the Court again grantedsummary judgment of non-infringement. The Court then entered judgment in favorof the Company. Multilyte has appealed the Court’s decision to the UnitedStates Court of Appeals for the Federal Circuit which held oral argument on theappeal on March 7, 2006.

The Company believes thatMultilyte’s remaining claims against it are without merit and has filed thedeclaratory judgment and nullity actions to protect its interests. However, theCompany cannot be sure that it will prevail in these matters. The Company’sfailure to successfully defend against these allegations could result in amaterial adverse effect on its business, financial condition and results ofoperations.

*Enzo Litigation*

On October 28, 2003, Enzo Life Sciences, Inc.,a wholly-owned subsidiary of Enzo Biochem, Inc. (collectively “Enzo”) fileda complaint against the Company that is now pending in the United StatesDistrict Court for the Southern District of New York for breach of contract,injunctive relief and declaratory judgment. The Enzo complaint relates to a1998 distributorship agreement with Enzo under which the Company served as anon-exclusive distributor of certain reagent labeling kits supplied by Enzo. Inits complaint, Enzo seeks monetary damages and an injunction against theCompany from using, manufacturing or selling Enzo products and from inducingcollaborators and customers to use Enzo products in violation of the 1998agreement. Enzo also seeks the transfer of certain Affymetrix patents to Enzo.In connection with its complaint, Enzo provided the Company with a notice of terminationof the 1998 agreement effective on November 12, 2003.

On November 10, 2003, the Company filed acomplaint against Enzo in the United States District Court for the SouthernDistrict of New York for declaratory judgment, breach of contract and injunctiverelief relating to the 1998 agreement. In its complaint, the Company allegesthat Enzo has engaged in a pattern of wrongful conduct against it and otherEnzo labeling reagent customers by, among other things, asserting improperlybroad rights in its patent portfolio, improperly using the 1998 agreement anddistributorship agreements with others in order to corner the market fornon-radioactive labeling reagents, and improperly using the 1998 agreement toclaim ownership rights to the Company’s proprietary technology. The Companyseeks declarations that it has not breached the 1998 agreement, that it isentitled to sell its remaining inventory of Enzo reagent labeling kits, andthat nine Enzo patents that are identified in the 1998 agreement are invalidand/or not infringed by it. The Company also seeks damages and injunctiverelief to redress Enzo’s alleged breaches of the 1998 agreement, its allegedtortious interference with the Company’s business relationships and prospectiveeconomic advantage, and Enzo’s alleged unfair competition. The Company filed anotice of related case stating that its complaint against Enzo is related tothe complaints already pending in the Southern District of New York againsteight other former Enzo distributors. The U.S. District Court for the SouthernDistrict of New York has related the Company’s case. There is no trial date inthe actions between Enzo and the Company.

The Company believes thatthe claims set forth in Enzo’s complaint are without merit and have filed theaction 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’sfailure to successfully defend against these allegations could result in amaterial adverse effect on its business, financial condition and results ofoperation.

86

----

*AdministrativeLitigation and Proceedings*

The Company’s intellectual property is subject to anumber of significant administrative and litigation actions. For example, inEurope and Japan, we expect third parties to oppose significant patents thatthe Company owns or controls. Currently, Multilyte Ltd. and ProtoGeneLaboratories, Inc. filed oppositions against the Company’s EP 0 619 321patent in the European Patent Office. PamGene B.V. has filed an oppositionagainst the Company’s EP 0 728 520 patent and it was revoked at oralproceedings on January 14, 2004. Affymetrix has appealed this ruling. Also,Abbott Laboratories, Applera, Clondiag and CombiMatrix are parties inopposition against the Company’s EP 0 834 575. An oral hearing was conducted bythe Opposition Division which upheld the patent on December 4, 2004, andthis decision has been appealed. Abbott Laboratories, CombiMatrix, PamGeneB.V., Applera and Dr. Peter Schneider filed an opposition against theCompany’s EP 0 834 576 patent. The Opposition Division revoked the patentduring an oral hearing on February 23, 2005 and Affymetrix has appealedthis ruling. CombiMatrix has filed an opposition against EP 0 695 941, Agilent,CombiMatrix, Clondiag and Applera have filed an opposition against EP 0 853679, Applera has opposed EP 0 972 564 and Degussa AG has filed an oppositionagainst EP 1 086 742. These procedures will result in the respective patentsbeing either upheld in their entirety, allowed to issue in amended form indesignated European countries, or revoked.

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

At this time, the Companycannot determine the outcome of any of the matters described above.

**NOTE13—CONVERTIBLE SUBORDINATED NOTES**

On September 22, 1999, the Company completed thesale of $150 million principal amount of 5% convertible subordinated notesdue 2006 (the “5% Notes”). The 5% Notes mature on October 1, 2006 and bearinterest at a rate of 5% per annum, which is payable semi-annually onApril 1 and October 1. The 5% Notes are convertible, at the option ofthe holder at any time prior to maturity or redemption, into shares of theCompany’s common stock at a conversion price of $61.50 per share, subject toadjustment. The Company can redeem some or all of the 5% Notes at any timeafter October 7, 2002, and the debt holder has a right to require theCompany to purchase all or a portion of the 5% Notes upon a change in control.The 5% Notes are subordinated to all of the Company’s existing and futuresenior indebtedness. Total offering expenses related to the 5% notes were$5.4 million and have been included in other assets. These expenses willbe amortized to interest expense over the life of the notes.

On February 14, 2000, the Company completed thesale of $225.0 million principal amount of 4.75% convertible subordinatednotes due 2007 (the “4.75% Notes”). The 4.75% Notes mature on February 15,2007 and bear interest at a rate of 4.75% per annum, which is payablesemi-annually on February 15 and August 15. The 4.75% Notes areconvertible, at the option of the holder at any time prior to maturity orredemption, into shares of the Company’s common stock at a conversion price of$160.50 per share, subject to adjustment. The Company can redeem some or all ofthe 4.75% Notes at any time after February 20, 2003 and the debt holdershave a right to require the Company to purchase all or a portion of the 4.75%Notes upon a change in control. The 4.75% Notes are subordinated to all of theCompany’s existing and future senior indebtedness. Total offering expensesrelated to these notes were $7.2 million and have been included in otherassets. These expenses will be amortized to interest expense over the life ofthe 4.75% Notes.

87

----

Between August 2001and June 2003, the Company repurchased $59.5 million and$48.0 million principal amounts of its 4.75% Notes and 5% Notes,respectively. On January 9, 2004, the Company completed the redemption ofits 5% Notes ($102.0 million face value). In connection with theredemption, the Company recorded a charge of $3.2 million to interestexpense in the first quarter of 2004, related to the unamortized issuance costsand redemption fee associated with the repurchased notes. On February 19,2004, the Company also completed the redemption of its 4.75% Notes ($165.5 millionface value). In connection with the redemption, the Company recorded a chargeof $4.9 million to interest expense related to the unamortized issuancecosts and redemption fee associated with the repurchased notes.

**NOTE 14—SENIOR CONVERTIBLE NOTES**

On December 10, 2003, the Company issued$120.0 million of 0.75% Senior Convertible Notes (the “0.75% Notes”) due December 15,2033. The net proceeds after issuance costs (which will be amortized over5 years, the earliest term for redemption outside of the Company’scontrol), from the 0.75% Notes offering were $116.0 million. The 0.75%Notes bear interest of 0.75% per year on the principal amount payablesemi-annually in arrears on June 15 and December 15 of each year,beginning June 15, 2004. The Company used the net proceeds of the offeringto repurchase its 4.75% Notes. The 0.75% Notes are convertible into 32.2431shares of Affymetrix common stock per $1,000 principal amount of notes whichequates to 3,869,172 shares of common stock, or $31.01 per share of commonstock subject to adjustment, prior to the close of business on the business dayprior to the maturity date under the following circumstances: (1) duringany quarterly conversion period prior to December 15, 2028, if the salesprice of the Company’s common stock for at least 20 trading days in the 30consecutive trading-day period ending on the first day of such conversionperiod reaches a specified threshold, (2) on or after December 28,2028, at any time after the sale price of the Company’s common stock on anydate is greater than 130% of the then current conversion price, (3) duringthe five consecutive trading-day period in which the average of the tradingprices for the notes was less than 98% of the average of the sale price of theCompany’s common stock multiplied by the then applicable conversion rate, (4) the0.75% Notes are called for redemption, or (5) specified corporatetransactions have occurred.

On December 15, 2008,the security holders have the option to deliver the 0.75% Notes to Affymetrixand require the Company to repurchase all outstanding 0.75% Notes for $1,000 incash each up to a maximum of $120.0 million for all outstanding 0.75%Notes. Additionally, security holders also have the option to require theCompany to repurchase the 0.75% Notes payable in cash along with any accruedbut unpaid interest on December 15, 2013, 2018, 2023, and 2028.Additionally, Affymetrix has the option of redeeming all or part of the 0.75%Notes plus accrued but unpaid interest on or after December 15, 2008 forcash.

**NOTE 15—STOCKHOLDERS’ EQUITY**

**STOCKHOLDER RIGHTS PLAN**

On October 15, 1998, the Board of Directors ofthe Company declared a dividend of (i) one preferred share purchase right(a “Right”) for each outstanding share of common stock of the Company, and (ii) anumber of Rights for each share of Series AA Preferred Stock of theCompany equal to the number of shares of common stock into which such share of Series AAPreferred Stock was convertible. The dividend was paid on October 27, 1998(the “Record Date”) to the stockholders of record on that date. Each Rightentitles the registered holder to purchase from the Company one one-thousandthof a share of Series B Junior Participating Preferred Stock, par value$.01 per share, of the Company (the “Series B Preferred Stock”) at a priceof $62.50 per one one-thousandth of a share of Series B Preferred Stock,subject to adjustment. The Rights will be exercisable if a person or grouphereafter acquires beneficial ownership of 15% or more of the common stock ofthe Company or announces a tender offer for 15% or more of the 

88

----

common stock. The Board ofDirectors will be entitled to redeem the Rights at one cent per Right at anytime before any such person acquires beneficial ownership of 15% or more of theoutstanding common stock. If a person or group acquires 15% or more of theoutstanding common stock of the Company, each Right will entitle its holder topurchase, at the Right’s exercise price, a number of shares of common stockhaving a market value at that time of twice the Right’s exercise price. Rightsheld by the 15% holder will become void and will not be exercisable to purchaseshares at the bargain purchase price. If the Company is acquired in a merger orother business combination transaction after a person acquires 15% or more ofthe Company’s common stock, each Right will entitle its holder to purchase, atthe Right’s then-current exercise price, a number of the acquiring company’scommon shares having a market value at that time of twice the Right’s exerciseprice.

On February 7, 2000,the Company’s Board of the Directors approved an amendment to its stockholdersrights plan. The amendment increases the exercise price of the Preferred SharePurchase Rights to $625.00 and extends the expiration date of the plan to February 2010.Under the amended plan, each Preferred Share Purchase Right entitlesstockholders to buy one one-thousandth of a share of Series B JuniorParticipating Preferred Stock of the Company at the new exercise price of$625.00. The Rights will be exercisable if a person or group acquiresbeneficial ownership of 15% or more of the common stock of the Company orannounces a tender offer for 15% or more of the common stock.

**STOCK OPTION AND BENEFIT PLANS**

In 1996, the Board of Directors adopted the Affymetrix1996 Non-Employee Directors Stock Option Plan (the "1996 StockPlan"), which was amended and restated in 2001, under which onlynonqualified stock options may be granted to non-employee directors of theCompany. Options granted under the 1996 Stock Plan expire no later than tenyears and two days from the date of grant. The option price shall be at least100% of the fair value of the Company's common stock on the date of grant (110%in certain circumstances), as determined by the Board of Directors. Optionsgranted under the 1996 Stock Plan are subject to the vesting provisions setforth in that plan. A total of 600,000 shares of common stock are authorized forissuance under the 1996 Stock Plan and the shares are subject to repurchase bythe Company under the terms of the grant. All options granted under the 1996Stock Plan are exercisable in full six months after the date of grant and aresubject to repurchase at the original exercise price by the Company over theremaining vesting period which is generally five years for initial grants andone year for annual grants. At December 31, 2005, there were no shares subjectto repurchase under this plan.

In 1998, the Board of Directors adopted the Affymetrix1998 Stock Incentive Plan (the “1998 Stock Plan”) under which nonqualifiedstock options and restricted stock may be granted to employees and outsideconsultants, except that members of the Board of Directors and individuals whoare considered officers of the Company under the rules of the NationalAssociation of Securities Dealers shall not be eligible. Options granted underthe 1998 Stock Plan expire no later than ten years from the date of grant. Theoption price shall be at least 100% of the fair value of the Company’s commonstock on the date of grant (110% in certain circumstances), as determined bythe Board of Directors. Options may be granted with different vesting termsfrom time to time as determined by the Board of Directors. A total of 3,600,000shares of common stock are authorized for issuance under the 1998 Stock Plan .

In 2000, the Board of Directors adopted the 2000Equity Incentive Plan (the “2000 Stock Plan”), which was amended and restatedin 2001, under which restricted shares, stock units, stock options and stockappreciation rights may be granted to employees, outside directors andconsultants. Options granted under the 2000 Stock Plan expire no later than tenyears from the date of grant. The option price shall be at least 100% of thefair value of the Company’s common stock on the date of grant (110% in certaincircumstances), as determined by the Board of Directors. Options may be grantedwith different vesting terms from time to time as determined by the Board ofDirectors. In 2004, the 2000 Stock Plan was 

89

----

amended and restated toincrease share availability by 2,500,000 shares bringing the total shares ofcommon stock authorized for issuance under the 2000 Stock Plan to 7,500,000.

On October 21, 2005, Affymetrix completed theacquisition of ParAllele and assumed all options outstanding under its stockoption plan, which was subsequently amended and is now the Affymetrix/ParAllele2001 Stock Option Plan (“ParAllele Stock Plan”). If all assumed options underthe ParAllele Stock Plan became fully vested and exercised, they would convertto 190,944 shares of Affymetrix’ common stock. No additional options areauthorized for grant. Options granted under the ParAllele Stock Plan expire nolater than ten years from the date of grant.

Activityunder the stock plans through December 31, 2005 is as follows (inthousands, except per share amounts):

| ** **                         | ** ** | ** **                         | ** ** | **Options Outstanding** | ** ** |
|------------------------------------|------------|------------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **Options  Available  for  Grant** | ** ** | **Number  Outstanding**      | ** ** | **Weighted  Averaged  Exercise Price  Per Share** | ** ** |
| Balance at  December 31, 2002 |       |                               | 2,082      |                         |       |   | 11,126 |   |   |   | $ | 24.66 |   |   |
| Granted                            |       |                               | (436       | )                            |       |   | 436 |   |   |   | $ | 23.10 |   |   |
| Exercised                          |       |                               | —     |                         |       |   | (834 | ) |   |   | $ | 14.33 |   |   |
| Canceled                           |       |                               | 652        |                         |       |   | (653 | ) |   |   | $ | 24.21 |   |   |
| Expired                            |       |                               | (660       | )                            |       |   | — |   |   |   | — |   |   |
| Balance at  December 31, 2003 |       |                               | 1,638      |                         |       |   | 10,075 |   |   |   | $ | 25.48 |   |   |
| Authorized                         |       |                               | 2,500      |                         |       |   | — |   |   |   | — |   |   |
| Granted                            |       |                               | (1,729     | )                            |       |   | 1,730 |   |   |   | $ | 30.75 |   |   |
| Exercised                          |       |                               | —     |                         |       |   | (2,101 | ) |   |   | $ | 17.32 |   |   |
| Canceled                           |       |                               | 361        |                         |       |   | (361 | ) |   |   | $ | 39.05 |   |   |
| Expired                            |       |                               | (43        | )                            |       |   | — |   |   |   | $ | 23.01 |   |   |
| Balance at  December 31, 2004 |       |                               | 2,727      |                         |       |   | 9,343 |   |   |   | $ | 27.72 |   |   |
| Authorized                         |       |                               | 191        |                         |       |   | — |   |   |   | — |   |   |
| Granted                            |       |                               | (1,076     | )                            |       |   | 1,076 |   |   |   | $ | 45.08 |   |   |
| Exercised                          |       |                               | —     |                         |       |   | (3,294 | ) |   |   | $ | 22.89 |   |   |
| Canceled                           |       |                               | 368        |                         |       |   | (368 | ) |   |   | $ | 37.25 |   |   |
| Expired                            |       |                               | (15        | )                            |       |   | — |   |   |   | — |   |   |
| Balance at December 31, 2005  |       |                               | 2,195      |                         |       |   | 6,757 |   |   |   | $ | 31.31 |   |   |

 

Thefollowing table summarizes information concerning currently outstanding andexercisable options at December 31, 2005:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**    | ** ** |
|---------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  (in thousands)** | ** ** | **Weighted-Average  Remaining  Contractual Life  (In Years)** | ** ** | **Weighted-Average  Exercise Price  Per Share** | ** ** | **Number  (in thousands)** | ** ** | **Weighted-Average  Exercise Price  Per Share** | ** ** |
| $  0.26 -  $20.38                 |       |                         | 1,069      |                            |       |   | 4.18 |   |   |   | $ | 13.81 |   |   |   | 876 |   |   |   | $ | 14.59 |   |   |
| $20.50 - $24.44                             |       |                         | 1,429      |                            |       |   | 4.37 |   |   |   | $ | 23.41 |   |   |   | 1,246 |   |   |   | $ | 23.53 |   |   |
| $24.48 - $30.32                             |       |                         | 894        |                            |       |   | 4.85 |   |   |   | $ | 26.97 |   |   |   | 500 |   |   |   | $ | 26.59 |   |   |
| $30.34 - $34.51                             |       |                         | 1,278      |                            |       |   | 5.85 |   |   |   | $ | 31.23 |   |   |   | 635 |   |   |   | $ | 31.23 |   |   |
| $34.56 - $45.94                             |       |                         | 647        |                            |       |   | 6.13 |   |   |   | $ | 40.60 |   |   |   | 192 |   |   |   | $ | 37.14 |   |   |
| $45.98 - $50.07                             |       |                         | 1,000      |                            |       |   | 5.04 |   |   |   | $ | 47.88 |   |   |   | 841 |   |   |   | $ | 47.86 |   |   |
| $50.28 - $60.94                             |       |                         | 407        |                            |       |   | 6.35 |   |   |   | $ | 55.53 |   |   |   | 151 |   |   |   | $ | 55.52 |   |   |
| $61.25 - $133.50                            |       |                         | 33         |                            |       |   | 4.70 |   |   |   | $ | 77.95 |   |   |   | 33 |   |   |   | $ | 77.95 |   |   |
| Total                                       |       |                         | 6,757      |                            |       |   | 5.07 |   |   |   | $ | 31.31 |   |   |   | 4,474 |   |   |   | $ | 29.86 |   |   |
|                                             |            |                              |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

90

----

**RESERVED SHARES**

At December 31,2005, the Company has shares reserved for future issuance as follows (inthousands):

| Options  outstanding                 |   | 6,757  |   |
|--------------------------------------|--------|--------|--------|
| Options available  for future grants |   | 2,195  |   |
| Convertible  subordinated notes      |   | 3,870  |   |
|                                 |   | 12,822 |   |

 

**NOTE 16—INCOME TAXES**

Thefollowing table presents the U.S. and foreign components of consolidated income(loss) before income taxes and the provision for income taxes (in thousands):

| ** **                                                 | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| **INCOME (LOSS) BEFORE INCOME TAXES:** |       |                                       |       |   |   |   |   |
| U.S.                                                       |       | $                                          | 127,382    |   | $ | 48,208 |   | $ | 15,064 |   |
| Foreign                                                    |       | (64,774                                    | )          | 2,726 |   | 1,784 |   |
| Income (loss)  before income taxes                         |       | $                                          | 62,608     |   | $ | 50,934 |   | $ | 16,848 |   |
| **PROVISION  FOR INCOME TAXES:**                           |       |                                       |       |   |   |   |   |
| Current:                                                   |       |                                       |       |   |   |   |   |
| Federal                                                    |       | $                                          | 30,380     |   | $ | 437 |   | $ | 1,500 |   |
| State                                                      |       | 2,663                                      |       | 280 |   | 293 |   |
| Foreign                                                    |       | 1,969                                      |       | 2,609 |   | 770 |   |
| Subtotal                                                   |       | $                                          | 35,012     |   | $ | 3,326 |   | $ | 2,563 |   |
| Deferred:                                                  |       |                                       |       |   |   |   |   |
| Federal                                                    |       | $                                          | (29,170    | ) | $ | — |   | $ | — |   |
| State                                                      |       | —                                     |       | — |   | — |   |
| Foreign                                                    |       | (750                                       | )          | — |   | — |   |
| Subtotal                                                   |       | $                                          | (29,920    | ) | $ | — |   | $ | — |   |
| Provision for  income taxes                                |       | $                                          | 5,092      |   | $ | 3,326 |   | $ | 2,563 |   |

 

91

----

Thedifference between the provision for income taxes and the amount computed byapplying the Federal statutory income tax rate (35%) to income before taxes isexplained as follows (in thousands):

| ** **                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Tax at federal  statutory rate                      |       | $                                          | 21,913     |   | $ | 17,827 |   | $ | 5,896 |   |
| Previously  unbenefited losses                      |       | (49,279                                    | )          | (17,503 | ) | (6,571 | ) |
| State taxes, net                                    |       | 4,042                                      |       | 182 |   | 190 |   |
| Non-deductible  stock compensation                  |       | 281                                        |       | 322 |   | 783 |   |
| Foreign taxes                                       |       | 523                                        |       | 1,657 |   | 748 |   |
| Unbenefited foreign  loss                           |       | 28,597                                     |       | — |   | — |   |
| Alternative  minimum taxes                          |       | —                                     |       | 1,751 |   | 1,500 |   |
| Non-deductible  in-process research and development |       | 2,910                                      |       | — |   | — |   |
| Research credits                                    |       | (2,137                                     | )          | — |   | — |   |
| Export tax  benefits                                |       | (1,142                                     | )          | — |   | — |   |
| Domestic  manufacturing deduction                   |       | (840                                       | )          | — |   | — |   |
| Other                                               |       | 224                                        |       | (910 | ) | 17 |   |
|                                                |       | $                                          | 5,092      |   | $ | 3,326 |   | $ | 2,563 |   |

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of theCompany’s deferred tax assets are as follows (in thousands):

| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Deferred tax assets:                         |       |                  |       |   |   |
| Net operating loss carryforwards             |       | $                     | 52,925     |   | $ | 64,034 |   |
| Tax credit carryforwards                     |       | 29,024                |       | 16,682 |   |
| Deferred revenue                             |       | 12,899                |       | 18,631 |   |
| Capitalized research and development costs   |       | 3,126                 |       | 3,985 |   |
| Intangibles                                  |       | 2,242                 |       | 2,704 |   |
| Accrued compensation                         |       | 3,492                 |       | 3,349 |   |
| Accrued warranty                             |       | 2,452                 |       | 1,652 |   |
| Equipment reserve                            |       | 4,452                 |       | 2,477 |   |
| Other, net                                   |       | 9,209                 |       | 4,668 |   |
| Total deferred tax assets                    |       | 119,821               |       | 118,182 |   |
| Valuation  allowance for deferred tax assets |       | (82,324               | )          | (118,182 | ) |
| Net deferred tax assets                      |       | 37,497                |       | — |   |
| Net deferred tax  liabilities:               |       |                  |       |   |   |
| Property and equipment                       |       | (1,944                | )          | — |   |
| Net deferred tax  assets                     |       | $                     | 35,553     |   | $ | — |   |

 

As of December 31, 2005, the Company had totalnet operating loss carryforwards of $186.9 million, comprised of $144.2 millionfor U.S. federal purposes and $42.7 million for state purposes. The netoperating loss carryforwards expire in the years 2018 through 2023. Additionally,the Company has federal and state research and development tax creditcarryforwards and other various tax credit carryforwards of approximately $35.6million, which expire in the years 2007 through 2025. Utilization of theCompany’s net operating loss and tax credit carryforwards may be subject tosubstantial annual limitations due to the ownership change limitations providedby the Internal Revenue Code and similar state provisions. Such an annuallimitation could result in the expiration of the net operating loss beforeutilization.

92

----

The valuation allowance decreased by $35.9 million and$3.1 million for the years ended December 31, 2005 and 2004, respectively.Based upon the weight of available evidence, which included an analysis ofprojected future book and taxable income, as of December 31, 2005, theCompany retained a valuation allowance of $82.3 million.

During fiscal 2005, the Company reduced its deferredtax asset valuation allowance by approximately $35.9 million. In assessing therealizability of its deferred tax assets, the Company considers whether it ismore likely than not that some portion or all of the deferred tax assets willnot be realized. The Company considered historical book income, the scheduledreversal of deferred tax assets, and projected future book and taxable incomein making this assessment. Based upon a detailed analysis of historical andprojected book and taxable income, the Company determined that the realizationof certain deferred tax assets for which a valuation allowance had beenpreviously recorded is considered more likely than not.

Approximately $73.4 million of the valuation allowanceas of December 31, 2005 is attributable to the income tax benefits ofstock option deductions, the benefit of which will be credited to stockholders’equity when, and if, realized. The remaining valuation allowance ofapproximately $8.9 million as of December 31, 2005 is attributable to theacquisition of certain ParAllele tax attributes, the benefit of which will becredited to goodwill when, and if, realized.

Cumulative unremitted foreign earnings that areconsidered to be permanently invested outside the United States and on which noU.S. taxes have been provided were approximately $6.0 million as ofDecember 31, 2005. The residual U.S. tax liability, if such amounts wereremitted, would be nominal.

Of the total tax benefitsresulting from the exercise of employee stock options and other employee stockprograms, the amounts booked to stockholders’ equity were approximately $33.1million and $0.7 million for the years ended December 31, 2005 and 2004respectively.

**NOTE 17—PRODUCTSALES, GEOGRAPHIC SALES, AND SIGNIFICANT CUSTOMERS**

TheCompany has determined that, in accordance with Statement of FinancialAccounting Standards No. 131, “Disclosures about Segments of an Enterpriseand Related Information”, it operates in one segment as it only reportsoperating results on an aggregate basis to the chief operating decision makersof the Company. The Company reported product and product related revenue bytype and by region as follows (in thousands):

| ** **                                 | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Total product and product related revenue: |       |                                       |       |   |   |   |   |
| Probe arrays                               |       | $                                          | 197,949    |   | $ | 168,243 |   | $ | 139,591 |   |
| Reagents                                   |       | 42,428                                     |       | 31,744 |   | 20,419 |   |
| Instruments                                |       | 62,636                                     |       | 77,269 |   | 62,738 |   |
| Subscription fees                          |       | 12,448                                     |       | 20,669 |   | 26,208 |   |
| Service and other                          |       | 20,172                                     |       | 15,526 |   | 18,451 |   |
| License fee and  milestone revenue         |       | 14,557                                     |       | 17,434 |   | 13,373 |   |
| Total product and  product related revenue |       | $                                          | 350,190    |   | $ | 330,885 |   | $ | 280,780 |   |
| Customer location:                         |       |                                       |       |   |   |   |   |
| United States                              |       | $                                          | 173,496    |   | $ | 171,674 |   | $ | 152,937 |   |
| Europe                                     |       | 108,907                                    |       | 100,553 |   | 82,850 |   |
| Japan                                      |       | 47,920                                     |       | 43,488 |   | 35,409 |   |
| Other                                      |       | 19,867                                     |       | 15,170 |   | 9,584 |   |
| Total                                      |       | $                                          | 350,190    |   | $ | 330,885 |   | $ | 280,780 |   |

 

There were no customersrepresenting 10% or more of total revenue in 2005, 2004 and 2003.

93

----

**NOTE18—DEFINED-CONTRIBUTION SAVINGS PLANS**

**401(K) PLAN**

The Company maintains adefined-contribution savings plan which is qualified under Section 401(k) ofthe Internal Revenue Code. The plan covers substantially all full-time U.S.employees. Participating employees may defer a portion of their pretaxearnings, up to the Internal Revenue Service annual contribution limit. TheCompany’s expense associated with matching employee contributions totaled$3.3 million in 2005, $3.0 million in 2004 and $1.7 million in2003. Company contributions vest to employees ratably over four years.

**DIRECTORAND EXECUTIVE DEFERRED COMPENSATION PLAN**

In December 2004, theBoard of Directors approved the creation of the Affymetrix, Inc. DeferredCompensation Plan (the “Plan”). The Plan provides directors, executive officersand other eligible employees with the opportunity to enter into agreements todefer specified percentages of their cash compensation derived from basesalary, bonus awards and other specified compensation (including directorfees). Distributions occur upon termination of service (or the 6-monthanniversary after termination), death, or upon such other dates that may beelected by the participant in accordance with the terms of the Plan. Generallyparticipants may elect for distributions of deferred amounts upon terminationor death to be paid in the form of either a lump sum or in annual installments.Distributions would be made in the event of a change of control of Affymetrix.Deferrals are adjusted for gain or loss based on the performance of one or moreinvestment options selected by the participant from among investment fundschosen by the Compensation Committee of the Board. The Company in its solediscretion may suspend or terminate the Plan or revise or amend it in anyrespect, except that no such action may reduce vested amounts credited todeferral accounts, and such accounts will continue to be owed to theparticipants or beneficiaries and will continue to be a liability of theCompany until paid. For the years ended December 31, 2005 and 2004, theCompany incurred no significant expenses in connection with the Plan.

**NOTE19—UNAUDITED QUARTERLY FINANCIAL INFORMATION**

| ** **                                    | ** ** | **2005**                                                              | ** ** | **2004**           | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                    | ** ** | **Fourth  Quarter(3)**                                                | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Third  Quarter** | ** ** | **Second  Quarter** | ** ** | **First  Quarter(1)** | ** ** |
| ** **                                    | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Total revenue (excluding Perlegen)            |       |                                                                  | $          | 108,734            |       |   |   | $ | 81,227 |   |   |   | $ | 82,140 |   |   |   | $ | 86,428 |   |   | $ | 106,383 |   |   | $ | 78,988 |   |   |   | $ | 78,362 |   |   |   | $ | 76,984 |   |   |
| Perlegen revenue                              |       |                                                                  | $          | 2,755              |       |   |   | $ | 2,220 |   |   |   | $ | 1,911 |   |   |   | $ | 2,187 |   |   | $ | 1,325 |   |   | $ | 2,742 |   |   |   | $ | 1,392 |   |   |   | $ | 1,649 |   |   |
| Total cost of goods sold (excluding Perlegen) |       |                                                                  | $          | 30,653             |       |   |   | $ | 23,410 |   |   |   | $ | 20,411 |   |   |   | $ | 21,784 |   |   | $ | 26,808 |   |   | $ | 19,474 |   |   |   | $ | 21,464 |   |   |   | $ | 23,588 |   |   |
| Perlegen cost of goods  sold                  |       |                                                                  | $          | 803                |       |   |   | $ | 1,359 |   |   |   | $ | 1,750 |   |   |   | $ | 1,242 |   |   | $ | 572 |   |   | $ | 569 |   |   |   | $ | 1,099 |   |   |   | $ | 1,371 |   |   |
| Net income (loss)                             |       |                                                                  | $          | 24,774             |       |   |   | $ | 8,713 |   |   |   | $ | 7,811 |   |   |   | $ | 16,218 |   |   | $ | 27,055 |   |   | $ | 15,377 |   |   |   | $ | 7,009 |   |   |   | $ | (1,833 | ) |   |
| Basic net income (loss)  per share            |       |                                                                  | $          | 0.38               |       |   |   | $ | 0.14 |   |   |   | $ | 0.12 |   |   |   | $ | 0.26 |   |   | $ | 0.44 |   |   | $ | 0.25 |   |   |   | $ | 0.12 |   |   |   | $ | (0.03 | ) |   |
| Diluted net income  (loss) per share(2)       |       |                                                                  | $          | 0.35               |       |   |   | $ | 0.13 |   |   |   | $ | 0.12 |   |   |   | $ | 0.24 |   |   | $ | 0.41 |   |   | $ | 0.24 |   |   |   | $ | 0.11 |   |   |   | $ | (0.03 | ) |   |

----

(1)    In January 2004,the Company completed the redemption of its 5.0% Notes ($102.0 millionface value). In connection with the redemption, the Company recorded a chargeof $3.2 million to interest expense in the first quarter of 2004, relatedto the unamortized issuance costs and redemption fee associated with therepurchased 5.0% Notes. In February 2004, the Company also completed theredemption of its 4.75% Notes ($165.5 million face value). In connectionwith the redemption, the Company recorded a charge of $4.9 million tointerest expense related to the unamortized issuance costs and redemption feeassociated with the repurchased 4.75% Notes.

(2)    In September 2004,the Emerging Issues Task Force reached a consensus on Issue No. 04-8,“The Effect of Contingently Convertible Debt on Diluted Earnings Per Share,” (“EITF04-8”) which addresses when the dilutive effect of contingentlyconvertible debt instruments should be included in diluted earnings per share.EITF 04-8 requires that contingently convertible 

94

----

debt instruments beincluded in the computation of diluted earnings per share regardless of whetherthe market price trigger has been met. EITF 04-8 also requires that priorperiod diluted earnings per share amounts presented for comparative purposes berestated. EITF 04-8 is effective for reporting periods ending after December 15,2004. The Company’s diluted earnings per share calculation has been restated toinclude shares issuable upon conversion of the Company’s 0.75% seniorconvertible notes issued in 2003 for periods where the Company reported netincome. There were no changes to reported diluted earnings per share except forthe third quarter of 2004 where the diluted earnings per share decreased from$0.25 to $0.24.

(3)    On October 21, 2005, we recorded a charge ofapproximately $8.3 million related to acquired in-process technology inconnection with our acquisition of ParAllele BioScience, Inc. (“ParAllele”),a provider of comprehensive genetic discovery solutions to the lifescience research, pharmaceutical and diagnostic sectors.

**ITEM 9.   CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

Not applicable.

**ITEM9A.   CONTROLS AND PROCEDURES**

**DisclosureControls and Procedures**

As required byparagraph (b) of Exchange Act Rules 13a-15 or 15d-15,Affymetrix’ management, including our Chief Executive Officer and ChiefFinancial Officer, conducted an evaluation as of the end of the period coveredby this report, of the effectiveness of Affymetrix’ disclosure controls andprocedures as defined in Exchange Act Rule 13a-15(e) and 15d-15(e).Based on that evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that Affymetrix’ disclosure controls and procedures wereeffective as of the end of the period covered by this report.

**Management’sReport on Internal Control Over Financial Reporting**

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and15d-15(f). Under the supervision of our Chief Executive Officer and ChiefFinancial Officer and with the participation of our management, we conducted anevaluation of the effectiveness of our internal control over financialreporting as of December 31, 2005 based on the framework in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Our assessment of andconclusion on the effectiveness of internal control over financial reportingdid not include the internal controls of the operations acquired from ParAlleleBioScience, Inc. on October 21, 2005, which are included in our fiscal2005 consolidated financial statements and which, in the aggregate, consistedof $5.4 million and $4.5 million of total assets and net assets,respectively, as of December 31, 2005 and which in the aggregate,represented $4.5 million and $1.1 million of revenues and losses fromoperations, respectively, for the year then ended. Based on that evaluation,our management concluded that our internal control over financial reporting waseffective as of December 31, 2005. Management’s assessment of theeffectiveness of our internal control over financial reporting as of December 31,2005 has been audited by Ernst & Young LLP, an independent registeredpublic accounting firm, as stated in their report which appears below.

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directors and Stockholders ofAffymetrix, Inc.

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control over FinancialReporting, that Affymetrix, Inc. maintained effective internal controlover financial reporting as of December 31, 2005, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (the COSO criteria).Affymetrix, Inc.’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial 

95

----

reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

As indicated in the accompanying Management’s Reporton Internal Control over Financial Reporting, management’s assessment of andconclusion on the effectiveness of internal control over financial reportingdid not include the internal controls of ParAllele BioScience, Inc., which isincluded in the 2005 consolidated financial statements of Affymetrix, Inc. andconstituted $5.4 million and $4.5 million of total and net assets, respectively,as of December 31, 2005 and $4.5 million and $1.1 million of revenuesand losses from operations, respectively, for the year then ended. Our audit ofinternal control over financial reporting of Affymetrix, Inc. also did notinclude an evaluation of the internal control over financial reporting ofParAllele Bioscience, Inc.

In our opinion, management’s assessment thatAffymetrix, Inc. maintained effective internal control over financialreporting as of December 31, 2005, is fairly stated, in all materialrespects, based on the COSO criteria. Also, in our opinion, Affymetrix, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2005, based on the COSO criteria.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofAffymetrix, Inc. as of December 31, 2005 and 2004, and the relatedconsolidated statements of operations, comprehensive income, stockholders’equity, and cash flows for each of the three years in the period ended December 31,2005 of Affymetrix, Inc. and our report dated March 2, 2006 expressed anunqualified opinion thereon.
| /s/ Ernst & Young  LLP |   |
|---------------------------------|--------|
| Palo Alto,  California,         |
| March 2,  2006             |

 

96

----

**Changes in Internal Control Over Financial Reporting**

Other than as set out inthis Item 9A, there were no changes in our internal control over financialreporting identified in connection with the evaluation required byparagraph (d) of Exchange Act Rules 13a-15 or 15d-15that occurred during our last fiscal quarter that have materially affected orare reasonably likely to materially affect, our internal control over financialreporting.

**ITEM 9B.   OTHER INFORMATION**

Not applicable.

**PART III**

**ITEM10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

Information regarding ourdirectors and executive officers is incorporated by reference to the sectionsof the Company’s proxy statement for the 2006 Annual Meeting of Stockholders(the “Proxy Statement”) entitled “Election of Directors” and “Management.”

The information concerningour audit committee required by this Item is incorporated by reference to thesections of the Proxy Statement entitled “Governance of the Company” and “Reportof the Audit Committee.”

The information concerningcompliance with Section 16(a) of the Exchange Act required by thisItem is incorporated by reference to the section of the Proxy Statemententitled “Section 16(a) Beneficial Ownership Reporting Compliance”under the heading “Stock Ownership of Principal Stockholders and Management.”

**CODE OF ETHICS**

Affymetrix has adopted acode of business conduct and ethics for directors, officers (includingAffymetrix’ Chief Executive Officer, Chief Financial Officer and CorporateController) and employees, known as the Code of Business Conduct and Ethics.The Code of Business Conduct and Ethics is available on Affymetrix’ website at *http://www.affymetrix.com* in the CorporateGovernance section under the “Investors” link. Stockholders may request a freecopy of the Code of Business Conduct and Ethics by sending an email request toinvestor@affymetrix.com.

**ITEM11.   EXECUTIVE COMPENSATION**

Incorporated by referenceto the sections of the Proxy Statement entitled “Executive Compensation,” “CompensationCommittee Report,” “Certain Transactions” and “Compensation of Directors.”

**ITEM12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS.**

Incorporated by referenceto the section of the Proxy Statement entitled “Stock Ownership of PrincipalStockholders and Management.”

**ITEM13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

Incorporated by referenceto the section of the Proxy Statement entitled “Certain Transactions.”

**ITEM14.   PRINCIPAL ACCOUNTING FEES AND SERVICES**

Information aboutprincipal accountant fees and services as well as related pre-approval policiesappears under “Fees Paid to Ernst & Young LLP” and “Audit and FinanceCommittee Pre-Approval of Audit and Permissible Non-Audit Services ofIndependent Registered Public Accounting Firm” in the Proxy Statement. Thoseportions of the Proxy Statement are incorporated by reference into this report.

97

----

**PART IV**

**ITEM 15.   EXHIBITS AND FINANCIAL STATEMENTSCHEDULES**

(a)(1)            FinancialStatements. The financial statements as set forth under Item 8 of thisreport on Form 10-K are incorporated herein by reference.

(a)(2)            FinancialStatement Schedule—Schedule II—Valuation and Qualifying Accounts. Allother schedules have been omitted as they are not required, not applicable orthe information is otherwise included.

(a)(3)            Exhibits:
| EXHIBIT   NUMBER | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **DESCRIPTION OF DOCUMENT** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|
| 2.1(1)           |       | Agreement and Plan of Merger dated as of  May 31, 2005 among ParAllele BioScience, Inc.,  Affymetrix, Inc., Pinecone Acquisition, Inc. and Jonathan  MacQuitty.                                                                                                                                                                                                                      |
| 2.2(1)           |       | Form of Voting and  Lockup Agreement dated as of May 31, 2005 between Affymetrix and each of  Abingworth Management, Ronald Davis, Bill Ericson, Malek Faham, Maneesh Jain,  George Karlin-Neuman, Elizabeth Krodel, Jonathan MacQuitty, André Marion, MDV  Partners, Nicholas Naclerio, Camille Samuels, Robert Smith, Aaron Solomon,  Versant Ventures, Gregory Went and Thomas Willis. |
| 2.3(2)           |       | Amendment No. 1,  dated as of September 1, 2005, to Agreement and Plan of Merger dated as  of May 31, 2005 among ParAllele BioScience, Inc.,  Affymetrix, Inc., Pinecone Acquisition, Inc. and Jonathan MacQuitty.                                                                                                                                                         |
| 2.4(3)           |       | Amendment No. 2,  dated as of October 5, 2005, to Agreement and Plan of Merger dated as of  May 31, 2005 among ParAllele BioScience, Inc.,  Affymetrix, Inc., Pinecone Acquisition, Inc. and Jonathan  MacQuitty.                                                                                                                                                          |
| 3.1(4)           |       | Restated Certificate of  Incorporation.                                                                                                                                                                                                                                                                                                                                                                  |
| 3.2(5)           |       | Bylaws.                                                                                                                                                                                                                                                                                                                                                                                                  |
| 3.3(6)           |       | Amendment No. 1 to  the Bylaws dated as of April 25, 2001.                                                                                                                                                                                                                                                                                                                                     |
| 3.4(7)           |       | Summary of Rights to  Purchase Shares of Preferred Stock pursuant to the Rights Agreement dated as  of October 15, 1998.                                                                                                                                                                                                                                                                            |
| 4.1(8)           |       | Rights Agreement, dated  October 15, 1998, between Affymetrix, Inc. and American Stock  Transfer & Trust Company, as Rights Agent.                                                                                                                                                                                                                                                    |
| 4.2(9)           |       | Amendment No. 1 to  Rights Agreement, dated as of February 7, 2000, between  Affymetrix, Inc. and American Stock Transfer & Trust Company,  as Rights Agent.                                                                                                                                                                                                                     |
| 4.3(10)          |       | Indenture dated as of  December 15, 2003, between Affymetrix, Inc. and The Bank of New  York, as Trustee.                                                                                                                                                                                                                                                                                      |
| 4.4(10)          |       | Affymetrix, Inc.  0.75% Senior Convertible Notes due 2033 Registration Rights Agreement dated  December 15, 2003.                                                                                                                                                                                                                                                                              |
| 10.1(11)†   |       | 1993 Stock Plan, as  amended.                                                                                                                                                                                                                                                                                                                                                                            |
| 10.2(11)†   |       | 1996 Nonemployee  Directors Stock Option Plan.                                                                                                                                                                                                                                                                                                                                                           |
| 10.3(12)         |       | Lease between Sobrato  Interests and Affymetrix, Inc. dated June 12, 1996 (3380 Central  Expressway, Santa Clara, CA).                                                                                                                                                                                                                                                                         |
| 10.4(12)         |       | Lease between Sobrato  Interests and Affymetrix, Inc. dated May 31, 1996 (3450 Central  Expressway, Santa Clara, CA).                                                                                                                                                                                                                                                                          |

98

----

 
| 10.5(13)†  |   | 1998 Stock Incentive  Plan.                                                                                                                                                                                                     |
|-----------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.6(13)†  |   | Form of Officer and  Director Indemnification Agreement.                                                                                                                                                                   |
| 10.7(14)        |   | Lease Agreement by and  between the Company and Aetna Life Insurance Company dated as of  July 30, 1999.                                                                                                                   |
| 10.8(15)        |   | Amendment No. 1 to  the 1996 Nonemployee Directors Stock Option Plan of Affymetrix, Inc.                                                                                                                              |
| 10.9(16)        |   | Amended and Restated  1996 Non-Employee Directors Stock Plan.                                                                                                                                                                   |
| 10.10(17)*      |   | Common Terms Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                                                                                               |
| 10.11(17)*      |   | License Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                                                                                                    |
| 10.12(17)*      |   | Affymetrix Instrument  and Chip Supply Agreement between F. Hoffmann-La Roche Ltd. and  Affymetrix, Inc. dated January 29, 2003.                                                                                      |
| 10.13(17)*      |   | Research &  Development Collaboration Agreement between F. Hoffmann-La Roche  Ltd. and Affymetrix, Inc. dated January 29, 2003.                                                                         |
| 10.14(17)*      |   | Diagnostic Product and  Instrument Agency Agreement between F. Hoffmann-La Roche Ltd. and  Affymetrix, Inc. dated January 29, 2003.                                                                              |
| 10.15(17)*      |   | Affymetrix Instrument  Agency Agreement between F. Hoffmann-La Roche Ltd. and  Affymetrix, Inc. dated January 29, 2003.                                                                                          |
| 10.16(18)       |   | Lease between Sobrato  Interests and Affymetrix dated July 3, 2002 (3420 Central Expressway,  Santa Clara, CA).                                                                                                            |
| 10.17(18)       |   | First Amendment to Lease  between Sobrato Interests and Affymetrix dated September 30, 2003 (3420  Central Expressway, Santa Clara, CA).                                                                                   |
| 10.18(18)† |   | Loan Agreement in  principal amount of $1.2 million executed by Barbara A. Caulfield  dated January 7, 2004 pursuant to an extension of credit made to  Ms. Caulfield by the Company on July 16, 2001. |
| 10.19(19)       |   | Affymetrix, Inc.  Amended and Restated 2000 Equity Incentive Plan.                                                                                                                                                         |
| 10.20(20)       |   | Form of Non-Qualified  Stock Option Agreement under the Affymetrix, Inc. Amended and Restated  1996 Non-Employee Directors Stock Plan.                                                                                |
| 10.21(20)       |   | Form of Stock  Option Agreement under the Affymetrix, Inc. Amended and Restated 2000  Equity Incentive Plan.                                                                                                          |
| 10.22(21)       |   | Affymetrix, Inc.  Deferred Compensation Plan.                                                                                                                                                                              |
| 10.23(22)       |   | Fifth Amendment to Lease  between Sobrato Interests and Affymetrix, Inc. dated July 3, 2002  (3380 Central Expressway, Santa Clara, CA).                                                                              |
| 10.24(22)       |   | First Amendment to Lease  between Sobrato Interests and Affymetrix, Inc. dated July 3, 2002  (3450 Central Expressway, Santa Clara, CA).                                                                              |
| 10.25           |   | Lease between Keppel  Logistics Pte Ltd. and Affymetrix Pte Ltd. dated as of January 1, 2006  (7 Gul Circle, Singapore 629363).                                                                                       |
| 10.26           |   | Form of Restricted  Stock Agreement under the Affymetrix, Inc. Amended and Restated 2000  Equity Incentive Plan.                                                                                                      |
| 21              |   | List of Subsidiaries.                                                                                                                                                                                                           |

99

----

 
| 23   |   | Consent of Independent Registered Public Accounting  Firm.                                             |
|------|--------|--------------------------------------------------------------------------------------------------------|
| 31.1 |   | Certification of Chief  Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of  2002. |
| 31.2 |   | Certification of Chief  Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of  2002. |
| 32.1 |   | Certification of Chief  Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of  2002. |
| 32.2 |   | Certification of Chief  Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of  2002. |

----

(1)          Incorporated by reference to Registrant’s Form S-4as filed on July 20, 2005 (File No. 333-126718).

(2)          Incorporated by reference to Registrant’s Form S-4/Aas filed on September 1, 2005 (File No. 333-126718).

(3)          Incorporated by reference to Registrant’s Form S-4/Aas filed on October 5, 2005 (File No. 333-126718).

(4)          Incorporated byreference to Registrant’s Form 8-K as filed on June 13, 2000(File No. 000-28218).

(5)          Incorporated byreference to Appendix C of Registrant’s Definitive Proxy Statement onSchedule 14A as filed on April 29, 1998 (File No. 000-28218).

(6)          Incorporated byreference to Registrant’s Form 10-Q as filed on May 15, 2001(File No. 000-28218).

(7)          Incorporated byreference to Registrant’s Form 8-K as filed on October 16, 1998(File No. 000-28218).

(8)          Incorporated byreference to Registrant’s Form 8-A as filed on October 16, 1998(File No. 000-28218).

(9)          Incorporated byreference to Registrant’s Form 8-A/A as filed on March 29, 2000(File No. 000-28218).

(10)   Incorporated by reference toRegistrant’s Form S-3 as filed on January 29, 2004 (File No. 333-112311).

(11)   Incorporated by reference toRegistrant’s Registration Statement on Form S-1 (File No. 333-3648),as amended.

(12)   Incorporated by reference toRegistrant’s Quarterly Report on Form 10-Q as filed on August 14,1996 (File No. 000-28218).

(13)   Incorporated by reference toRegistrant’s Report on Form 10-K as filed on March 31, 1999(File No. 000-28218).

(14)   Incorporated by reference toRegistrant’s Form 10-Q as filed on August 16, 1999 (File No. 000-28218).

(15)   Incorporated by reference toRegistrant’s Registration Statement on Form S-3 as filed on July 12,1999 (File No. 333-82685), as amended.

(16)   Incorporated by reference toRegistrant’s Form 10-Q as filed on May 15, 2001 (File No. 000-28218).

(17)   Incorporated by reference toRegistrant’s Form 10-Q as filed on May 15, 2003 (File No. 000-0-28218).

(18)   Incorporated by reference toRegistrant’s Form 10-K as filed on March 15, 2004 (File No. 000-28218).

100

----

(19)   Incorporated by reference toRegistrant’s Form 10-Q as filed on August 9, 2004 (File No. 000-0-28218).

(20)   Incorporated by reference toRegistrant’s Form 10-Q as filed on November 9, 2004 (File No. 000-0-28218).

(21)   Incorporated by reference toRegistrant’s Form 8-K as filed on December 14, 2004 (File No. 000-28218).

(22)   Incorporated by reference toRegistrant’s Form 10-K as filed on March 16, 2005 (File No. 000-28218).

*                    Confidentialtreatment granted

†                    Managementcontract, compensatory plan or arrangement

101

----

**AFFYMETRIX, INC.Schedule II—Valuationand Qualifying Accounts(in thousands)**

| ** **                          | ** ** | **Balance at  Beginning of  Period** | ** ** | **Recorded to  Costs and  Expenses** | ** ** | **Deductions(1)** | ** ** | **Balance at  End of Period** | ** ** |
|-------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|
| Year Ended  December 31, 2005: |       |                                           |       |                                           |       |              |       |                                         |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts    |       |                                           | $          | 841                                            |       |              |       | $                                            | (33        | ) |   |   | $ | (393 | ) |   |   | $ | 415 |   |   |
| Year Ended  December 31, 2004: |       |                                           |       |                                           |       |              |       |                                         |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts    |       |                                           | $          | 761                                            |       |              |       | $                                            | 144        |   |   |   | $ | (64 | ) |   |   | $ | 841 |   |   |
| Year Ended  December 31, 2003: |       |                                           |       |                                           |       |              |       |                                         |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful  accounts    |       |                                           | $          | 2,835                                          |       |              |       | $                                            | (1,224     | ) |   |   | $ | (850 | ) |   |   | $ | 761 |   |   |

----

(1)          Uncollectible accountswritten off, net of recoveries.

102

----

**SIGNATURES**

Pursuantto the requirements of Section 13 of 15(d) of the Securities ExchangeAct of 1934, the registrant has caused this Report to be signed on its behalfby the undersigned, thereunto duly authorized.
|                    | AFFYMETRIX, INC. |
|--------------------|------------------|
|               | (Registrant)     |
| March 9, 2006 | By:              | /s/  STEPHEN P.A. FODOR, PH.D. |
|               |             | Stephen P.A.  Fodor, Ph.D. |
|               |             | *FOUNDER,  CHAIRMAN OF THE BOARD AND* |
|               |             | *CHIEF  EXECUTIVE OFFICER* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
|        | ** ** |                                     | **Name** | ** **                              | ** ** |                    | **Title** | ** ** | ** ** |  | **Date** | ** ** |
|--------|------------|-------------------------------------|----------|-----------------------------------------|------------|--------------------|-----------|------------|------------|--|----------|------------|
| By:    |       | /s/ STEPHEN  P.A. FODOR, PH.D.      |     | Founder, Chairman  of the               |       | March 9, 2006 |
|   |       | Stephen  P.A. Fodor, Ph.D.          |     | Board and Chief  Executive Officer |       |               |
|   |       |                                |     | (Principal Executive  Officer)          |       |               |
| By:    |       | /s/ GREGORY T.  SCHIFFMAN           |     | Executive Vice  President               |       | March 9, 2006 |
|   |       | Gregory  T. Schiffman               |     | and Chief Financial  Officer       |       |               |
|   |       |                                |     | (Principal Financial  Officer)          |       |               |
| By:    |       | /s/ JOHN D. DIEKMAN, PH.D.          |     | Director                                |       | March 9, 2006 |
|   |       | John  D. Diekman, Ph.D.             |     |                                    |       |               |
| By:    |       | /s/ PAUL BERG, PH.D.                |     | Director                                |       | March 9, 2006 |
|   |       | Paul  Berg, Ph.D.                   |     |                                    |       |               |
| By:    |       | /s/ SUSAN D. DESMOND-HELLMANN, M.D. |     | Director                                |       | March 9, 2006 |
|   |       | Susan  D. Desmond-Hellmann, M.D.    |     |                                    |       |               |
| By:    |       | /s/ VERNON R. LOUCKS, JR.      |     | Director                                |       | March 9, 2006 |
|   |       | Vernon  R. Loucks, Jr.         |     |                                    |       |               |
| By:    |       | /s/ SUSAN E. SIEGEL                 |     | Director                                |       | March 9, 2006 |
|   |       | Susan  E. Siegel                    |     |                                    |       |               |
| By:    |       | /s/ DAVID B. SINGER                 |     | Director                                |       | March 9, 2006 |
|   |       | David  B. Singer                    |     |                                    |       |               |
| By:    |       |                                |     | Director                                |       |               |
|   |       | Robert  H. Trice, Ph.D.             |     |                                    |       |               |
| By:    |       | /s/ JOHN A. YOUNG                   |     | Director                                |       | March 9, 2006 |
|   |       | John A. Young                       |     |                                    |       |               |

 

 

103

----

**INDEX TO EXHIBITS**
| EXHIBIT   NUMBER | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **DESCRIPTION   OF DOCUMENT** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|
| 2.1(1)           |       | Agreement and Plan of  Merger dated as of May 31, 2005 among ParAllele BioScience, Inc.,  Affymetrix, Inc., Pinecone Acquisition, Inc. and Jonathan  MacQuitty.                                                                                                                                                                                                                      |
| 2.2(1)           |       | Form of  Voting and Lockup Agreement dated as of May 31, 2005 between Affymetrix  and each of Abingworth Management, Ronald Davis, Bill Ericson, Malek Faham,  Maneesh Jain, George Karlin-Neuman, Elizabeth Krodel, Jonathan MacQuitty,  André Marion, MDV Partners, Nicholas Naclerio, Camille Samuels, Robert Smith,  Aaron Solomon, Versant Ventures, Gregory Went and Thomas Willis. |
| 2.3(2)           |       | Amendment  No. 1, dated as of September 1, 2005, to Agreement and Plan of  Merger dated as of May 31, 2005 among ParAllele BioScience, Inc.,  Affymetrix, Inc., Pinecone Acquisition, Inc. and Jonathan  MacQuitty.                                                                                                                                                        |
| 2.4(3)           |       | Amendment  No. 2, dated as of October 5, 2005, to Agreement and Plan of Merger  dated as of May 31, 2005 among ParAllele BioScience, Inc., Affymetrix, Inc.,  Pinecone Acquisition, Inc. and Jonathan MacQuitty.                                                                                                                                                           |
| 3.1(4)           |       | Restated  Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                  |
| 3.2(5)           |       | Bylaws.                                                                                                                                                                                                                                                                                                                                                                                                  |
| 3.3(6)           |       | Amendment  No. 1 to the Bylaws dated as of April 25, 2001.                                                                                                                                                                                                                                                                                                                                     |
| 3.4(7)           |       | Summary of Rights  to Purchase Shares of Preferred Stock pursuant to the Rights Agreement dated  as of October 15, 1998.                                                                                                                                                                                                                                                                            |
| 4.1(8)           |       | Rights Agreement,  dated October 15, 1998, between Affymetrix, Inc. and American Stock  Transfer & Trust Company, as Rights Agent.                                                                                                                                                                                                                                                    |
| 4.2(9)           |       | Amendment  No. 1 to Rights Agreement, dated as of February 7, 2000, between  Affymetrix, Inc. and American Stock Transfer & Trust Company,  as Rights Agent.                                                                                                                                                                                                                     |
| 4.3(10)          |       | Indenture dated  as of December 15, 2003, between Affymetrix, Inc. and The Bank of  New York, as Trustee.                                                                                                                                                                                                                                                                                      |
| 4.4(10)          |       | Affymetrix, Inc.  0.75% Senior Convertible Notes due 2033 Registration Rights Agreement dated  December 15, 2003.                                                                                                                                                                                                                                                                              |
| 10.1(11)†   |       | 1993 Stock Plan,  as amended.                                                                                                                                                                                                                                                                                                                                                                            |
| 10.2(11)†   |       | 1996 Nonemployee  Directors Stock Option Plan.                                                                                                                                                                                                                                                                                                                                                           |
| 10.3(12)         |       | Lease between  Sobrato Interests and Affymetrix, Inc. dated June 12, 1996 (3380  Central Expressway, Santa Clara, CA).                                                                                                                                                                                                                                                                         |
| 10.4(12)         |       | Lease between  Sobrato Interests and Affymetrix, Inc. dated May 31, 1996 (3450  Central Expressway, Santa Clara, CA).                                                                                                                                                                                                                                                                          |
| 10.5(13)†   |       | 1998 Stock  Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                              |
| 10.6(13)†   |       | Form of  Officer and Director Indemnification Agreement.                                                                                                                                                                                                                                                                                                                                            |
| 10.7(14)         |       | Lease Agreement  by and between the Company and Aetna Life Insurance Company dated as of  July 30, 1999.                                                                                                                                                                                                                                                                                            |
| 10.8(15)         |       | Amendment  No. 1 to the 1996 Nonemployee Directors Stock Option Plan of  Affymetrix, Inc.                                                                                                                                                                                                                                                                                                      |
| 10.9(16)         |       | Amended and Restated  1996 Non-Employee Directors Stock Plan.                                                                                                                                                                                                                                                                                                                                            |

104

----

 
| 10.10(17)*      |   | Common Terms Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                                                                                               |
|-----------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.11(17)*      |   | License Agreement  between F. Hoffmann-La Roche Ltd. and Affymetrix, Inc. dated  January 29, 2003.                                                                                                                    |
| 10.12(17)*      |   | Affymetrix  Instrument and Chip Supply Agreement between F. Hoffmann-La Roche Ltd.  and Affymetrix, Inc. dated January 29, 2003.                                                                                      |
| 10.13(17)*      |   | Research &  Development Collaboration Agreement between F. Hoffmann-La Roche  Ltd. and Affymetrix, Inc. dated January 29, 2003.                                                                         |
| 10.14(17)*      |   | Diagnostic  Product and Instrument Agency Agreement between F. Hoffmann-La  Roche Ltd. and Affymetrix, Inc. dated January 29, 2003.                                                                              |
| 10.15(17)*      |   | Affymetrix  Instrument Agency Agreement between F. Hoffmann-La Roche Ltd. and  Affymetrix, Inc. dated January 29, 2003.                                                                                          |
| 10.16(18)       |   | Lease between  Sobrato Interests and Affymetrix dated July 3, 2002 (3420 Central  Expressway, Santa Clara, CA).                                                                                                            |
| 10.17(18)       |   | First Amendment  to Lease between Sobrato Interests and Affymetrix dated September 30,  2003 (3420 Central Expressway, Santa Clara, CA).                                                                                   |
| 10.18(18)† |   | Loan Agreement in  principal amount of $1.2 million executed by Barbara A. Caulfield  dated January 7, 2004 pursuant to an extension of credit made to  Ms. Caulfield by the Company on July 16, 2001. |
| 10.19(19)       |   | Affymetrix, Inc.  Amended and Restated 2000 Equity Incentive Plan.                                                                                                                                                         |
| 10.20(20)       |   | Form of Non-Qualified  Stock Option Agreement under the Affymetrix, Inc. Amended and Restated  1996 Non-Employee Directors Stock Plan.                                                                                |
| 10.21(20)       |   | Form of  Stock Option Agreement under the Affymetrix, Inc. Amended and Restated  2000 Equity Incentive Plan.                                                                                                          |
| 10.22(21)       |   | Affymetrix, Inc.  Deferred Compensation Plan.                                                                                                                                                                              |
| 10.23(22)       |   | Fifth Amendment  to Lease between Sobrato Interests and Affymetrix, Inc. dated  July 3, 2002 (3380 Central Expressway, Santa Clara, CA).                                                                              |
| 10.24(22)       |   | First Amendment  to Lease between Sobrato Interests and Affymetrix, Inc. dated  July 3, 2002 (3450 Central Expressway, Santa Clara, CA).                                                                              |
| 10.25           |   | Lease between  Keppel Logistics Pte Ltd. and Affymetrix Pte Ltd. dated as of January 1,  2006 (7 Gul Circle, Singapore 629363).                                                                                       |
| 10.26           |   | Form of  Restricted Stock Agreement under the Affymetrix, Inc. Amended and  Restated 2000 Equity Incentive Plan.                                                                                                      |
| 21              |   | List of  Subsidiaries.                                                                                                                                                                                                          |
| 23              |   | Consent of  Independent Registered Public Accounting Firm.                                                                                                                                                                      |
| 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.                                                                                                                          |

105

----

 
| 32.1 |   | Certification of Chief  Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of  2002. |
|------|--------|--------------------------------------------------------------------------------------------------------|
| 32.2 |   | Certification of Chief  Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of  2002. |

----

(1)          Incorporated by reference to Registrant’s Form S-4as filed on July 20, 2005 (File No. 333-126718).

(2)          Incorporated by reference to Registrant’s Form S-4/Aas filed on September 1, 2005 (File No. 333-126718).

(3)          Incorporated by reference to Registrant’s Form S-4/Aas filed on October 5, 2005 (File No. 333-126718).

(4)          Incorporated byreference to Registrant’s Form 8-K as filed on June 13, 2000(File No. 000-28218).

(5)          Incorporated byreference to Appendix C of Registrant’s Definitive Proxy Statement onSchedule 14A as filed on April 29, 1998 (File No. 000-28218).

(6)          Incorporated byreference to Registrant’s Form 10-Q as filed on May 15, 2001(File No. 000-28218).

(7)          Incorporated byreference to Registrant’s Form 8-K as filed on October 16, 1998(File No. 000-28218).

(8)          Incorporated byreference to Registrant’s Form 8-A as filed on October 16, 1998(File No. 000-28218).

(9)          Incorporated byreference to Registrant’s Form 8-A/A as filed on March 29, 2000(File No. 000-28218).

(10)   Incorporated by reference toRegistrant’s Form S-3 as filed on January 29, 2004 (File No. 333-112311).

(11)   Incorporated by reference toRegistrant’s Registration Statement on Form S-1 (File No. 333-3648),as amended.

(12)   Incorporated by reference toRegistrant’s Quarterly Report on Form 10-Q as filed on August 14,1996 (File No. 000-28218).

(13)   Incorporated by reference toRegistrant’s Report on Form 10-K as filed on March 31, 1999(File No. 000-28218).

(14)   Incorporated by reference toRegistrant’s Form 10-Q as filed on August 16, 1999 (File No. 000-28218).

(15)   Incorporated by reference toRegistrant’s Registration Statement on Form S-3 as filed on July 12,1999 (File No. 333-82685), as amended.

(16)   Incorporated by reference toRegistrant’s Form 10-Q as filed on May 15, 2001 (File No. 000-28218).

(17)   Incorporated by reference toRegistrant’s Form 10-Q as filed on May 15, 2003 (File No. 000-0-28218).

(18)   Incorporated by reference toRegistrant’s Form 10-K as filed on March 15, 2004 (File No. 000-28218).

(19)   Incorporated by reference toRegistrant’s Form 10-Q as filed on August 9, 2004 (File No. 000-0-28218).

(20)   Incorporated by reference toRegistrant’s Form 10-Q as filed on November 9, 2004 (File No. 000-0-28218).

106

----

(21)   Incorporated by reference toRegistrant’s Form 8-K as filed on December 14, 2004 (File No. 000-28218).

(22)   Incorporatedby reference to Registrant’s Form 10-K as filed on March 16,2005 (File No. 000-28218).

*                    Confidentialtreatment granted

†                    Management contract, compensatoryplan or arrangement

107

----